Cyrus Sanati in Fortune:
France's problem is that it simply has been living beyond its means for way too long. While not as bad as Italy, France has a very high debt compared to its economic output. Its total government debt of around 1.3 trillion euros equates to a debt-to-GDP ratio of around 83%. That is relatively low in comparison to the likes of Greece, which is at 140%, and Italy, which is at 120%, but it is high for a country that has a perfect triple-A credit rating -- much higher than the United States, which lost its triple-A rating earlier this summer.But if not, France's failure could take much of the Eurozone down with it.
If France's economic growth prospects were strong, then its debt-to-GDP ratio wouldn't be an issue, but the country is facing some serious challenges on that front. France's once strong manufacturing sector has decayed in recent years causing it to import increasingly more goods. Where once the country ran large trade surpluses, it now runs large deficits. In the first six months of this year France had a trade deficit of 37.5 billion euros. While that's a large number, what's really troubling is how fast it has grown, up 36% compared to the same time last year.
France's high labor costs seem to be behind the drop off in exports. The Germans have trounced the French in both internal and external eurozone trade. France is actually helping the Germans win in two ways. First, it has allowed its workforce to become less competitive. In 2000, French workers were paid 8% less than German workers. Now, French workers are paid 10% more than German workers. Second, France runs a trade deficit with Germany of around 1 billion euros a month. That is a complete reversal from 2004 when it was Germany that was running the billion-euro-a-month trade deficit with France.
What has happened to the French economy? The 35-hour government mandated work week surely hasn't helped matters much, but it goes deeper. France has the highest level of government spending in the eurozone at around 54% of GDP. That high level of spending goes to support the generous French welfare state, which is funded through borrowing and high taxes. Those taxes are passed through businesses, making French goods very expensive and ultimately uncompetitive on the world market. Today, around half of the gross labor costs in France go to prop up the French welfare state, while it is just 28% in neighboring Germany, according to MEDEF, France's largest union of employers.
The market was looking for France to finally announce plans to reduce its spending and force through meaningful cuts in its social safety net. Instead, it got a plan where France would try to tax its way out of its problems. Meaningful cuts in government spending, followed by liberalization of the nation's labor laws, will go a long way to solving France's fiscal dilemma. That would require a showdown with the country's powerful unions, something that not even conservative President Nicolas Sarkozy seems to have the stomach for at this point.