Download The Economic Consequences of President Mitterrand

The economic consequences of
President Mitterrand
Sachs
Jeffrey
HarvardUniversity
and CEPR
CharlesWyplosz
INSEAD, Fontainebleauand CEPR
1. Introduction
The economic managementof France under the Socialistsin the 1980s
is widely regarded as a major failure. Relative to the enthusiastic
promisesof PresidentMitterrand'sgovernmentfollowingthe election
victoryof May 1981, thatharsh assessmentis warranted.The governmentcame to officepromisingrapid growthand a reductionin unemployment.Instead, it has presided over fouryearsof slow growth,and
a risein unemploymentfrom7% in 1981 to 10% in October 1985. The
Socialistattemptto revivethe French economy sank on the shoals of
risinginflationand a foreignexchange crisisby early 1983, so thatthe
governmentof the left has in the end introduced a tougher, more
marketorientedprogrammethananythingconsideredby the previous
administrationof Giscard d'Estaing.
centre-right
In politics,consistencycan be more importantthan correctness,so
that the Socialist U-turn and subsequent policies have garnered less
applause thanmightbe expected.The austeritysince 1983 has reversed
a trend of high and increasinginflationthat gripped France in the
1970s and early 1980s. The policies have also stabilized the fiscal
accountsand greatlyimprovedFrance's externalbalance. Nonetheless,
the Socialistsremain condemned by the failureof theirinitialexperiment. According to opinion polls withinFrance, they have alienated
the leftwithoutattractingnew electoralsupport fromthe centreand
the right.
I
I
* Usefulcommentshave been receivedfromseveral
participantsat the Panel and our discussants,
fromparticipantsat the Paris Seminaired'Economie MonetaireInternationaleand the Business
Economics Workshopat INSEAD. We also thankH. Delestre,P. Dubois, J. Melitz,G. Laroque
and G. Oudiz for assistance withdata collection,and Fergal Byrne for useful research help.
Financial support fromINSEAD is gratefullyacknowledged.
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EconomicPolicy April 1986 Printedin GreatBritain
SUMMARY
FranceunderMitterrand
Sachs and CharlesWyplosz
Jeffrey
While French economic performancehas not conformedto
the enthusiasticpromisesof early 1981, thispaper argues that
the widelyheld view thatit has been an unmitigatedfailure
is unwarranted.First,the general deteriorationcan largely
be dated back to the early seventies.Second, the early and
unfortunateattemptat a demand-led expansion was both
moderate in size and quicklyreversed.Finally,the post-1983
anti-inflationary
policieshave been successfulso that,overall,
the disappointingFrench performancehas been on a par
with,and in some waysbetterthan, the restof Europe.
But the main theme of the paper is the emphasis on the
supply side. The analysisis organized around the NAIRU,
the thresholdrate of unemploymentbelow which inflation
rises. In an attemptto explain the factorswhich have led to
a continuousriseof the NAIRU since 1973, the paper focuses
on labour costs,particularlyon the 'wedge' betweenthe costs
borne by employersand net take-homepay. To achieve and
sustain a significantly
lower level of unemployment,labour
taxes mustbe cut,thus reducingthe wedge and the NAIRU,
and there mustbe a correspondingdemand stimulusso that
actual unemploymentcan fallto thislevel.
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Mitterrand
The economicconsequences
ofPresident
263
Our paper aimsto providea broader perspectiveon Socialistmanagementof the Frencheconomy,by placingrecenteconomicperformance
in the context of longer-termdevelopments,and by comparing the
macroeconomicoutcomes in France with the resultsachieved in the
other major industrialeconomies. We argue that the economic crisis
in France did notbegin withthe Socialistsin the 1980s,butin the 1970s,
under Presidents Pompidou and Giscard d'Estaing. Macroeconomic
policies emphasized aggregate demand managementduring a period
in which aggregate supply conditionsseriouslydeteriorated.Because
of thisdeterioration,both inflationand unemploymentrose sharplyin
the seventiesin France as elsewherein WesternEurope.
Certainly,the early Mitterrandperiod did nothingto reverse this
trend; the policies pursued were more naivelydemand orientedthan
in anyothermajor industrialcountry.Startingfroma positionof double
digitinflation,the Mitterrandgovernmentblithelystepped on the fiscal
accelerator,hoping that the stimuluswould raise output,spur investment, and thereby lead to anti-inflationary
productivityincreases.
Labour costs were substantiallyraised by higher minimum wages,
increasedpaid holidays,and a shorterworkingweek. In the shortterm,
France avoided the deep 1982 recession sufferedby its neighbours.
However, French inflationremained veryhigh in 1981 and began to
risein 1982, whileinflationabroad fellsignificantly.
Also,withdomestic
demand expansion and a worldwide recession, the trade balance
deterioratedsharply.Withthe Franc under attack,the fiscalexpansion
was quicklyabandoned. Since mid-1983,the fiscalexpansion has been
nearlyreversed,and wage policieshave been successfulin holdingdown
the growthof real labour costs.
Table 1 shows the time paths of inflation,unemployment,and the
external balance, in the past fifteenyears. Clearly,PresidentGiscard
bequeathed a poorlyperformingeconomyto the Socialistsin May 1981.
The unemploymentrate had risen in everyyear since 1974 to a rate
of 6.3% in 1980, and the inflationrateincreasedto 12.2% in 1980. Both
measures were far higher than in Germany,France's major political
and economic partner.The currentaccount was in substantialdeficit.
In 1982, the situationdeteriorated,with higher inflation,unemployment,and currentaccount deficits.By 1985, aftermore than twoyears
of austerity,substantialprogresswas finallymade on two of the three
and
major targetsof the government:inflationhad fallensubstantially,
the currentaccount was back in balance. However,the unemployment
rate,once the prioritytargetof the Mitterrandgovernment,had risen
sharplyto over 10%.
One popular wayto compare the relativesuccessof the fightagainst
inflationin different
countriesis to calculatesacrificeratios.For a given
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Sachs and CharlesWyplosz
Jeffrey
264
Table 1. Macroeconomic indicators
1974-80
1980
1981
1982
1983
1984
10.5
4.7
16.1
12.2
4.5
19.8
11.8
4.2
11.8
12.6
4.4
7.4
9.5
3.3
5.0
7.1
1.9
4.4
6.0
2.3
5.0
Unemploymentrate(%)
France
4.8
3.2
Germany
UK
5.3
6.3
3.0
6.6
7.4
4.4
10.0
8.1
6.1
11.4
8.3
8.0
12.6
9.7
8.5
13.0
10.1
8.8
13.2
3.1
2.4
1.5
1.0
1.9
-2.2
0.5
-0.2
-1.3
1.8
-0.1
1.8
0.7
1.3
3.2
1.6
2.6
1.6
1.0
2.3
3.3
Currentaccount (% of GDP)
France
-0.3
0.2
Germany
UK
0.5
-1.4
-1.8
1.8
-0.8
-0.8
2.9
-2.2
0.5
1.9
-0.9
0.6
0.8
-0.2
1.0
0.0
0.1
2.1
0.3
Structuralbudget deficit(% of GDIP)
-0.7
0.6
France
3.2
3.2
Germany
-4.0
UK
1.9
0.3
3.0
-4.4
0.7
1.6
-4.5
0.8
0.4
-1.5
0.2
-0.8
-1.8
Net public debt (% of GDP)
France
11.5
-8.2
Germany
UK
75.3
10.6
17.5
48.2
12.5
19.8
47.2
15.0
21.5
49.0
17.6
21.7
49.8
Inflation(% p.a.)
France
Germany
UK
GDP growth(% p.a.)
France
Germany
UK
9.1
14.3
48.9
1985
Sources:Price and Muller (1984), DRI data bank. 1985 data are forecastsfromOECD
EconomicOutlook(December 1985).
Notes:CurrentAccount data in column 1 referto 1975-80 for France and Germany,
1977-80 for the UK. StructuralDeficitis inflation-adjustedat mid-cycle.Net Public
Debt Data in column 1 referto 1970.
period, the sacrificeratio is defined as the cumulative increase in
unemploymentdivided by the reductionin the annual inflationrate.
It is a crude measure of the additional short-termunemployment
burden required to get inflationdown 1 percentagepoint.From Table
1 we see thatFrenchinflationfellfrom11.8% in 1981 to 16.0% in 1985,
a reductionof 5.8%. Over the same period the cumulativeincrease in
unemploymentwas 12.1%. Hence during 1981-85 the sacrificeratio
was 2.1. For Germanyand the UK, over the same period the sacrifice
In thissense,Table 1A showsthat
ratioswere 10.9 and 4.0 respectively.
than
trade-off
France faced a more favourableinflation-unemployment
other European countries.
Whilstthe Socialist experimenthas been no great success, French
performancein some ways has been better than that in the rest of
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The economicconsequences
Mitterrand
ofPresident
265
Table 1A. Sacrificeratios, 1981-85
Cumulativeextra unemployment(%)
Reduction in inflation(%)
Sacrificeratio
France
Germany
UK
12.1
5.8
2.1
20.8
1.9
10.9
27.2
6.8
4.0
Source:as Table 1.
Europe. During the 1970s and 1980s, for most European countries,
ever-higherunemploymentrateshave proved necessarymerelyto hold
inflationin check,muchlessto reduce it.The so-called'non-accelerating
inflationrate of unemployment'(NAIRU), whichmeasures the lowest
unemploymentrate that can be sustained withoutfear of increasing
inflation,appears to have risensharply.Note, forexample, thatduring
the Giscard d'Estaing administration,the historicallyhigh and rising
unemploymentrates during 1977-79, between the two oil shocks,did
littleto reduce French inflation(see Table 1).
In our view, the anti-supplyside policies of both Giscard d'Estaing
and Mitterrand,like the policiespursued in othercountriesof Europe,
contributedto this distressingdevelopment. The post-1983 period
under Mitterrandhas begun to alleviate the problem,but in spite of
thewillingnessofthegovernmentto undertakepolitically
toughpolicies,
it has stillnot shown a deep appreciationof the need forcoordinated
supplyand demand measures.Some measurementsofaggregatesupply
conditionsthatwe develop latershow onlyslightglimmersof improvement. Our policy recommendationsat the end of this paper focus
squarely on the need for furtherimprovementsin aggregate supply
conditions.
We must spell out at the beginninghow our approach differsfrom
The
'supply-side'economicsas preachedbythe Reagan Administration.
on
on
the
effects
of
income
tax
cuts
focus
Reaganomics supply-siders
the incentivesto save and work. Individuals, it is argued, will work
withlowermarharder,and undertakemore entrepreneurialactivities,
of household behaviourto
ginal tax rates. In our view,high sensitivity
to
be
demonstrated:
we do not depart from
rates
has
tax
yet
marginal
thetraditionalmacroeconomicassumptionofa fairlyinelasticlong-term
labour supply of primarywage-earners.
