The French Public Debt Worries and. Solutions

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1 The French Public Debt Worries and Solutions Vesselina Spassova Pierre Garello Abstract: In the context of debt crisis in the European Union, the French public debt finally attracts the attention of the government. Is the situation still under control and is there a chance for French authorities to limit the deterioration of public finances? To answer the question, the authors are providing the last figures and trends and explaining what is at stake. 1

2 In view of the recent public finances disasters that threaten several European countries, French public debt is starting to attract serious attention, including that of the French government. During the past weeks, François Fillon, who was just freshly renewed in his functions as Prime Minister by President Sarkozy, stated repeatedly that the reduction of deficits and public debt will be the priority of the (not-so-new) government for the coming months. As a matter of fact, the debt has been valued by the French Institute for National Statistics (INSEE) to billion at the end of the second trimester 2010, which equals 82.9% GDP points. Compared to the previous trimester, the debt increased 56 billion, that is, with approximately 2.5 GDP points. More than 30 years without a balanced budget The sharp increase in public debt is due mainly to the cumulated deficits of central and local administrations (figures 1-2) to which must be added the recurrent and increasing deficit of the social security system (which includes health insurance and pensions). Also, in the past two years, an additional deficit was reported by the State Shareholdings Agency (Agence des participations de l Etat, the organism in charge of managing the State s participations in private corporations and in state owned enterprise such as the railway company SNCF, the main maritime ports, the postal company etc). 2

3 Figure 1. French budget deficit (% of GDP) Figure 2. Evolution of French Public debt (% of GDP) Source: Cour des Comptes, Situation et perspectives des finances publiques

4 But those figures still present a too optimistic picture of the situation: they report levels of public debt computed according to Maastricht's definition. If instead we apply to national accounts the same accounting principles applied to enterprises (according to international accounting standards such as IFRS), all optimism vanishes. When off-balance-sheet commitments (for example pensions to be paid in the future) are added to the Maastricht debt, the new estimates inflate the French debt by as much as 1000 billion (Rapport Pebereau, 2005, 38-39). Comparing public debt with private debt and tax revenues What does that represent? Should French citizens be worried about it? Taking the last estimates ( 2591 billion) which gives a more accurate evaluation of the liabilities of the State, in 2010 a newborn in France starts in life with a public debt burden of approximately Limiting ourselves to the Maastricht debt one still gets a level of public debt per habitant at It might be interesting to translate those numbers at the household level in order to compare private indebtedness with public one (Table 1). Table 1. Comparing public with private debts Public debt Public debt Disposable Private debt (Maastricht) (all liabilities) income ( ) ( ) ( ) ( ) Per habitant Per household Source: IREF based on INSEE data The average level of (private) debt for a French household reaches today 76.5% of disposable income (INSEE). The most recent data give disposable income at per habitant and 2.3 persons per household (INSEE approximation for 2008). Hence the level of (private) debt per habitant is approximately ; 4

5 much less than what you get taking the narrowly defined public debt per habitant ( ). Taking the household as basic unit, the average French household today has an ongoing private debt of to which must be added its share of public debt amounting to or depending whether you include all the liabilities of the State or limit yourself to the Maastricht debt. Now, it is often heard that no one ever pays the debt itself, but only the interest on the debt. As a matter of fact, the interest paid in 2010 amounts to 656 per capita. In 2010, the interest on the service of the debt cost to French citizens no less than billion. To compare, it means that more than four fifths of corporate tax revenues served to pay interest on the public debt. With this money French firms could hire all the unemployed in the country (more than 2 million people) and pay them the minimum wage. Today, the French State pays more on the charge of the debt than on defence and it is not unthinkable, and even likely, than in five years from now more will be spent on debt service than on education. Finally, if one considers the total service of the debt (interest and maturing principal), it amount almost to the entire budget of the State. On September 30, the State had already issued for billion in bonds for the year, going basically to the reimbursement of previously emitted bonds. Since the 70s, France entered progressively international financial markets and in 2010, 70.6% of the national debt is in the hands of non-residents (2/3 of them living outside the EU). It is interesting to notice that being only at 28% in 1999, this percentage more than doubled in 10 years. The interest rates on French government bonds are still low, going from 2.5% (10 years) and 4.25% (13 years) to 4% (50 years) on the primary market. Any increase in those rates would have a devastating impact on the cost of the debt. Is French public debt sustainable? It is often rightly - said that the sustainability of the debt depends on the gap between, the real interest rate (that is, the cost at which the government can borrow money) and the rate at which the economy grows (real GDP growth), the 5

