OPINION. When a very serious economic and financial crisis occurs in a context of near-zero short-term interest rates and prior over-indebtedness, central banks turn to unconventional monetary policies.
Some push interest rates below zero, and all launch a Quantitative Easing (QE) programme to control the long-term rates and risk premiums (spreads) of both public and private debt. This means central banks can use their conventional and unconventional policies to bring short and long interest rates to very low levels and prevent spreads from rising to levels that would trigger a catastrophic chain of bankruptcies due to a sharp rise in insolvency. Very low rates also have a direct positive effect on demand, as well as on the value of capital assets (real estate and equities in particular), which has a positive impact on demand and supports credit.
During these crises, monetary policy – even of the unconventional type – has the de facto objective of lowering nominal interest rates below the nominal growth rate. This clearly helps revive the economy and facilitates deleveraging by making debt easier to repay.
So what could possibly be the danger of such a monetary policy that protects the economy against systemic crisis and a deep recession? The risk lies in adopting a monetary policy which, in fact, is asymmetric. While it is very useful – essential, even – when central banks adopt this type of policy in such situations, in reality we are witnessing a problematic asymmetry: when growth returns with a noticeable recovery in credit, central banks fail to sufficiently reverse their policy, increase their interest rates or scale down their QE – that is, the quantity of central bank money – if they do so at all.
In the eurozone, the official reason has often been that inflation was still too low, meaning the inflation target had not yet been reached, which justified maintaining an ultra-accommodative monetary policy. However, isn’t inflation structurally, and not cyclically, very low, due to the effects of globalisation and technological progress (automation) – which exert downward pressure on wages – combined with the ageing of the world’s population? In this case, is monetary policy capable of increasing it? If monetary policy cannot raise inflation that is fundamentally very low, it obviously becomes dangerous to continue to pursue such a policy for too because it then keeps interest rates below growth rates for too long – “too low for too long”. This causes a financial loop: debt rises faster than economic growth, which leads to over-indebtedness all over again and the return of real-estate or stock bubbles.
It is a vicious cycle, because debt is also used to buy these capital assets, which feeds the bubbles and facilitates more debt. That is how the entire economy becomes more financially vulnerable, with risks embedded in the balance sheets which only grow:
1/ In the assets of financial investors and/or savers
They are looking for even a small return at any cost, since interest rates are too low. So they’re going to take more and more risk in order to get it. The risk premiums are thus compressed in a way that is completely abnormal and obviously dangerous, because when the bubbles burst, the spreads will simply not have covered the cost of the proven risk. The assets of savers and financial investors (who work for the savers: pension funds, insurers, investment funds, etc.), are thus made vulnerable. Pre-pandemic, this led to, among other things, a sharp historical drop in yields on investments in infrastructure, historically low credit spreads, very high valuations for listed and private equity companies, and investment funds holding assets that were more and more illiquid and/or with very long maturities, while ensuring the daily liquidity of these same funds, etc.
2/ In borrowers’ liabilities
Borrowers’ are taking on too much debt under these conditions, which leads to excessive leverage. Among other things, there has been a great deal of share buybacks by companies themselves, notably in the United States. So now it’s the liabilities themselves that are becoming vulnerable. They are vulnerable to a drop in cash flows linked to a slowdown in growth as well as a rise in interest rates. This, in turn, leads to a significantly larger risk of insolvency.
When the above two points combine, there is growth in the number of “zombie companies”, that is to say companies which survive, but which are not structurally profitable and which would go bankrupt at normal interest rates. This phenomenon naturally contributes to a less-efficient economy and lower productivity gains.
Maintaining interest rates that are too low for too long, when they are no longer necessary to fight against insufficient growth of the economy and loans, therefore creates a very risky situation in the long term. An asymmetric monetary policy reaction can thus lead to more financial instability, the progressive loss of economic efficiency with a decline in productivity gains and, ultimately, a succession of financial crises. This was the pre-COVID-19 situation.
The financial situation thus became catastrophic at the very beginning of the COVID crisis because the pandemic produced a dizzying drop in production and violent contractions in income and cash flow for companies against a prior backdrop of significant financial vulnerability.
By the end of March, the financial crisis caused by COVID was already more severe than that of 2008-2009, with stock-market volatility twice as high, spreads which shot up, and very problematic liquidity shortages, particularly in investment funds. Fortunately, the central banks responded at lightning speed: they lowered their rates when it was still possible – in the United States in particular – though not on the European side because they had not come back up even after growth returned in previous years. They also began to buy public and private debt, including high-yield debt, and sometimes even equities, by increasing their quantitative easing considerably. They also adopted macroprudential adjustment measures.
Central banks thus quite rightly made it possible to relieve a catastrophic financial situation within a few weeks and have supported the efforts of governments in favour of the economy through the massive use of an unconventional monetary policy. But, very soon, we’ll have to answer the following question: When growth does return to a satisfactory level, how can we exit this monetary policy if governments and companies are even more indebted? Of course, right now the central question is how to get out of an unprecedented economic crisis. And yet, despite everything, we must now think about how we will eventually escape from an exceptional situation where central banks have rightly suspended the logic of the market temporarily, by intervening deliberately and massively to ensure the liquidity of the markets and the solvency of governments and, in conjunction with government action, the solvency of companies by controlling interest rates and spreads.