In our interpretation,sensitivity
of workersto tax rates occurs not
at the household level, but at the level of wage bargaining between
firmsand workers,and in political lobbying for governmentwage
policies (see Bruno and Sachs, 1985, and Knoesterand van der Windt,
1985). As we showbelow, unions willtryto pass on labour tax increases
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266
Sachs and CharlesWyplosz
Jeffrey
by raisingwages, even if such wage increaseswillengender unemployment for other workers,and even if unions faithfullyrepresentthe
interestsof memberswhoseindividuallabour supplyis completelywage
inelastic!Because unions have monopolypower,theychoose willingly
to acceptmore unemploymentin returnforhigherwages.When labour
taxes or oil price increases adverselyshiftthe demand for workers,
unions are likelyto accept higherunemploymentin order to preserve
real incomes.The same argumentcould be applied to politicalpressures
forincreasesin governmentsalaries,or in government-regulated
wage
levels (as with the minimum wage). Even those voters who would
willinglywork at much lower wages will often support government
policies that preserve higher wages at the cost of higher aggregate
unemployment(of others?).
To quantifythe factorsthathave contributedto a risingNAIRU we
constructa variablethatmeasuresthe 'wedge' betweencoststo the firm
and net-of-taxtake home pay of workers.The theorysuggeststhat a
rise in the wedge willtend to raise the NAIRU, since unions willresist
the real wage reductionsthatwould otherwisebe necessaryin order to
preventhigherlabour costs fromreducing the demand for labour by
firms.We findthatthe 'wedge' has increasedmarkedlyin France,under
Giscard d'Estaing as well as Mitterrand,mainlybecause of the increase
in social securitytaxes.The risein thewedge seemsto be wellcorrelated
with the rise in the non-inflationary
thresholdof unemploymentin
France. For this reason, we share the Reagonomics emphasis on the
efficacyof tax reductions as a way of reducing unemployment,
especiallysince France has had one of the fastestincreasesin the Social
Securitytax burden in the OECD in the past fifteenyears,as shownby
the data in Table 2.
The plan of the paper is to review the Mitterrandexperience,
emphasising both aggregate supply and aggregate demand factors.
Section 2 describes the Socialist outlook at the time of the election
victoryin May 1981, and its economic program,which combined a
Keynesiandemand expansion,a Blum-stylesetofsupply-sidemeasures,
and nationalizationof major industrialgroups. Why this initialprogrammefailedis the subjectof some dispute.In Section3, we consider
threepossible reasons: the worldrecession,adverse supplyconditions,
and a crisisof confidence.While all of these explanationshave some
merit,we make one centralpoint:the NAIRU, or thresholdunemployment rate, was simplytoo high to allow for a sustaineddemand-led
recovery,and thiswas compounded by adverse supply-sidemeasures.
While the debacle of this phase is well known, the brevityand
moderation of the demand expansion that actuallytook place is not
widelyappreciated. As we show, the expansion was already winding
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The economicconsequences
Mitterrand
ofPresident
267
Table 2. Social securityexpenditures
(Structurallevel as % of potential GDP)
1970
1975
1980
1981
1982
1983
France
Germany
UK
US
16.8
19.1
22.6
23.4
24.2
24.1
13.3
16.2
16.3
16.3
15.8
14.9
8.5
9.2
10.0
10.0
10.5
10.5
7.5
9.7
10.0
10.0
9.7
9.8
Source:Mullerand Price (1984).
Note: Data measure social securityexpendituresat full
GDP. The strucemployment,as % of full-employment
tural level of social securityexpendituresis constructed
analogouslyto the structuralbudget deficit;it is the level
of spendingwhichthe systemwould produce at a normal
level of economic activity.
down by the second devaluationcrisis,in June 1982, a mere 13 months
afterthe Socialistscame to power. However, March 1983 broughtthe
decisivebattleforcontroloftheFrencheconomyand theSocialistparty.
Since March 1983, demand managementhas been geared, successfully,
towardsa reductionof inflation.Althoughthesupplyside has continued
to receiveonly fragmentary
attention,the wage policyhas been one of
moderation (at significantpoliticalcost). Even so, unemploymenthas
risensharply.The outcome to date of 'socialistausterity'is reviewedin
Section 4.
In Section 5, the currentmacroeconomicenvironmentis surveyed,
and some policyrecommendationsare offered.Accordingto our estimates,a reductionof the unemploymentrateto 5% is achievablein the
next few years,througha combinationof demand expansion coupled
witha significantreductionin labour costs.A cut in labour taxes would
be useful in reducing labour costs to firms,therebyspurringemploymentand investment.
2. The firstthousand days
2.1. The political background
The election of Francois Mitterrandas Presidentin May 1981 was a
major politicalchange. The lefthad not been in power since 1958, and
Mitterrand'sbrand of socialism was perceived as more ferventand
the
dogmaticthan the socialismof the countlesscoalitionsin the fifties,
shiftbeing clearlyunderlinedbythe explicitagreementto rule together
withthe Communistparty.
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Sachsand CharlesWyplosz
Jeffrey
268
The changes were to cover the whole spectrumof economic policy:
nationalizationof severalof the largestindustrialcorporationsremaining in the privatesector,new taxes (especiallya wealthtax), new labour
market regulations (the Auroux Laws), and a new orientationfor
macroeconomic policies. Many of the changes were based on a
specificallysocialistperspectiveon the economy,but there was also a
general perceptionin France thatthe previous economic policies had
failed and thata change was needed.
The left wing of the Socialistparty,nurturinga strongscepticism
towardmarketforces,was attachedto the ideological principlesincorporated in the joint programmeadopted withthe CommunistPartyin
1972,and enshrinedin the 'ProgrammeCommun'. They wereprepared
to go ahead with a large expansion of the public sector,quickly to
redistributeincome and strengthenthe hand of the governmentin
runningthe economy.It seems fairto say thatthiswas the dominating
view in the Spring of 1981.
At the otherend of the spectrum,the approach was more pragmatic
and cautious. The examples of the Front Populaire in 1936 and of
Chile's Allende governmentwere cited.' Several adviserswere aware
thathighunemploymentand highinflation,
a delicateexternalsituation
and verynervousemployersand investorsrequireda carefulapproach.
2.2. The French economy in 1981
A carefulstudyof the economic policies of the Giscard era is beyond
the scope of this paper. As later under Mitterrand,there were two
periodsassociatedwiththetwoPrimeMinisters.JacquesChiracpresided
over an expansion in the aftermathof the firstoil shock. It led to a
quicklyrisinginflationrate,a stubbornlyupward creeping unemploymentrate,and severeexternalimbalanceswhichtwicepromptedFrance
to leave the European currencyarrangementknown as the Snake.
Raymond Barre replaced Chirac in late 1976 and quicklyestablished
his mark as a 'dismal' economistbent on the hard work of deflation.
His main themeswere balancingthe budget, strengthening
the Franc
and wage moderation.In a laterstage he engineereda historicalbreak
fromthe entrenchedpracticeof pervasivepricecontrols.He succeeded
in balancingthebudget,in leading France intothe European Monetary
Systemand in never havingto devalue the Franc.
Over the period 1973-81, in France as elsewherein Europe, the rise
in unemploymenthad been met by a series of measures which conC. Kom,La
1S.
S. C. Kolm, 'La
TransitionSocialisteFrancaise,' Le Monde 17-18 June 1981.
TransitionSocialisteFrancaise,' Le Monde 17-18 June 1981.
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The economicconsequences
Mitterrand
ofPresident
269
tributedto a furtherrise of unemployment.Unemploymentbenefits,
mainlyfinancedbytaxes on wages,increasedfasterthanactual salaries,
along with other social transfersalso financed by labour overheads
(healthand retirementbenefits,as wellas the elaboratesystemof family
allowances). By 1981, 25% of GDP was being thus redistributed,
financedby wage taxes,the singlelargesttax in France. In thiscontext,
stabilizinglabour costswould have requiredeitheran explicitagreement
withthe trade unions on wage moderationor relyingon the pressure
of high unemployment.Giscard and Barre's hostilerelationshipwith
the trade unions meant thatthe formersolutionwas ruled out. Rising
unemploymentin 1980 allowed for a stabilizationof real take-home
wages, but increasingoverhead charges kept real labour costs rising,
althoughat a slower pace.
The combined rise of inflationand unemployment,along withan
emergingcurrentaccount deficitin 1980, was of course related to the
two oil shocks.But, as evidenced by Germany'ssuperiorperformance,
thiscould not be the only explanation (for some detailed comparisons
of Franceand Germany,see De Meniland Sastre,1985). Indeed, France
had largelyfollowedthe general European trend of supply-sidemismanagement,withexcessivelabour costs,a fastgrowthof the welfare
system,and continuouslyspreading regulation of labour markets.
Anotherliabilityinheritedby Mitterrandwas an overvaluedexchange
rate.Since thecreationoftheEMS and despitean unfavourableinflation
differentialvis-a-visGermany,the parityof the Franc had remained
unchanged. In theevent,thereal appreciation(about 10 to 12%) proved
to be the firsthurdle on whichthe Socialistsstumbled.
The brightside of Giscard'sand Barre's legacyresided in the public
finances.With the exception of the early Chirac expansion and the
temporary'locomotive'agreementof the 1978 summit,the budget had
remained almostbalanced. As a result,France's public debt (relativeto
GDP) was in 1980 one of the smallestamong OECD countries(Table
1). Mitterrandenjoyed fromthe beginningmore budgetaryfreedom
of manoeuvre than was actually available to most other European
countries,and it is perhaps not surprisingthatthis is where he chose
to move forcefully.
2.3. Policy measures
Fairlyquickly,the new governmentenacted a seriesof policymeasures:
a fiscal expansion with monetaryaccommodation, minimum wage
policies,a reductionof the workweekand new laws concerninglabour
relations.
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270
Sachs and CharlesWyplosz
Jeffrey
%
26 24- -
2
-
'
'
i
22 20 -
I
10
;I 8
I
/May81
'IV
8 1I
10
80
II
i
I,
1I I
,I I
I
LondonEuro Market
l ,i (Frenchfrancrate)
\'-
Tv..
I
I ' I
March83
~-,
Paris
I I I I I| I I I Ii
MoneyMarket
I
-
81
1I
-
82
83
84
85
Figure 1. Short-terminterestrates
Source:IMF
2.3.1. Fiscal policy.The supplementary1981 budget increased spending
withtaxes almostunchanged. In 1981, mostof the increasedspending
was in transfersto households,and subsidiesto both state-ownedand
privatecorporations,while investmentspending by public enterprises
was boosted in 1982. Also, the governmentdirectlyhired 200,000 civil
servantsin 1981 and 1982.
As a measure of the expansionaryimpulse,we considerthe OECD's
structuralbudgetbalance (fora criticism
of anysingle
inflation-adjusted
measureof fiscalpolicystancesee Buiter,1985), shownin Table 1. The
fiscalexpansion contributed1% of GDP in 1981, risingto a cumulative
impactof 1.5% of GDP in 1983. As a matterof comparisonthe Chirac
expansion contributed1.1% in 1975 over 1974, while the post-Bonn
summitboost amounted to 1.5% in 1978 (followedby a reductionof
2.8% between 1978 and 1980!).
