Reference no: EM131737632

Case Scenario: FRANCE: THE CASE OF FAILED SOCIALISM

France deserves separate treatment because of its much greater socialist orientation. Whereas the public sector accounts for one-third to a half of total GDP in the US, UK, and Germany, the figure for France is about 55%. France used to be a relatively high-inflation economy. From 1950 to 1965, the inflation rate averaged 5.0%, compared to 3.6% in Italy, 3.4% in the UK, 2.2% in Germany, and 1.8% in the US. The French franc (FF) was frequently devalued relative to the DM and the dollar, falling from FF3.50/$ in 1950 to FF4.90/$ in 1965 at the same time that the DM appreciated slightly relative to the dollar, rising from 4.2 to 4.0/$. From 1965 through 1987, the disparity continued, with the inflation rate in France rising an average of 4.1% per year more than in Germany. The disparity between the currencies also widened, with the franc falling to 6/$ and the DM improving to 1.8/$. In other words, the franc depreciated an average of 4.6% per year relative to the DM.

That conforms fairly closely to the PPP theory of exchange rates. By the end of the 1980s, the burden of a large government sector and high tax rates had reduced growth in France so much that it was willing to take drastic measures to bring its rate of inflation down to that of Germany, stabilizing the FF/DM exchange rate. That goal could have been accomplished using either tighter fiscal or monetary policy. Tighter fiscal policy would have meant cutting the growth rate in government spending, which was considered but not implemented. Tighter monetary policy meant offsetting the inflationary impacts of a large government sector and big deficit ratios through higher interest rates. The latter method was chosen, with the result that real growth in France stagnated and the unemployment rate rose to 12%, the highest of any major country in Europe, although it then declined to 8.5%. France generally failed to participate in the recent technological revolution that boosted productivity in the US, the UK, Japan, and southeast Asia. Its trade policies, while liberal on the surface, contain far more exceptions than most other countries, protecting the jobs of so-called ‘‘honest French workers,'' especially farmers.

As a result, France did not receive the supply-side benefits of international trade that would ordinarily boost productivity. Also, lower inflation did not boost the growth rate. That is because the major benefit of lower inflation is to spur productivity. But with the dead hand of a large government sector, those benefits were not forthcoming. Labor demanded that the government keep their full range of benefits intact whether inflation rose or fell, and whether productivity growth rose or fell. Lower inflation did not lead to the creative, innovative solutions of cost-cutting in France that occurred in other countries. France used monetary policy to bring inflation under control and stabilize the currency. Yet the anticipated pickup failed to occur because capitalism wasn't there to provide the spur for greater productivity, and archaic trade regulations reduced the benefits of international trade. This is a prime example of how monetary policy is necessary but not sufficient to spur growth and return an economy to full employment. Appropriate fiscal and trade policies are also needed to achieve that goal. Joining more closely with the rest of Europe by itself will not help the French economy. Indeed, to the extent that trade, labor, and capital barriers are lowered, it will be even easier for resources to move outside the country. Most French political leaders understand these facts. Nonetheless, attempts to moderate excessive labor demands, particularly in the areas of early retirement and generous pension benefits, have been uniformly rebuffed. As of 2002, no solutions for these problems have yet appeared on the horizon.