By Céline Antonin

While Matteo Renzi had enjoyed a relative “state of grace” since his election in February 2014, the Senate vote in early December on the hotly disputed reform of the labour market (the Jobs Act) has led to a general strike, a first since he took office. Is this the end of Matteo Renzi’s honeymoon with the Italian people? Although his ascension to power had sparked a wave of hope, the initial results have been disappointing. The reforms are going down poorly as Italy experiences its third consecutive year of recession (-0.2% growth forecast in 2014), and the country is facing criticism from the European Commission for its inability to reduce its structural deficit. This reform is inspired by a free market approach and aims to introduce a flexi-security system. The measure that is the particular focus of passion would remove Article 18 of the Labour Code, which allows reinstatement in the case of unfair dismissal.

In the latest Note de l’OFCE (no. 48, 16 December 2014), we study the reform of the labour market being undertaken in Italy, which is a major challenge due to the segmentation of the labour market, high youth unemployment and inappropriate costs relative to labour productivity. However legitimate the Jobs Act may be, it seems too partial to have any real impact. In the short term, Italy’s priority should be on investment. The only way the country can re-establish normal access to bank financing and return to growth is through the combination of an expansionary monetary policy, the continued pursuit of a banking union, and an ambitious public investment policy. Once these conditions have been met, then the question of a structural reform of the labour market will arise; this reform must be coupled with reform of the goods market in order to allow Italy to restore productivity and achieve a sustainable improvement in its growth potential.

By Céline Antonin and Vincent Touzé

On 4 November 2014, the European Central Bank became the single supervisor of banks in the euro zone. This was the first step in the banking union.

The economic and financial crisis that started in 2007 has exposed several European weaknesses:

1. The national bank markets, though seemingly compartmentalized, proved to be highly interdependent, as was seen in the high level of propagation-contamination;
2. There was often a lack of coordination in the national support provided;
3. Given the context of high public indebtedness, State support for the bank system led to a strong correlation between bank risk and sovereign risk;
4. The absence of fiscal transfer mechanisms strongly limited European solidarity.

In 2012, the idea of a banking union arose out of a triple necessity: to break the link between the banking crisis and the sovereign debt crisis by enabling the direct recapitalization of troubled banks through the European Stability Mechanism; to prevent bank runs; and to prevent the euro zone banking markets from fragmenting.

The banking union is being built on three pillars: a single supervision mechanism (SSM); a single resolution mechanism (SRM), with a resolution fund and a bail-in process; and a single deposit guarantee system with a guarantee fund.

The banking union sets out new solutions. Nevertheless, grey areas remain, and the European solidarity provided by the banking union could prove insufficient to deal with major shocks.

The latest Note de l’OFCE (no. 46 of 18 November 2014) reviews the context surrounding the establishment of the banking union and takes stock of the advantages and limitations of the progress made in constructing the union. This Note was produced as a special study entitled “Comment lutter contre la fragmentation du système bancaire de la zone euro?”, [How can the fragmentation of the euro zone banking system be fought?] Revue de l’OFCE, no. 136 (2014).

By Raul Sampognaro

If the budget submitted by France is out of step with the rules on fiscal governance in the euro area (see the recent posts on this subject by Henri Sterdyniak and Xavier Timbeau), Italy is also in the hot seat. The situations of France and Italy are, however, not directly comparable: the case of Italy could be far more restrictive than that of France, once again reflecting the perverse effects of Europe’s new governance. While, unlike France, Italy is no longer subject to an Excessive Deficit Procedure (EDP), with its budget deficit at the 3% threshold since 2012, it is still covered by the Stability and Growth Pact’s preventive arm and thus enhanced surveillance with respect to the debt criterion. The country’s debt of 127% of GDP is well above the 60% level set by EU rules and, according to its medium-term budgetary objective (MTO), Italy must come close to balancing government spending.

While the French budget deficit for 2015 will be the highest in the entire euro area (excluding countries subject to a programme [1]), since the latest announcements on October 28, Italy has a deficit of 2.6%, which should not trigger a new EDP. However, the Pact’s preventive arm puts constraints on changes in the country’s structural balance:

–          (i) in the name of convergence towards its MTO, Italy must make a structural adjustment of 0.5 percentage point per year for 3 years (i.e. cut its structural deficit by 0.5 point per year),

–          (ii) if the structural deficit defined in the MTO is not sufficient to reach a debt level of 60% within 20 years, the country must make an extra effort under the debt criterion. According to the latest forecast by the Commission, Italy must provide an average annual structural effort of 0.7 point in 2014 and 2015.

Yet the government is counting on a deterioration in the structural balance of 0.3 point in 2014, followed by an improvement of 0.4 point in 2015.

Thus, while according to the Commission the treaties require Italy to make a cumulative effort of 1.4 point in 2014 and 2015 (for its part the Italian Government considers that this effort should instead be 0.9 point), Italy is announcing an improvement in its structural balance of 0.1 point during the period, a difference of 1.3 points from that demanded by the Commission. From this perspective, Italy is further from European requirements than France, and will have to justify its lack of a structural adjustment. In addition, Italy is not expected to reach its MTO in 2015, even though at the end of the European Semester in July 2014 the Council had recommended it stick to the 2015 target.