2.3.2. Monetarypolicy. Monetary policy was mainly accommodating. The
sharp increase in interestrates shown in Figure 1 may be misleading
in this respect,because of the French practiceof creditceilings:each
yeareach bank is givena maximumallowed growthrate foritsvolume
of creditoutstanding.These ceilingswere moderatelyraised in June
1981 and graduallybroughtback down in 1982. Interestrates do not
clear the marketfor credit,but ratherare directedby the Banque de
France withan eye set towardeitherinvestmentand public borrowing
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The economicconsequences
ofPresidentMitterrand
271
conditions,or the foreignexchange market,depending on the prevailing circumstances.In 1981-83 themainconsiderationwas the perceived
need to protectthe Franc. Consequently,the 24 hour interbankrate
jumped from 10.9% in February 1981 to 18.9% in June, to decline
thereaftertoward 15% by end 1982. In the event, capital controls
preventedan even steeper rise in interestrates in face of an intense
speculation.This is shown in Figure 1 as the London Eurofrancrate
whichis an indicationofthe levelcompatiblewiththe expected depreciation (and temporarilyfallsaftereach EMS realignment).Yet all this
as the M2 target(10%) was overrun
does not signalmonetarystringency
to
an
in 1981 (11.4%), leading
upward adjustmentof the reference
trendfor1982. This overrunin factdid notcorrespondto anyexpansion
of credit to the private sector,but rather to direct financingof the
governmentborrowingrequirement(one thirdof the deficitfor 1981
was money financed).
2.3.3. Labour market.Mitterrand'selection was perceived by the trade
unions as a momentouschange. The pledge to fightunemployment,
togetherwith a host of specificpromises to redistributeincome and
strengthenthe hands of trade unions enshrined in the 'Programme
Commun', were perceived as the beginningof a new era, akin to the
historictransformationsachieved during the short tenure of Leon
Blum at the head of the Front Populaire in 1936-37. Nationalization
and the new tax on wealth were preciselydesigned to symbolizethe
shiftof power.While itis hard to assess the macroeconomicsignificance
of some of these changes, we shall emphasise the effectsof three
particularmeasures concerningthe labour market.
The minimumwage: In 1981 a view commonlyheld in France, and
incorporated in some macroeconometric models, was that an
autonomous increase in real wages has an expansionaryeffect.The
usual mechanismis a transferfromfirmsto groupswitha highmarginal
propensityto consume, increasingprivateconsumptionwhich,via the
familiarmultiplier-accelerator
mechanism,generatesmore investment
in
of
the
spending spite
profitsqueeze. The adverse effectof the profit
squeeze on outputand investment
spendingis delayedand is dominated
in the interimby a reductionof unused capacity.2The sharp increases
in the minimumwage (the SMIC) were thus expected to fulfilltwo
and higheremployment.The
major objectives;income redistribution
SMIC was raised by 10% in nominal termsin June 1981, followedby
I
2
1
This resultwas commonin 1981 models likeMETRIC but seemsto have been modifiedrecently.
Sterdyniaketal. (1984) reportthatin the OFCE model investmentspending fallsimmediately,
but total spending increasesfortwo years,followedby a severe recession.
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272
Sachsand CharlesWyplosz
Jeffrey
severalsmallerincrements.It rose bya cumulated38.9% over 1981-82,
and in real termsby 11.4% between April 1981 and July1982. The
number of workersreceivingthe SMIC doubled to about 8% of the
labour force (Bourit, Hernu and Perrot, 1982). Overall, the average
real hourlywage rate increased by 5.2% during the same period.
The Auroux Laws: Several measures were aimed at changing the
relationshipbetweenemployersand trade unions. The best knownof
themconstitutedthe 'Lois Auroux', a seriesof new laws whichcodified
and often enlarged the statutoryrole of trade unions. These laws,
named after the Minister of Labour, Jean Auroux, provide union
leaders with increased protectionagainst disciplinarymeasures and
establishthe rightof workersat the shop floorand factorylevels to be
involved in productionorganizationchoices. They also require wage
eliminating
negotiationswithtradeunionsat leastonce a year,effectively
the scope for non-union wage settlements.Despite the fact that less
than 20% of the labour forceformallybelong to a union, most of it is
de factounionized, forexample because in manylow-paid,non-union
sectorswages are set close to the minimumwage level, which in turn
is set by the governmentafterconsultationwiththe unions.
Other labour measurescontinuedthe trendof the seventiesin reducing the abilityof employersto dismissredundantworkersor to resort
to part-timeand temporaryemployment.Since 1975 collectivedismissals must be submittedto administrativeapproval. Such approval,
althoughusually granted,may be, and was, routinelydelayed.
Shorterhours and longer holidays: Two decisionswere designed to
reduce the lengthof workingtime. The firstextended the lengthof
mandatorypaid vacations from 4 to 5 weeks per year. The second
reduced the 'legal' workweekfrom40 to 39 hours as of January1982,
and was meantto be a firststeptowardsa 35 hour weekto be established
by 1985.3 The legal workweekis the number of weeklyhours beyond
whichworkersmustbe offeredovertimerates,whichincrease steeply.
The actual systemis quite complicatedand need not be explained in
detail. It is enough to note that average hours per year declined by
more than 3% between 1981 and 1983.
Aftera major debate, Mitterrandexpressed publiclyhis desire to see
thatmonthlypay remainunaffectedby the reductionof the workweek.
Estimatesreported by Marchand, Rault and Turpin, (1983), indicate
that such was indeed the outcome for the overwhelmingmajorityof
cases. Consequently,real hourlysalariesrose quite sharplyin 1982: the
3 These decisionswere also a
powerfulsymbolicgesture,echoingthe introductionof the 40 hour
workweekand paid vacations in 1936 by Leon Blum, considered by many people to be his
major achievement.
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Mitterrand
The economicconsequences
ofPresident
273
additional vacationweek raised them by about 2%, withanother 2.5%
correspondingto the reduced workweek.
2.4. The nationalizationprogramme
Since the signingof the 'ProgrammeCommun' in 1972, nationalization
had been a major commitmentforMitterrand.The argumentsbehind
this programme reached deep into the social historyof France, and
there was littleroom in 1981 for questioningthe principlesinvolved:
the governmentfelt the need to control directlysensitiveparts of
the economy (bankingsector,high-technology,
naturalmonopolies) in
order to guaranteemore growthand greaterequity.Debate concerned
only the size of the programme.
The final decision was half-waybetween the maximalistproject of
the CommunistPartyand the shorterlistof the Socialists'rightwing.
It involved 12 industrialfirms,36 banks and 2 financialcorporations.
As of May 1981, industrialstate-ownedcompanies representedabout
5% of GDP, withthe share risingto about 8% afterthe new nationalization measures. The newly nationalized industrialgroups employed
some 550,000 workers,2.6% of the work force. By 1981, the publicly
owned banks already received60% of all deposits.New nationalization
took this share to almost 90%. When it is recognized that the largest
insurance companies and a host of financialinstitutionswere already
in the public sector,virtuallythe whole financialsectoris now directly
controlledby the government.
The question of interesthere is the macroeconomic
impactof nationalization. This would require a difficult
analysis,beyond the scope of
this article.We limitourselvesto remarksabout the conditionsunder
whichthe macroeconomiceffectsare likelyto be significant.
First,the governmentmay intend to use the nationalized sectorto
achieve macroeconomictargets.While jobs were created in 1981-82 in
the governmentadministration,
nothingmuchwas evidentin the public
industrialsector.At most,lay-offs
were postponed.But since 1983 there
have been deep cuts in the steel industry,the automobile sector
(Renault), and several other newlynationalizedcorporations.
Second, the governmentmay change the allocation of resources,
drawingfundstowardstate-ownedcorporations.It is truethatbetween
1981 and 1983 subsidies to the public sector rose markedly,but this
trendhas now been reversed.By 1984, mostof the newlynationalized
firmshave seen theirsubsidiesfallor disappear and have restoredtheir
financialequilibrium.
Third, the governmentmaynow be temptedto alteritstrade policies
to protectthe public corporationssince, while before 1981 the output
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274
Sachs and CharlesWyplosz
Jeffrey
of the public sectorwas largelyinternationally
nontradable(electricity,
railroad,telephoneand postalservices),all the newlynationalizedfirms
tradable sector.Casual evidence suggests
belong to the internationally
that France has always protectedits corporations,public or private,
whenitwas deemed necessary.The governmenthas mainlyencouraged
a wave of mergers (the so-called restructuring),
all motivatedby the
of
international
As
noted
pressure
competition.
by Stoffaes(1985), this
is likelyto be the major impactof nationalization,and we tentatively
conclude that nationalization has probably not had major
macroeconomiceffects.
2.5. The outcome
The evolutionof the French economyduring 1981-83 certainlyfailed
to conformto the Government'sexpectations.The officialforecastsfor
1982 and 1983 announced a rate of growthof real GDP of 3.1 and 2%
whiletheactual resultswere 1.8 and 0.7%. For the inflation
respectively,
the
forecasts
of 13.4 and 8.2% mustbe compared withthe realized
rate,
values of 12.6 and 9.5%. Unemploymentdid not fall,and the Franc
was buffetedby several crises. This sequence of setbackshas deeply
impressedobserversof the Frencheconomy,to the pointof frequently
overshadowingthe subsequent economic accomplishments.Yet the
episode of expansionarypolicieswas relativelyshortlived,and a complete explanation of what went wrong does not seem to have been
offered.Before turningin the nextsectionto an analysisof thisperiod,
we firstpresentthe main factsand show how a successionof foreign
exchange crisesbroughtabout a complete policyreversal.
Unlike other large OECD countrieswhichsufferedtwoyearsof real
GDP reductionin theearlyeighties(Table 1), FrenchGDP neveractually
fell. On the other hand, inflation,which had remained stubbornly
around 10%, startedto rise in 1980 afterthe oil shock and increased
again in 1982, while most other industrialcountrieswere achieving
significantreductions(see Table 1).
To characterizethe employmentsituation,Table 3 separates the
competitivesectorfromthe shelteredsector.The latterincludes those
industrieswhich are not subjected to marketforcesbecause theyare
dominated by state-ownedmonopolies. We furtherseparate out the
competitivesectorinto its tradable and non-tradablecomponents(for
details see the notes on Table 3).
