How France became the sick man of Europe

If Paul Krugman says that a country’s deficit is too high, and that the financial markets are not entirely wrong to demand higher interest rates, then the situation is truly serious. Especially if that country is not the United States under Trump – for Krugman, US debt was never a problem whilst the Democrats were in government – but France. The Nobel laureate in Economics, a leading voice for the progressive world, has always defended the French model of generous welfare and high taxes against criticism from the Anglo-Saxon and liberal-conservative press.

But now even he says it’s gone too far: “The current situation in France is worrying,” writes the American economist on Substack. “It is on a fiscally unsustainable path. Debt is already very high relative to GDP, and the government is making it worse by running huge budget deficits.” 

Public deficits are a problem shared by many developed countries, starting with the United States, but amongst economies with fiscal problems – writes Krugman – France stands out for one particular characteristic: “Its persistent inability to be realistic about pensions”. As is well known, the retirement age in France is just 62, whilst in Italy, following the Fornero reform, it is 67, and will rise to 67 years and one month in 2027 and to 67 years and three months in 2028. France’s retirement age is the lowest in Western Europe and is clearly unsustainable given demographic trends. President Emmanuel Macron had attempted to push through a reform in 2023 that would gradually raise the retirement age from 62 to 64, but he failed: not only did he lose much of his political capital, but the reform – due to strong social and cross-party opposition, from the far right to the far left – has been suspended until 2028.

According to Krugman’s analysis, although the young people currently protesting in the streets are among the fiercest opponents of the ‘neoliberal’ reforms being attempted by Macron, this unsustainable system is precisely one of the causes of the problems and dissatisfaction faced by the younger generations: “The tax burden, caused largely by France’s extremely generous public pension system, has led to cuts in other areas of spending, particularly in education,” argues the economist. “France is, in effect, providing substantial subsidies to the elderly at the expense of everyone else. The massive nationwide student demonstrations should come as no surprise.”

A further problem is that virtually all the presidential candidates – but especially those most likely to win – have no intention of implementing any pension reform: Marine Le Pen, the far-right candidate leading in the polls, wants to freeze the retirement age at 62; whilst Jean-Luc Mélenchon, the far-left candidate who, according to the polls, is set to face her in the run-off, wants to lower that threshold to 60.

Consequently, much of the fluctuation in government bond yields is due to this factor: the general reluctance of French politicians to face up to reality. Admittedly, the deterioration in public finances is evident. Public debt has reached 120 per cent of GDP (it stood at 60 per cent 25 years ago) and the projected deficit of 5.4 per cent is set to rise to 6.6 per cent by 2027, in the absence of the 54 billion fiscal consolidation proposed by Prime Minister Lecornu, which, however, lacks the necessary parliamentary support. However, the sharp rise in yields and the spread over the past few weeks is pricing in a much greater risk than can be explained by the deterioration in public finances alone.

According to an analysis by ABN AMRO, the markets are demanding a premium for levels of public debt and interest expenditure amounting to 140 per cent and 3.7 per cent of GDP respectively – figures far higher than the actual figures of 120 per cent and 2.8 per cent. The Dutch bank has therefore broken down the French spread into various components, such as factors common to the Eurozone, general interest rate volatility and French credit risk as measured by CDSs: according to ABN AMRO, there remains an ‘unexplained’ residual component amounting to around 60 basis points, significantly higher than the normal 25-point increase caused by electoral uncertainty. “France represents a clear exception,” writes ABN AMRO. “Investors are demanding a return well above that implied by observable market and credit fundamentals, as well as by the premiums for election-related uncertainty.”

Like Krugman, investors see the budget figures – and, above all, the political debate – as a uniquely French folly. One which, however, risks spreading to the Eurozone. Over the last three months, the spread on French OATs has risen by around 60 basis points and that on Italian BTPs by 40, even though nobody in Italy is questioning the Fornero reform any longer.