Italy is the first country to be constrained by the debt criterion and is serving as a laboratory for the application of the rules by showing some of their adverse effects. Indeed, the adjustment required under the debt criterion is changing in line with several parameters, some of which were not really anticipated by the legislator. For example, the amount of the adjustment depends on a forecast of the ratio of nominal debt / nominal GDP at the end of the transition phase. However, the fall in prices currently underway in Italy is lowering the nominal GDP forecast for the next three years, without any change in fiscal policy. Thus, the debt criterion is tightening mechanically without any government action, endlessly increasing the need for structural adjustment as the new adjustments induce more deflation. In addition, the procedures used to find deviations from the debt criterion are slower because the controls are carried out essentially ex post, based on the accumulated deviations observed over two years. However, the magnitude of the deviation announced by the Italian government could spark procedures based on ex ante control. Recall, however, that unlike France, Italy is not currently in a procedure. This would have to be opened before any sanctions could be envisaged against Italy. This preliminary and necessary step gives the Italian government time to take suitable measures or to justify its deviation from the MTO.

Furthermore, the EDP’s preventive arm provides more opportunities for deviation than the corrective arm. In addition to the clause on exceptional economic circumstances, Italy can argue major structural reforms that will improve the future sustainability of the debt. This argument, which is also raised by the French government, is not set out in the EDP text (the Commission could accept some flexibility). Here, however, the Renzi government is drawing on its reputation as more of a reformer than the French government.

Both governments have requested the application of the exceptional economic circumstances clause in order to break their commitments. The Commission could be more sensitive to the Italian request because its economic situation has deteriorated: Italy has seen 3 years of falling GDP, which is continuing in the first half of 2014. The country’s GDP is 9 points below its pre-crisis peak, while in France it is one point higher. The latest survey indicators, for example on industrial production, do not augur well for recovery in the short term. Finally, Italy is suffering deflation.

In summary, while the Italian gap seems larger than that of France, it could benefit from greater indulgence. The procedures applied to each country differ and give Italy more time before any sanctions can be applied. The country’s willingness to reform could win it higher marks than France from the Commission. Finally, the most important point in the discussion is that Italy’s economic situation is much more serious, with an uninterrupted recession since the summer of 2011 and with prices falling.

But in both cases the reinforced pact, whether it is corrective or preventive, implies endless structural adjustment. Italy demonstrates that getting out of the excessive deficit procedure will demand continuing efforts to meet the debt criterion. If France leaves the EDP in 2017, its debt will be, according to government forecasts, around 100% of GDP. It must then continue with adjustments of more than 0.5%. Confirmation of deflation will make the Pact’s rules even more recessive and absurd. Ultimately, the fiscal pact meant to preserve the euro by chasing free-riders or stowaways could lead to blowing it apart through an endless recession.

[1] Greece, Ireland and Portugal have received European aid and thus have been subject to joint monitoring by the ECB, the IMF and the European Union. Ireland and Portugal are now out of their bailout programme.

By Jean-Luc Gaffard

Jean Tirole, this year’s winner of the Bank of Sweden’s Prize in Economic Sciences in Memory of Alfred Nobel, is an exceptional economist. This is reflected in the academic quality of his published works, both in the discipline’s major journals and in books where he builds on his own research to engage with the major issues facing economics in the field of industry, regulation and finance. It is also reflected in his clear determination to address genuine issues that are important to an understanding of the functioning of market economies and in his concrete proposals for public policy to deal with this. It is also reflected in the way he explores these issues through developing powerful new analytical tools. And finally, it is reflected in the modesty of the judgments he renders on his results and their practical implications, a modesty befitting a true scientist.

It is fashionable in some circles to pigeonhole economists in one category or another, usually to stigmatize them. Jean Tirole is no exception to this parlor game. Detractors of the field of microeconomics, which focuses on company strategies, would have him more accustomed to frequenting the media than his research desk, and to be a defender of theses that could be termed free market if not ultra-liberal, more or less a sycophant of the markets and a fighter against government action. Nothing could be further from the truth.

Jean Tirole explores the functioning of markets populated by companies that are seeking to exploit their market power to mislead regulators whose choices are affected by a lack of information and by the existence of specific political constraints. He deals seriously with the fact that information is incomplete, that market situations and behaviors are imperfect, and that rational bubbles might even arise. If in the face of the crisis, everyone is now calling for stimulating R&D, developing vocational training, and expanding public investment, everyone should also be aware that the results are subject to the prevailing forms of organization, which are subtle and varied mixtures of competition and cooperation at the heart of the contracts between private and public actors on the various markets. This is what the work of Jean Tirole has drawn to our attention, along with the discussion that is needed about methodology and the choice of tools and standards that government should use.