Total employment,measured by the number of employed workers,
had been practicallystagnantsince the early seventiesand declined
marginallyafter1980, hence the steadyincreasein the unemployment
rate given a trend growthof 0.7% in the labour force.The stabilityof
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The economicconsequences
Mitterrand
ofPresident
275
Table 3. Indices of employment(E) and manhours (MH) (1980 = 100)
1973
1979
1981
1982
1983
1984
Competitivesector: E
MH
100.1
108.5
100.2
100.2
98.8
96.8
98.1
93.7
96.7
91.4
95.0
88.9
tradable
E
MH
111.0
125.0
101.6
103.2
98.8
95.7
95.0
91.6
92.9
87.8
90.4
84.7
nontradable
E
MH
90.7
95.6
99.0
97.8
100.5
97.6
100.8
95.5
100.0
94.3
99.0
92.5
Shelteredsector:
E
92.3
99.1
101.1
103.3
105.1
106.1
Total
E
MH
97.9
101.5
99.9
98.5
99.4
100.8
99.6
98.3
99.1
97.7
98.1
98.0
Source:INSEE: Rapportsur les Comptesde La Nation.
Notes:tradables (those sectorswhere exportsplus importsat least 5% of value added;
agriculture,manufacturing);nontradables:construction,retailand wholesale services;
financial.
sheltered:energy,transport,telecommunications,
total employment,in France as in most other European countries,
conceals the divergentevolution of a declining traded sector and a
growingnon-tradedsector.Overall employmentwas maintainedclose
to its 1980 level largelyas the resultof an increase in the number of
workersin the shelteredand governmentsectors.In conclusion,while
the expansionarymeasuresmayhave insulatedFrance fromthe worldwide recession in 1982, they certainlyfailed to deliver the expected
increase in employment.
The new governmentwas also confrontedwith several speculative
attackson the Franc. The firstone actually started in the last days
beforethe electionand swelledimmediatelythereafter,promptingthe
centralbank to interveneheavilyand to raise interestrates. Minister
of Economic AffairsJacques Delors wanted an immediatedevaluation
whilethe President'sotheradvisersdid not wantto give an impression
of weaknessin the face of speculativeattacks.The latterviewprevailed,
leavingFrance withan overvaluedexchange rate,thatbecame increasinglyso as inflationedged upward while abating abroad. The current
account deficitworsened,lending strengthto the beliefthata devaluationwithintheEMS could notbe avoided. And theFrancwas devalued,
not once but three times.
The firstdevaluationoccurredin October 1981. Aftersix monthsof
continuingpressure,the CentralBank had exhaustedmostofitsoptions
of capital controls,and heavyuse of
(high interestrates,strengthening
the foreignexchange reserves).The officialviewwas thatthe exchange
rate devaluation representeda technicaladjustmentpromptedby the
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276
Sachs and CharlesWyplosz
Jeffrey
legacy of a high inflationrate and a wave of unfriendlyscepticismon
the financialmarkets.
Paradoxically,the devaluationstrengthenedthe hand of the leftwing
withinthe Government.It was, they said, a proof that 'new' policies
could not be successfulwithinan economydominatedby the iron law
of markets.More control, not less, was required. The Government
pressed ahead withthe implementationof the ProgrammeCommun.
To manyobservers,France had embarkedon a path thatwould eventually lead it towards more controls,more dirigismand a break-away
fromthe EMS and EEC. Givensuchexpectations,theexchangemarkets
remained sceptical.By March 1982, the pressurebuiltup once again,
interestrates were raised and capital outflowsswelled to new heights.
In June 1982, Mitterrandwas hostingthe Chiefsof Stateforthe annual
summitmeetingin the magnificent'grandeur' of Versailles,while the
Banque de France was depletingits reserves.Immediatelythereafter,
the Franc was devalued by 10% vis-a-visthe DM. This time,the devaluationwas accompaniedbystabilizationmeasures.First,pricesand wages
were frozenuntilOctober 1982. Second, new taxeswere raised through
higher social securitycontributions.Third, the budget deficitwas
targettedat a level not to exceed 3% of GDP. Fourth, some public
expenditureswere delayed untilfurthernotice.
For the firsttime,the word 'austerity'surfaced,suggestingan end
to the expansionaryphase of the previous year, and a returnto the
rulesof the game of the EMS. Thejoint freezeof bothpricesand wages,
for the firsttime since 1958, signalled a decisive shifttowards more
controls.In viewof thiscombinationof policies,it was unclear whether
the Socialistswould abandon theirmacroeconomicpoliciesand return
to Barre's medicine, or would go furtherin restrictingthe market
economy,eventuallyleavingthe EMS. The answercame in March 1983
when, aftera furtherexchange rate crisis,the Franc was devalued by
8% vis-a-visthe DM.
The external constrainthad forced Mitterrandto make a political
decision he would rather have avoided. For Industry Minister
Chevenementand his left-wingbackers,the only solutionwas to leave
the EMS, abandon austerityand expand byincreasingpublicspending,
especiallythroughthe enlarged public sector.The externalconstraint
would be taken care of by protectionistmeasures, and if need be, a
temporarysuspensionof EEC agreements.For Finance and Economics
MinisterDelors and the more market-oriented
wing,the externalconstraintrequired a strengtheningof the austeritymeasures phased in
since the previous devaluation, while leaving the EMS would only
worsen the situation. The President, after wavering, finallychose
to shifttowards more restraintat home. This was the end of the
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The economicconsequences
Mitterrand
ofPresident
277
short-livedexpansionaryprogramme,alreadyshakenafterthe previous
devaluationofJune1982. Hereafter,theSocialistswould pursuepolicies
which looked a lot more like those of Barre than those they had
advocated during the campaign. Chevenement left the Ministryof
Industryand the Cabinet, and was replaced by Fabius, while Delors'
responsibilitieswere enlarged.
3. Anatomyof a policy failure
It took the Mitterrandgovernmentno more than two yearsto reverse
its expansionarypolicy stance,only about a year if one notes that by
June 1982 fiscalexpansion was already being cut back markedly.It is
now officialdoctrinein the Socialistpartythat'we have learned a lesson'.
Yet itis not clear whathas been learned. One interpretation,
articulated
Fonteneau
and
Muet
is
that
the
main
was
the delay
(1983)
by
problem
in the world recovery.In this view France was sufferingonly from
insufficient
aggregate demand. Accordingly,an expansion was warrantedin 1981, and could have been sustainedwithoutmajor external
deficitshad the worldrecoverymaterializedthatyear,as mostforecasts
then predicted.
Another possibility,which we stronglyendorse below, is that the
various early measures affectingthe labour marketsand the taxes on
corporations furtherworsened supply-side conditions which were
alreadyunfavourableby 1981. Several studies(Bruno and Sachs, 1985,
Bruno, 1986,Artus,1984), have previouslysuggestedthatan expansionary policywould largelyfail to generate more employmentand more
output,or would do so onlyat the costof higherinflation.But we would
stillhave to account for the sharp slowdown in investmentspending
and the sheer size of capital outflows.Could it be, then,thatthe mere
electionof a Socialistgovernmentcommittedto sweepingsocial changes
and income redistribution,prompted a crisis of confidence among
investors,forcingthe Franc down and provokinga deep slump on the
stockmarket?
This sectionpresentsan attemptat disentanglingthe threeexplanations.Theyare not mutuallyexclusive,and all carrysome explanatory
power. Each of them,though,has different
implicationsregardingthe
evaluationof the post-1983policiesand, more importantly,
the outlook
for France as of 1986.
3.1. Can demand factorsexplain everything?
One importantinterpretationof the failureof the 1981-82 expansion
is thatthe world recessionof 1982 overwhelmedthe domesticdemand
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Sachs and CharlesWyplosz
Jeffrey
278
stimulusin France. Such a view has received widespread expression
both in France (Fonteneau and Muet, 1983, Muet, 1985, Beudaert,
1983) and abroad (WorldFinancial Markets,1983). There is certainly
muchmeritto thisview.As we showbelow,thesize ofthecontractionary
impulsecoming fromabroad in 1981 and 1982 was a large proportion
of the size of the direct demand stimulusfromfiscalpolicy. If world
demand had recoveredin 1982, ratherthancontractingsharply,French
growthwould probablyhave been significantly
higher,and the external
deficitwould have been reduced.
But this would not have been the end of the story.Higher growth
would almost surelyhave produced an even fasterupturnin inflation
than in fact occurred, and the real appreciation of the Franc would
have been even more severe. Accordingto our estimatesFrance's 7%
thresholdat that
unemploymentin 1981 representedthe inflationary
time.A lower unemploymentrate could certainlyhave been sustained,
accelerationof inflation.
but only at the cost of a significant
The Mitterrandexpansion did have a temporaryeffectin boosting
growthin the French economyin 1981. A comparisonof France and
Germanyprovidesa good illustrationof thispoint.Based on the structuralbudget deficitfiguresof Table 1, the shiftof fiscalpolicybetween
1980 and 1983 amountsto a contractionof 2.8% of GDP in Germany,
and an expansion of 1.5% of GDP in France. Over 1981-83, the rise
in unemploymentin France is a moderate 1.9%, as compared with5%
in Germany,and 4.2% in the EEC as a whole. By buckingthe trendof
fiscalcontractionin the rest of the OECD, the Socialist government
clearlyboughtsome moderationin theupwardtrendin unemployment,
at least temporarily,but by less than had been expected in 1981.
To gauge the effectsof the world recessionon France, we consider
the change in the size of the export market in which France was
competing. Export volume growthfor the industrialcountries as a
whole slowed down quicklyafter1980, actuallydecreasingby 1.7% in
1982. Given the previoustrend,we estimatea shortfallof exportsdue
to the world recession of 4.5% in 1982, and another 0.4% in 1983.4
The elasticityof demand for French goods withrespectto the overall
marketforindustrialcountryexportsis approximately1.0. Thus, as a
rough approximation,we can argue thatFrenchexportswere reduced
by approximately4.5% in 1982 because of the world recession.Since
French exports of goods and non-factorserviceswere about 20% of
GDP in the early 1980s, the first-roundcontractionaryeffectof the
i
4
1
Estimatebased on authors' regressions,and is similarto the 5.2% reductionin foreigndemand
estimatedby Fonteneau and Muet (1983).
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The economicconsequences
Mitterrand
ofPresident
279
reduced exports(i.e. before any demand multiplieris considered) was
approximately0.9% of GDP in 1982. This is more than half of the
increase in the structuralbudget deficitin 1981 and 1982.
In this sense, the assertionthat the demand stimuluswas sharply
curtailed by the world recession is probablycorrect.This conclusion
underscores the relativelysmall amount of fiscal stimulusthat was
impartedin 1981 and 1982, as well as the severityof the global downturn.However, the world recessionwas not the only limitingfactorin
successfullyreducing unemployment.For we should ask what would
have happened to French inflation,and to the pressureon the Franc,
in the event of a larger net expansion domestically.The inflation
equations of the next sectionare emphaticon a key point: France was
already at the inflationarythresholdlevel of unemploymentin 1981.
Withmore expansion, inflationwould have had no place to go but up!
It is importantto stressthat the rebound in inflationin France in
1982 was home made, rather than imported by the devaluations of
1981 and 1982. Import prices rose at the same rate as domesticprices
in 1982 (12.2% forimportpricesand 12.6% forthe GDP deflator).This
is not surprisingin thatthe devaluationsdid littlemore than keep the
Franc depreciating at a rate equal to the inflationdifferentialwith
France's EMS tradingpartners.Thus, withno world recession,there
is littlecase for arguing that importprice inflationwould have been
sharplylower.
