How France Lost Its Economic Oomph

by: Christopher Dembik

Summary

Brutal tax regime makes France seem "anti-wealth" and "anti-business" for foreign investors. It mainly explains why direct foreign investments decreased in 2012 and in 2013.

France missed the opportunity to implement reforms, but still remains one of the biggest markets in Europe.

Business opportunities are numerous in France in listed companies, but also in innovative small businesses in the fields of fintech, dronautic and renewable energies.

In 2013, I had the chance to meet former Polish finance minister Grzegorz Kołodko, who is considered the key architect of the Polish economic miracle by pushing for a liberal agenda in the middle of the 1990s. We discussed the French economic slowdown, and I will always remember his witticism about the 75% marginal tax rate on the wealthy: "Even the communists would not have dared such a measure!"

Since 2012, much attention has been devoted to the perception of France as being "anti-business" and "anti-wealth". Tax hikes and support for protectionism by former economy minister Arnaud Montebourg were of no help to the French economy. It had negative economic impact and certainly contributed to the decrease of direct foreign investments in 2012 and in 2013.

A decade ago, France was at the forefront of European economies. France's GDP per capita was the same as Germany's. Now, it is 8% lower. While Germany implemented a very pragmatic reform program, the so-called Agenda 2010, France was sleeping on its laurels. France has always been in the cradle of some very innovative companies which quickly become leaders in their businesses in Europe or even in the world. Its desire to innovate has driven France to build incredible things such as electric cars and high-speed rail. The country ranks well among the world's best education systems and is well-known for its start-up culture.

Persistent stagnation

Despite its strengths, France seems unable to recover from the crisis. It has not been accustomed during the past 100 years to an economy growing at close to zero. The situation did occur much more often in the 19th century. However, all the economic figures indicate that France is stuck in stagnation. In the best-case scenario, France's economic growth may jump slightly above the key level of 1.5% in 2016. This level of growth is barely enough to reduce unemployment. In any case, the French may need to get used to high unemployment, considering the natural rate of unemployment has increased from 7% to around 9% over the past several years.

Contrary to its neighbours, France seems least likely to benefit from the exceptional economic conditions (historically low interest rates, weak euro and a 50% decrease in oil prices). The two recent periods of strong economic growth (1986-1990 and 1997-2001) were characterised by an oil shock and accommodative monetary policy, but a third element is essential for economic growth: technological revolution and/or financial innovations.

Financial liberalisation was a key driver for the period 1986-1990, which experienced an annual average GDP growth at 3.4%, while the development of the Internet ecosystem pushed up the economy at the end of the 1990s.

Innovations are still numerous in the fields of fintech, dronautic or renewable energies, but it hasn't yet fostered the development of large new industrial sectors. The current technological cycle is still in its infancy and cannot therefore have a significant positive impact on the economy.

Private investment dearth

The low level of private investment is probably the biggest challenge of France's economy. Despite the so-called "responsibility pact" with businesses, private investment will remain at least for the next two or three years under its pre-crisis level. The road for innovation implies higher private investment. But companies cannot maintain a decent level of OPEX and investment if their expected profitability does not recover at some point.

Since the 1980s, French companies' profitability has decreased considerably because of the gargantuan and complex French tax system. In France, companies need to pay more than 153 direct and indirect taxes compared with 55 taxes in Germany. This has clearly created disincentive to invest. Only further tax cuts for small and medium-sized companies could reverse this negative trend and positively impact business confidence.

For instance, it would make sense to give them a competitive advantage compared with bigger companies by reducing the corporate income tax under the reference rate at 33.3%. It would be just and fair considering that big corporations have more money and knowledge to exploit loopholes in the law to pay less tax than smaller corporations.

But France lacks political will to reform. François Hollande was not elected by his base to pursue austerity, but rather to boost growth and keep a high level of public sector jobs. Under the pressure of the EU, he pushed for a very moderate reform agenda, but the opposition was so strong inside the Socialist Party that the government had to resort to rarely-used constitutional measures to force the bill through by decree. It does not look very good for further reforms in the short term. Two years before the presidential election, it is very likely that François Hollande will adopt a wait-and-see position.

The problem is that the economic situation is not bad enough to push for ambitious reforms. Despite an economic growth rate at 1%, France remains one of the wealthiest countries in the world. It does not encourage policymakers to take courageous measures. Facing electoral wipeout in 2017 against the Front National, Socialist MPs may even feel the need to distance themselves from the government and its moderate reform agenda in order to save their seats. There is not much to expect in terms of reforms over the next two years. France's economy will certainly grow slightly, but it will be lagging behind Europe's economic recovery.

Reasons to be cheerful

However, France is not a lost cause. There are many reasons to be optimistic in the long term. France is opening the door to new cultures, experiences and models. Hiring foreign business leaders to manage French companies used to be a heresy ten years ago. It is not unusual anymore. Right now, France focuses a lot on the German model, but there are also many things to learn from Eastern Europe, North America or even Asia and that can inspire policy-making in France.

The French are traditionally risk averse, which is a cultural trait, but things are slowly changing. They have realised that the welfare state is not sustainable anymore because of the impact of the demographic pressure on the labour market and the pension system and the high level of public debt. The discourse has changed; the state encourages risk-taking and creates better incentives for entrepreneurs and foreign investors. "The more risks you take, the more risks we will take," says economic minister Emmanuel Macron. It will take time, but things will get better. I have no doubt France's golden age is before us, not behind us.

A better business environment

This new discourse will probably have a significant impact on foreign investors. France remains one of the biggest consumer markets in Europe and a key gateway to other Euro area countries. Despite low margins and high taxes, investing in listed companies in France remains very profitable. The CAC 40, Paris' main stock exchange index, increased by 30% since last October, which makes it one of the top performers in the Euro area. Clearly, there are good reasons for activist funds to be interested in French companies. It would probably be a mistake to focus only on big companies. There are many small innovative businesses over there waiting for foreign investors too.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.