Back to basics: the French problem, supply or demand?

The Great National Debate sought by Emmanuel Macron to purge the French of an anger so fiercely  expressed by the “yellow vests” has just been launched. It focuses primarily on administrative organisation, public expenditure, taxes, and the relationship between citizens and institutions. There is no mistake about it, we are in France, a country where everything starts and ends with the state. No mention is made of Europe, nor of issues that are vital for activity and wealth creation: access to the labour market, international competition, the burden of public debt, to name but a few.

The fortnight’s focus The French economy continued to grow in Q4 2018… An admittedly weak growth rate, but one that might have been feared lower since external demand has weakened and the domestic social climate has suddenly deteriorated. No government official has come to boast about the positive growth figures given that the immediate horizon is far from clear. There are some positive factors. The mobilisation of the gilets jaunes (“yellow vests”) has moderated, and activity is no longer directly disrupted. The household tax measures announced last month will come into effect. The amount at stake, about half a percentage point of GDP, is normally enough to provide support for disposable income and consumption as early as Q1, especially if the effect of lower inflation is added. In reality, however, there is often a smoothing over time and some of the additional income could be saved in the short term.

Over a longer period, household financial savings tend to evolve in tandem with the labour market situation. An increase in unemployment encourages people to save, and vice versa. As a result of the cyclical recovery, unemployment has declined over the past three years, but the slow pace of decline suggests that there are significant structural barriers. The increase in the duration of unemployment-insurance is an illustration of this (chart lhs). The lack of flexibility in the labour market has multiple causes due to the shortcomings of the education system, regulatory complexity, labour costs, all of which have been widely identified in the past. On the business side, supply problems are deemed to be significantly more intense than normal. This is a point that was reiterated in a report on industry by INSEE published in recent days. Since the end of 2016, when the economic recovery began to accelerate, industrial groups have reported increasing recruitment difficulties and a growing number of bottlenecks . Beyond the short term, for which fears about demand are legitimate, it is on the supply-side that the main limitation to economic activity and employment growth lies.

 The fortnight’s economic newsflow

  • In January, business climate surveys produced partly inconsistent results, both in terms of level (expansion vs contraction) and variation (improvement vs weakening). The companies surveyed by INSEE indicate that confidence has stabilised. This follows the disastrous results of the previous survey carried out just after the urban riots in Paris, images of which had had a strong impact in France and around the world. According to INSEE, the confidence level is 2% above its historical average all sectors included, in other words it is at least 10-15% above what we would see if the French economy were in recession. Unsurprisingly, it is the retail and wholesale trade sectors, directly affected by the “yellow vests” movement, that reflect the lowest level of confidence, but this level is only marginally below normal. These results would suggest that the maximum impact of the recent social crisis has passed. The demonstrations continue, granted, but with decreasing participation and no major violence; they are no longer blocking commercial activities or warehouses.
  • The message is quite different if we consider Markit’s surveys, which, it should be noted, are carried out on a sample about ten times smaller than that of INSEE. The PMI-composite activity index continued to decline in January (-0.8pt), whereas it had collapsed in December in rarely seen proportions (-5.5pts). It is now at a level (47.9) that would be justified if economic activity were to contract slightly. It is not unusual for the various business climate surveys to diverge for one or more months, as they are not conducted at the same time, with the same companies and following the same approach. The last time such a significant gap appeared was in 2013-2014. Note that the INSEE and Banque de France indices proved to be much better proxies for the pace of activity at the time than the PMI indices. Nevertheless, it is the PMI indices that attract the most attention from investors, probably because they are easy to read (vs the symbolic 50pts threshold) and easily lend themselves to comparisons between countries.
  • With regards to households, in January the confidence index wiped out December’s sharp decline (-5 points), thus confirming this was an exaggerated reaction to the “yellow vests” crisis. The level remains low. Spending intentions and the outlook for living standards rose sharply, although remain below normal levels.
  • According to the first estimate of the national accounts for Q4 2018, real GDP was up by 0.3% q-o-q and 0.9% y-o-y. The weakness in demand is primarily visible at the level of households. Their investment in housing has been on a downtrend for two quarters. Consumption suffered the triple blow of a correction in the automotive market (introduction of new norms stimulated new car registrations in Q3), unseasonably warm weather (decline in energy spending) and disruption caused by the “yellow vests” movement. INSEE has been reluctant to issue any quantified data or even to blame this last factor, but based on other episodes of social unrest, this shock could have wiped off a tenth of a point of growth in Q4.

Bruno Cavalier
Chief Economist – ODDO BHF