First of all, the exit will need to be a very gradual one. The situation will indeed be problematic, because at the end of the crisis a number of companies will be over-indebted, especially because they will have had, and fortunately will have been able, to finance their losses, and many governments will be over-indebted, too. In addition, we will have to deal with bubbles on capital assets; prices are already rising sharply, both for residential real estate and equities. If we then raise rates too quickly by a poorly-planned withdrawal of QE, and if we hastily put an end to negative interest rates, it could have a disastrous effect on solvency in the private and public sectors. This, of course, could lead to the risk of a crash in capital-asset markets, which would reinforce widespread insolvency. The exit must, therefore, be very gradual.
Central banks would also be in a bind if inflation recovered in two or three years. If it did, should they maintain the solvency of economic agents at the cost of potentially uncontrollable inflation? Or do the opposite?
But, even if inflation did not recover, should central banks continue their QE ad infinitum if governments and companies – whether by necessity or by choice – did not deleverage? This would result in structurally increased financial instability, both in terms of over-indebtedness and increasingly extreme bubbles, with all the dangers such instability would involve. There would be an increasing moral hazard since borrowers, both private and public, would no longer fear over-indebtedness. Investors would believe that central banks would always rescue them from crashes with no repercussions, and would thus be encouraged to underweight the price of risk in their financial calculations in the long-term. Lastly, the economy would see more and more zombie companies and less of the creative destruction necessary for growth. This would lead to a lasting decline in productivity gains that would, among other things, structurally slow down gains in real purchasing power.
Ultimately, the risk of the unlimited monetisation of debts would lead to a catastrophic flight from currency.
First conclusion: to maintain their credibility, and therefore their efficiency, including during systemic crises, central banks must protect themselves, not only against the well-known risk of fiscal dominance, but also against that of financial market dominance to avoid falling into increasingly strong, violent and potentially very dangerous crises. In other words, they must not be dominated either by governments which might want their continuous intervention to “guarantee” their solvency, or by the financial markets. Central banks need to be in a strategic relationship with financial markets. And they should not be afraid to channel collective images and average market opinions into sustainable fluctuation ranges, insofar as possible, or to counter them if need be. Even if the markets today are always asking for more aid to continue their upward momentum. As Fed Chair Jerome Powell said recently, and quite rightly: “The danger is that we get pulled into an area where we don’t want to be, long-term. What I worry about is that some may want us to use those powers more frequently, rather than just in serious emergencies like this one clearly is”.
Second conclusion: alongside the policies implemented by central banks – which need to start thinking about how they will eventually escape their ultra accommodative policies – we need fiscal policies that are sustainable in the medium-term. Not immediately, however, because we need to avoid austerity at all costs in the coming years. Structural reforms will also be necessary to increase the growth potential of each economy. Ultimately, this is the best way to escape over-indebtedness.
That includes policies that aim to increase corporate equity. To reduce excess debt – without hindering growth – we will need much more investment in equity and quasi-equity (equity loans, convertible bonds, etc.). Incentives will therefore be needed to direct household savings towards riskier capital, as well as measures targeting the cost of excess reserves of banks and insurers so as not to make their investments in corporate equity prohibitive. Temporarily, a system where the government partially guarantees the invested capital may prove necessary.
Central Banks cannot do everything on their own. Expecting too much of them can be dangerous, even for their efficiency, when it becomes necessary again.
When a very serious economic and financial crisis occurs in a context of near-zero short-term interest rates and prior over-indebtedness, central banks turn to unconventional monetary policies. Some push interest rates below zero, and all launch a Quantitative Easing (QE) programme to control the long-term rates and risk premiums (spreads) of both public and private debt. This means central banks can use their conventional and unconventional policies to bring short and long interest rates to very low levels and prevent spreads from rising to levels that would trigger a catastrophic chain of bankruptcies due to a sharp rise in insolvency. Very low rates also have a direct positive effect on demand, as well as on the value of capital assets (real estate and equities in particular), which has a positive impact on demand and supports credit.
During these crises, monetary policy – even of the unconventional type – has the de facto objective of lowering nominal interest rates below the nominal growth rate. This clearly helps revive the economy and facilitates deleveraging by making debt easier to repay.
So what could possibly be the danger of such a monetary policy that protects the economy against systemic crisis and a deep recession? The risk lies in adopting a monetary policy which, in fact, is asymmetric. While it is very useful – essential, even – when central banks adopt this type of policy in such situations, in reality we are witnessing a problematic asymmetry. When growth returns with a noticeable recovery in credit, central banks fail to sufficiently reverse their policy, increase their interest rates or scale down their QE – that is, the quantity of central bank money – if they do so at all.
In the eurozone, the official reason has often been that inflation was still too low, meaning the inflation target had not yet been reached, which justified maintaining an ultra-accommodative monetary policy. But isn’t inflation structurally, and not cyclically, very low? In this case, is monetary policy capable of increasing it? If monetary policy cannot raise inflation that is fundamentally very low, it obviously becomes dangerous to continue to pursue such a policy for too long, because it keeps interest rates lower than growth rates, so interest rates remain too low for too long. This causes a financial loop: debt rises faster than economic growth, which leads to over-indebtedness all over again and the return of real-estate or stock bubbles. It is a vicious cycle, because debt is also used to buy these capital assets, which feeds the bubbles and facilitates more debt.
The entire economy becomes more financially vulnerable, with risks embedded in the balance sheets which only grow:
First, in the assets of financial investors and/or savers: they are looking for even a small return at any cost, since interest rates are too low. So they’re going to take more and more risk in order to get that tiny return. The risk premiums are thus compressed in a way that is completely abnormal and obviously dangerous, because when the bubbles burst, the spreads will simply not have covered the cost of the proven risk. The assets of savers and financial investors (who work for the savers: pension funds, insurers, investment funds, etc.), are thus made vulnerable. Pre-pandemic, this led to, among other things, a sharp historical drop in yields on investments in infrastructure, historically low credit spreads, very high valuations for listed and private equity companies, and investment funds holding assets that were more and more illiquid and/or with very long maturities, while ensuring the daily liquidity of these same funds, etc.
