France: Moment of truth for Macron’s reform ambitions

On 5 December, France saw the largest industrial action since railway strikes paralysed the country in the second quarter of 2018 (when the government decided to reform the national rail operator SNCF). Most unions joined the movement in December but mainly in the public sector (public transport and hospitals, justice, schools). Unrest is expected to continue until the end-of-year holiday period.

Pension reform is another politically symbolic move that President Macron pledged to enact during his campaign and is opposed by the same people involved in the yellow vest protests, reflecting a divided France. Public support for the reform (or at least what they know about it) is fading overall (29% supporting it in early November, against 33% in October in an Elabe poll) and is very weak among extreme right and left voters (where 79% and 72% oppose it, respectively). However, support remains strong among La Republique En Marche voters (80%) and The Republicans (43%).

The biggest question, therefore, is whether this will revive the grass roots yellow vest movement which paralysed the country in the final quarter of 2018 and first quarter of this year (without being backed or organised by unions and which went well beyond the public sector). There is a high risk that the 800,000 people marching across France on 5 December will do so again: a recent poll by Elabe showed that two thirds of the French public are expecting more social unrest. However, it seems that the yellow vest movement has faded after a long period of national debate gave way to new public spending (estimated at €17 billion or 0.7% of GDP). Can the Government buy is way out of the current tensions. It is possible.

The aim of the pension reform is to merge – as of 2025 - the 42 different French pension regimes into one, based on the number of years each worker has contributed throughout his or her career, rather than a given retirement age. The official age (62 years old, but 67 years old with full pension rights) should not be challenged, the aim being to increase the actual age of departure (currently closer to 61 if the OECD is to be believed, having been below 60 during the period 1993-2015). Another survey by Elabe in early December showed that 67% of French people are in favour of a single common pension system, 57% think that workers will need to work longer and 55% agree that the current system is not financially sustainable (the last official report showed a likely deficit of 0.5% of GDP in 2025). Put simply, there is a consensus on the need for action, little clarity about what is actually in the reform and little willingness to pay for it. That is why we think that the government could again buy its way out.

This is what Prime Minister Édouard Philippe tried to do on 11 December when detailing the government’s proposal. By leaving out all those born before 1975, ensuring a minimum pension allowance (at 85% of the minimum wage), ensuring higher allowances for women and parents of large families and offering extra guarantees to school teachers, Philippe has tried to minimise opposition to the reform. The financial trajectory of the new system is still to be determined and lies largely in the hands of social partners in forthcoming negotiations. The amount of the bill is yet to be known but is certainly lower than the cost of leaving things unchanged, unless the final reform does exactly that.

Nevertheless, uncertainty around social stability will remain high in the months to come at a time when the French economy is set to face external risks. We are therefore very cautious about GDP growth at the beginning of next year.

The second half of 2019 should still see higher GDP growth rates than in the rest of the eurozone. So far this year, France has been the main contributor to eurozone GDP for the first time since the financial crisis. GDP growth was 0.3% quarter-on-quarter, slightly weaker than in 2Q19 (0.35%), confirming that a 1.3% GDP growth rate is reachable for 2019 as a whole. In the second half of 2019, it was mainly a domestic demand story. In particular, GDP numbers for the third quarter continued to show the strength of the private consumption engine.

Private consumption growth reached 0.4% QoQ in 3Q19 and the fourth quarter has also started on the right note: consumer expenditures on goods were up by 0.1% month-on-month in October. The spike was especially strong in food and transport equipment. Given that household purchasing power has increased by 0.6% in 3Q19 (thanks to higher wage growth and higher social benefits), we expect this trend to remain positive.

Consumer confidence surveys, in particular, indicate that purchasing intentions remained very high in November: at -4, the index has not been higher since March 2018. Consumer confidence as a whole even increased in November on the back of stronger confidence in the economic environment and employment prospects. Fear of unemployment has reached its lowest level since 2008. In this regard, we did not see any strong correction in the large drops seen in the unemployed population registered in August and September: unemployment was broadly stable in October and hiring intentions remain elevated in the service sector. This should lead to further declines in the household saving ratio, which peaked at 15% in 1Q19 and was down to 14.2% in 3Q19, supporting consumer spending. Over a year, private consumption rose by 1.4% in 3Q19, which should lead to 1.2% growth in 2019 after the 0.9% achieved in 2018.

In addition, household investment in new construction experienced a rebound in 2Q19 (+1.7% QoQ) and 3Q19 (+0.7% QoQ). It should be noted that the fall in mortgage interest rates after 2014, even if it took time to have an impact, has allowed investments to rebound from 2016 onwards: growth since then has averaged 3.6% per year. We expect the catch-up to continue in the first half of 2020.

Despite the drop in sentiment seen throughout Europe and especially in neighbouring Italy and Germany, French indicators remained robust throughout the second half. PMI indicators have rarely fallen below 50.0 and industrial production has slowed less steeply than in other countries (it was slightly lower than a year ago at the beginning of 4Q19). Capacity utilisation has remained high in comparison with Germany. However, confidence indicators suggest the stagnation in activity is likely to continue with a toxic mix of rising inventories and declining order books.

Thanks mainly to the service sector and very supportive credit growth, business investment continued to perform well in the third quarter. With growth of 1.2% QoQ, this was above expectations. Even if we see a slowdown in the last quarter of the year, business investment growth should still reach 4.1% in 2019 after 3.9% in 2018.

It should also be noted that public investment growth continues to contribute positively to GDP. After several years of negative contributions (2013-2016), public investment boosted growth by 0.3% in 2018, a figure that is expected to double this year. Thus, after growth of 2.4% year-on-year in 2018, this should grow by nearly 4% in 2019. Even if it's still 4% below the 2008 level, this is certainly a welcome comeback.

Despite the trade war and the slowdown in global export growth, French exports have benefited from the euro weakness. In the first 10 months of 2019, export growth to the eurozone slowed to 2.2% (compared to 5.1% over the same period last year), all other regions posted higher growth rates (Figure 3).

The trade balance with the US has strongly improved since the beginning of 2018 and is balanced for the first time in 15 years. President Trump has recently pledged new taxes on €2.4 billion on exports of wines and luxury bags, but these items are not the main factors behind the improvement. Aircraft exports (€12.2 billion) represent more than 25% of French exports to the US and increased by 49% in 2019. So while tariffs on champagne and luxury bags are likely to hurt French exports, the main shock will come from the new 10% tariff increase that the US will impose on Airbus exports. This new phase of the trade war should affect French exports in 2020.

While net exports had a particularly high contribution to growth in 2018 (0.6% was the highest since 2012), we do not think it can be repeated in 2019 and 2020. For this year, we expect a slightly negative effect on growth from foreign trade. On one side, the slowdown in world trade and eurozone growth had an impact on French external demand. On the other, the recovery in domestic demand should continue to support imports. This outlook should deteriorate further in 2020 where we expect a 0.4% negative contribution from net exports on the back of the new tariffs and a stronger euro.

The hard data is still encouraging for the last quarter of the year, but the beginning of 2020 looks far from accident prone. Business investment growth will abate with the manufacturing slowdown and a renewed period of uncertainty triggered by social unrest. The labour market- which is still the main factor supporting current growth- could also slow down earlier than expected because of this instability, sending consumer confidence back down. At this stage, we do not expect the impact to be as large as during the yellow vest crisis of 2018, but the unrest around the pension reform will negatively affect 1Q20 growth: larger episodes of strikes and a prolonged manufacturing slowdown could lead to temporary hiring freezes and hit consumer sentiment, which is why we expect a slow start to the year, limiting GDP growth to 1% in 2020 after 1.3% this year.