Jean Tirole and his friend and co-author Jean-Jacques Laffont, who died too young, with whom he would likely have shared the prize awarded to him today, set themselves the task of analyzing the relationships that link business and State in the key sectors of telecommunications, energy and transport, while trying to determine the conditions in which these are socially efficient. These two are worthy successors of a prestigious French tradition, that of the French “economic engineers” – including Clement Colson, Marcel Boiteux and Maurice Allais – who as both researchers and engineers worked to establish the place and role of government in the functioning of a market economy. It is a tradition of public economics that the two nevertheless revolutionized by showing, through the new tools they used, that protecting the public interest assumed an ability to understand the detailed functioning of markets that differ greatly from one another and at the same time the shortcomings of a state that is neither omniscient nor spontaneously benevolent. In doing this, they emphasized the complexity of situations and, consequently, the complexity of contractual rules – complexities that it would be illusory and dangerous to ignore. They were able to highlight the true nature of a market economy in which the State, far from replacing the market, helps it to function properly through targeted interventions. In this respect, and in a domain that they made their own, that of analyzing companies and markets, they were part of a stream of social philosophy much like that developed by Keynes.

Does this mean that no criticism can be made of the work done? This is surely not the approach of the author himself, who knows that scientific progress grows out of controversy and debate so long as this is conducted according to fair play by researchers with proven expertise. The impossibility of setting out general rules is undoubtedly a weakness of an approach in industrial economics that Franklin Fisher (1991) [1] characterized as a theory that takes the form of examples and risks only producing taxonomies, which could mean that anything can happen, making it difficult to establish guidelines for public policy. This approach cannot dispense with the image of the heterogeneity that characterizes market economies, without which it is, in any event, vain to imagine effective public policy. Furthermore, many studies by Jean Tirole have the virtue of adjusting the specifications of the theoretical models to the particular configuration of the industries, businesses and technologies under study. Other approaches are undoubtedly possible, which would break with the hypothesis of agents practicing intertemporal optimization in a world of rational expectations. They would insist on the sequential nature of the choices made by trial and error in an uncoordinated economy, even in a state of bad equilibrium, due to the significance of innovation, which implies both the irreversibility of investment decisions and incomplete knowledge of the future configuration of the markets. Taking on board this aspect of industrial reality would mean recognizing that it is just as important to understand how firms acquire knowledge – incomplete knowledge at that – about the reactions of their competitors as it is to establish the impact of this. Following a line of thought that is rooted more in Marshall and Hayek than in Walras and Cournot, it would be possible to provide another perspective on the functioning of market economies and the role of collusion and of networks, which could sometimes lead to different recommendations for public policy. It would also be necessary that the approaches chosen, which would be geared more toward the issue of coordination than of incentives, would have the robustness needed to enrich if not outright challenge established theory. This is what Jean-Jacques Laffont impressed on me during a long conversation we had while awaiting our respective flights that had been delayed by a strike – a situation not irrelevant to our discussion.

[1] See “Organizing Industrial Organization: Reflections on the Handbook of Industrial Organization”, Brookings Papers on Economic Activity. Microeconomics, vol. 1991 pp. 201-240.

By Paul Hubert

Private expectations – about inflation, growth and interest rates – are a critical component of most modern macroeconomic models, as they determine the current and future realizations of these very variables. Monetary policy has been shaped more and more by the incorporation of these expectations in central bankers’ calculations and the influence they have on private expectations through interest rate decisions and the way these are communicated. The establishment by the central banks of a forward-looking policy orientation, called “forward guidance”, has further reinforced the importance of central bank macroeconomic forecasts as a tool of monetary policy for influencing private expectations.

A recent article in the Revue de l’OFCE (no. 137 – 2014) evaluates the forecasting performance of the US Federal Reserve relative to that of private agents. This empirical review of the existing literature confirms that the Fed performs better than private agents in forecasting inflation, but not on GDP growth. Furthermore, the Fed does even better over longer forecast horizons. Despite this, its superiority seems to have been declining in recent times, though it’s still significant. This article highlights the potential reasons for the Fed’s superior performance, and suggests that this could stem from better information about the shocks hitting the economy rather than from a better model of the economy. The publication of these macroeconomic forecasts therefore helps to disseminate information among economic agents and boosts the effectiveness of monetary policy by allowing private agents to better foresee trends and possible developments.

By Sarah Guillou

The 2014-2015 edition of The Global Competitiveness Report [1] by the World Economic Forum sheds light on the political debate between those who like to prioritize a supply policy and those who instead make the conditions governing offer their top priority. Note that competitiveness is a key factor in future growth in mature economies that specialize in high-tech or high added-value products [2].

France ranks 23rd in terms of the global competitiveness indicator calculated by the World Economic Forum. This competitiveness indicator goes beyond conventional measures based on relative production costs to incorporate many sub-indicators (100 in total) that cover a variety of dimensions, including the functioning of product markets, labour markets, and institutions; indicators about human capital, infrastructure and innovation; and qualitative measurements from business surveys. The result is a set of dimensions that identifies a country’s level of productivity in detail. The competitiveness indicator proposed is “global” in terms of both the extent of the dimensions included and the number of countries covered.

Competitiveness is measured relative to 143 countries. The weighting of the sub-indicators is deduced from the membership of countries in a category based on their level of economic development: Phase 1, governed by the availability of factors; Phase 2, in transition from Phase 1 to Phase 3; Phase 3, governed by the efficiency of the factors; Phase 4, in transition from Phase 3 to Phase 5; and Phase 5, governed by innovation. Depending on the category, the weight assigned to each sub-indicator in determining the level of competitiveness differs. This explains why the ranking does not fully reflect the traditional hierarchy of countries based on their level of economic wealth. Moreover, the diversity of the indicators that come into play can result in countries with very different economic profiles being ranked more closely: hence Russia (53^rd) is nipping at the heels of Italy (49^th), and the UAE comes right after Norway (11^th).