Second, borrowers’ liabilities: borrowers are taking on too much debt under these conditions, which leads to excessive leverage. Among other things, there have been numerous share buybacks by companies themselves, notably in the United States. So now it’s the liabilities themselves that are becoming vulnerable. They are vulnerable to a drop in cash flows linked to a slowdown in growth or a rise in interest rates. This, in turn, leads to an increased risk of insolvency.
When the above two points combine, there is growth in the number of ‘zombie companies’, that is to say companies which survive, but which are not structurally profitable and which would go bankrupt at normal interest rates. This phenomenon naturally contributes to a less-efficient economy and lower productivity gains.
Maintaining interest rates that are too low for too long, when they are no longer necessary to fight against insufficient growth of the economy and loans, therefore creates a very risky situation in the long term. An asymmetric monetary policy reaction can thus lead to more financial instability, the progressive loss of economic efficiency with a decline in productivity gains and, ultimately, a succession of financial crises. This was the situation before COVID.
The financial situation thus became catastrophic at the very beginning of the COVID crisis because the pandemic produced a dizzying drop in production and violent contractions in income and cash flow for companies against a prior backdrop of significant financial vulnerability.
By the end of March, the financial crisis caused by COVID was already more severe than that of 2008-2009, with stock-market volatility twice as high, spreads which shot up, and very problematic liquidity shortages, particularly in investment funds. Fortunately, the central banks responded at lightning speed: they lowered their rates when it was still possible – in the United States in particular – though not on the European side because they had not come back up even after growth returned in previous years. They also began to buy public and private debt, including high-yield debt, and sometimes even equities, by increasing their quantitative easing considerably. They also adopted macroprudential adjustment measures.
Central banks thus quite rightly made it possible to relieve a catastrophic financial situation within a few weeks and have supported the efforts of governments in favour of the economy through the massive use of an unconventional monetary policy. But, very soon, we’ll have to answer the following question: When growth does return to a satisfactory level, how can we exit this monetary policy if governments and companies are even more indebted? Of course, right now the central question is how to get out of an unprecedented economic crisis. And yet, despite everything, we must now think about how we will eventually escape from an exceptional situation where central banks have rightly suspended the logic of the market temporarily, by intervening deliberately and massively to ensure the liquidity of the markets and the solvency of governments and, in conjunction with government action, the solvency of companies by controlling interest rates and spreads.
First of all, the exit will need to be a very gradual one. The situation will indeed be problematic, because at the end of the crisis a number of companies will be over-indebted, especially because they will have had, and fortunately will have been able, to finance their losses, and many governments will be over-indebted, too. In addition, we will have to deal with bubbles on capital assets; prices are already rising sharply, both for residential real estate and equities. If we then raise rates too quickly by poorly calibrated QE’s withdrawal, and if we too rapidly put an end to negative interest rates, it could have a disastrous effect on solvency in the private and public sectors. This, of course, could lead to the risk of a crash in capital-asset markets, which would reinforce widespread insolvency. The exit must, therefore, be very gradual.
Central banks would also be in a bind if inflation recovered in two or three years. If it did, should they maintain the solvency of economic agents at the cost of potentially uncontrollable inflation? Or do the opposite?
But, even if inflation did not recover, should central banks continue their QE ad infinitum if governments and companies – whether by necessity or by choice – did not deleverage? This would result in structurally increased financial instability, both in terms of over-indebtedness and increasingly extreme bubbles, with all the dangers they bring. There would be an increasing moral hazard since borrowers, both private and public, would no longer fear over-indebtedness. Investors would believe that central banks would always rescue them from crashes with no repercussions, and would thus be encouraged to underweight the price of risk in their financial calculations in the long-term. Lastly, the economy would see more and more zombie companies and less of the creative destruction necessary for growth. This would lead to a lasting decline in productivity gains that would, among other things, structurally slow down gains in real purchasing power.
Ultimately, the risk of the unlimited monetisation of debts would lead to a catastrophic flight from currency.
First conclusion: to maintain their credibility, and therefore their efficiency, including during systemic crises, central banks must protect themselves against the well-known risks of fiscal dominance and financial market dominance to avoid falling into increasingly strong, violent and potentially very dangerous crises. In other words, they must not be dominated by governments which might want their continuous intervention to ‘guarantee’ their solvency, attempting to resist rate hikes for too long. But central banks should not be dominated by financial markets, either. They need to be in a strategic relationship with financial markets.
And they should not be afraid to channel collective images and average market opinions into sustainable fluctuation ranges, insofar as possible, or to counter them if need be. Even if the markets today are always asking for more aid to continue their upward momentum. As Fed Chair Jerome Powell said recently, and quite rightly: “The danger is that we get pulled into an area where we don’t want to be, long-term. What I worry about is that some may want us to use those powers more frequently, rather than just in serious emergencies like this one clearly is”.
Second conclusion: alongside central bank policies, we need fiscal policies that are sustainable in the medium-term. Not immediately, however, because we need to avoid austerity at all costs in the coming years. Structural reforms will also be necessary to increase the growth potential of each economy. Ultimately, this is the best way to escape over-indebtedness.
