When Francois Hollande won the French election back in May 2012, Paul Krugman mocked the media “hysteria” about the victory of a left-wing politician who promised to revive the French economy by raising taxes even higher on wealthy Frenchmen. I, as usual, took a more moderate, nuanced and balanced view, writing a squib titled “Seven New Reasons Not to Create Jobs in France.” They were: a new wealth tax, a 75% top marginal income tax rate, a hike in the estate tax, a hike in business taxes, a “dividend tax” on companies (to encourage reinvestment), higher taxes on bonuses and stock options, and a rise in the tax on equity trades.
In addition to chasing Gerard Depardieu to Russia, these tax hikes killed lots of jobs. In May 2012 the unemployment rate was 10%; now it is 10.8% and headed higher in a moribund, uncompetitive economy with a rising trade deficit despite weak domestic demand. It turns out that, contra Dr. Krugman, job growth is not all about aggregate demand. The supply side matters too. If you attack employers with a raft of taxes you get less employment, less economic growth, and weak tax revenue. Hollande almost sounded like Larry Kudlow when he exclaimed at his press conference, “How can we run a country if entrepreneurs don’t hire?” (But then he returned to form, asking “And how can we redistribute if there’s no wealth?” Please take note, Mayor DeBlasio.)
How do you say U-turn in French?
To save his presidency, Hollande has reversed some of his anti-business policies. Only a few. It will be a long time before he is as popular in the corporate boardroom as he is in the Parisian boudoir. Hollande’s U-turn exemplifies a trend toward healthy international competition within Europe. While Hollande was busy proving Dr. Krugman wrong, so were British Prime Minister David Cameron and Chancellor of the Exchequer George Osborne. These benighted conservatives adopted a dreaded “austerity” program of cutting spending in order to rein in budget deficits and shore up Britain’s credit rating. After a slow start, this policy has worked, with economic growth picking up nicely and the unemployment rate declining from 8.2% in May 2012 to 7.4% recently. Meanwhile, the German economy has been expanding and Spain, through a brutal process of “internal devaluation” (slashing real wages because the country could not devalue its currency), has also become much more competitive. Will Italy follow? (Another positive sign: Europe is starting to notice that its renewables-first energy policy will be an economic disaster because it impoverishes consumers and makes heavy industry uncompetitive versus the all-fracked-up United States. Germany’s giant chemical industry, for example, could relocate to Texas and Louisiana.)
With France falling behind long-standing rivals Britain, Germany and Spain, Hollande decided he had to change course. It is far from clear his reforms are deep enough. In his press conference he was vague about how he would cut spending to pay for tax cuts, and many politicians in his coalition hate capitalism and capitalists. When the government spends 57% of GDP, you have a long long way to go before you have a vibrant capitalist economy.
In truth, I have been somewhat too bearish on Europe. The Euro still seems to me to be fundamentally dysfunctional, and Germany’s prescription that all nations in the EU should run trade surpluses is absurd. With banks still in deleveraging mode, lending may be too weak to fund healthy growth. Nevertheless a few years of pain and agony have indeed driven salutary reforms that are improving economic performance. Maybe even in France, eventually. This is positive for U.S. profits; something like 15% of S&P profits are in Europe, and while growth will not be strong it is far better for it to be growing than shrinking.