With respect to the debate on supply-and-demand dynamics, it is interesting to note that the global competitiveness indicator is based on a set of sub-indicators that are not all associated with structural reforms associated with supply, and many of them result from a balanced support for demand. For example, the provision of high-quality human capital (skilled, healthy, etc.) requires not only an environment that values labour and rewards merit but also a level of security and social welfare which contributes to a quality of life that attracts and retains human capital, and therefore a certain level of public spending. This is also the case for infrastructure. More generally, the competitiveness indicator is the result of achieving a balance between the level of public spending and structural reforms in such a way that the indicators wind up complementing each other.

Switzerland’s no. 1 ranking recognizes the quality of its business environment – infrastructure, human capital, institutions, trust, macroeconomic stability – which makes up for the weakness of its market size and its degree of openness and specialization in high-tech manufacturing industries [3]. Six European countries are in the top 10, which is reassuring for the European model [4]. The French economy has stabilized its position in the ranking with respect to the previous year, following four years of decline – it was ranked 16th in 2008.

Of the 144 countries ranked, France owes its position in the first quintile (the top 20%, i.e. the first 28 countries) to the quality of its infrastructure and educational system, its technological level and its entrepreneurial culture [5]. Competitiveness is primarily a relative concept, and in a global economy where more and more countries aspire to be in the top 10 economic powers, judgments about the French economy depend heavily on the group to which it aspires to belong. What raises questions is that France long belonged to the top 10, and its main companions historically are still there (Germany, the United Kingdom, Belgium, Netherlands and the United States). Relative to the first quintile, which includes 13 other European countries, the United States, Canada, Japan and China, France’s position at the tail end is far from glorious and requires us to take a look at the indicators that rank the French economy among the least competitive. The main reasons for this result are the functioning of the labour market, the State’s fiscal position, and the country’s relatively poor performance in providing an environment favourable to work and investment.

More specifically, an analysis of the specific sub-indicators (from the 100) for which France’s performance puts it in the bottom third of the 144 countries, i.e. a ranking between the 96th and 144th spots, and a comparison with its neighbours (see Figures 1-3), reveals the following points:

1) The dimensions that show the greatest contrast relative to Germany, the United Kingdom and the United States include the burden of administrative regulations, the impact of taxes on investment incentives, the impact of taxes on work incentives, cooperation in labour-management relations, hiring and firing practices and the rate of taxation as a percentage of profits.

2)   France’s lacklustre performance is often exceeded by that of Italy.

3)   The indicators on French fiscal policy are problematic, but this is not strongly different from the situation of its partners.

The functioning of the labour market, and more generally the regulatory environment influencing incentives to work and invest, thus emerge as the dimensions pushing down the global competitiveness indicator. Note that these indicators are derived from objective measures (such as number of regulations, level of taxation, macroeconomic data) but also in large part from responses to a survey of business leaders. These leaders have to indicate on a scale of 1 to 7 their assessment of the various factors underlying the indicators. In the main the indicators thus express a felt reality. For France, the low ranking in the dimensions identified in point 1) reveals the severity of the judgment of these business entrepreneurs.

The lessons for economic policy are as follows: the scope for progress and the specific reasons for France’s position lie in the dimensions outlined in point 1). The priorities for structural reform are cumbersome administrative regulations, incentives for work and investment, and the quality of labour-management relations. But what policies are needed to deal with these issues?

Administrative simplification and the Responsibility Pact are a step in the right direction, but it is questionable whether the measures taken will affect the way business perceives economic incentives in the administrative-legal environment. Moreover, nothing is being done in terms of improving labour-management relations. Finally, it would be desirable for government to adopt a neutral and stable position vis-à-vis companies, a position that neither maligns their economic rationality nor undermines their power over the industrial future. And even if the divorce between the State and business is in part “constitutional”, as Jean Peyrelevade [6] argues, we cannot give up efforts to improve social dialogue and to reconcile French companies with their economic and regulatory habitat. This is one of the keys to French competitiveness.

Finally, the three lessons of this Report are 1) to keep in mind that competitiveness reflects a combination of many elements that cannot simply be reduced to facilitating the exercise of economic activity (i.e. tax cuts, labour market flexibility), 2) the most competitive economies are not those where public authority has retreated, as many dimensions require a State that makes effective investments (in education and infrastructure) and guides capital (for example, into renewable energy); and 3) the margin for progress towards a more competitive France today lies not in public investment, but in incentives for social dialogue, employment, labour and investment.

The WEF classification thus provides clear evidence that supply conditions in France can be greatly improved and that to prioritize the competitiveness of the French economy reforms in this direction are imperative.

[1] The World Economic Forum began to calculate competitiveness in 1979, and since then has gradually extended its efforts to embrace more dimensions and countries.