That includes policies that aim to increase corporate equity. To reduce excess debt – without hindering growth – we will need much more investment in equity and quasi-equity (equity loans, convertible bonds, etc.). Incentives will therefore be needed to direct household savings more towards capital, i.e. riskier saving, as well as measures targeting the cost of excess reserves of banks and insurers so as not to make their investments in corporate equity prohibitive. Temporarily, a system where the government partially guarantees the invested capital may prove necessary.
Central banks must adopt symmetric monetary policy rules. But they can’t do it all on their own. And asking too much of them can be very dangerous, even for their credibility and efficiency, the next time they are needed.
The central banks took swift and effective action. States also acted rapidly in an attempt to handle the cost of the unprecedented fall in production as effectively as possible. They did so by enabling the financing of company losses and by taking on the cost of labour, since businesses generating zero revenue cannot continue paying their employees. The aims are to prevent layoffs and bankruptcies, protect production capacity and avoid an appalling rise in poverty.
The set of measures temporarily lifts monetary constraint – vital in normal circumstances to the efficient functioning of the economy – from economic players, businesses and households.
Monetary constraint
But in today’s economic meltdown, the normal exercise of monetary constraint would be catastrophic, leading to bankruptcies and countless irretrievable job losses. For their part, the central banks, while ensuring the liquidity necessary to the financial system, have wisely suspended the monetary constraint of states.
Once the health crisis is over, putting an end to this exceptional suspension will not be an easy task, and it would be dangerous to let people believe that monetary constraint at all levels could be durably lifted simply by central banks buying state and company debt on an ad lib basis.
While monetary constraint should not be abruptly reintroduced, as this could send the economy into a new downward spiral, neither should it be suspended for too long. This is because we must absolutely avoid a flight from currency, the value of which is wholly dependent on the trust placed in the effective exercise of monetary constraint, and hence in banks and central banks, as well as in the quality of debt, including public debt.
Fatal illusion
Central banks should make a part of the additional public debt resulting from the health crisis interest-free on a practically indefinite basis to lighten the load and foster the return of growth. But they must do so in a precise and strictly circumscribed manner. The idea of central banks permanently suspending monetary constraint is a fatal illusion. The major risk involved in acting as if monetary and economic constraints no longer exist is thus not a return of traditional inflation but a loss of confidence in currency. Sooner or later, this would lead to the appearance of a form of hyper-inflation and deep financial instability.
Pressure from public opinion
The reopening could thus entail elevated risks of economic policy mistakes. Under pressure from public opinion, policy may seek to return too swiftly to orthodoxy or assume that we are exempt indefinitely from any and all constraints.
A solid supply policy must be led to rebuild the country’s production capacity and even increase it to reduce its strategic dependence. The process will require all the capacity for work and entrepreneurial spirit of everyone involved. The supply policy must further mobilise labour and include a substantial focus on recapitalising businesses and facilitating investments. Failing this, companies will exit lockdown heavily in debt and may well be unable to invest sufficiently on a lasting basis.
The supply policy must be accompanied by a policy to boost demand, since both have suffered considerably during the crisis. Increasing taxes will not be compatible with either policy. Consequently, we will need to accept budgets with extremely gradual deficit reductions and the fact that monetary policies can only return to their unconventional practices in a cautious fashion. But to salvage trust in state debt and in currency, this should be achieved as part of a highly explicit plan.
Let’s look at the pension reform as it stands, however well or badly prepared it may be.
Currently, the reform, as presented by the Prime Minister, is both fair – it significantly improves the pensions of many people who receive little or no protection from the law or unions – and fully funded by age-based measures.
The issue of whether the reform should be solely “systemic” (or made universal, meaning a single system for everyone) rather than “parametric” (changing of the parameters to ensure balance) is a very surprising one. French people are much more worried about the amount of their future pensions than about whether the system is made universal, even though a universal system would be fairer.
This is probably where a lot of the mistrust is coming from: a points-based pension system may make people think that the system might be balanced by manipulating the value per point, and therefore the amount of the pensions paid, more particularly downwards. French people therefore needed to feel secure about their future pensions by being shown that the system would be safe-guarded, in other words funded.
The only way of effectively ensuring that pay-as-you-go pension systems are balanced, without lowering pensions, is to adjust the length of people’s working lives, based on demographic changes. Otherwise, they can only be balanced by increasing employee and/or employer social security contributions. This would affect purchasing power and/or make the economy less competitive, immediately or at a later date, and so ultimately reduce the growth rate, employment and purchasing power in both cases. As companies in France already pay 60% higher social security contributions than companies elsewhere in the euro area, any further rise would be unacceptable, both socially and economically, as it would go against the interests of the French economy and of everyone working in it.
This leaves age-based measures as the only way of making the interests of current and future pensioners compatible with aiming for the highest potential growth for the economy. In France, in 1960, there were four taxpayers for every pensioner. In 2010, there were only 1.8 taxpayers per pensioner. At the same time, in 1958, the life expectancy at pension age was 15.6 years for women and 12.5 years for men. In 2020, this has increased to 26.9 and 22.4 years respectively. And the pension age is lower now than in 1958. The healthy life expectancy after retirement has also increased considerably.
Everyone understands this and expects the length of people’s working lives to change. Moreover, all of France’s neighbours have similarly raised their pension ages. We therefore also need to come to terms with reality so that our precious pay-as-you-go pension system is not endangered by an inability to fund it. In France, only around 30% of people aged 60 to 64 work, whereas in the other euro area countries nearly 50% work on average, with 57% in Germany and 68% in Sweden. Of course, work is not only necessary economically, it is also very often a means of integration, socialisation and self-fulfilment. Work also creates work in the dynamics of an economy, something that all the empirical studies have confirmed.
