May 15, 2017    4 minute read

The French Economy: Has Macron Won a Pyrrhic Victory?

A Tall Order    May 15, 2017    4 minute read

The French Economy: Has Macron Won a Pyrrhic Victory?

After months of persistent uncertainty, the defeat of Marine Le Pen, leader of the “Front National”, has vested markets with newfound confidence over the future of the French economy.

However, the victory of Emmanuel Macron, leader of the centrist “En Marche!” party, fails to put the nail in the coffin of populism in both France and Europe. Instead, his election triumph appears to be a Pyrrhic victory, as the results of the first round forecast the lack of a mandate to introduce badly-needed economic reforms in France. Without such reforms, the spectre of populism will remain alluring for many voters.

The French Labour Market

As a key example, institutional malaise in the French labour market is pervasive, as its rigid structure significantly impairs macroeconomic adjustment. In terms of unemployment, France is the seventh weakest performer within the EU, finding itself in the company of perpetually crisis-plagued member states.

Sluggish labour-side adjustment dynamics within the French economy become even more apparent when one compares France (the EU’s third largest economy) to Europe’s leading economy, Germany. Following the outbreak of the eurozone crisis, French unemployment shot up from 7.4% in 2008 to 10.4% in 2015. Conversely, over the same period, German unemployment contracted from 7.4% to 4.6%.

To visualise the cost of sluggish adjustment in GDP terms, one may look at the output gap (distance between actual and potential output). Since 2009, France only narrowed the wedge between actual and potential output from -2.75% to -1.96% of potential GDP. On the other hand, Germany recorded a swift bounce back to efficient production levels (1% in 2011 and 0.43% in 2012) from a 2009 output gap of -4.01%.

Rigidities in the French labour market primarily manifest themselves through unemployment adjustment and only to a lesser extent through adjustment in wages. In particular, labour market adjustment in France is hampered by high labour costs, high level of employee protection which supports a dual labour system (and which sets insiders against outsiders), and poor matching technology characterised by low labour mobility and an ineffective training system.

These factors contribute to an environment of sluggish adjustment to adverse macroeconomic shocks, where idle stocks of labour and capital account for the underperformance of the French economy vis-à-vis its full potential.

The German Example

Differences in economic performance between France and Germany do not stem from German federal policy in the labour market, but from lack thereof. Decentralisation of wage bargaining during the early 1990s allowed growth in wages to lag productivity growth, which introduced significant declines in unit labour costs and substantial competitiveness gains.

The Hartz reforms, seen by many as a bifurcation point, merely supported existing labour market flexibility by capping unemployment benefits and creating personal service agencies to match unemployed people with employers. Contrast this with Germany’s western neighbour, where the French labour market has largely remained as it was in 1995, requiring a minimum of 1.5% y/y GDP growth just to keep the unemployment level at stasis.

In a manner similar to his predecessor, President Macron’s ability to introduce significant labour market reforms does not only rely on his capacity to pass legislation through parliament, a factor which will be determined in the June 2017 parliamentary elections. More importantly, the reform rests on the appetite of the French population to support the government in reforming labour markets.

Unfortunately, the first round of the elections signified a limited desire for economic liberalisation as the two populist parties, Front National and La France Insoumise, jointly attracted the support of 40.9% of the population.

This foreshadows a reform deadlock, a resolution of which will likely resemble that of the July 2016 labour law. Last year, President Hollande made use of the controversial Article 49-3 of the Constitution, sanctioned under the state of emergency in France, to pass a watered-down version of the original reform, despite the French people’s disapproval.

Rock and a Hard Place

Macron may soon find himself standing between a rock and a hard place, as labour reform comes at a high political price. Reverting to the use of emergency power will undoubtedly give strength to populism in France. Alternatively, by choosing to ignore his core electorate he fails to introduce reforms that the French economy badly needs to ignite growth.

This unstable equilibrium only showcases the strength of populism in France, not its weakness. Le Pen may have lost the election, but her damaging economic ideas appear to be winning the hearts and minds of the French people.

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