Macron, the budget and Europe


The French 5-year budget plan currently under review in the French Parliament deserves careful attention because it is the first one under President Macron and a unique opportunity to address some of the structural weaknesses of the Eurozone’s second largest economy: a high level of taxes and public spending, a competitiveness problem and high unemployment. In NIESR’s November Review, we simulated the main measures of the plan and analysed their macroeconomic impact. We find that this plan strikes a fine balance between improving the French economy’s medium-term growth prospects, returning public finances to a more sustainable path and not damaging short-term GDP growth. However, the quantitative objectives set forth in the plan of reducing public deficit by 2 per cent of GDP and debt by 5 per cent of GDP by 2022 appear too optimistic, and this view is shared by the European Commission.

Alexandre III bridge during a flood of the river Seine (June 2016 - picture taken by the author)

1. A positive but more medium-term impact on GDP

The budget plan can be summarised in a couple of simple measures: reduction in taxes by 1 per cent of GDP and reduction in public spending by 3 per cent of GDP within 5 years. The tax cuts, which would benefit both households and companies, are designed to encourage investment in productive capital and raise the economy’s competitiveness. They would be partly offset by an increase in ‘green’ taxes, mainly carbon and diesel taxes, which we expect to push up domestic prices. In order to spur future growth, there would also be an increase in public investments of around €50 billion over five years, to reverse the 12 per cent decline in public investment between 2009 and 2016.
Our analysis suggests that the fiscal package has the potential to stimulate the supply side of the economy (via corporate tax cuts) much more than the demand side (via tax cuts targeted on households). By 2022, real GDP would be only a quarter of a per cent higher than it would otherwise have been as the negative effect of the reduction in public spending almost completely offset the positive effect of tax cuts and increased investments (figure 1 shows the individual and aggregate impact of fiscal measures on GDP). But the structural shift towards lower taxes and lower public expenditure would significantly improve growth prospects in the medium term, once the fiscal consolidation is over.

Figure 1: Impact on real GDP



2. A moderate impact on the deficit

While the ambitious reduction in public spending by 3 per cent of GDP would clearly lead to a consolidation of the government’s budget, the other measures would dampen this effect. The front loading of the tax cuts and the initially moderate spending cuts mean that fiscal policy would actually be expansionary in the first year (figure 2 compares our estimates against the government's estimates of the impact on the budget balance of the plan). Interestingly, the French government has just revised up its deficit forecast for 2018.  In the following years, as the reduction of public spending becomes broader, the budget deficit would be reduced by up to 1.3 percentage points of GDP in 2022. Even though it goes some way towards achieving fiscal sustainability, it is still less than the 2 per cent in the government’s plan for several reasons. First, the increase in government investment weighs on the deficit. Secondly, the scale of the tax cuts naturally reduces the fiscal consolidation effort. This can be seen in the public debt ratio, which would decline by 2.9 percentage points of GDP, much less than the 5 per cent in the budget plan.

Figure 2: Impact on the general government’s budget balance to GDP


One risk that we highlighted in our study is the timing of the public sector cut. In his term, President Hollande promised a growth of public spending of 0.5 per cent per annum in volume, but could only achieve 0.9 in 3 years (2013-2016). By assigning a large majority of the reduction in public sector expenditure to the second half of the 5-year term, President Macron risks not having enough political capital left to enforce an unpopular measure at the end of his term, when he might be running for re-election and the economy might be in a less favourable part of the business cycle. A smaller reduction in public spending would be positive for GDP and negative for the budget balance.

3. Brussels challenges Macron's European credentials

The European Commission, fulfilling its role of monitoring of national budgets, picked up on the risk of insufficient fiscal consolidation and singled out France as the only European country at risk in its European Semester report. Including all fiscal measures in the budget plan (and not only the main ones as we did in our simulation), the European Commission evaluates the structural effort in 2018 to be null, far from the 0.6% of GDP that would be required to satisfy the Stability and Growth Pact. In a slightly cavalier manner, the French Finance Minister, Bruno Le Maire, responded by a letter on 31 October 2017 that the European Commission's calculation was wrong and that, even if it was right, there was no legal obligation for France to abide by the European rule. While I don't have the expertise or knowledge to say who's right, this row raises the interesting question of whether fiscal rules are a good and credible policy tool.

Rules are usually designed as a way to constrain governments to limit spending in a transparent way. In this setup, the Treasury is emboldened to limit spending by other government's department. It also improves the inter-temporal trade-off because the government is restrained from borrowing too much at the expense of future generation, which could otherwise have occurred in a political system that favours short-term policies. But history has proven that there are multiple drawbacks to fiscal rules and Iain Begg [1] showed that most rules failed to reach their objectives because they ignored political and economic incentives. First, the rule often ends up becoming the norm, even if it was defined as a boundary. Setting a limit on public deficit at 3% of GDP leads the government to target a deficit of 3%, no more and no less. This is because the responsibility of ensuring fiscal sustainability is in practice transferred from the Treasury to the rule, when a rule is implemented. Even if an economic analysis showed that it was optimal to borrow more (for example in a recession to provide a boost to domestic demand), then the government would not be able to do it because of the rule. And if a fiscal sustainability analysis showed that it was a good time to reduce the budget more aggressively, then the government may not do it either because it would not reap fully the political benefits of having managed the budget conservatively: political opponents would claim that the rule ensured by itself sound public finance management, not the government.

Clearly, the row between the Commission and the French government has damaged Macron's effort to appear as a convincing and enthusiastic European leader. How can he promote more European integration while his government appears to try and extract itself from European best-practices?

[1] Begg, Iain (2017), Fiscal and other rules in EU economic governance: helpful, largely irrelevant or unenforceable?, National Institute Economic Review No 239

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