Now it must be considered whether it is better to establish a pivot age or to adjust the number of years worked, as this adjustment would take long careers and the strenuousness of the work more effectively into account, which would be fairer.
A good reform is one that is desirable and credible. This reform is desirable because it is fairer and because it gives French people greater security with regard to the amount of their future pensions. It is credible because it should be funded by adjusting the length of people’s working lives. It is desirable and credible if it does not increase social security contributions in France further, as they are already much higher than in other euro area countries.
For all these reasons, this reform will be positive and helpful for French people and the country’s economy.
By nature, the topic of inequality covers several aspects. If we look at the global level, levels of inequality between poor and rich countries have decreased considerably since the 1980s. According to the World Bank, 40% of the world’s population in 1981 lived below the extreme poverty line compared with only 11% today. The growth rate of emerging countries has therefore substantially reduced inequalities between the average living standards of the various countries. And if we focus on just China and India, which have experienced and continue to see the strongest economic development since the 1980s, 2 billion people have risen above the poverty line. That’s great progress and one of the obvious benefits of globalisation.
That’s true not only for income, but also for health. My data are less recent, and it has improved even more since then. In 1940, life expectancy in developing countries was 44.5 years. In the 80s, it reached 64.3 years. That’s an increase of 20 years over this 40-year period. Meanwhile, people in developed countries are living nine years longer. Here again, we can see that inequalities in health and life expectancy have decreased.
On the other hand, inequalities within each country, whether developed or emerging, have increased on average with globalisation and growth. That’s because although the growth process allows the greatest number of people to increase their standard of living, some in each country are progressing faster than others, and in some countries, people at the top of the pyramid have access to a larger share of national income. The standard of living has therefore increased for nearly everyone. However, inequality has still managed to grow, simply because certain people’s situations have improved more quickly than others. That’s the nature of happiness, measured by economists in an informative way. All the studies show that happiness is relative. We’re happy when we’re doing better and when our situation improves faster than others. In other words, by comparison. In relative terms. So, even though everyone’s standard of living is rising, the increase in inequality is quickly becoming a social and political topic. We’re therefore seeing a phenomenon needing better clarity: dramatically smaller inequality between countries and growing inequality within countries, even though the level of wealth and well-being has increased overall.
The issue of inequality can therefore be addressed and analysed in various ways.
Income inequality can be measured by looking at the share of the country’s income held by the top 1%. Inequality can also be measured much more precisely and undoubtedly with more relevance with the Gini index. Gini was an economist and statistician who invented the method of studying the distribution of inequality across the entire population. We look at the differences between everyone two by two and average the differences from each to each. If the average of the differences is zero, that means that everyone has exactly the same income. An average of 1 means total inequality. These indices are measured across all OECD countries.
Lastly, a third way doesn’t look at income inequality but at inequality of opportunity. Of course, we’re talking about social mobility and the “poverty traps” that generations can fall into. Equal opportunity is obviously crucial because it relates to the republican pact, the social pact, and the ability to live together and obviously because it is fundamental for the health of a society and its cohesion. When inequality of opportunity is low, more people can be mobilised. That means that no matter where you’re born, if you have talent and equal opportunities, you’ll manage to advance. So, not only is the belief that everyone has the same opportunities an important factor of social cohesion, but it also helps to foster growth because it mobilises all talents wherever they are. The issue of inequality of opportunities is therefore crucial. It means knowing whether they are still the same and their children who all have their opportunities to succeed or if the pathways can be fluid without too much determination for the original social environment. And we’ll see that in France, there is a strong adhesion at both the top and the bottom.
Findings: I’ll start by presenting a few figures and then some analysis.
In France, compared with neighbouring countries, income inequality after distribution is rather low, whereas income inequality before distribution is rather high. Meanwhile, inequality of opportunities is rather high.
We’ll use these findings to try to come up with some possible conclusions in terms of economic policy and necessary reforms.
First, let’s take a look at the measurement of income inequality before distribution and after distribution. Before allocation, it’s clear, for example, that inequality is greater if wages range from 1 to 1,000 rather than 1 to 100. But we also have to consider people who aren’t working and therefore have very low incomes. The more people there are excluded from employment, the greater income inequality before redistribution is. And the more powerful the redistribution system is, whether through taxes, support income, and or other ways, the lower income inequality after distribution is.
Before distribution, the GINI index rose from 0.477 in the United States in 1996 to 0.507 in 2016. In the UK, contrary to what one might think, there has been little increase. It increased from 0.473 to 0.504 in the EU and from 0.409 to 0.488 in Japan. So, what do we see? Inequality has actually risen everywhere. And in the US, it hasn’t risen much more than elsewhere, before distribution. Its level of inequality isn’t really much higher than in the eurozone, while in Japan it’s lower.
After distribution, the US fell from 0.507 to 0.391 in 2016. We can therefore see the effect of distribution. It clearly reduces income inequality. There has been a sharp decline in the UK as well. After distribution, the eurozone is a much more egalitarian system than the US since it’s much lower after distribution there. Europe therefore has a system that does more to reduce inequality. And Japan lies between them.