[2] These productive activities are in effect associated with increasing returns to scale (due to high fixed entry costs, in particular R&D), which implies economic viability on a large scale: in other words, on a scale that goes beyond simply the domestic market.

[3] Likewise, political transparency is more highly valued than economic transparency.

[4] Switzerland, Finland, Germany, Netherlands, United Kingdom, Sweden.

[5] “the country’s business culture is highly professional and sophisticated” (page 23).

[6] J. Peyrelevade, Histoire d’une névrose, la France et son économie, Albin Michel, 2014.

By Christophe Blot and Jérôme Creel

The debate on economic policy in Europe was re-ignited this summer by Mario Draghi during the now traditional symposium at Jackson Hole, which brings together the world’s main central bankers. Despite this, it seems that both the one side (Wolfgang Schaüble, Germany’s finance minister) and the other (Christine Lagarde, head of the IMF) are holding to their positions: fiscal discipline plus structural reforms, or demand stimulus plus structural reforms. Although the difference can seem tenuous, the way is now open for what Ms. Lagarde called “fiscal manoeuvring room to support a European recovery”. She is targeting Germany in particular, but is she really right?

In an interview with the newspaper Les Echos, Christine Lagarde said that Germany “very likely has the fiscal manoeuvring room necessary to support a recovery in Europe”. It is clear that the euro zone continues to need growth (in second quarter 2014, GDP was still 2.4% below its pre-crisis level in first quarter 2008). Despite the interest rate cuts decided by the ECB and its ongoing programme of exceptional measures, a lack of short-term demand is still holding back the engine of European growth, mainly due to the generally tight fiscal policy being pursued across the euro zone. In today’s context, support for growth through more expansionary fiscal policy is being constrained by tight budgets and by a political determination to continue to cut deficits. Fiscal constraints may be real for countries that are heavily in debt and have lost market access, such as Greece, but they are more of an institutional nature for countries able to issue government debt at historically very low levels, such as France. For Ms. Lagarde, Germany has the manoeuvring room that makes it the only potential economic engine for powering a European recovery. A more detailed analysis of the effects of its fiscal policy – both internally and spillovers to European partners – nevertheless calls for tempering this optimism.

The mechanisms that underlie the hypothesis of Germany driving growth are fairly simple. An expansionary fiscal policy in Germany would boost the country’s domestic demand, which would increase imports and create additional opportunities for companies in other countries in the euro zone. In return, however, the impact could be tempered by a slightly less expansionary monetary policy: as Martin Wolf argues, didn’t Mario Draghi ensure that the ECB would do everything in its power to ensure price stability over the medium term?

In a recent OFCE working document, we have tried to capture these various commercial and monetary policy effects in a dynamic model of the euro zone. The result is that a positive fiscal impulse of 1 GDP point in Germany for three consecutive years (a plan involving 27.5 billion euros per year [1]) would boost growth in the euro zone by 0.2 point in the first year. This impact is certainly not negligible. However, this is due solely to the stimulation that would benefit German growth and not to spillovers to Germany’s European partners. Indeed, and as an example, the increase in Spain’s growth would be insignificant (0.03 point of growth in the first year). The weakness of the spillover effects can be explained simply by the moderate value of Germany’s fiscal multiplier [2]. Indeed, the recent literature on multipliers suggests that they rise as the economy goes deeper into a slump. But based on the estimates of the output gap retained in our model, Germany is not in this situation, and indeed the multiplier has dropped to 0.5 according to the calibration of the multiplier effects selected for our simulations. For an increase in German growth of 0.5 percentage points, the effect of the stimulation on the rest of the euro zone is therefore low, and depends on Germany’s share of exports to Spain and the weight of Spanish exports in Spanish GDP. Ultimately, a German recovery would undoubtedly be good news for Germany, but the other euro zone countries may be disappointed, just as they undoubtedly will be from the implementation of the minimum wage, at least in the short term, as is suggested by Odile Chagny and Sabine Le Bayon in a recent post. We can also assume that in the longer term the German recovery would help to raise prices in Germany, thereby degrading competitiveness and providing an additional channel through which other countries in the euro zone could benefit from stronger growth.

And what would happen if the same level of fiscal stimulus were applied not in Germany, but rather in Spain, where the output gap is more substantial? In fact, the simulation of an equivalent fiscal shock (27.5 billion euros a year for three years, or 2.6 points of Spanish GDP) in Spain would be much more beneficial for Spain but also for the euro zone. While in the case of a German stimulus, growth in the euro zone would increase by 0.2 percentage points over the first three years, it would increase by an average of 0.5 points per year for three years in the event of a stimulus implemented in Spain. These simulations suggest that if we are to boost growth in the euro zone, it would be best to do this in the countries with the largest output gap. It is more effective to spend public funds in Spain than in Germany.

In the absence of any relaxation of the fiscal constraints on Spain, a stimulus plan funded by a European loan, whose main beneficiaries would be the countries most heavily affected by the crisis, would undoubtedly be the best solution for finally putting the euro zone on a path towards a dynamic and sustainable recovery. The French and German discussions of an investment initiative are therefore welcome. Hopefully, they will lead to the adoption of an ambitious plan to boost growth in Europe.

[1] The measure is then compensated in a strictly equivalent way so that the shock amounts to a transient fiscal shock.

