The Two Pillars of French Economic Reform

Philippe Aghion, Benedicte Berner

French labor code

PARIS – The French government has just announced the guidelines for a new labor code, its first major reform to boost France’s economy, by giving more flexibility to companies to adapt to the marketplace. The second major reform sought by President Emmanuel Macron’s cabinet – an overhaul of the French state – is set to follow.
The changes to the labor code have four goals. First, direct negotiations between employers and employees in small and medium-size firms (accounting for 55% of the workforce) would be facilitated by allowing such companies to negotiate with elected representatives not mandated by the trade unions. Second, social dialogue within larger firms would be simplified by merging separate workers’ committees (for hygiene, health, safety, and so on) into a central body. Third, collective bargaining over wages and employment would be decentralized from national to sectoral and/or firm level. Finally, laying off employees would become easier and more predictable, in particular with the introduction of upper and lower levels on payouts issued by labor courts.
The reform of the labor code will soon be accompanied by reforms of the unemployment insurance and job training systems. On the former, the government will take over from the unions, in order to provide unemployment benefits to all categories of workers, including the self-employed and those who voluntarily quit their current job to search for a new one. The cost of reforming unemployment insurance, however, is estimated at €3-5 billion ($3.6-6 billion), which may prove difficult to square with 2018 budget plans, which foresee a €20 billion cut in spending.
Altogether, the labor market reform is intended to reconcile more flexibility for firms to hire and shed workers – which is needed in an economy where growth is driven by innovation and creative destruction – with more income security and more training for the unemployed. The French labor market currently suffers from a huge divide between qualified workers under long-term contracts and low-skill workers who shuttle constantly between unemployment and short-term jobs. The government’s reform is meant to close this divide by increasing social mobility.
The second pillar of Macron’s economic program, reform of the state, has two major components: a revamp of fiscal policy and an overhaul of the public spending system. Here, too, the reform aims to address four main long-standing problems.
First, capital income is too heavily taxed in France, compared to other developed countries, which discourages innovation and entrepreneurship. Second, public money is not invested in the most cost-effective and growth-enhancing way. Third, France suffers from a multiplicity of administrative layers, which generates inefficiencies and redundancies in the provision of public services. Finally, France remains a highly corporatist country, with a multiplicity of health, pension, and family subsidy systems; in an innovation-driven economy where individuals are likely to change jobs and sectors repeatedly over their lifetime, this bureaucratic thicket becomes a source of inefficiency and risk.
On the fiscal front, Macron has made two important moves. First, on the revenue side, capital income would be taxed at a flat 30% rate, whereas before capital was taxed more than labor.

Second, the wealth tax on non-real-estate assets will be eliminated – a move meant to encourage entrepreneurs and innovators.
The government has not yet decided on a precise course of action for spending, although Macron and his team are looking closely at the reforms carried out by Canada and Sweden in the 1990s. In particular, the government may decide to reduce the number of civil servants by eliminating some administrative layers of regional and local government, and by delegating some administrative tasks to autonomous agencies. Moreover, the government may – and should – merge all existing pensions schemes into a single system (as it should with the social security, health insurance, and family subsidy systems). This would enable the government to invest in education, unemployment insurance, and innovation, while abiding by its European budgetary commitments.
After decades during which France experienced slow growth, high unemployment, industrial decline, and rigid corporatist institutions blocking all attempts at reform, a new hope for change has emerged.
Decisions made in the coming year will tell us whether this hope is to be fulfilled.

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