French Public Debt and Deficit- how to avoid the precipice

04.10.2024 5 min
Published by Revue Banque, this article deals with a hot topic, the French public debt and deficit. A clear and credible response, because it is substantiated and configured with determination, is essential to avoid financial instability which could be devastating economically and socially. By avoiding false solutions such as the cancellation of the debt or the increase in the tax burden (which in France is already at a level much higher than those of comparable countries, while ensuring income equality after redistribution among the very best of Europe). And by making sustainable an asset to be protected: the social protection system.

5.5% of GDP in 2023: the French public deficit rate is posted at an unexpected level and one of the highest in the European Union. Why is this a serious problem? What are the possibilities for getting out of the trap that France has been stuck in for a long time?

A deficit may be desirable when fiscal policy plays its countercyclical role during recessions, for example. However, if French and European growth proved weak in 2023, the recession feared due to the historic rise in interest rates did not occur. After years of very high public deficits (6.6% in 2021 and 4.8% in 2022), it was hoped that last year’s deficit would be at a much lower level and that its decline would be premeditated and credible for the following years. France has continuously run public deficits since 1974, though, empirically, there is no long-term positive correlation between public deficits and the growth rate.

If the public debt rate were low, or even average, a few years of public deficits at high levels would not be dangerous. But our public debt (social protection system included) exceeds 110%. Our primary deficit (before payment of debt interest) is close to 4% of gross domestic product (GDP). Our potential growth is low and the real long-term interest rate has become slightly positive. We have come out of the period of low rates for good. With free money having disappeared, the cost of public debt rose from 34 billion euros in 2020 to more than 50 billion in 2023 and will reach more than 70 billion in 2027. There is no more magic money. This very unfavourable combination could thus lead us to experience a snowball effect of public debt, which consists of borrowing even more to pay the interest on the debt itself, in an endless and very destabilising growth of public debt. The French public debt rate stood at 20% of GDP in 1980, 60% in 2000 (same in Germany) and 110.6% in 2023 (compared to around 65% in Germany). Finally, if the public debt rate has increased by approximately 25 points of GDP for the entire euro zone since 2000, it has increased by 50 points for France, or twice as much as the euro zone.

There are possible ways to break the deadlock, of course being protected by the euro which has protected us since 2000, but which could sooner or later no longer be enough.

No room for manoeuvre

The cancellation of the debt held by the central bank is not only highly perilous, but also useless because the interest lost by the monetary authority would be equally lost by the State which receives revenue through the results of the issuing institution.

Raising taxes would be a solution if France did not already have a total tax rate (43.5% of GDP in 2023) among the highest in the world. But today, this would lead to slower growth and sooner or later further deterioration of the deficit and debt. And further lower the employment rate. And fall back into France’s vicious circle. This recipe can only work when there is room to manoeuvre. This is no longer the case in France.

The income tax rate for more than half of households is zero in France and the rates are lower than in the rest of the euro zone for the first levels of the scale. But the marginal rate on household income stands at 55.2% in France compared to 47.5% in Germany; it is also higher in France than in Italy, Spain, the Netherlands and Belgium…It therefore hardly seems feasible to cause even more imbalances by increasing the rate scales of the wealthiest households. The capital tax rate, for its part, still remains higher than the European average. In addition, the level of income inequality in France is one of the lowest in Europe.

Companies, for their part, despite the efforts of recent years, are still experiencing levies well above their European competitors: taxes on production, for example, are still 2.4 points of GDP higher in 2022 compared to the euro zone average and 3.7 points compared to Germany.

In 2022, the total tax rate was 6.1 GDP points higher than the euro zone average rate. It is the highest in the European Union. The budgetary weapon can be very useful, but only if one is able to reload it regularly.

Significantly lowering the level of public spending in relation to GDP is therefore desirable when reaching these peaks. In the case of France, it would be necessary to carry out a re-engineering of the territorial organisation and the management of public services. Which can only take time and cause discontent. However, the need for it is great and the superficial shaving method is very limited in its effectiveness.

However, it is unreasonable, with very low growth, to carry out a rapid and indiscriminate reduction in public spending because it could lead to a recession in the short term which would have negative effects on the deficits themselves. Stabilising their volume level and redirecting them is, however, particularly desirable and greatly improves their efficiency. By involving public service employees (including those within social security in the broad sense of the term) to show them the benefits that they themselves could gain from it. By working from administration to administration and transversally on each topic, calmly but without prevaricating or procrastinating. With the support of digital tools, among others, it is possible without human impact. Saying it and doing it in a credible way is essential. Credibility is, in fact, key to financial stabilisation.

At least three levers

Could this be enough? No. Two additional levers are necessary, to be used in conjunction with the previous one, and to be announced publicly, displaying unfailing determination and clear programming. The credibility of public authorities is essential to convince all stakeholders.

Pursue structural reforms that increase growth, i.e. increase the quantity of people available for work and increase productivity gains. The excess growth generated would make it possible to relieve the deficit rate and public debt by increasing the denominator.

But faced with the French and European delay in terms of technological innovations and industries of the future, these actions alone would again probably not be enough.

The development of programs like the American IRA, backed by a well-thought-out industrial policy, would be unavoidable, but illusory with current debt. It is also probably illusory to think that the European Union would agree to launch a second common loan similar to the one launched during the pandemic.

Only the concomitance of these three lines of action can avoid a predictable catastrophe. It is necessary to combine investments in growth and competitiveness, the financing of which would be pledged on a recurring reduction in operating expenditure in relation to GDP, the greater efficiency of public services (in health, as in education for example, French public sector expenditure by GDP is among the highest in Europe, yet it is both felt and measured to have deteriorated significantly) and the improvement in potential growth generated through structural reforms.

Public debt, when it is no longer sustainable, leads to the worst economic and social consequences. Monetary and financial disorder due to excessive and unsustainable debt for too long can suddenly lead to breakdowns in the confidence of citizens, as well as in the international financial markets (foreign investors finance more than 50% of French public debt). And in the absence of a sudden rupture, uncontrolled debt can lead to an inexorable decline, the economic and social consequences of which are, ultimately, just as bad, if not brutal. Only the commitment to a clear and planned pursuit of the three action plans described here, in short, only the presentation of a legible and credible trajectory, because it is solidly documented and substantiated seems to be able to avoid such a risk.

Olivier Klein
Professor of Economics and Finance and CEO of Lazard Frères Bank