[2] Recall that the fiscal multiplier reflects the impact of fiscal policy on economic activity. Thus, for one GDP point of fiscal stimulus (or respectively, tightening), the level of activity increases (respectively, decreases) by k points.

By Céline Antonin, Félix de Liège and Vincent Touzé

There is great diversity to Europe’s tax systems, reflecting the choices of sovereign States with differentiated destinies. Since the Treaty of Rome, the Member States have steadily refused to give up national authority over taxation, with the exception of a minimum level of coordination on value-added tax (VAT). Europe now faces a real risk of a rise in non-cooperative tax strategies, with each country seeking to improve its economic performance at the expense of the others. This kind of aggressive strategy is being fuelled by two factors: on the one hand, a drive for competitiveness (fiscal devaluation), aimed at reducing the tax burden on businesses so as to improve price competitiveness; and on the other, a drive for fiscal advantage, aimed at luring the rarest factors of production to the national territory. On a macroeconomic level, it is difficult to distinguish clearly between these two factors. However, one way of understanding how the European states have improved their position may be to look at how the tax burden on business has evolved in comparison with the burden on households.

OFCE Note no. 44 describes changes in the compulsory tax burden (TPO) in Europe. It is based on statistics from Tendances de la fiscalité, which is published jointly by Eurostat and the European Commission’s Taxation and Customs Union Directorate. These statistics have the advantage of providing harmonized data on tax rates, with a breakdown of the tax base (capital, labour, consumption) and the type of paying agent (household, business, individual entrepreneur). We study the period 2000-2012: it is of course always difficult to separate trends in taxation from cyclical adjustments, especially as budget constraints tighten. Nevertheless, the 2000-2012 period should be sufficiently long to reveal changes of a structural nature.

Based on these data, we first highlight contrasting trends in the tax burden in the European Union, which can be broken down into four phases: two phases of rises (between 2004 and 2006 and since 2010) and two phases of reductions (before 2004 and from 2006 to 2010), which is linked in particular with cyclical factors. In addition to this common dynamic, we can see non-convergent adjustments made by the European countries in the taxation of households and the taxation of business (see graph). We then focus on possible tax substitutions between payroll taxes and consumption, and between payroll taxes and employee contributions.

Over the period 2000-2012, it is difficult to talk about tax competition at a global level, even though there was a slight decrease in the average tax burden within the European Union and very specific moves in this direction by certain countries. While some countries have definitely reduced the tax burden on business (UK, Spain, Germany, Ireland, Sweden, etc.), others have increased it (Belgium, France, Italy, etc.). However, in the long-term, it would seem difficult to maintain such a high level of tax diversity. At a time when European integration is being intensified, greater tax harmonization seems more necessary than ever.

par Gilles Le Garrec

In 1950, life expectancy at birth in Western Europe was 68 years. It is now 80 years and should reach 85 by 2050. The downside of this trend is the serious threat that is hanging over the financing of our public retirement systems. Financed on a pay-as-you-go (PAYG) basis, i.e. pension benefits are paid through contributions of contemporary workers, the systems must cope with an increasingly large number of pensioners compared to the number of contributors. For example, leaving the average age of retirement unchanged in France would lead to a ratio of pensioners to workers (the dependency ratio) of 70.1% in 2040, whereas this ratio was 35.8% in 1990. Changes are unavoidable. Maintaining the current level of benefits within the same system in the near future requires to increase either the contribution rate or the length of contribution (by delaying the age of retirement).

This financing problem calls into question the role of PAYG retirement systems in our societies. For instance, by evaluating the real pre-tax return on non-financial corporate capital at 9.3% and the growth rate over the same period (1960 to 1995) at 2.6%, Feldstein[1] unequivocally advocates the privatization of retirement systems and a switch to fully funded systems. He assesses the potential present-value gain at nearly $20 trillion for the United States. However, beside the change in the nature of the risk,[2] replacing conventional PAYG systems by financial – or funded – defined contribution (FDC) systems would certainly involve prohibitive social and political costs because one generation will have to pay twice. Implementing such a reform in Western democracies thus appears difficult. For that reason, in recent years a large focus has been put on non-financial – or notional – defined contribution (NDC) systems as legislated in Sweden in 1994. NDC systems are PAYG systems that mimic FDC systems. Individual contributions are noted on individual accounts. Accounts are credited with a rate of return that reflects demographic and productivity changes. Obviously, replacing conventional PAYG systems by NDC systems does not address the main concern of Feldstein, that is, the low return associated with the PAYG financing method. However, supporters of NDC systems claim that conventional systems, by linking pension benefits only partially to contributions, distort individual behaviours, inducing reduced work efforts or earlier retirements. In addition, they claim that only an explicit defined contribution system will be able to stabilize contributions in spite of aging populations.

