France: Turn the music off to hear the bells tolling

This combination of a low effective retirement age and high further life expectancy is one cause of the comparatively high cost of public pensions in France: Before the outbreak of the Covid-19 pandemic, public pension spending amounted to 14.8% of GDP, which was the third-highest ratio within the EU. Only in Greece and Italy was this share higher, while the EU average stood at 11.6%.  

Pension reform becomes all the more urgent when we consider the rising trend of life expectancy. In fact, according to preliminary INSEE data, the average life expectancy of women in France already increased by three months in 2021, and that of men by two months. Until mid-century, the average life expectancy is expected to increase by more than two years  and the number of people aged 63 and older is set to rise from 15.4mn today to 20.4mn in 2050.

At the same time, the working age population aged between 20 and 62 years is going to shrink by almost 2mn to around 33mn.  This implies that the number of retirees per person in working age is set to increase markedly if there is no further reform of the statutory retirement age. Currently there are 45 retirees per 100 persons in working age between 20 and 62 years.

In this context, we find that increasing the low retirement age is the best – if not the only feasible – option that is left to put the finances of the pension system on a more sustainable footing. If the government fails to raise the effective retirement age by increasing the statutory retirement age, there will be 62 retirees per 100 potential contribution payers by mid-century. An effective retirement age of 65 years would markedly reduce this increase of the old-age dependency ratio to 54 % (see Figure 5).

Figure 5: France’s old-age dependency ratio is set to deteriorate further

A higher retirement age would also dampen the demographic impact on the labor market by adding around an average 1.8mn people each year and thus keeping the total number of people in working age at almost at the same level as in 2021. However, to keep the old-age-dependency ratio, i.e., the ratio of pension receivers to contribution payers, constant at 45% would need a further increase of the retirement age to 68 years, or alternatively more than 12mn immigrants added into the labor market by 2050.

Further measures to strengthen the pension system’s long-term sustainability and adequacy could include a reduction of the pension benefit level, complemented by a strengthening of the capital-funded pillars, or an increase of the contribution rate and state subsidy. But leeway is very limited in those respects. Further decreases of the benefit ratio, for example, could jeopardize the adequacy and acceptance of the pension systems as the benefit level is already set to decline in coming years, thanks to earlier reforms. Promises to increase the minimum pension hint at efforts to maintain the attractiveness of the pension system.
A further increase of the already high contribution rates would not only lead to higher financial burdens on younger generations, but also to higher labor costs, which would impair French companies’ competitiveness and the country’s attractiveness for sought-after high-qualified workers from abroad. A further increase of the state subsidies is also hardly an option, given the already stretched situation of public finances – and the new demands on the government, from defense to energy security and the green transformation.

Redirecting households’ excess savings to corporate investment could address mounting debt, reducing the risk of financial instability.

Both consumption (+4.8%) and private investment (+6.1%) rebounded stronger in France compared to Eurozone peers. In fact, the dynamism of domestic demand was the key driver of France’s quick and forceful post-Covid economic recovery (+7% GDP growth in 2021). At the same time, abundant public support to the corporate sector since 2020 — which shows no sign of reversing yet — has helped companies build solid cash buffers and ensure greater resilience amid a challenging international environment. Non-financial corporates held EUR206bn in excess cash as of February 2022, the highest level in Europe.  

The flipside of the story is that French non-financial corporates are highly indebted. Since the 2008-09 crisis, we have seen a clear shift in corporate net lending in Germany, Italy and Spain, with corporates becoming net savers. However, in France, corporates have remained net borrowers (Figure 6), absorbing a significant part of (domestic and international) household savings. The high level of debt only increased during the Covid-19 crisis: Under the state-guaranteed loan (SGL) scheme (EUR140bn take-up), French corporates took on greater amounts of debt (+14pp of GDP) than the Eurozone average (+9pp of GDP).

Figure 6: Non-financial corporate debt to GDP (%)

The extension and increase of the SGL program in 2022 will push corporates to accumulate even more debt. We estimate that at least EUR60bn of additional loans could be taken up by corporates by year-end. This will add up to EUR206bn of corporate excess cash since the start of Covid-19. This debt accumulation could expose them to greater financial vulnerabilities in the medium run, notably a confidence shock, creating greater need for deleveraging in anticipation of an economic downturn.

dummy Using panel data, we estimate that non-financial corporates’ margins need to increase by +1.5pp on average in order to absorb the remaining +8.7pp increase in the corporate debt-GDP ratio since the outbreak of Covid-19. This is likely to be increasingly challenging in an environment of prevailing high cost inflation and slowing demand, which could lower corporate pricing power in the coming quarters.  In a context of rising rates, French corporates are likely to post the highest losses in terms of margins: an increase of 100bp in key interest rates would translate into a -2.3pp fall in NFC margins in France compared to -1pp in Germany, -1.5pp in the UK and -1.4pp in the US (see Figure 7).

