French elections: at best a Pyrrhic victory for the French economy

By: Iakov Frizis, CASE Economist

After months of persistent uncertainty, the defeat of Marine Le Pen, leader of the “Front National”, has vested markets with newly found confidence about the future of both France and Europe. However, the victory of Emmanuel Macron, leader of the centrist “En Marche!” party, fails to put the nail in the coffin on populism in either France or Europe. Instead, his election triumph appears to be a Pyrrhic victory, as the results of the first round forecast the lack of a mandate to introduce badly-needed economic reforms in France. Without such reforms, the specter of populism will remain alluring for many voters.

As the key example, institutional malaise in the French labor market is pervasive, as its rigid structure significantly impairs macroeconomic adjustment. In terms of unemployment, France is the 7th weakest performer within the EU, finding itself in the company of primarily crisis-plagued Member States. Sluggish labor-side adjustment dynamics within the French economy remain visible when one compares France (the EU’s 3rd largest economy) to Europe’s leading economy, Germany. Following the outbreak of the Eurozone crisis, French unemployment shot up from 7.4% in 2008 to 10.4% in 2015. Conversely, over the same period, German unemployment contracted from 7.4% to 4.6%.

Rigidities in the French labor market primarily manifest themselves through unemployment adjustment and only to a lesser extent through adjustment in wages. In particular, labor market adjustment in France is hampered by high labor costs, high level of employee protection which supports a dual labor system (and which sets insiders against outsiders), and poor matching technology characterized by low labor mobility and an ineffective training system. These factors contribute to an environment of sluggish adjustment to adverse macroeconomic shocks, where idle stocks of labor and capital account for the underperformance of the French economy vis-à-vis its full potential.

Differences in economic performance between France and Germany do not stem from German federal policy in the labor market, but from lack thereof. Decentralization of wage bargaining during the early 1990s allowed growth in wages to lag productivity growth, introducing significant reductions in unit labor costs as well as substantial competitiveness gains. The Hartz reforms, seen by many as a bifurcation point, merely supported the existing labor market flexibility by capping unemployment benefits and creating personal service agencies to match unemployed people with employers. Contrast this with Germany’s western neighbor, where the French labor market has largely remained as it was in 1995, requiring a minimum of 1.5% y/y GDP growth just to keep the unemployment level at stasis.

In a manner similar to his predecessor, President Macron’s ability to introduce significant labor market reforms does not only rely on his capacity to pass legislation through parliament, a factor which will be determined in the June 2017 parliamentary elections. More so, the reform rests on the appetite of the French population to support the government in reforming the labor market. Unfortunately, the first round of the elections signified a limited desire for economic liberalization as the two populist parties, Front National and La France Insoumise, jointly attracted the support of 40.9% of the population. This foreshadows a reform deadlock, whose resolution will likely resemble that of the July 2016 labor law. Last year, President Hollande made use of the controversial Article 49–3 of the Constitution, sanctioned under state of emergency in France, to pass a watered-down version of the original reform, despite the French people’s disapproval.

Macron will soon find himself standing between a rock and a hard place, as labor reform comes at a high political price. Reverting to use of emergency power will undoubtedly give strength to populism in France. Alternatively, if he chooses to ignore his core electorate, he will fail to introduce the reforms that the French economy badly needs to ignite growth. This unstable equilibrium only showcases the strength of populism in France, not its weakness. Le Pen may have lost the election, but her damaging economic ideas appear to be winning the hearts and minds of the French people.

CASE — Center for Social and Economic Research is an independent, non-profit economic and public policy research institution, established in 1991 in Warsaw.