Looking at the empirical facts, the supposed inefficiency of conventional retirement systems must be reconsidered. Firstly, even if their pension benefits are linked to partial earnings history, most conventional systems are close to actuarial fairness[3] as NDC systems because high-income earners live longer and have steeper age-earnings profiles. Secondly, stabilizing contributions can be achieved similarly within the scope of more conventional defined benefit systems, as seen in the “point system” in France or in Germany. In that case, the unit of pension rights is earnings points (not euros) and can be adjusted according to demographic and productivity changes, as in an NDC system. Cleverly designed conventional retirement systems can often do the same job as NDC systems. Finally, empirical findings from Sala-i-Martin[4] and Zhang and Zhang[5] tend to support a positive impact of retirement systems on economic growth through the human capital channel.

To explain the positive link between PAYG retirement systems and economic growth that is suggested by the empirical findings, previous authors have then focused on the human capital channel, and more particularly on parental altruism. In this strand of the literature, PAYG retirement systems result in higher economic growth because they provide an incentive for altruistic parents to invest more in their children’s education, even if investment per child remains insufficient to be socially optimal. In addition, they also provide an incentive for parents to have fewer children. In that context, when private behaviour is not observable, Cigno, Luporini and Pettini[6] show that a second-best policy would be to provide parents with subsidies linked to the number of children they have and their future capacity to pay taxes. To that end, Cigno[7] suggests that unconventional children-related pension systems be added to conventional retirement systems so as to allow individuals to earn a pension by raising children and by investing in their human capital. Introducing such an unconventional system could stimulate both fertility and economic growth. In France, the 10% bonus on pension benefits for parents of three children or more is such a pension-based fertility subsidy. However, for both reasons of economy and equity[8], these subsidies are taxed since the reform of 2013, with the risk of lowering the fertility incentives. This latter reform will imply more profound changes as from 2020 proportional subsidies will be replaced with payments only given to women on a per-child basis (the first child inclusive).

Beyond the impact of PAYG systems on parents’ behavior, results have first appeared mixed when considering people investment in their own education. On the one hand, Kemnitz and Wigger[9] and Le Garrec[10] have shown that conventional retirement systems provide an incentive for people to be trained longer because training results in steeper age-earnings profiles. On the other hand, Docquier and Paddison[11] have shown that in reducing the actualized return to education conventional retirement systems dissuade less able people from investing in their education. By embedding both channels, Le Garrec[12] shows that the positive impact dominates the negative one so that the average length of training and then economic growth was increased with conventional retirement systems, at least for low contribution rates. In the spirit of Cigno, this result suggests that a desirable feature of any retirement system would be to subsidize people who invest in their own education by linking pension benefits to the best – or last – years’ average annual earnings, not to full lifetime average earnings as in NDC systems. From that perspective, the Balladur reform of 1993 inFrance went in the wrong direction. Indeed, in the private sector earnings-related benefits were linked to the ten best years before the reform, then gradually to the 25 best years after.

Starting from the empirically supported assumption that conventional retirement systems are close to actuarial fairness and yield more economic growth, it is then not straightforward to determine whether the introduction of individual accounts and the stabilization of contributions are desirable objectives. To analyze this issue and the relevancy of the switch from conventional unfunded public pension systems to notional systems we have extended in a recent article[13] the social security-growth literature in two directions. First, following Le Garrec (2012), we consider investment in human capital through both the proportion of individuals who decide to invest and the time they invest. With more general specifications, we can provide explicit and general conditions so that the positive effect associated with the lengthening of training may be dominated by the negative effect, i.e. the decrease in the proportion of educated individuals. We then show that economic growth may exhibit an inverse U-shaped pattern with respect to the size of an actuarially fair retirement system in which pensions are linked to the best – or last – years’ average annual earnings, while an NDC system has no impact on economic growth. Second, we consider the aging process, not by assuming decreased fertility as it is usually done in the literature, but through increased longevity. This has important consequences. Indeed, as increased longevity raises the value of investments that pay over time, it generates stronger incentives for people to invest in their education[14]. Therefore, social security interacts with longevity in determining the individual level of investment in education. We then show that increased longevity may raise the size of the conventional retirement system rate that maximizes economic growth.

For policy-making, the message in Le Garrec (2014) is clear: increased longevity should be associated with an increase in the size of the existing conventional retirement systems, not with a switch towards NDC systems. However, there is no guarantee that the political process leads to the optimal size. According to Browning[15], there even are good reasons to think that the political process leads to a PAYG size exceeding the growth-maximizing level. Indeed, he showed that workers tend to increase their support for the PAYG retirement system as they approach retirement. Consequently, considering that the pivotal voter is middle-aged worker, by definition closer to retirement than a young worker, this could strengthen support for a PAYG size that exceeds the growth-maximizing (or the welfare-maximizing) level. Does this mean that in practice an NDC system is preferable to a conventional system? Not necessarily. Indeed, an assessment that the conventional PAYG size exceeds the growth-maximizing level does not necessarily mean that an NDC system would allow greater economic growth. Quite the opposite, if we give credence to the empirical results reported by Sala-i-Martin (1996) and Zhang and Zhang (2004), economic growth would be slowed down when switching to an NDC system.

