The Long Run Is Near

• Author: Kevin Cheng, Erik De Vrijer, and Irina Yakadina
• Position: a Senior Economist, is an Assistant Director, and is an Economist in the IMF's European Department.

FRANCE has begun to recover from the Great Recession earlier than most advanced European economies. However, weak domestic demand, as well as the slow recovery in its main trading partners in Europe and elsewhere, has resulted in a sluggish rebound with high unemployment. Turbulence in European debt markets and the possible spillovers are also weighing on the short-term economic outlook.

But if the near-term prospects are less than stellar, the longer-term fiscal prospects are perhaps more clouded. Not only are public finances feeling the adverse effects of the recession, an aging population with its attendant health and pension costs will put increasing pressure on France’s fiscal future—as they will in most advanced economies (see “How Grim a Fiscal Future?” in this issue of F&D).

The government is left with a delicate balancing act. On the one hand, it is wary of taking steps to reduce the budget deficit too rapidly for fear of derailing the fragile recovery. On the other, it cannot delay instituting policies that aim at getting revenue and spending in line over the longer term. The government has announced a sizable fiscal consolidation over 2011–13 to pave the way for such fiscal sustainability. Among the items in this medium- and long-term consolidation is a politically controversial reform of the pension system.

A weakened fiscal position

France’s fiscal challenges have both acute and chronic causes. The acute dimension is the recession, which exacted a large toll, both direct and indirect, on public finances. The direct impact includes the cost of the fiscal stimulus package that replaced private demand with public demand and support for the financial sector. The indirect impact includes the crisis-related revenue loss (mainly taxes and social security contributions), the cost of automatic stabilizers (such as unemployment benefits), and the loss in output—which makes the public debt larger relative to the national income.

As a result of the crisis, France’s fiscal position has weakened (see chart). After shrinking from 4.1 percent of gross domestic product (GDP) in 2003 to 2.3 percent in 2006, the overall deficit began to climb again in 2007, and spending is expected to exceed revenue by about 8 percent of GDP in 2010. Under current policies, the ratio of public debt (which represents accumulated deficits) to GDP could grow within a few years by more than 25 percentage points above its pre-crisis level—to 90 percent of GDP.

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