Once mighty Old World economies may fall as the eurozone debt crisis continues to spread. On Nov. 10, Standard and Poor’s accidentally issued a warning message to subscribers that France’s prized AAA credit rating was to be downgraded. S&P apologized for the “technical error,” but it’s becoming increasingly apparent the French have a AAA rating in name only.
Investors aren’t fooled. They look at the rising possibility of default and have increased the cost of borrowing to reflect the risk. French debt yields have hit 20-year highs, and the spread between French and German bonds is now more than 2 percent. Yields are currently up 2.82 percent, up from 2.31 percent in the previous auction - not exactly a trend favorable to the French government. French bonds rates are a long way from the 7 percent that triggered bailouts for Greece, Ireland, Portugal and, before long, Italy. The market has much more confidence in the German and U.S. markets, where bond rates remain near zero.
France’s problems run deep. A recent study by the Brussels-based think tank the Lisbon Council ranked the country last among the six AAA-rated eurozone countries. It ranked 13th overall for financial security, only one place above troubled Italy. French banks have substantial exposure to Greece, Italy and Spain, but the French ministry so far has declined to comment on the impact of these investments.
On the Euro Plus Monitor’s scoreboard measuring economic reform, France came in 15th out of 17 and was given “the Leviathan award” for its bloated public spending. More than half of the nation’s economic output, 54 percent of gross domestic product, is doled out by the government. That’s high even for the European Union, which isn’t exactly known for lean operations.
French taxes are high to pay for the massive entitlement state, but industry finds it difficult to meet the burden, saddled with inflexible employment laws. The work week, for example, is limited to 35 hours, and such factors have driven French labor costs beyond Germany’s. As a result, economic growth has been throttled at a barely measurable 0.1 percent last quarter.
If France is to return to a sustainable growth path, deep reform is needed now. Instead, Prime Minster Francois Fillon’s long-awaited austerity package largely consisted of tax increases. He would raise the corporate tax 5 percent and increase the value-added tax on services by 1.5 percent. The boldest proposal was an increase in the retirement age from 60 to 62 - in a country where average life expectancy is more than 81 years. Not surprisingly, the markets reacted to this milquetoast “reform” by pushing French bond yields higher.
Paris cannot tax its way out of a problem created by decades of overspending. As in every other nation with an unsustainable welfare state, government must be scaled back. For France, that means taking on the unions. If it fails to do so, it will surrender much more than its AAA rating.