Starting then from a situation where conventional PAYG systems yield more economic growth, what may happen with increased longevity. Firstly, as the pivotal voter approaches retirement, it is likely that the PAYG size supported by a majority will increase. Two configurations may then occur. If the effective PAYG size increases less or only slightly more than the growth-maximizing level, the superiority of a conventional system over an NDC system may be preserved. In that case, a switch towards NDC systems will not be optimal. By contrast, if the effective PAYG size increases significantly more than the growth-maximizing level, conventional retirement systems may become harmful for economic growth. In that case, as suggested by Belan, Michel and Pestieau[16], a Pareto-improving transition towards a fully funded system may exist if it results in a significant increase in economic growth. More likely, if such a transition does not exist, a switch to NDC systems can then be considered as a desirable policy for increasing economic growth and social welfare.

In Le Garrec (2014), all the solutions coping with increased longevity have been considered while keeping the calculation of pension benefits actuarially fair. If the main problem of existing retirement systems is that they are too large, another solution would be to make the system more progressive. Indeed, as highlighted by Koethenbuerger, Poutvaara and Profeta[17], the size of the retirement system chosen by the median voter tends to decrease as the link between contributions and benefits is loosened. It is a fact that progressive systems appear smaller than actuarially fair systems. However, as argued by Le Garrec[18], more progressivity also leads to fewer incentives for people to invest in their education. At this stage, the impact of introducing more progressivity on economic growth appears uncertain, unless it also strengthens majority support for public education funding, as argued by Kaganovich and Meier[19]. From that perspective, incorporating public education in the analysis appears to be a promising avenue for further research.

By Jean-Luc Gaffard

The situation of Alstom has hit the headlines since the company executives announced their intention to sell the energy branch to General Electric and to carry out a restructuring that strongly resembles a unit sale. The government reacted strongly to what it saw as a fait accompli, seeking another buyer, namely Siemens, with a view to creating one or more European companies in a sector considered strategic, along the lines of Airbus – before it came round to the General Electric solution, which in the meantime had improved in terms of both the amount paid for the buy-out and the arrangements for the future industrial organization. These events, important as they are, should not obscure the more general fact of ongoing deindustrialization, which is taking the form, among others, of the break-up of certain large companies, and which is resulting from inconsistencies in the governance of what French capitalism has become today.

Deindustrialization is generally attributed either to competition from countries with low wages, and thus to excessive labour costs, or to insufficient innovative investment, and thus to a lack of non-price competitiveness. The solutions sought in terms of public policy oscillate between reducing wage costs and supporting R&D, usually with little regard to the conditions of corporate governance. The emphasis is on the functioning of both the labour markets, with the aim of making them more flexible, and the financial markets, which are considered or hoped to be efficient, without really taking into account the true nature of the company. But a firm is part of a complex network of relationships between various stakeholders, including managers, employees, bankers, customers and suppliers. These relationships are not reducible to market relations encumbered with imperfections that generate poor incentives and that need to be corrected so as to ensure greater flexibility. They are part of more or less long-term contractual commitments between the various stakeholders in a company, which are exceptions to the state of pure competition, even though they are essential to the realization of the long-term investments that bring innovation and growth. The duration of these commitments is in fact the foundation for the average performance of the companies, the structuring of the industry and ultimately the industrialization of the economy.

Alstom’s troubles, following on the heels of the difficulties encountered by other firms like Pechiney and Rhône Poulenc that are no longer on the scene, reflect this organizational reality. With sales barely equal to one quarter of the figure for Siemens and one-fifth for General Electric, the size of the company and its various activities has been judged by its leaders to be largely insufficient to meet the demands of competition. With the agreement of the European Commission, the State already had to intervene back in 2004 to recapitalize the company so as to avoid bankruptcy. It then faced the obligation to hive off certain activities and cut jobs drastically. Today, the only way ahead is to carry out a new restructuring, with the hope of saving skills and jobs by integrating them into a larger, more efficient entity while absorbing the accumulated debts. This cannot take the appearance of a final break-up that benefits one or another of the competitors who managed to develop the right strategies, far from the recommendations of those who fawned over what was once called the new economy. In this case, the beneficiary will be General Electric. This ultimate solution is taking place due to Alstom’s inability to benefit in the recent or earlier period from the longer-term financial commitments that would have allowed it to implement an effective growth strategy.

This disappointment, on the heels of numerous others, reveals the inconsistency that has befallen French capitalism between the organization of its industry and of its financial system, which was criticized back in 2012 in a book by Jean-Louis Beffa (La France doit choisir, Paris: Le Seuil). The new financial model, inspired by the Anglo-Saxon model, no longer seems to respond to the needs of mature enterprises engaged in activities with investment needs that are substantial and long term and which are subject both to performance cycles related to fluctuations in demand and to the constraints of the innovation process. The ensuing lack of commitment was bound to lead to break-ups, but it would be wrong to equate this to an increased modularity of industrial production resulting from the introduction of new information and communication technologies and which would be valued by the financial markets, as the head of Alstom seemed to think in the late 1990s when advocating a company without factories.

Under these conditions, a recovery in production cannot take place through the invariably one-off specific interventions of the public authorities aimed more or less explicitly at creating national or European champions that are, after all, not very credible. What is needed are structural reforms to deal, not with the rules on market functioning, but with modes of governance, and in particular a revision of the way the financial system is organized.

These observations are developed in greater depth in “Restructurations et désindustrialisation : une histoire française”, Note de l’OFCE, no. 43 of 30 June 2014.