It is sometimesargued that even withhigher,and rising,inflation,
the policy would have been sustainable in the absence of a world
recession, since the external balance would have been substantially
improved.On the firstround, exportswould have risenby about 0.9%
of GDP, with the ultimatecurrentaccount improved by a somewhat
smaller amount (after second-round induced importsare accounted
for). Thus, the currentaccount deficitmighthave deterioratedfrom
about 0.8% of GDP in 1981 to perhaps 1.7% of GDP in 1982, rather
than the 2.2% level thatwas actuallyreached. Nonetheless,the current
account positionwould stillhave been adverse (as should be expected
afterany fiscalexpansion).
Furthermore,the currentaccount is not the only channel through
whichthe externalconstraintis felt.All threerealignmentswhich,taken
together,led to a 32.2% devaluationof the Franc vis-a-visthe Deutschmark,followedintensespeculativerunswhichall but depleted France's
non-goldforeignexchange reserves.As can be seen fromTable 4 much
of the action in 1981 took place throughthe capital account: between
the firstand the second subperiod,the overallbalance worsensby 2.1%
of GDP, of whichonly 0.4% is attributableto the currentaccount. As
for 1982, the dramaticimprovementin the capital account is largely
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Sachs and CharlesWyplosz
Jeffrey
280
Table 4. Selected items in the balance of payments:quarterlyaverages
(% of GDP)
CurrentAccount
Long-Term Capital
Short-TermPrivateCapital
Errorsand Omissions
Overall Balance
Short-termPublic Capital
1980Q1-1981Q1
1981Q2-1982Q2
1982Q3-1983Q1
1983Q2-1985Q1
-0.8
-0.3
0.6
0.2
-0.3
-1.1
-1.2
-0.5
-0.2
-0.4
-2.4
2.9
-2.6
1.5
-0.0
-0.1
-1.3
0.4
-0.3
0.5
-0.1
0.2
0.3
-1.0
Source: Banque de France, BulletinTrimestriel.
Note: The ShortTerm Capital Accountexcludes the BankingSectorwhichis included
in the Overall Balance. All data are on a quarterlybasis and the ratiosare averaged
over each subperiod.
explainedbytheincreasinguse ofthetimehonouredpracticeofinstructing publicly owned corporations to borrow abroad ('emprunts
encourages') as an indirectmeans of interveningon exchange markets.
The currentaccount,therefore,is onlya partialmeasureofthe external
constraint.Even withoutthe 1982 world recession,the Franc would
almostsurelyhave been under stress.
3.2. The supply side
While mostEuropean countrieswentthrougha period of slow growth
and regularlydeclining inflationin 1982 and 1983, consumer price
inflationbegan to risein mid-1981and remainedstronguntilmid-1982
when most prices were frozen. We have already noted that foreign
pricesand the exchange rate depreciationscannot be held responsible
forthisdevelopment.Rather,7% unemploymentrepresenteda 'tight'
labour market in 1981, offeringlittle scope for noninflationary
expansion. A NAIRU of 7% was of course extraordinary,given the
much lower average employmentrates of the 1960s and 1970s, and
few analystsshowed any awarenessof how tightthe situationwas.
The evidence rejects the key element of simple demand-centred
policyanalyses:theassumptionofa constantNAIRU. WhentheNAIRU
can change overtime,movementsofactualunemploymentratesrelative
to theirhistoricalaverages providelittledirectevidence as to whether
a demand expansion is warrantedor is likelyto be inflationary.As
voluminousrecentresearchhas shown,the scope fordemand expansion
can be determinedonlyaftera carefulanalysisof supplyconditionsin
the economy.This analysisis unfortunately
hampered by the absence
of an agreed framework.
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The economicconsequences
Mitterrand
ofPresident
Real
takehome
pay (W)
281
S
--
--
-\
L
I
I
Lu
Lu
F F
L
Employment(L)
Figure 2. The labour market
Our approach makes the NAIRU the cornerstoneof the analysisof
supplybehaviour. In doing so we seek to answer the question: what is
the lowest unemploymentrate that can be sustained in the medium
and long-termwithoutproducinga continuouslyrisinginflationrate?
Thus the NAIRU is not a barrierabove whicha fiscalexpansion will
not raise output or lower unemployment;it is only a barriervis-a-vis
the long-run sustainabilityof a demand expansion. In the short-run
unemploymentmay fall below the NAIRU, but ultimatelyonly at the
cost of risinginflation.Our model of supply behaviour is compatible
witha varietyof storiesabout short-runbehaviour. In particularit is
quite consistentwithan approach that has been especiallypopular in
France which treatswages and prices as fixed in the short run and
admits rationingin goods and/orlabour markets(see Artus,Laroque
and Michel, 1984; Lambert,Lubrano and Sneessens, 1984; Bouissou,
Laffontand Vuong, 1984; Malinvaud, 1986). Such models address the
different
question of whethera demand expansion would be successful
at reducing unemploymentin the shortrun irrespectiveof any effect
on inflation.
Figure 2 depicts a simple diagram of the labour market. Firms'
demand for labour will,for a given capital stock,be lower the higher
is the real cost of labour. However the real cost of labour differsfrom
real take-homepay of workers(W) for three reasons. First,whereas
workersdeflatenominalwages by consumer
prices,firmscare about the
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282
Sachs and CharlesWyplosz
Jeffrey
level of wages relativeto the productprice. Second technicalprogress
which increases the productivityof labour for a given capital stock
reducesthe effective
costof labourand increasesthe demand forlabour
even whentake-homepayis unchanged.Finallyemployerand employee
taxes drive an additional wedge between take home pay and labour
costs. Figure 2 shows a labour demand curve DD for given levels of
capital,technicalknowledge,taxes, etc. An increase in taxes, or lower
level of capital or technicalproductivity
would reduce the demand for
labour at any given level of take-homepay, shiftingthe curve to D'D'.
Econometricevidence suggests,at least for primarywage-earners,
that real take-homepay has littleeffecton labour-forceparticipation.
Hence we draw a verticallabour supply schedule at L in Figure 2. A
major theme of our discussion,however,is that if wages are set by
unions, ratherthan by competitivelabour markets,the union 'supply'
schedule mightin factbe quite elastic5.In fact,one importantspecial
case derived in Appendix B showsthata rationalunion mightchoose
to fixthe level of real take-homepay at a level such as Wu,no matter
what the implicationsare for the employmentlevel. In other words,
the union 'supply' schedule would be perfectlyelasticat the wage level
Wu,as shown in Figure 2.
Now letus considersome alternativescenarios.Beginningwithlabour
demand DD, fullemploymentin a competitivelabour marketis at point
F, withreal take-homepay W and employmentL.
Now suppose instead thatthe labour marketis fullyunionized,with
unions demanding real take-home pay level Wu. The union-based
equilibriumwillbe at the point U.
Unemploymentis given as L- L", and the (proportional)deviation
of the actual union wage Wu fromthe level warrantedby fullemploymentis (Wu - W)/W. This deviationof the actual fromthe warranted
wage is called the wagegap.
Suppose now thatpayrolltaxes are raised, so thatthe demand curve
shiftsto D'D'. The full-employment
wage fallsto W'. The new equilibrium is given by U' in Figure 2, with employmentLu and real
take-homepay fixedat W". Note thatthe verticalshiftof the demand
curve, and hence the increase in the wage gap equals the amount of
the tax increase.
In this union-based theoryof the NAIRU, the 'equilibrium'rate of
unemploymentdepends on the size of the wage gap and the slope of
the labour demand curve. (Obviously,this formulationabstractsfrom
5Although,as a monopolisticsupplierof labour,the union does not have a supplyschedule that
is independent of demand, it is expositionallyconvenientto maintainthis fiction.A rigorous
analysisis given in Appendix B.
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Mitterrand
The economicconsequences
ofPresident
283
purely frictionalcomponentsof the NAIRU, say due to job turnover
or search; we assume thatsuch frictionalcomponentsare constant,for
reasons that we outline below.) When the demand curve is DD the
NAIRU is then determinedas U* = L-L".
Factorswhichshiftthe labour forceL, the demand curve DD, or the
targetwage Wu shiftthe NAIRU. Primecandidatesforsuchshiftfactors
include the wedge, the capital stock,and the stateof technicalknowor a
ledge. A fall in the capital stock,a fall in technicalproductivity,
rise in the wedge would both raise the NAIRU and raise the wage gap.
Our empiricaldiscussionthatfollowsexamines these presumptions.
In our interpretationof the Phillips curve, we assume that union
wage-settersgradually reach their target employmentlevel LU and
targetreal wage level WU. In particular,we assume thatunions increase
theirreal wage demands wheneveractual employmentL exceeds their
targetlevel Lu, and lower theirdemands when L is less than LU. We
thereforespecifythe nominalwage change 7rwas a functionof expected
or lagged inflation r-1,and the deviationof the unemploymentrate
fromthe NAIRU, U-U*:
w = a(U-
U*)+
r_-
(1)
Price inflation r7 is closely related to wage inflation mwand the
precedingdiscussionof whatdeterminesthe NAIRU, U*, coupled with
our hypothesisabout how unions gradually adjust actual wages and
employmentto targetlevels, allows us to derive (in Appendix B) the
empirical Phillips curve which forms the basis of our econometric
estimatesin the next section.
The key noveltyin thisapproach is thatthe model underscoresthe
factorsthat shiftthe NAIRU, and in turn cause shiftsin the Phillips
curve. Variables that shiftthe NAIRU should also shiftthe wage gap.
Thus, in examiningthe evidence for the 1970s and 1980s, we expect
to findthatboth the wage gaps and the NAIRU have risen in France.
Indeed we findstrongevidence forboth of these trendsafter 1973.
3.2.1. Wage gaps. Wage gaps have been calculated forFrance's manufacturing sector by Bruno and Sachs (1985), Artus (1984) and Bruno
to obtainas theyrequire,in principle,
(1986). Such measuresare difficult
theestimationof productionfunctions,fromwhichto deduce the slopes
of labour demand schedules. Our intentionhere is to update previous
estimatesand to measure wage gaps forsectorsotherthan manufacturing, as the manufacturingsector represents a small, and secularly
declining,portion of France's output (22% in value added terms in
1984, down from26% in 1963).
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Jeffrey
284
Table 5. Wage gaps (% of labour costs, base years 1976-78)
Manufacturing
1976-78
1980
1981
1982
1983
1984
0
1-7
4-9
3-9
4-12
6-17
Building and
Construction
Retail and
Wholesale Trade
0
1-5
3-7
2-8
2-9
2-10
0
1-5
0-6
0-10
2-12
4-14
Notes: For details of constructionsee Appendix A. Range of estimates
assume an elasticityof substitutionof between 1/2 and 1 and allow for
eitherHarrod or Hicks-neutraltechnicalprogress.The base years correspond to an average unemploymentrate of 5%.
