15th July 2013: French Economic Prospects

France’s domestic economy is essentially stagnant with the country reliant on an improved external environment to drive the recovery.

Preliminary first quarter numbers showed the economy shrank by 0.2% from the previous quarter pushing France into a technical triple-dip recession. Although some improvement in conditions will be seen in the second half of the year, overall the economy will contract in 2013.

Preliminary GDP data showed that France once again slipped into recession in the first quarter of 2013. GDP shrank by 0.2% in 2013q1 after a fall of similar magnitude in the previous quarter. Technically, the French economy suffered a triple-dip recession but, more realistically, its growth has flatlined. There is little to suggest that the next few quarters will be any different. While the economy may see marginal growth of, 0.1% or 0.2% in the next few quarters, this will be insufficient to pull France out of its malaise.

Three key factors hold France back from enjoying a stronger recovery along the lines of its key Eurozone partner, Germany. First, public sector spending, which accounts for over a quarter of total GDP, is unlikely to see a recovery any time soon. Although France’s government was elected amidst promises to ‘end austerity’, it is struggling to achieve this in the backdrop of a triple-dip recession. The government is, admittedly, holding off large spending cuts, but some cuts are expected to push France towards the official government deficit target of 3% of GDP.

Second, the unemployment rate is now at a 15-year high which is holding back a recovery in consumer incomes and spending. There will be little pressure on wages to rise in 2013 and 2014 as the economy absorbs the existing excess pool of labour. Consumer spending is even more constrained due recent tax rises imposed by the government to lower its deficit. The 2013 budget saw the government introduce new taxes targeting high-income earners. Even though it is being argued that higher earners have a lower propensity to consume, which limits the impact of the tax rise on domestic demand, the overall impact of this would be only a small decline in disposable incomes in 2013.

Thirdly, firm productivity and investment remains poor and unable to provide the impetus for a robust return to growth. French corporations are amongst the most heavily taxed in the EU, with high payroll and corporation taxes a constraint on competitiveness and hiring. In recognition of this fact, the government has recently announced CICE tax credits for firms paying low to medium wages. The aim is to encourage employment growth and foster competitiveness.

With domestic demand practically stagnant, France is reliant on a turnaround in the external environment and its exports – notably, growth in Germany – to drive its recovery. This is not very unlike the trend seen in the pre-recession decade. In the 1997-2007 period, average annual growth of 2.3% was driven primarily by export growth and public spending. Consumer spending and investment growth was essentially flat in this period.

Our baseline forecasts for 2014 do show a modest strengthening, as healthier exports return on the back of the pick-up in the global economy, coupled with a rise in business investment as confidence builds again in the economy. Consumer demand will remain steady as the labour market stabilises in the backdrop of low inflation and low interest rates. As global and domestic economic conditions improve, inventories will be rebuilt, boosting investment and employment growth.

However, like several of its Western European counterparts, France faces the risk that the high and persistent unemployment and weak investment in the last few years has damaged the economy’s long-term potential. Poor demographics such as an ageing population and weak growth in the working-age population will put added strain on the country’s already stretched finances in the long term.

Written by Laila Dib