Let’s analyse France. Before redistribution, the Gini index rose from 0.490 in 1998 to 0.516 in 2015. That’s a fairly small upward trend in inequality. Are these inequalities big or small compared with other countries? In 2015, France was a little more unequal before redistribution than the US. Is it because there’s a broader range of wages? Of course not. It’s because there are many more people out of work. That’s an essentially French problem. Other countries very often have an employment rate 10 points higher (75% compared with 65% in France). Germany is almost at the US level. And we know that the unemployment level is very high there. Spain’s level of inequality before redistribution is even greater than France’s. Not surprisingly, Sweden is a more egalitarian country even before distribution. We can therefore see that France had high levels of inequality before redistribution.
But after redistribution, what’s the finding?
In 2015, France was at 0.295, one the lowest indices of all the countries considered. That means it went from having one of the highest indices in terms of inequality before redistribution to one of the lowest after redistribution. We can therefore see that redistribution is very strong in France. In the US, the level of inequality after redistribution is much higher than in France. But in Spain, Italy, and Germany, the level of income inequality after redistribution is about the same as in France. And France’s levels, again after redistribution, are quite comparable to Sweden’s.
France thus has a one of the highest redistribution policies, relative to GDP, of all OECD countries. The advantage is reduced inequalities, but there are also disadvantages. It means much higher taxes and mandatory contributions, which is not without consequences. We can easily see a correlation between the Gini index after redistribution and the burden of social benefits relative to GDP. And, thanks to one of the strongest redistributions among OECD countries, France has one of the lowest income inequalities. Only Denmark, Finland, and Sweden have lower levels.
Now let’s consider the proportion of national income received by the 1% of individuals with the highest national income. In France, they received 9% of national income in 1995. In 2015, they received 10.5%. For the sake of comparison, Sweden had the lowest percentage at 6% of national income versus 9% in France in 1995 and 8% versus 10.5% in 2015. That’s not a huge difference. Let’s look at the United States. In 1995, the richest 1% received 15% of national income. In 2015, this figure was a little over 20%. That’s clearly a striking figure. It’s twice as much as in France. And the increase in the share received by the richest 1% has been much more brutal. In Germany, growth has been a little stronger than in France. While it was also 9% in 1995 like in France, it was 13% in 2015. However, we’re very far from the US. All in all, the richest 1% have received a growing portion of national income. But the phenomenon is much more visible in the US than in Europe.
Another way to analyse inequality is to look at the percentage of individuals at the poverty line.
The customary international way of calculating it can be called into question, but at least it’s an indicator used everywhere. We look at the median income of the French or Americans, for example, as a percentage. Anyone under 50%, or 60% like in our figures on this medium income, is considered poor. It is a relative notion of poverty.
In France, few people are below the poverty line, meaning below 60% of French median income. Meanwhile the percentage is higher in Spain and Italy. It’s also higher in the US. And the percentage of the French population under the poverty line even decreased between 1998 and 2016. It increased in Germany over the same period. So, again, we can’t say that poverty is high or has increased in France. What we sometimes hear in the media is simply statistically false.
However, in France, inequality of opportunity is rather high compared with similar countries.
According to opinion polls conducted by the OECD, 44% of French respondents believe that education passed down by parents is important for progress through life. In the OECD, which includes Chile, Mexico, all European countries, the United States, etc., the average opinion is at 37%. This reflects a rather high sense of inequality of opportunity in France. Unfortunately, this opinion is correct. In France, socio-economic status is passed on more strongly than elsewhere from one generation to the next. The relative income level is passed on more strongly from one generation to another than in other countries. Lastly, the level of education and diploma is passed on more strongly from parents to children than in other countries. According to these three criteria, inequality of opportunity is greater in France than elsewhere.
Of course, inequality of opportunity exists everywhere, since the socio-cultural environment is very important in the life and development of children. But the way we manage to partially correct the phenomenon can be more or less strong. The OECD calculated this and published a report on this subject, taking intergenerational mobility into account. Then we look at how many generations it takes for a family at the bottom of the ladder to reach the middle range. Clearly, the fewer generations required to reach the average, applying the average mobility of society, the less inequality of opportunity there is. The more generations it takes to achieve this, the more one is confined to the bottom of the ladder or symmetrically protected at the top of the ladder.
In Denmark, it takes 2 generations. In Norway, 3; in Finland, 3; in Sweden, 3; in Spain, 4. In New Zealand, Canada, Greece, Belgium, Australia, Japan, and the Netherlands, 4. In the United States, 5.And in France, 6.
Six generations so that someone at the very bottom of the income ladder has a chance that their great grandchildren will reach the middle income level, given French mobility. Germany doesn’t do better, and neither does Chile! And the average for the OECD is between 4 and 5.
Studies have reached the same conclusions about the inequality of opportunity in France, relative to comparable countries, by calculating the correlations between the income of parents and the income of children once they reach adulthood. The findings regarding correlations of diploma level are similar.
What structural reforms should be done to combat inequality of opportunity?
Of course, the reform of national education must be mentioned. There is currently much less mobility and equality of opportunity in France than many years ago when teachers who supported and pushed their deserving pupils were called “horsemen of the Republic”. This state of mind has not been abandoned, but it is much less widespread, and in reality, national education has declined in overall effectiveness for many reasons that can be explained more or less easily. The effectiveness of education is measured and compared using level tests carried out internationally by the OECD.
Comparative studies show that national education must be able to devote slightly more resources to children in disadvantaged areas or neighbourhoods. It’s also known that a lot comes into place early in life, in kindergarten, and in elementary school. That’s where more resources are needed. But let’s not fool ourselves. It’s a question of efficiency and not global means within national education in France, which has a much higher budget-to-GDP ratio than the other European countries for a disappointing result in the tests. People also must be supported during their career so that they can progress. Professional training in France is very inefficient and is in the process of being reformed.