6 later representing somehow the rate of profit or return obtained by the borrower. If the cost of the debt (interest) is below the return (real growth), then the situation is sustainable. Otherwise, the debt to GDP ratio starts growing and, unless the government is able to have a positive primary balance (that is, makes no deficit even after paying the interest on the debt), a snow bawl effect is at work that will drive public finances towards disasters. To increase the likelihood of a real growth rate above the interest rate and therefore keep the debt sustainable it is essential that the borrowed money be put to good use. Sustainable governance requires that the public debt be turned into growth-generating investments, and not used to cover current expenses. Let us note in passing that sustainable debt is not to be confused with efficient debt: because of the crowding-out effect on private investment, public investment is not necessarily an advisable move. Nevertheless, looking at the destination of the borrowed money offers a rather consensual criterion to check the sustainability of the financial situation of the State. As a matter of fact, it is easy to check that, at least in France, the loans behind the increase of public debt do not go to investment. For the 2011 budget, the share of investment is planned to be at 4.1% of total State expenditures (Projet de loi des finances 2011). This largely explains why higher debt does not fit with higher growth and why, as a consequence, the debt is not sustainable. France is surely not the only country where deficits are structural rather than investment-related. This goes a long way in explaining the facts presented in the following graph (Figure 3). For 18 OECD countries, the average rate of growth (real GDP) over a 19 years period ( ) has been plotted against the average level of public debt to GDP (the level of indebtedness). Clearly, going to debt has rarely be a route to higher growth. If anything the contrary would be the case. 6

7 Figure 3: Average debt and economic growth ( ) Average GDP growth, Corée y = -0,0211x + 3,8441 R 2 = 0, Australie Norvège Espagne Etats-Unis Pays-Bas Royaume-Uni Canada Autriche Finlande Suède Danemark Allemagne France Suisse Belgique Japon Italie Average public debt (% of GDP) Source: IREF based on OECD data Table 2: Average growth rate and public debt in OECD countries Country Average level of public debt (as % of GDP) Average growth of real GDP Australia Austria Belgium Canada Denmark Finland France Germany Italy Japan Korea Netherlands Norway Spain Sweden Switzerland United Kingdom United States

8 Those figures are consistent with the picture one can get from the history of the accumulation of debt in France. In the early 80s, the debt of French public administrations was increasing at a pace of 2.3 GDP points per year. The government of that time was pushing an extensive social policy: retirement age decreased at 60; nationalization of the largest corporations, and so on. Then came the recession of the early 90s ( ), and the debt kept growing, this time at a faster pace 5.3 GDP points per year with an increase of public expenses and public health insurance deficits. This trend was then reversed due to the desire of the government to join the common currency project; at the end of the 90-ies the State is trying to moderate its appetite in order to fulfil the Maastricht criteria. In the 2000, the growth of public debt and public deficits resumed (2001 crisis) and kept going without any noticeable increase in investment projects financed by the State. Finally, the 2008 crisis contributed for an astonishing jump of the debt to GDP ratio of no less than 15 % and, again, the largest part of this money is financing current expenses. The recovery plan launched by Sarkozy required 20 billion. The remaining 256 billion of debt have been used to cover current expenses of the State pensions, health insurance, unemployment insurance etc. What next? Prior to the euro, the public debt was usually absorbed by inflation, that is, with spoliation of people s savings. Fortunately, at least in Europe, this practice is no longer considered an option; but that translated in the past 20 years in a soaring debt with interest rates (3.24% on average) well above growth rates (1.8% on average). The question is therefore how the French government intends to solve the problem of national debt within a Euro zone, non-inflationary context? 8

9 Figure 4: France interest on debt and GDP growth interest rate on government bonds (10 years) corrected for inflation real GDP growth rate Source : IREF based on Eurostat and INSEE data We have been suggesting that the usual answer -- betting on economic growth in future periods to reimburse the debt is not a satisfactory one, at least as long as no radical change in economic policy and in the missions devoted to the State are undertaken. Why should a policy that has never worked in the past suddenly deliver the expected result? The present government seems, at last, to feel concerned about the problem and ready to tackle it. The official target for public deficit has been set at 3% of GDP in Prime Minister, François Fillon, recently announced a freeze on public expenses for the three years ahead. Some benefits will be cut as well and the policy to replace only one retiring civil servant out of two is maintained. Some tax credits and tax exemptions will be suppressed as well. But Presidential elections are just around the corner (2012) and another obvious target for the government is to reduce unemployment. If the choice of an "active policy" is made, then all the efforts to reduce deficits will be wasted. The government apparently has gotten lesson lumber one: big deficits and high level of indebtedness are not conducive to growth and generate an unsustainable dynamics. It must now go to lesson number two: unemployment is best fought with private initiatives and for this you need to restore incentives and lower tax rates. And, 9

10 contrarily to what is too often claimed, this will not lead to further deficits but to more wealth creation, more tax revenues, less need for unemployment benefits and lower deficits. It is about time to abandon the vicious circle of taxation financing public spending and redistribution for the virtuous dynamics of private saving financing entrepreneurship and growth. 10

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