Government Spending and Growth

French president Francois Hollande seems to have realized that something needs to change in France, as the economy continues to remind one of an overcooked vegetable – limp, soggy and all around unappealing.

As a reminder, when Hollande ran for the presidency, he was trying to pass himself off as the coming 'growth president'. The growth miracle was going to be achieved by adopting an 'anti austerity' stance, so in essence, Hollande propagated the theory that deficit spending by government creates economic growth. This economically illiterate position is also held by many prominent economists, so one can probably not blame a professional bureaucrat-politician for believing it. The vagaries of the market are unknown to him – he has been a government apparatchik throughout his career.

Aggregate economic statistics make it appear as though government consumption contributes to growth, but that is mainly a case of 'garbage in, garbage out'. Just because a nonsense number is added to some other numbers, one cannot assert that the resultant new nonsense number represents 'growth'. Imagine for a moment that government could only spend what it receives in tax revenue. It would be perfectly clear to everyone in that case that government can only spend what it first takes from someone else, who in turn can no longer spend it. If one looks at it that way, the argument is immediately reduced to its essence: namely the question, who is more likely to allocate the funds in a manner conducive to growth: government bureaucrats or the private sector?

Once the argument is formulated correctly, there is not much need to debate the issue any further. Since bureaucrats don't have to worry about profit and loss, they cannot possibly judge opportunity costs. As long as they are surrounded by a market economy, they can engage in rudimentary economic calculation, but it is a severely limited version of it, more akin to a game than the real thing (this results in such disasters as government constructing the most expensive web site ever built, only to find out it doesn't even work properly).

A sight that frequently greets visitors of the most expensive web site ever built – click to enlarge.

The government's spending on 'healthcare.gov' will be reflected as having contributed to 'economic growth' in the official GDP accounts. The problem is of course that it has done no such thing: it has done the opposite, by wasting scarce resources that would have been better employed elsewhere. Some experts argue that the total cost amounts to about a 100 times of what one should have reasonably expected (the source of these reports is not completely unbiased; but we agree that building a web site is not exactly rocket science and that it should have been possible to do it much cheaper).

The false belief that government possesses a magic wand, a cornucopia of free goodies it just needs to lavishly distribute and presto, there is 'growth', probably has much to do with the fact that no citizen ever considers the government's growing debt burden as something he or she is personally liable for. No household includes its theoretical share of government debt on the family balance sheet. There never seem to be any consequences to the borrowing and spending.

Government borrowing of course doesn't change what was said above in the slightest – the funds still have to come from somewhere. People (and institutions investing on their behalf) don't lend money to government because they believe it will invest it wisely and profitably (in other words, they do not expect any satisfaction of consumer wants to result from the employment of their funds). They lend to it because they rely on its powers of coercion. These are thought to make the debt 'safe' (until it isn't anymore, such as happened in Greece). The underlying dynamic is such that it will one day very likely lead to a painful and depressing discovery of major errors. One of them is that it is implicitly assumed that government can stipulate for all eternity (since for all practical purposes, the debtberg has become eternal).

Hollande Wants to 'Do Something'

President Hollande has a slightly different problem though: he can no longer employ deficit spending to create a temporary illusion of growth, since the EU's treaties are limiting his maneuvering room (even though the limits are largely a charade, it is a good bet he would be borrowing and spending more freely without them). In order to keep extremely high government spending in France going (it amounts to about 57% of economic output),  he had to raise a plethora of taxes, including a widely publicized attempt to stick it to the rich that caused a number of defections of prominent high income earners from France.

French Government spending is at a new record high. So is the public debt to GDP ratio, which at more than 90% is way above the Maastricht limit - click to enlarge.

However, the bulk of the tax increases have naturally hit business and the middle class (there simply is not enough that can be taken from rich people in France). The regulatory and taxation policies enacted by Hollande's government have left the economy moribund and made the president deeply unpopular. In fact, he has become the most unpopular French head of state of the entire post WW2 period.

This is quite a contrast to the high hopes French voters harbored after his election – at the time many apparently felt that bigger doses of socialism would set the economy right (French politics is nowadays generally only about the relative degree of socialistic policies adopted. There are no truly market-friendly parties, even though there exists a conservative bloc that occasionally pays lip service to capitalist ideals).

France's manufacturing sector remains mired in crisis conditions - click to enlarge.

From a political point of view, the weak labor market represents the government's biggest problem. Reuters reports:

“President Francois Hollande said on Friday France needed to cut the high cost of labor in France to bring down stubbornly high unemployment in the euro zone's second-biggest economy.

His remarks came as a newspaper reported that Hollande's government was exploring possible measures to lower the cost of labor, which economists see as one of the main reasons France has lost competitiveness internationally in recent years.

