13 graphs, in addition to articles :
«Lack of growth and lack of reforms: time for action», published in Les Echos 17 July 2014
«Structural reform is difficult, but unavoidable», published in Le Monde 20 March 2014
Category: Economical policy
The structural reforms capable of improving growth potential and the efficaciousness of the economy are today well known. The question is not one of political left or right. There is an economic and social urgency for stemming French decline and defending our model by rendering it sustainable. Why are we experiencing so many difficulties in resolving the twin problems of the French economy, lack of growth and lack of reforms?
Our conflictual culture – left/right, employers/employees, rich countries/poor countries, multinationals/peoples etc. – should no longer blind us from reality and the need to deploy necessary and tangible concrete solutions.
Another hindrance on reform: a historically super-powerful centralising government. This organisational structure, once useful for France, is no longer adapted to a global economy and a society organised in networks. Digital technology has changed the relationships with authority. By its omnipresence, the State intermediates in the relationships between each citizen and society, between each citizen and other citizens. Instead of feeling responsible towards the collectivity, the individual expresses strong demands of Government. Everyone then rejects reforms, distrustful of the reality of the effort required from others and questioning the inability of the State to take charge of all problems.
Simultaneously over time, powerful corporatist interest groups have been established. Trade unions are not truly representative within private enterprises. The result: a vacuum of social construction, a kind of “social corporatism”, duplicated by “social technocracy”*. This makes it difficult to think in symmetrical fashion of one’s duties as well as one’s rights and to accept reform.
Add in a historic cultural heritage which frequently makes compassion the alpha and omega of political action and media debate and prevents us from seeing things as they truly are or giving ourselves the means to correct the situation. Declining competitiveness, high unemployment, the exclusion of far too many young people from the labour market, increasing inequality of opportunity, average skill levels too low relative to other countries… Confronted by the reality of the facts, compassion cannot serve as a policy and exempt us from overcoming a certain number of fixed ideas and specifically French ways of thinking.
Fortunately the French are becoming aware of the limits of inadequate competitiveness. Rules which are too restrictive. Abuses which are all too frequent and uncorrected. And permanent public deficits caused by a public sector which has long not adequately strived for efficiency in the system, resulting in expenditure of GDP (and so of taxes) among the highest in Europe, whereas the quality of public services is only average.
Our citizens are now learning, on the strength of the examples set by foreign neighbours, the benefits of the reforms needed to end this suicidal downward spiral and to protect our way of life and our standards of social protection, to enable the happy and necessary conjunction of living in society and fostering entrepreneurship. In a society founded on fairness.
This new awareness should allow governments to combat the specifically French atavisms and to find credible answers to questions so that the French cease to be one of the most pessimistic populations in the world regarding the collective future of their country.
Relying on public opinion, perhaps daring to conduct referendums to counter corporatist opposition, the government must have the courage to find the way towards change, to explain implications and to convince the population. A reduction in public expenditure is of course a must, but with an overall plan for effective reorganisation of the public sector. But again, reform must be free of ideology, notably with regard to the employment market and the pension system, to take into account the increase in life expectancy and to balance the books. Finally, competitive policies must be implemented, notably by reducing taxes and the social security contributions of enterprises. All these changes together will make possible, despite our constraints, long-term protection of our standards of living and social protection, combining in the medium term an increase in growth and a reduction in public deficits.
There remains one key element: how to formulate the right programme and the right support. We must trust that if the pathway followed is virtuous and resolved, the rate of change will be adjustable.
*Expression coined by Denis Olivennes
«Complement to the article : 13 graphs»
Donwload «Lack of growth and lack of reforms: time for action» (PDF)
Read in french «Manque de croissance et manque de réformes : le temps de l’action»
The crisis has led to many banks worldwide suffering losses. And yet, they cannot raise new equity capital in the marketplace since investors fear the health of the banks may deteriorate further. In order to respect their solvency ratio (Basel 2), they are therefore forced to reduce their assets so that they again meet the maximum regulation multiple return (12.5 times) of their equity capital. So governments are intervening by going directly into the banks’ capital, supplanting the market and so counteracting as best they can a credit “crunch” which would be otherwise inevitable.
If this sequence of events is familiar, Basel 2 provokes another one sequence less well known, however dangerous. Even when the banks are not at a loss, when times are rough they are driven to reduce their credits and their market positions. The financial and economic crisis triggers an increasing effect on the calculated value of the banks’ assets. It is not the occurrence of nominal assets but of assets weighted by the risk they represent (risk weighted assets or RWA). This risk is measured by volatility of the positions in the financial markets, and by the probability of failure in the case of credits. In both cases the calculation of risk is based on the events of the recent past. The observation of the price drop in financial assets and of the increase of their volatility raises the value of their weighted assets by their risk and thus leads to the increase of the required level of their equity capital.
At the same time, the deterioration of borrower’s grading caused by the economic crisis mechanically increases the value of banks’ risk weighted credits, and so too their need for equity capital. And yet if, because the stock market doesn’t allow it as is the case today, the banks cannot manage to increase their equity capital to re-establish their ratio, they can only reduce their market positions by selling a portion of their financial assets. In doing so, they worsen the drop in the markets and their volatility, so provoking a new increase in their risk value. In the same way, on the credit side they cannot reduce their borrowings and so de facto they further weaken the economic agents, and the risk value of existing credits. It is here that at this point the vicious circle is perfectly complete!
Of course, faced with this risk of endless deterioration of asset prices and the economy, the Governments have thankfully reacted very quickly by directly investing in banks’ capital or by guaranteeing some of their assets at risk, or more precisely by buying these assets directly. This is absolutely necessary but the action which would help to break the vicious circle at the very moment that it is formed would be to urgently revise the methods of calculation of risk to the banks’ assets, by stopping their worrying procyclicity since they are largely based on recently observed risks. Or instead, by conserving the same methods, to adjust the required level of equity capital in an anticyclical way against the assets calculated in this way. Although today, while the economy and markets are doing well, the banks can take more and more risks with unchanged equity capital, thus strengthening the possibility of a boom. And conversely in the event of a reversal of speculation and the markets. It would clearly be preferable to progressively demand more equity capital since everything improves and maintains the same conservative level when everything deteriorates as it has today.
Even if that is insufficient, this necessary reform requires an international agreement, whereas the Governments intervene nationally. This is why the scope of the current crisis is forcing Governments to act without delay. However, with a certain parallelism, the IFRS standards which themselves are strongly procyclical have been significantly softened as soon as the end of 2008. And yet the urgency for a revision of prudential standards is also imposed. The progressive nationalisation of banks or the investment to their equity capital of funds borrowed by the Governments themselves is obviously essential but cannot be a long-term solution. It must be combined with a conservative structural reform of the calculation of bank equity capital required by Basel 2.