Contraryto the other worksmentioned,we do not use econometric
estimatesto measure the wage gap. Ratherwe specifyalternativeparametersof an assumed productionfunction,and finda resultingrange
of estimatesforthe gap. The procedureis fullypresentedin Appendix
A and only brieflyexplained here. First,by observingvalue added,
factorinputsand factorshares,we directlymeasure the rateof technoto be labouraugmenting,
logicalchange (whichis assumed,alternatively,
or both capital and labour augmenting).The production functionis
then fully characterizedby assumingthe elasticityof substitutionand
measuringthe labour share in the base period. The derived labour
demand is then computed (this is the DD curve in Figure 2) which
allows us to findthe warrantedreal labour cost,i.e. the level at which
firmswould hire the amount of labour correspondingto fullemployment.A baselineof sectoralfullemployment,in turn,is estimatedgiven
an aggregate full employmentlevel and the trend in inter-sectoral
employmentshifts.
We presentin Table 5 a range of estimatesforthe wage gaps in three
sectors: the manufacturingsector, the building and construction
industry,and retailand wholesaletrade. The range of estimatescorresponds to the extremevalues obtainedallowingthe slope of the labour
demand curve to varywithinreasonable bounds and forboth general
and labour-augmentingtechnologicalprogress.In all cases, the chosen
base period (definedas 'fullemployment')is 1976-78 when unemploymentaveraged 5%.
These numbersare meantto answerthe followingquestion: by how
much should labour costsbe reduced in a given sectorand in a given
year to prompta demand for labour correspondingto an overall 5%
unemploymentrate? The table shows large numbers (around 10%),
with some differencesacross sectors. These numbers do not differ
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Mitterrand
The economicconsequences
ofPresident
285
markedlyfromthose computedforthe manufacturingsectorby Artus,
Bruno and Sachs.
3.2.2.The NAIRU. In view of the traditionallink of the NAIRU with
'frictional'unemployment,it mightseem fruitfulto tryto explain its
rise withvariablesthat mightshiftthe frictionalrate. Such candidates
include: demographicshiftsin the labour force,such as a risingproportion of young workers,who have historicallyhad high rates of unemploymenteven when the aggregateunemploymentrate has been low;
job mismatch,as evidencedbya shiftin therelationshipbetweenvacancy
and unemploymentrates; regional and industrialmismatch,as evidenced byan unusual rateof structuralchange or compositionalchange
in the labour force.A large numberof studieshave triedto trackdown
these possible culprits,and the resultshave been disappointing(see
Layard etal., 1984, and the recentcountrystudiespresentedat an LSE
conferenceon the Rise in Unemploymentincludinga studyon France
by Malinvaud).
The inabilityof standard frictionalvariablesto account formuch of
the increase in the NAIRU in Europe has led us to emphasize explanationsdrawingdirectlyon themodel ofthefirm-union
bargaindeveloped
in the previous section,and formallyset out in Appendix B. Thus we
expect the NAIRU to increasewhen the unions' targetwage increases,
when productivitygrowthslows,and when the wedge increases.
In this section,we verifythat such a mechanismhas been at work.
Recent studies have shown thatFrance, like mostEuropean countries,
has suffereda rise in the NAIRU in the 1970s and 1980s (See Grubb,
Layard and Symons 1984, Grubb, Jackmanand Layard, 1982, 1983,
Layard etal., 1984, Coe and Gagliardi,1985). The significant
European
exceptionsappear to be Italy and Austria,and the remainingnotable
exception in the OECD is the United States.6
To estimate these effectswe use an equation which generalizes
Equation (1). The NAIRU depends on the wedge x, technicalproductivity(/, and the targetwage W'. We cannot gather data directlyon
the targetwage, and we adopt the simple device of proxyingit witha
time trend t. The wedge (the differencebetween real take-homepay
and real labour cost to the firm)depends on labour taxes and on any
I
I
6
The followingestimatesof the NAIRU are taken fromCoe and Gagliardi:
1967-70
1981-83
Germany
France
UK
Italy
Austria
Netherlands
US
0.7
3.6
2.2
7.7
2.1
9.4
7.5
5.4
1.1
2.4
3.0
8.7
5.4
6.1
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286
Sachs and CharlesWyplosz
Jeffrey
Table 6. The Phillips curve (Dependent variable: change in inflationrate, AwT,
annual data, 1963-84)
Variable
constant
unemployment(u)
lagged change in relative
importprices (A(pm-p)_1)
minus wedge
productivity
(4 - x)
lagged change in inflation
rate (Air-)
lagged error (e1)
timetrend (t)
dummyvariables:DV1
DV2
Standard error
(percentagepoints)
Regression1
estimated
t
coefficient statistic
Regression2
t
estimated
coefficient statistic
205.64
-4.16
(3.77)
(4.86)
251.51
-4.75
(6.69)
(8.41)
0.07
(2.33)
0.06
(2.81)
-42.57
(3.76)
-52.05
(6.67)
-0.31
(4.03)
3.23
(7.47)
2.01
(8.61)
-
-
-0.58
2.76
1.16
(3.29)
(4.27)
(2.48)
0.98
0.60
Notes: (a) p and pm denote GDP deflatorat factorprices and importprice deflator
respectively.Lower case lettersdenote logarithmsand r= 100 (p-p-_). $/ is the log
of productivity(adjusted for capital deepening) and x the log of the wedge (see
Appendix B). (b) Dummy variables are defined thus: DV1 takes the value minus
unityin 1964, 1965, 1974, 1976, and 1983, the years in which severe wage or price
controlswere in force,and otherwisetakes a zero value. DV2 additionallytakes the
value plus unityduringthe years 1963, 1973, 1975, and 1982 to capture the effectof
anticipatedtighteningof price controls.
discrepancybetweenthe pricesrelevantto firmsand to workers.Since
income tax rates change littleover our sample period, we simplifyby
omittingincome tax ratesincludingonly employerand employee payroll taxes and the ratio of importto domesticprices.
Ratherthan assume thatunions continuouslyattaintheirtargetreal
wage, we postulatesluggishadjustmentof actual to targetreal wages.
In termsof our estimatedequation, this introduceslagged values of
some variables to capture this sluggishadjustmentof actual to target
real wages. Finally,we includetwoalternativespecifications
ofa dummy
variableDV to captureperiodsin whichunusuallyseverepricecontrols
temporarilydistortedthe wage bargainingprocess.
Having examined several regression equations for 1963-84 with
annual data, we show our preferredequations in Table 6. They differ
primarilyin the definitionof the price control dummyvariable (see
Footnote (b) to Table 6). Regression(2) uses a dummyvariable which
allows anticipatedas well as contemporaneouseffectsof severe wage
and price controls and produces a better fit,though we also show
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Mitterrand
The economicconsequences
ofPresident
287
Table 7. Actual unemploymentand the estimated NAIRU (%)
Actual
NAIRU:
Equation (1)
NAIRU:
Equation (2)
1963
1973
1978
1980
1981
1982
1983
1984
1.2
2.7
5.3
6.4
7.3
8.1
8.3
9.7
1.1
2.9
5.4
6.9
7.4
7.7
8.3
8.9
1.2
2.9
5.4
6.8
7.4
7.7
8.3
9.0
estimatesfor an equation in whichthe dummyvariable only includes
contemporaneouseffects(Regression(1)). The choice of dummyvariable leads us to choose a slightlydifferent
dynamicspecificationin each
the
but
two
case,
reportedequations are verysimilarin theireconomic
implications.
Both equations show the crucial significanceof the level of productivity4fand the wedge x. In fact,it is an implicationof our theorythat
the two variablesshould have equal coefficients
but opposite signs,an
empiricalpredictionwe testedbeforecombiningthese two variablesin
Table 6. The time trend and eitherspecificationof the price controls
dummyhave the expected effect,and changes in importpricesrelative
to domestic prices also affectthe wage bargain. Other results are
we could not detecta role, jointly
reportedin Appendix C. Specifically,
or severally,forthe followingvariables:changes in the unemployment
rate,the ratio of unemploymentbenefitsto wages, the level of unemploymentbenefitsor of the minimum real wage, and the ratio of
vacancies to unemployment(a crude indicatorof mismatch).
As we explain in Appendix B, the equations of Table 6 can be solved
to derive an estimatefor the NAIRU. Essentiallythis involvesusing
theequation to determinewhatvalue of unemploymentwould generate
no change in inflation,given other variablesin the equation. Table 7
shows the values of the NAIRU thus derived. Both regressionsgive
verysimilarestimates.The NAIRU has increased steadilyover the last
15 years,withmarked jumps in 1974 and 1980-81. The moststriking
implicationof Table 7 is thatactual unemploymenthas been veryclose
to the NAIRU, at least until 1984. Our procedure cannot distinguish
betweentwo competingexplanationsof thisfinding:first,thatmarkets
adjust veryquickly,and, second, thatpolicymakers,being sensitiveto
acceleratinginflation,have chosen or been forced to adjust demand
and employmentto levels correspondingto the NAIRU.
The role of the differentfactorsin the evolutionof the NAIRU can
be considered using Regression (1). During 1964-73, productivity
growthwas strongenough to absorb both a growinglabour forceand
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Sachs and CharlesWyplosz
Jeffrey
288
Table 8. Changes in unemploymentand NAIRU
(percentage points)
Change in actual unemployment
Change in NAIRU
contributionof:
slowdown
productivity
wedge increase
others
1973-80
1981-84
+3.7
+4.0
+3.3
+2.0
+1.6
+1.3
+1.1
+0.9
+0.5
+0.6
Note: NAIRU decomposition based on Regression (1) of
Table 6.
expectationsof risinglivingstandards.Had productivity
growthduring
1974-84 remainedat the 1963-73 rate (in otherwords,5.1% per year,
ratherthan the actual 2.7%) the NAIRU would have been reduced by
2.5% in 1984 (Table 8). During the same period 1974-84, the wedge
rose from41 to 69% of net take-homepay, contributinganother 1.8%
to the overall 6.0% increasingin the NAIRU. The restis eitherunexplained or captured by the time trend. The time trend may be interpretedin severalways.Firstit picksup risingexpectationsof increased
standardsof living,so thatthetargetwage setbyunions growsirrespective of actual productivityadvances. Second, it may also representa
gradual increase in labour marketregulation.Third, there have been
severaldemographicfactorsincreasingthe labour force,includingthe
postwarbaby boom and the entryof women. Finally,there is a trend
towardsreduced workingtimethatwe discussbelow.
3.2.3. The effectsof reduced workingtime. In January 1982, two changes
were introduced:the legal workweekwas reduced from40 to 39 hours,
withan objectiveof 35 hours by 1985, and a compulsoryfifthweek of
paid vacations.As alreadynoted,hourlywage rateswere raised to leave
workers'yearlyearningsunchanged. While some reductionsin labour
taxeswere grantedon a selectivebasis (smallfirms,or large firmswhich
hired new workers),labour costs neverthelessincreased. It was the
official
viewthatreductionofworkingtimeshould lead to moreemploymentthroughwork sharing.
