French economy. Sarkozy triumphant

A pick-up in the French economy rescues the public finances

AFTER three years in disgrace, could France at last be turning into a model economic pupil? That, on paper at least, was the message of the 2005 budget, unveiled this week by Nicolas Sarkozy, the centre-right finance minister. The government's budget deficit, he promised, will next year fall below the European Union stability pact's ceiling of 3% of GDP, for the first time since 2001. And the French economy is now growing faster than that of any other big euro-area country.

Presenting his first (and last) budget before he quits the government to take over as head of the ruling UMP party, Mr Sarkozy was triumphant. He had vowed to show that France would keep its word on controlling public finances. Sure enough, he forecast a deficit of 2.9%, thanks to a combination of better-than-expected tax receipts, frozen government spending, and a one-off payment of some €7 billion ($8.5 billion) from Electricite de France, the energy utility. This spared him the painful necessity of making deep spending cuts to meet his pledge - he will leave that task to his successor next year. Indeed, extra money was found for research, defence and “social cohesion”.

The economy has come to Mr Sarkozy's rescue. Last year's budget was based on a growth forecast of 1.7% for 2004. Now, the government expects 2.5% growth both this year and next. It could even be stronger. Year-on-year growth in the second quarter of 2004 reached a robust 3% - compared with a euro-area average of only 2%. The OECD this week revised upwards its forecast for French GDP growth this year, from 2% to 2.7%.

This has not only helped Mr Sarkozy to reduce government debt, but also to cut taxes. Not income tax: he was too responsible “as the guardian of the fruits of French people's hard work”, he stressed, to cut taxes recklessly, given the scale of the public debt. All the same, as part of a €2 billion fiscal package, he abolished inheritance tax on estates worth €100,000 or less; increased by 50% the tax relief for those with domestic employees; suspended a 3% corporate surtax; and established tax breaks to discourage industrial delocalisation, a buzz-word signifying the movement of jobs to low-cost locations, notably in central Europe.

The left immediately denounced the package as a give-away for the rich. But Mr Sarkozy insisted that it would reward families for hard work, encourage job creation, and also put more money in people's pockets.

The surprising feature of France's recent economic upturn is that it has been entirely demand-driven. Exports are growing, but more slowly than imports. Investment, on the other hand, is picking up. Above all, consumers are spending heavily. In August, household spending on durable goods was up by 7% on the previous year, after a year-on-year rise of 6% in the second quarter. Indeed, France's household-savings rate could fall this year to 14%, from 17% in 2002.

Mr Sarkozy wants to sustain this by boosting purchasing power. Hence, for instance, his 4% increase in the “employment bonus”, a tax credit for working, in 2005; a 5.4% rise in the minimum wage; and a tax incentive, already in place, to encourage grandparents to pass money to adult grandchildren.

So is greater confidence prompting all this consumer demand? Not at all. Household surveys show that confidence has been flat all year. Nor does job growth offer an explanation. Unemployment has been at 9.8% for over a year. Fears of losing jobs to low-cost central Europe are widespread, and signs of recruitment are strikingly scarce - Renault made headlines by announcing that it will hire 5,000 new workers in France next year. The buoyant housing market might be helping (average house prices have risen by 14.5% over the past year), yet it matters less in France than in Britain. “It is not as if the French are suddenly smiling about the future,” says Eric Chaney, head of European economics at Morgan Stanley in Paris. “They are simply starting to unwind an accumulation of savings that had reached an excess level.”

France's political leaders are certainly not benefiting from the consumer-led upturn. The French remain disillusioned with both a distant President Jacques Chirac - in New York this week to lecture on how to solve world poverty - and his enfeebled prime minister, Jean-Pierre Raffarin. According to a poll by Ifop, satisfaction with each fell a full six points in September: to 43% for Mr Chirac, and a miserable 31% for Mr Raffarin.

A pick-up in the French economy rescues the public finances.

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