While it remained unclear whether Hollande had any new measures in mind, Les Echos business daily said his government had asked a panel of experts to look into cost-lowering options, with a focus on welfare levies.

The Socialist leader is struggling to live up to a promise to get unemployment on a downward trend by the end of the year in the face of limp economic growth.”

(emphasis added)

It could be that the bitter economic realities are finally forcing Hollande to adopt meaningful reform, but it is noteworthy that he is once again offering nothing concrete. This has been his modus operandi throughout his reign – whenever he promises reforms held to be 'painful but necessary' ('painful' for certain vested interests anyway), he remains vague and appoints committees that then proceed to spend an eternity 'looking into the matter'. Almost nothing ever happens.  France's 'code du travail' (labor market regulation) is an enormously complex set of stifling rules that should simply be scrapped. It actively undermines employment by making it extremely difficult for companies to fire anyone. For many the solution is to simply remain small and not hire too many people in the first place (there is an arbitrary threshold: once a company has 50 or more employees, things become fiendishly difficult – hence France has a very large number of companies with exactly 49 employees).  Reuters continues:

“The INSEE official statistics agency forecast on Thursday that unemployment, which stood at 10.9 percent in the third quarter, was at best stabilizing before it was likely to tick up to 11.0 percent by mid-2014. "Even if INSEE talks about a stabilization, I confirm that everything is being done to get unemployment falling," Hollande told a news conference in Brussels on the sidelines of an EU summit.

Hollande is counting on a state-sponsored job contract scheme to reduce unemployment, although many economists say that such measures will only have a temporary impact.

The president said for unemployment to keep falling over time France needed "a structural policy to ease the cost of labor and improve professional training". His government has introduced a tax credit scheme aimed at reducing companies wage bill by 20 billion euros ($27.34 billion) annually, and employers and unions this month struck a deal on overhauling the costly and inefficient job training system.”

(emphasis added)

The steps that have been taken in terms of the tax credit scheme and the deal with unions over training are tiny and insufficient. Furthermore, they make an already complex system even more so (businesses now must administer the tax credit scheme in addition to the administrative burdens they already bear due to over-regulation. That may be no problem for large companies, but it is one for the small to mid-sized ones that create most of the jobs). 'State-sponsored job contract schemes' will do nothing to improve the situation. If  institutional unemployment is to be lowered, the labor market needs to be deregulated. So Hollande's statement about a 'structural policy' are not wrong,  only there is very good reason to doubt that he will deliver it. The main problem moreover is the lack of economic growth. Growth is not a result of rising employment – it is the other way around.

France's perennially high unemployment rate. In 'good times' (i.e., during inflationary booms) it tends to fall to levels that would be regarded as extremely concerning in the US – click to enlarge.

France's appallingly high unemployment rate actually looks better than it should, as the government employs a large number of people in what is essentially a giant 'make work' scheme, where they aimlessly spend their time producing nothing of value. This preponderance of government employment opportunities has had an effect on the career paths young people prefer to pursue these days. Most government jobs may be boring and offer little or nothing by way of personal fulfillment, but they are coveted for their perceived 'safety'. Meanwhile creative and entrepreneurial talents are emigrating in droves to places like London, where they are welcomed with open arms.

Hollande's reluctance to engage in meaningful reform may well be based on    fears that the more radical leftist party led by Jean-Luc Melenchon ('The Left Party') will take away votes that have traditionally gone to the socialists. A coalition of communists, the Left Party and the 'Unitarian Left' represented by Melenchon received more than 11% of the vote in the first round of the 2012 presidential election. Anti-capitalistic radical fringe parties are flourishing in France, with the Front Nationale of Marine Le Pen enjoying especially strong support. French politicians generally seem to feel a need to pander to the anti-capitalist mentality and have created today's economic wasteland in the process. And yet, blaming the market for everything that is going wrong never seems to be going out of fashion. What France needs is someone who is willing to step on a few toes in order to do what is right, not what is thought to win the next election. In fact, it may well turn out to be a politically more successful approach than the endless pandering to vested interests and economic illiteracy.

As Arthur Goddard wrote in the foreword to his translation of Frederic Bastiat's 'Economic Sophisms':

“Ever since the advent of representative government placed the ultimate power to direct the administration of public affairs in the hands of the people, the primary instrument by which the few have managed to plunder the many has been the sophistry that persuades the victims that they are being robbed for their own benefit. The public has been despoiled of a great part of its wealth and has been induced to give up more and more of its freedom of choice because it is unable to detect the error in the delusive sophisms by which protectionist demagogues, national socialists, and proponents of government planning exploit its gullibility and its ignorance of economics.”