Some countries do all this remarkably well, such as South Korea and the Nordic countries. They equip themselves with the means to ensure a good degree of social mobility in their country. Once again, that’s useful, not only for social cohesion, but also for the economy because there will be a search for talent that otherwise wouldn’t be able to express themselves and obviously contribute to the general growth.
In addition, long-term unemployment needs to be reduced, which means more effective support for returning to work and better incentives to take up a job. We also know very well that people in France are entitled to unemployment after four months of work. It’s one of the few countries where it takes so little time to be entitled to unemployment. That should be looked at. And, of course, we contributes to the creation of jobs must be facilitated…
It’s also important to work on territorial inequalities, because they exist.
So, there’s generally less social mobility in France than in other comparable countries, and this is reflected in the evolution between generations through income, degrees, and socio-professional categories.
Plus, we know that low mobility is not only intergenerational, but there is also fewer chances in France than elsewhere for people to be able to evolve during their life.
Two analyses:
From all this, I feel that there are two analyses that need to be given thought.
The first is the link between growth, innovation, and equal opportunities. The second is strong redistribution, which greatly reduces the initial inequalities that lead to a vicious circle.
First angle of analysis is the link between growth, equality, and innovation. For 20 years now, we’ve been living in a context of globalisation and a technological revolution related to digital. These two phenomena are increasingly eliminating repetitive work and the corresponding jobs.
Today, growing in an economy that is no longer a catch-up economy like in the post-war year requires being innovative. Innovation is crucial as the current driving force behind the growth of countries at the “technological frontier” (1). Emerging countries are catching up to developed countries, which must innovate constantly to continue to grow as emerging countries grow very quickly.
That means that we’re in an economy of knowledge and innovation – the only way to create growth and wealth.
As a result, we have to make sure to encourage innovation in our economy and our institutions (for example, organisational methods, labour market, and legislative framework). There’s also a link with equal opportunities because it’s obviously easier to fight poverty when there is growth. And it’s also easier to ensure social promotion to provide social mobility. If we step back and look at ourselves as a company rather than a country, we know that in a company that doesn’t develop, it’s very difficult to develop employees and help them grow. In a growing business, all those who are motivated and talented can be helped to grow.
Growth is therefore needed to reduce the inequality of opportunity and permit social promotion and mobility. If we don’t have enough growth and innovation, we end up with a blocked or jammed society and insufficient social mobility, and this leads to many social cohesion problems. In addition, as I already mentioned, the more we manage to promote equal opportunities, the greater the number of mobilised talents will be, and their energy will contribute to growth. So, we see the virtuous link between these different factors.
Plus, innovations create breakthroughs, which then create new sources of growth and wealth. Innovation therefore calls into question accrued benefits. And that’s also what enables social mobility. In the US, if we suddenly see people appear in the wealth rankings and develop new businesses very quickly, it’s because they seize innovations and can experience some amazing personal developments.
I’m not saying that this is a model in itself, but simply that, even at smaller scales, it’s essential. The more innovation, capacity to invest, and growth there are, the more it is possible to go beyond pensions and promote social mobility.
We therefore have to know how to ensure policies that facilitate innovation and promote this phenomenon. Once again, the innovation economy is the economy of knowledge: it’s education, it’s professional training, and it’s the promotion of all talents. It’s also means eliminating “poverty traps” by, as I already mentioned, better incentives to work, better support in finding a job, and easier abilities to switch jobs in shifting economies.
And that too is part of the necessary structural reforms. To encourage technical progress and innovation, competitiveness must also be encouraged through investment.
The second area of thought is the analysis of income inequalities before distribution and after distribution and the cost of this distribution (2).
The rather high income inequality before distribution is offset in France by redistribution, which is a strong redistribution because inequalities aren’t liked in France. In a way, what’s honourable is a collective choice. But a strong redistribution has a high cost in terms of social benefits and naturally social contributions and taxes. And because this leads to a lot of levies on companies, it spills over onto competitiveness. And lower competitiveness translates into fewer jobs. And the loop goes on. Because if there are fewer jobs, there are much stronger pockets of poverty and therefore large income inequalities before distribution. And then there’s long-term unemployment that must be offset by more redistribution and therefore more business costs. This leads us into a vicious circle.
The goal should therefore probably be to avoid over-repairing. Repairing is certainly normal, but better still is to do better upstream, to reduce income inequality before redistribution and avoid falling into this vicious circle. Prevent rather than repairing a lot of things.
The employment rate in France is 65%. That’s around 10% lower than in comparable countries. This is an unacceptable situation in itself. In France, there aren’t enough working-age people who are working. If we consider the two extremes, between the ages of 60 and 65, there are far fewer people working in France than elsewhere. Much fewer than in Germany, not to mention Sweden, in comparing France to countries with comparable models. Similarly, it’s very difficult for young people to find a job. And we can see the correlation: the lower the employment rate is, the higher the social benefits needed to offset the created inequalities.
Now let’s consider the correlation between employment rates and the size of distribution policies. In other words, employment rates and differences between the GINI indices before and after distribution. France has the strongest redistribution policies and the lowest employment rates.
Again, the correlation is obvious for OECD countries. Because of France’s significant redistribution policy, its social security contributions are roughly 60% higher than the eurozone average and therefore the contributions of neighbouring and comparable countries.
