Cablegate: The Spiraling Public Debt, Part I

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E.O. 12958: N/A
TAGS: EFIN ECON PGOV FR
SUBJECT: THE SPIRALING PUBLIC DEBT, Part I

1. SUMMARY. A government-commissioned report has warned that the
current financial situation could spiral out of control unless a
freeze is put on government spending over the next five years. The
report recommendations are likely to become an issue leading up to
the 2007 presidential elections. END SUMMARY

Public Debt Surges
------------------
2. After the June 2005 government cabinet shuffle, Finance Minister
Thierry Breton commissioned Michel Pebereau, the CEO of BNP Paribas
Bank, to produce a report meant "to launch a debate on public debt
and its consequences on France's economic policy." To avoid having
his report ignored for presumed bias, like the previous October 2004
Camdessus report ("Toward a new economic growth for France"),
Pebereau formed a 20-member non-partisan group of both center-right
and left politicians, senior civil servants, economists, and
businessmen, pointing out that "it is just good sense, this report
will be neither center-right or leftist." The report was published
on December 14, 2005, and appears to have avoided the fate of
previous reports. It highlights the tripling of the French public
debt over a 25 year period, from 20 to 66.5 percent of GDP, or from
roughly 91 million euros in 1980 to 1.1 billion euros in 2005. The
growth in French debt over the last decade was faster than in any
other industrialized country. Public debt increased significantly
faster than GDP, making France one of the most indebted European
countries along with Italy (108.6 percent of GDP), Greece (107.9
percent), Belgium (94.9 percent), Malta (77.2 percent), Cyprus (70.4
percent), and Germany (68.6 percent). More alarming still, when
French public debt is calculated including other government
liabilities, such as civil servant pensions, it is closer to 100
percent of GDP.

Unwillingness to commit to painful reforms
------------------------------------------
3. Debt accumulation in the last twenty years was not due to lower
economic growth or high interest rates, but to a lack of fiscal
restraint. The spectacular debt increase was primarily attributable
to the ever-expanding ranks of the civil service and their pension
liabilities. Pebereau did not mince words, saying that "debt has
neither spurred economic growth nor reduced unemployment - it has
slowed economic growth." Debt service (40 billion euros), the area
of largest government spending after education and before defense,
considerably reduced government investment opportunities. Government
spending accounted for 54.0 percent of GDP, compared with 48.6
percent in the euro zone and 40.8 percent in the OECD. France also
had the highest level of taxation in the G7 as a percent of GDP
(44.1 percent).

4. The report put the blame on a series of administrations "that
have all taken the easy option of public borrowing," noting that
France failed to respect its commitment to reduce the budget deficit
to below the EU limit of 3.0 percent of GDP, this due in large part
a reluctance to trim the civil service. The number of civil
servants actually increased 14 percent from 1982 to 2003 during the
government's "decentralization" program by which Paris sought to
transfer certain responsibilities from the central government to
various local entities.

Report urges government action
------------------------------
5. The report called for immediate initiatives, without which the
government would "lose control of the financial situation." Soaring
debt placed "a serious risk on France's future," and the burden will
only worsen due to the country's aging population. Payments of
retirement pensions by the central and local governments to their
direct employees alone will account for 0.65 percent of GDP as early
as 2015, a figure that will rise to 20 billion euros per year in
2020. Payments of health insurance benefits will amount to 22
billion euros per year in 2015 as well. Increased debt service due
to higher budget deficits will amplify the vicious cycle of budget
deficits, national debt, interest rate hikes, and debt service. The
result in the medium term would be double-digit interest rates, high
inflation, significant cuts in pensions, and possible emigration to
countries with better economic situations.

6. Not surprisingly, the commission argued strongly against:

(a) continuing to add to the public debt.
Raising interest rates indefinitely is not an option; an increase,
even by as little as 1.5 percent by 2008, for example, would require
an additional 33 billion euros to stabilize the debt by 2012.
Public debt would surge to 130 percent of GDP in 2020, 205 percent
in 2030, and close to 400 percent in 2050, and at some point before
that happened, "the government would lose the trust of financial

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markets." The Standard and Poor's rating agency said in December
2005 that it would not rule out downgrading France's debt if nothing
is done to correct the situation;

(b) falling back on the Pension Reserve Fund ("Fond de Reserve des
Retraites") or possible surpluses in the Unemployment Insurance Fund
and Family Allowances Fund, as any possible gains from these
resources would be insufficient to reduce budget deficits in any
considerable way; and,

(c) increasing taxes or other "social contributions," the logic
being that it would harm economic growth and make France less
competitive.

The Solution: a Freeze on Government Spending?
---------------------------------------------
7. The report recommended "balancing the government budget within a
period of five years," a gradual move that arguably makes the
objective achievable without hindering further economic growth. (It
should be noted that presidential terms in France are now five
years).

Recommendations include:
(a) freezing central government budget spending in euros, equivalent
to a 2 percent annual cut after inflation. Over the course of five
years, this would save 25 billion euros.
(b) using revenue gained through taxes and the privatization of
public assets to reduce indebtedness;
(c) balancing health insurance, retirement pension and unemployment
welfare accounts. The 2009 deadline to balance the health insurance
account has been deemed "imperative." Regarding retirement
benefits, the 2003 pension reform plan designated 2008 be set as the
year by which all conditions for the balancing of pension regimes,
good until 2020.
(d) stabilizing central government transfers to local authorities to
save 6 billion euros in four years.
(e) cutting inefficient expenditures by merging a number of
redundant administrative authorities, modernizing administrations'
human resources policies, and taking advantage of waves of
retirements to dramatically cut the number of civil servants.

Comment
-------
8. Analyses and recommendations of the Pebereau report are both
accurate and alarming. It remains to be seen if warnings will be
heeded or ignored. Candidates in the 2007 presidential elections
may look to the report when working out their own electoral
platforms or when criticizing those of their rivals. End comment.

STAPLETON

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