The argumentthat employmentmightrise has been articulatedin
the French case by Oudiz, Raoul and Sterdyniak(1979). It explicitly
recognizesthatthe desired job creationrequiresthathourlywages do
not increase and argues that the actual measues and the foreseen
reductionof the legal workweekto 35 hours would promptplant-level
reorganizationswhichshould in factreduce labour costsand raise the
overall demand for labour. This would be the case, for instance,if a
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Mitterranid
The economicconsequences
ofPresident
289
plantwere to use two shiftswhereit formerlyused one. But apart from
exceptional cases, the reductionof the workweekis likelyto produce
rathermarginalchanges in the plant level organizationof labour. It is
more plausibleto assume that,giventhe existingequipmentand lay-out
of most plants, operating less hours with more people will be more
costly,if only because if it had been in the firms'best interestto do so,
theywould not have waited for the mandatorychanges to introduce
the new system.
A formalanalysisof the issue (see Calmfors,1985; Wyplosz, 1985)
in the frameworkof the union wage model showsthatif workerscare
a lot for leisure,theywill accept a reductionin theirearned incomes
in exchange fora shorterworkweek.Their unions would thengo along
withno, or little,hourlywage increaseas itwould givefirmsan incentive
to maintaintheirdemand formanhoursand increase the chances that
work sharing occurs. If, in addition, there are no significantcosts of
producingwithmoreworkersworkingshorterhours,thenemployment
mustrise.
The evidence reported so far is that work sharingdid not occur in
France in 1982. We know thathourlywage rateswere not reduced so
thatlabour costsincreased.And thereis no evidenceof large scale plant
re-organizationwhichwould have broughtabout benefitsfromoperating with more workers.Thus the two necessaryconditionswere not
satisfied.Attemptsat measuringthe effectdirectlyconclude thatit was,
at best,verylimited.For example,Colin, Elbaum and Fonteneau (1984)
conclude that some 25,000 jobs were created in 1982, withno further
effectsthereafter.This representsabout 1.25% of the unemployed
population and 0.12% of total employment.If we consider that the
weekof paid vacationsreduced
reductionin workinghoursand thefifth
the numberof hours per workerby about 4.5% (2.5 and 2.0%, respectively),we conclude that these measures reduced the total volume of
manhoursbyabout 4%. As actual manhoursfellbyabout 2%, itappears
that these 'work sharing' measures in and by themselvesmore than
offsetthe effectsof all the other expansionarymeasures enacted in
1981-82.
3.2.4. Appraisal. This section has produced evidence that labour costs
have increased steadilyover the past 10 years,resultingin 'wage gaps'
of about 3% in 1973 to 7% in 1981. The 1981-82 expansion, coupled
with measures which furtherincreased labour costs, could not have
succeeded in creatingjobs in thecompetitivesectorin a non-inflationary
way.Withthe actual rate also around 7%, Mitterrand'selectoralpledge
to reduce unemploymentquicklycould not, in any case, be fulfilled
withoutan accelerationin prices.
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290
Sachs and CharlesWyplosz
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Our estimationof the NAIRU (Table 7) showsthata 10% reduction
in labour costs (via increased productivity
or a reductionin the wedge)
would lower the NAIRU by a littlemore than 1%. This would require
labour costs to fallby about 50% in order to reduce the NAIRU to its
1976-8 level! There is a large discrepancybetweenthe implicationsof
thewage gaps and thoseoftheNAIRU. Clearly,measurementproblems
may be part of the explanation. Yet there is another one. Given the
manylabour regulationsand the costsof alteringthe size of the labour
of demand
force,itmaybe thatin theshortrunthe firms'wage elasticity
for labour is quite small7. In this case, the Phillips curve estimates
whilethe wage gap estimatescapturethe
capturea short-runelasticity,
of
demand
to wages. Thus, we suspect that
labour
long-runresponse
the long-runfall in the NAIRU followinga rise in productivityor a
fallin the wedge is probablygreaterthan is suggestedby the estimates
of the Phillipscurve in Table 6. However,we have not yetinvestigated
the natureof union behaviourunder the assumptionthatthe long-run
labour demand elasticityexceeds its short-runvalue.
3.3. The confidence factor
No matterhow misplaced,thepolicymeasuresof 1981 wereofmoderate
magnitude.This standsin contrastwiththe verystrongreactionof the
exchange marketsto the change in governmentin 1981. We therefore
offera third hypothesisto explain whythe Socialistsfailed to sustain
theirpolicies,namelythattheyneverinspiredmuch confidenceamong
the investorsand privatecorporations,and thatwhatevergoodwillthey
may initiallyhave relied on was quicklyshattered.
To evaluate the role of thesefearsin the deteriorationon the French
situationbetweenMay 1981 and March 1983, we focuson two markets
where these expectationsare likelyto have been most powerful;the
stockmarketand the exchangemarket.Figure 3 showsa monthlyindex
of industrialshare prices deflatedby an industrialgoods price index
and theone-monthforwardexchangeratediscountoftheFrancvis-a-vis
the Deutschmark (the percentage forward discount is stated at an
annual rate). In principle,the firstvariablereflectsthe marketexpectation of futurediscountedprofits,while the second is a crude measure
I
I
7 The estimatesin Tables 6-8
suggestan elasticityof 0.1 of the NAIRU withrespectto (41-x).
Productionfunctionestimates(see Appendix B) suggesta value r/(1- SL) where r is the elasticity
of substitutionand SL (=0.66 in 1984) the share of labour in value added. Even an elasticityof
as low as 1/6would suggesta long run NAIRU elasticityof 0.5, considerablyabove
substitution
the shortrun estimategiven above.
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291
Mitterrand
The economicconsequences
ofPresident
I_ 1
discount
^QTForward
/
\
d
0
0.8 -
Source:
I
.
Data
:
0.6-
Ban&
:
.
May81
i
10
E
i March83
June82
0.4
Ill
74
llllllt
75
lll
76
77
78
79
u30
80
81
82
83
84
85
Figure 3. The real share price and the forward discount
Source: DRI Data Bank & IMF
of expected futureexchange rate depreciation(a negativevalue indicates an expected depreciation).
Three subperiods appear. In May 1981, there is a clear and sharp
fallin bothmeasuresfollowedbya hecticevolutionaround a downward
trenduntilJune 1982. Thereafterthe real share price remainsflatup
until early 1983 where it entersa thirdphase withan upward trend.
By mid 1985 it is back at its 1980 level,thoughsome 50% below itspre
oil-shocklevel of 1973. The patternof the forwarddiscountis similar,
in the intermediateperiod. The three subexcept for more voltatility
1981-85
withto the electionof Mitterrand
commence
periods during
in May 1981, the second devaluationaccompaniedbythe firstrestrictive
measures in June 1982, and the definiteturn to austerityat the time
of the thirddevaluationof March 1983.
In principle,we would liketo be able to saywhetherthe sharpchange
observed in May 1981 and untilMarch 1983 is a rationalanticipation
of whatwas to follow(indeed corporateprofitsfell,severalcorporations
were nationalized8and the Franc was devalued) or whetherit reflected
exaggeratedfears.In the firstcase, bybringingforwardfutureadverse
developments correctlyanticipated,the financialmarketsfulfillthe
paid (see Langohr and iallet, 1986).
8 Though compensationwas
Though compensationwas paid (see Langohr and Viallet, 1986).
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292
Sachs and CharlesWyplosz
Jeffrey
useful role of reducing possible misallocation of resources, both
nationallyand internationally.In the lattercase, a panic undermines
whatcould have been sensiblepolicies.Unfortunately
we are unable to
distinguishthese two views so that the objective of this section is the
more limitedone of documentingthe crisisof confidence.
3.3.1. The stockmarket.Share pricesare verymuchexpectationalvariables,
incorporatingall available informationabout future movementsin
profitsand interestrates. Changes occur mainlybecause of the arrival
of new information.In order to organize the evidence, we therefore
examine whetherquarterlychanges in this variable are explained by
changes in the factorspresumed to have an influence:monetaryand
fiscalpolicy,real interestrates,real wages (which affectprofits),and
importprices. We obtain the followingregression:
Aq = 0.03-7.21 Aw- 0.04 AB + 1.70 Am- 0.08D1 + 0.06D2
(1.43) (3.23)
(1.74)
(1.24)
(2.07)
(1.45)
(2)
Sample period, quarterly,1974Q1-1984Q1;
where t statisticsin brackets;standarderror= 0.08; DW = 1.92
Aq = quarterlygrowthin real sharepriceindex (nominalindex deflated
by index of industrialgoods' prices), Aw =quarterly growthin real
labour costs,AB = quarterlychange in public deficitas a proportionof
GDP, Am= quarterlygrowthin thereal moneystock(M2). Thus higher
real labour costs,a larger public deficit,and a lower real money stock
tend to reduce real share prices.We also include two dummyvariables
in Equation (2): D1 takes the value unityfromMitterrand'selectionto
the major policy reversalof March 1983, zero elsewhere; D2 is unity
thereafter,zero elsewhere.D1 documentsthe initialconfidencecrisis,
whilst D2 provides some evidence for a subsequent restorationof
confidence.
Thus, Mitterrand'selection had two major effectson share prices.
Firstthe directconfidenceeffectwhichalone accountsfora fall of 8%
during the initialperiod when share prices actuallyfell by some 20%
in May-June1981. Second, Equation (2) impliesthateach 1% increase
in real labour costsreduces equitypricesby 7%. Since we have argued
to real
that Mitterrand'slabour market policies added significantly
labour costs,thisreinforcedthe fall in share prices.
Nor are these effectsunimportant.Reductionsin real share prices,
by hittinginvestmentspending,mayhave weakened the initialstimulus
to aggregate demand. To investigatethis possibility,we estimatethe
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Mitterrand
The economicconsequences
ofPresident
293
followingregressionon quarterlydata from 1976Q1-1984Q4.9
i =0.24+0.02q -0.17r+0.18A4y+0.87i1
(2.72) (2.00) (1.67) (2.21) (17.31)
(3)
t statisticsin brackets;standarderror= 0.02;
where: q = (logarithmof) the real share price, i = (logarithmof) the
share of investmentin output, r=(ex post) real interestrate, 4y=
annual growthrate of corporateoutput.
This regressionconfirmsthe usual investmentequations of French
macro-modelswhich stressthe acceleratoreffectof growthand of the
real interestrate. What we add is the role of stockprices,and through
The
them, the impact of market expectations and of profitability.
the
the
effect
of
to
measure
when
simulated
40%
drop in
regression,
a
real share prices during the early Mitterrandperiod predicts fall of
0.7% in the ratio of investmentto output as compared withan actual
fallof 1.7%. These crude computationssimplyillustratethe plausibility
of the storywhichlinksadverse expectationsin financialcirclesto a fall
of stockprices,and thento a depressingeffecton investmentspending.