Companies are therefore structurally less competitive. After social contributions, there are left with a considerable disadvantage in terms of the overall cost of labour. This then means a lack of jobs, resulting in large income inequalities before redistribution. Hence the fact that we redistribute strongly… I don’t think redistribution should be stopped. That’s not my point at all. But to do sound, normal redistribution that doesn’t cost in terms of growth and jobs, we must strive to allow many more people to work and therefore allow our businesses to be more competitive. Otherwise, we enter a vicious circle. Therefore, the challenge is to ensure that, even before redistribution, there are fewer inequalities because many more people are working. Taking action upstream to repair less means entering a virtuous circle, and this obviously means allowing many more people to work, resulting in less income inequality before redistribution and, at the same time, increasing equality opportunities. More working people means more self-sufficient people, far fewer pockets of poverty, and many more socialised people, because work is one of the main forms of socialisation.
Let’s hope that these figures and findings, sometimes unexpected because they are little-known, like these analyses, will be able to contribute to a useful debate about the effective reforms to be conducted, without preconceptions or confusion between the ultimate objective of reducing inequalities, with a primary focus on the high inequality of opportunities in France, and the means to be used to achieve it. In the words of Bossuet: “God laughs at men who complain of the consequences while cherishing the causes”.
(1) On this topic, see Schumpeterian growth theory by Philippe Aghion.
(2) – The analysis of the cost of redistribution and the vicious circle created between income inequalities before and after redistribution and the lack of competitiveness of French companies was developed by Patrick Artus in several ‘economic flashes’.
Corporations are beginning to be redefined in France, and with it, governance is as well. Shareholders remain at the centre of governance. Proper compensation for risks requires acknowledging their essential role. The question is knowing how to better integrate the interests of the other stakeholders in the company alongside them.
For a long time, this question was not raised. At Wendel, Renault, Michelin, etc. shareholders and board members were the same people, and often families. The original family capitalism did not have problems with governance by construction. But, to help them grow, companies opened up their capital, and through the stock market, offered shareholders the ability to sell their shares for liquid assets. The shareholder base became disparate, and its power over board members became diluted.
In the post-war era, managerial capitalism became the most prevalent practice. Board members were emancipated from shareholders and controlled the company on the basis of their “technical” knowledge. This created a technocracy. The interests of the two parties were no longer aligned. Board members sought corporate growth and continuity, inserting employees into organisational pyramids. But this configuration did not always lead to the best efficiency or profitability, creating conglomerates that were often heavy and lacking in agility, which too often neglected shareholder interests.
In the 1980s, alongside financial globalisation, shareholders reminded board members of their existence and of the priority of maximising wealth. This change translated into the creation of committees (audit, compensation and appointment, strategy, etc.) and the development of incentive mechanisms (bonuses, stock options, etc.), to align the interests of the board members with those of the shareholders. A whole series of indicators was imposed (return on equity, distribution rate, etc.), in the same way the doctrine of value creation was developed. And if results were not achieved, shareholders allowed “raids” that organised offensive power takeovers to optimise value, sometimes by cutting out previously established groups. In parallel, these various compensation tools based on the growth of corporate value promoted innovation by allowing “start-ups” to recruit talent that shared in the company’s risks when salaries alone were not enough to tempt them.
But shareholder capitalism rapidly reached its limits. Because expected financial yields seemed guaranteed, speculation often outweighed reasonable gambles. To meet minimum short-term profitability standards (15%, regardless of the activity sector and risk-free interest rate, in the 1990s and 2000s), many companies bought back their shares to strengthen their securities and/or increase their leverage ratio. Board member income experienced growth that was difficult to justify. In 1965, the average income of a CEO of a major American group was 44 times that of a worker. In 2000, it was 300 times the lowest salaries. Even more serious, in the face of expected yields that were disconnected from reality, we saw the appearance of unethical creative accounting: Enron, WorldCom, Parmalat and others even more recently. In some respects, subprimes and their consequences stem from the same phenomenon.
The crises of 2000-2003 and 2007-2009 resulted directly or indirectly from this, along with their shares of very significant economic and social costs.
Hence the need to address a new age in governance, that of true partenarial capitalism that is able to put the company’s clients, employees, and the environment, in particular, back alongside shareholders, in a model better adapted to ongoing commercial, behavioural, ethical, managerial, and technological revolutions.
Shareholders must always hold a central place as principals for board members. This is because, in theory, they assume the risk without any certainty of future yield. The practice has made shareholders partly protected against negative changes in the business context by partially spreading the risk to other corporate stakeholders: to employees, for whom variability of compensation or employment has increased; and to sub-contractors, whose margins for negotiation with their ordering customers have significantly weakened. Sometimes clients are also balancing items, through the lower product safety or accelerated obsolescence imposed on them. The climate is also affected by corporate choices.
Therefore, it must be possible to take better consideration of these stakeholders within a balanced governance framework, as they also share in the company’s risk, and because over the long term a company is responsible to all of them. Regulatory methods that help achieve the best compromises among them must guarantee sustainable and profitable development for the company.
For this reason, by the fact that their clients are owners and elected members of the boards of administration, by their decentralised model that strengthens close relationships not only with the clients they serve, but also with the territories in which they operate in symbiosis, and lastly by the attention and role they give to employees without sacrificing any of efficiency, cooperative or mutual banks represent an interesting possible form for redefining the company with expanded governance. It is up to them to take advantage of new technologies that would help further strengthen the validity of their model and modernity.
It is up to each type of company, listed, private, or cooperative, large or small, to reinvent the definition of the company and its governance, to make it a real partenarial organisation. The future of our open economies and democratic societies also depends upon this.