Figure 7: Impact of rising bank interest rates over a year, pp of margin for NFCs

To help companies absorb the rise in debt, the French government should implement policies that redirect households’ record-high excess savings towards productive investment. A good step in this direction would be rechanneling households’ savings away from the real estate market towards equity participation in the capital of companies with high and sustainable growth potential. Using household savings to help accelerate the European economy’s modernization and decarbonization would benefit long-term growth potential. To do this, the government needs to address the lack of attractive financial products and low financial literacy. One particularly intriguing option would be to breathe fresh life into the idea of European long-term investment funds (ELTIFs) as part of the European Commission’s action plan to strengthen and complete Europe’s capital markets union. ELTIFs have been around for years but so far have existed mostly in the shadows and largely failed to appeal to retail investors. In addition, governments could provide direct subsidies for a certain amount of saving invested. Channeling excess private savings into long-term investments can thus support France’s green and digital transformation.

Export competitiveness is the Achilles' heel that requires bold structural reforms.

Deep-rooted structural shortcomings and political decisions for deindustrializing the country in favor of services have held back France’s export performance. France deindustrialized faster than its European peers: At 9.7% of GDP, the size of the French manufacturing sector is around half that of Germany.  In fact, China’s remarkable export expansion coincided with the dramatic decline of France’s global export shares over the past two decades (around -2 points of global exports), a decline larger than that of Germany and Italy.  France has been dummy losing export market shares not only to China but also to other Eurozone countries, especially in flagship sectors such as aircraft, pharmaceuticals, vehicles, electrical machinery and equipment.

Moreover, France continued to lose export market shares (-0.2pp per year) amid the Covid-19 crisis, even as Germany and Italy managed to preserve theirs. French exports dramatically contracted (-16.1%) in 2020 before recovering by +9% in 2021. However, they still remained -5% below the pre-pandemic level, even as the Eurozone as a whole exceeded this level by 3% at the end of 2021 (Figure 8).

Figure 8: Export volumes index, constant prices (2019 Q4=100)

Rising energy and input prices widened France's trade deficit in goods to -EUR84.7bn in 2021 (+EUR20bn from 2020), the highest on record (Figure 9). Since then, the invasion of Ukraine and new lockdowns in China have pushed up energy prices even further and extended supply bottlenecks, worsening the terms of trade (i.e. import prices have increased more than export prices). We calculate that the contribution of the energy deficit could reach EUR75bn or 2.9% of GDP in 2022 (vs. 1.9% of GDP in 2019). We expect a significant diffusion of high energy prices to overall import prices through the year. Thus, a sizeable improvement of the overall current account deficit is unlikely in 2022, despite the increasing surplus of trade services, particularly from maritime freight.  

As a direct consequence of the widening external deficit, a growing share of French national income has been transferred abroad. France's net international investment position (NIIP), which reflects the difference between the value of assets and liabilities vis-à-vis the rest of the world, widened to -EUR695.5bn (a deterioration of -EUR78.7bn since 2019), reaching -30.2% of GDP (-5 points since 2019). However, for now, despite the growing reliance on financing from the rest of the world, France’s NIIP remains below the alert threshold set by the European Macroeconomic Imbalance Procedure (-35% of GDP).

Figure 9: Current account balance (three-month moving average, EUR bn)

France’s wide trade deficit means that the country is not producing the goods that are consumed domestically. On the other hand, in flagship industrial sectors such as luxury goods and aircraft, above 80% of production is exported abroad. Domestic demand (consumption and investment) in France is dummy more reliant on imported goods compared to other European peers, namely Germany and Italy. This incapacity of domestic production to satisfy (domestic) demand exposes the economy to supply-chain bottlenecks and goods shortages in periods of global stress (e.g. a sanitary crisis or geopolitical tensions).

In the current context of escalating geopolitical tensions, Western sanctions against Russia have also raised the stakes for achieving energy independence by speeding up the development of alternative sources to fossil energies. Indeed, the recent developments of energy prices are set to reshuffle the comparative advantages of exporters even within Europe. France could possibly benefit from the changes related to the war in Ukraine, given its relatively smaller exposure to energy imports from Russia. But it still needs to actively invest in adapting its energy mix quickly.

In view of current global challenges, exporters face a fundamental transformation of their cost structures that will require a re-thinking sectoral specialization. France needs a clear roadmap to revise its industrial policy and upsize its manufacturing capacity. Obviously, re-industrialization does not mean bringing back the production of low value-added and polluting sectors back to France. To be fit for its purpose and create high-paying jobs, the new industrial policy ought to extensively rely on digital technologies, automated manufacturing and machining processes and clean energy sources. The new government should also continue with deep reforms of the labor market to address long-lasting weaknesses such as the lack of technical skills, low participation rates and the duality (fixed-term vs. permanent) and rigidity of work contracts.