In French malaise, a broader source of risk


French film star Gerard Depardieu, wearing a local costume, shows his Russian passport during a ceremony in the town of Saransk in Russia, Jan. 6, 2013. Depardieu received a hug from Russia's President Vladimir Putin and a passport on Sunday after abandoning his homeland to avoid a new tax rate for millionaires. (Reuters)

As France’s socialist government raised taxes on the wealthy and threatened to nationalize a steel plant last year, neighboring Spain reveled in the news that exports were rising and several auto plants would be expanded by their owners.

It was a small sign of what could become a defining trend in the euro zone. The most troubled nations, including Spain, have slashed wage costs and overhauled labor and social rules in an effort to become more competitive.

Now there is mounting pressure on France to do the same — or risk falling behind in Europe’s struggle for economic revival. The government of new President Francois Hollande has veered between promises of reform and sometimes fiery attacks on corporate interests and the rich, a fact that has worried public officials in Washington and elsewhere about the direction of the euro zone’s second-largest economy.

“France is losing ground in a relative sense to these other countries,” said Edward Gardner, assistant head of the IMF’s Europe department. “The outlook remains very weak, not only because of external conditions [in the global economy], but also an internal lack of dynamism.”

Across a broad set of indicators, the euro zone’s financial crisis has diminished. But its economic problems remain deep, limiting the region’s potential to boost global growth. In France, an important pillar in any European recovery, growth has stalled, unemployment is rising, and the political leadership seems torn between its socialist pedigree and the more market-friendly policies other euro-zone nations have adopted.

France faces broader economic risk.

Since taking office, Hollande and the government of Prime Minister Jean-Marc Ayrault have promised to make the country a welcoming place for entrepreneurs. Negotiations between major business and union groups last week produced a set of proposals to make it easier for businesses to trim work hours in a downturn while boosting unemployment benefits.

But they also raised taxes on wealth. And the threat to nationalize a steel plant owned by Indian billionaire Lakshmi Mittal reverberated in boardrooms and public agencies where Hollande is seen as holding onto a piece of old Europe at a time when other countries are trying to come to terms on a new one.

“It is raw nationalism, and that does not bode well” for the direction of the French economy, said Joseph P. Quinlan, chief market strategist at U.S. Trust, the private-wealth arm of Bank of America.

Quinlan, also a fellow at the German Marshall Fund, recently authored a U.S. Chamber of Commerce study encouraging American companies to remain invested in Europe. Many are scaling back investments that were built up in the decades since World War II but are now out of line with Western Europe’s aging populations — as Ford did recently when it closed a vintage 1960s plant in Ghenk, Belgium. Quinlan said that even those who accept his argument that Europe remains too large and rich to ignore have watched Hollande carefully, noting that they could just as easily invest in Poland or, within the euro zone, in a nation such as Spain, which is pressing hard to regain its competitiveness.

“They have to realize they are not competing with China. They are competing with Poland or Spain for the next dollar in investment,” Quinlan said.

French officials note that the dispute with Mittal ended in a compromise and say that despite the country’s sometimes complex internal politics, Hollande is intent on keeping France competitive with the rest of Europe. He has been adamant about meeting deficit targets — a difficult political stance for a socialist politician battling high unemployment.

“There is not the slightest doubt among the government that openness to foreign investors is key to the French economy,” said a spokesman at the French Embassy in Washington.

Meanwhile, there is evidence that other countries are making progress at France’s expense. In a recent report, the International Monetary Fund compared decreasing production costs in Spain and other more-troubled nations with those in France, which remain high and subject to strict union contracts and other rules that keep them there.

While there is skepticism about whether proposed reforms or other changes will do much to change that, there is also a strong argument that something will have to give. As neighboring countries retool their labor laws, trim social benefits and overhaul Europe’s social contract, they may be forming a new baseline France will have to match.

“They are about to be overtaken on a lot of these competitiveness issues by the very peripheral countries they have been trying to distance themselves from,” said Jacob Funk Kirkegaard, a fellow at the Peterson Institute for International Economics who closely follows the euro zone. “Everyone will have to adopt a certain standard — you are converging toward a lower level of employment protection, a lower level of centralization in wage negotiation” that allows each plant or company to set benefit levels depending on its particular conditions.

The euro was adopted with the expectation that its member economies would converge toward common wage, productivity and income levels. But it was supposed to work in the opposite direction, with investment from wealthy nations such as Germany improving productivity and living standards in less-advanced countries such as Greece.

Instead, the grim conditions in Europe’s southern periphery may force an adjustment onto France, a nation often stereotyped as in love with leisure time and skeptical of wealth. The country’s debt levels are expected to climb to above 90 percent of annual economic output this year, but Hollande has pledged to control annual deficits.

“It’s not a risk of a race to the bottom,” said the embassy official. “There’s a need for every country to have social systems that can be financed over the long term.”

The IMF says France’s current plans are based on overly optimistic assumptions about economic growth — meaning more may have to be done, particularly if the country is to avoid another downgrade in what was once a AAA bond rating.

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