Ignoringthese links,as do the usual French investmentequations,led
to unpleasant surprises,as the governmentwas obviouslybettingon
theresumptionofgrowthto boostinvestmentspending.The investment
recoverynever occurred.
3.3.2. Capital flows and the EMS constraint. The other gauge of confidence
is the internationalmonetarysituation.We already noted the high
correlation between share prices and the discount on the forward
exchange rate. Capital outflowsare anotherchannelof interestbecause
theymay exacerbatethe pressurefaced by the monetaryauthoritiesas
theyattemptto maintaina given paritywithinthe EMS. In order to
assess the role of capital flight,a certainnumber of precautionsmust
be taken. First,because exchange controlsare widespread in France
(see Claassen and Wyplosz,1985) and have been strengthenedin June
1981 and furtherconsiderablytightenedfromMarch 1983 to January
1984, capital flightis observed both in the shortterm capital account
and in errorsand omissions.Second, both directlyand throughstateowned corporations,the Governmenthas been able to borrowabroad
when private outflowsswelled. This is why we show in Figure 4 the
sum of the short-termprivate capital account and the errors and
omissions,labelled the speculativecapital account.
9 Recognisingthat q is endogenous, we have re-estimatedEquation (2) using 2SLS, but obtained
practicallyidenticalestimates.
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294
Sachs and CharlesWyplosz
Jeffrey
2
Iq!,l,
!,
'
,!
SI,
-2 -
~/ V|
81:2
-4
i I I I I
80
E"s
82:2
I I I I II
81
82
I I
83
-~
Current
account
Speculativeaccount
83:1
I i I
84
II I
85
I
Figure 4. The currentaccount and the speculative capital account
Source: Banque de France
The quarterlyfigures,the only ones available, probablyunderstate
the size of outflowsimmediatelypreceding a devaluation, since the
outflowsbecome inflowsin the aftermathof the devaluation,or when
the expectationsturnout to be unwarranted.Thus, the quarterlydata
tend to smoothout larger short-term
swings.Yet, we observe massive
outflowsin 1981 untilthe firstdevaluationin October,a refluxdelayed
untilthe second devaluationofJune 1982, quicklyreversedbythe crisis
in the firstquarter of 1983 whichled to the thirdand last devaluation
in March.
As in thecase ofstockprices,capitaloutflowsand theforwarddiscount
may well have been rational anticipationsof futurecurrentaccount
or else theymighthave reflected
deficitsand devaluations,respectively,
a componentof irrationalfear.What is importantis thattheyall point
towarda significantworseningin confidence.
The role of externalpressurewas extremelyimportant,since there
is good reason to believe thatFrench commitmentsto the EMS tipped
the balance towards austerity.Unlike the much looser commitments
under the European Snake in the 1970s, whichFrance abandoned on
twooccasions,membershipoftheEMS has been investedwithenormous
politicalimportanceat the veryhighestlevels of the government.That
is whythe debate over leavingthe EMS was treatedas synonymouswith
the debate over abandoning other spheres of cooperation in Europe,
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The economicconsequences
Mitterrand
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including participationin the Common Market. Apparentlyfew participantsin the debate opted foran intermediatestrategyof continued
free trade, but witha floatingFranc outside the EMS.
Thus, the episode is an importantcase study of the possibilityof
applying international monetary agreements to restrain domestic
policies.Economistshave long debated whetherinternationalexchange
rate agreementscan reallybind national policies, since the sanctions
forbreakingagreementsare so small and diffuse.The example of the
Socialistturnaroundin March 1983 suggeststhatan internationalagreementcan help to tip the balance towardsdomesticrestraint.
Perhaps a more interestingaspect of the EMS constraintis that it
representeda way for one politicalpartyin France to bind the future
actionsof another.Afterall, Giscardtook France intothe arrangement
in 1979, but the constraintunder the arrangementreallyonlybecame
exerciseda strong
bindingunder Mitterrand.Thus, Giscard effectively
vote on French policy long afterleaving office.This form of future
control might be an argument for the Conservative Party under
Thatcher to lead the UK into EMS membership:not to bind its own
austere by itself,but ratherto bind the
behaviour,whichis sufficiently
actions of a successor government,which is likely to be far more
expansionary.
Note thatthe EMS could one day servethe interestsof the Socialists
by preventingoverlycontractionarypolicies of a right-winggovernment,since excessiveappreciationcarriesresponsibilitiesforintervention and adjustment as does excessive depreciation (of course, the
principalburden of adjustmentfallson the countrywiththe depreciating currency).
3.4. Summing-up
The Socialist spending expansion added a verymodest 1.5% of GDP
to totaldomesticdemand, and in theend, employmentdeclined outside
the non-competitive
and public sectors.We agree thatthe unexpected
world recessionin 1982 played an importantrole in underminingthe
Frenchattemptat unilateralexpansion,yetthisis onlya partialexplanation of the policy failure.Confidencewas shaken, and we found that
thisalone accountsfora fallof privateinvestmentspendingrepresenting 0.7% of GDP. Coming on top of the 0.9% of GDP lost in exports
because of the world recession,we see thattherewas never much of a
net demand stimulus.At best therefore,the monetaryand fiscalpolicy
mix of 1981-82 was enough to keep France out of the world recession.
The resultingcurrentaccount deficit,togetherwithconfidence-related
capitaloutflows,createdthe conditionsfora balance of paymentscrisis.
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In the end, Mitterrand'schoice to remainwithinthe EMS lefthimwith
no other choice than to reverse his policy stand and join France's
partnersin austerity.
The strikingelementof 1981-83, datingback to the earlyseventies,
was the simultaneousproblem of high unemploymentand continued
stronginflationary
pressures.The NAIRU had risen sharplyover the
1970s, and continuedto rise in 1981 and 1982. The high level of the
NAIRU was accompanied by large and growingwage gaps. The proximate cause of the risingNAIRU was the combinationof slow productivitygrowthin France and a continuingincrease of real labour costs,
due to higherlabour taxes, the secular growthof real take-homepay,
and cost-raising
measuressuchas theshortenedworkweek.Hence, even
withoutthe problemsinduced by a world recessionand a collapse of
confidence,Mitterrandhad littlescope in 1981 to embarkon a sustained
demand expansion withoutquicklygeneratingacceleratinginflation.
4. Socialist austerity:a success story
Hesitantlybetween June 1982 and March 1983, and more boldly
thereafter,the Socialistgovernmenthas completeda turnaroundin its
economic policies.The fightagainstunemploymentis no longerat the
forefrontof the government'sobjectives. The key words are now:
external balance, modernizationand rationalizationof the economy,
and wage moderation.By thetimeofthe March
greatercompetitiveness
1986 election,therefore,Mitterrandwillhave presided over two years
of expansionarypoliciesand threeyearsof austerity.In thissectionwe
present an overviewof these new policies and an early assessment,
concluding that the governmenthas successfullyfought inflation,
restoredthe currentaccountbalance, made some progresson the wage
front,but has not yet grasped the full importanceof the supply side.
4.1. The external balance target
The decisionto stayin the EMS meantthat,unless the currentaccount
was quicklybroughtback into balance, a new crisiswould erupt. Such
an objective was stated explicitlyby Mitterrand,and was part of the
agreementreached withGermanyat the timeof the currencyrealignment.Assigningtasksin 1983 for Mauroy's new government,Mitterrand asked him to 'bringdown inflationto a rate compatiblewithour
competitors... restore within two years our external trade balance... and respectthe financialequilibriumof Social Securitywhile
maintainingthe publicbudgetdeficitwithinitscurrentlevels' (Le Point,
March 28, 1983).
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This is exactly what happened. The budget deficitwas stabilized
around 3% of GDP. This was achieved by freezingbudgeted expenses
and by raising taxes: a 1% additional income tax to finance Social
Securityand a compulsorysubscriptionto publicborrowingrepresenting 10% of 1982 income taxes.
The OECD measuresofstructuraldeficitconfirmtherestrictive
stance
of fiscalpolicy after 1983 (Table 1). Indeed, while the actual deficit
rose slightlyfrom 1983 to 1984, the structuraldeficitwas reduced by
0.5% of GDP. Monetarypolicyalso remained contractionary,
although
the squeeze has come from a differentchannel. While previous
monetarycontractionswere achieved throughbinding credit ceilings
and (relatively)low interestrates,since 1983, and more so since 1984,
interestrates have been kept so high thatthe creditceilingshave not
been binding.
The role of the exchange rate is more difficultto assess. With an
withGermanyrunningat about 4%, and assuming
inflationdifferential
that the Franc-Deutschmarkparitywas satisfactoryafter the March
1983 devaluation,this would implya gradual overvaluationreaching
about 8% by mid-1985. But the Franc-Deutschmarkparityis not the
only indicatorof France's competitiveness.An effectiveexchange rate
index also includes the dollar and reflectsits appreciation. From the
end of 1980 to the end of 1984, the dollar appreciated in real terms
vis-a-visthe ECU by about 50%. Againstthe dollar the ECU was undervalued, while within the ECU, the Franc was overvalued and the
Deutschmarkundervalued. Viewed this way,the improvementof the
currentaccountin 1983 and 1984 was helped bythedollarappreciation.
Thus, 1983-84 in many respects looks like the mirror image of
1981-82. A standard Keynesianexpansion was replaced by a standard
contraction,while the rest of the world pulled itselfout of recession.
In 1982, final domestic demand in France grew by 3.9% while it
remained flatin the OECD zone. For 1984, the numbersare 0.5% for
France and 5.1% forthe OECD. This reversalmusthave been a major
factorbehind the balancing of the currentaccount in 1984 and 1985.
in themeantime
the situationis notperfectly
symmetric:
Unfortunately,
both the public debt (see Table 1) and the externaldebt have grown,
on thebudgetand thecurrent
therebycomplicatingthebalancingefforts
account. Also, as noted by Fonteneau and Gubian (1985) the 1981-82
fiscalexpansion was based on permanentfeatures(new hiringsof civil
servants)whichare not as easilyreversableas increasesin spending on
goods. Debt service in 1984 represented4% of public spending, i.e.
about 2% of GDP, a figurewhichcan be compared to the budget deficit
of 3%. A returnto budgetbalance would now requiremore contraction
of spending or fastergrowthgeneratinghigherrevenues. This leaves
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298
the French government,presentand future,witha limitedmarginof
freedomto use fiscalpolicy.
The external debt situationis oftendescribed withalarmistundertones. Cumulated currentaccount deficitshave raised France's gross
liabilitiesby some 8% of GDP between 1980 and 1984. But as of June
1985, France's external assets (export credits, foreign exchange
the externaldebt liabilities.'0It is truethatmany
reserves,etc.) exceeded
of the French assets are knownto be held in LDCs and are therefore
at risk. Yet, by all measures, the external debt situationcannot be
considered as a major source of concern,as France's ratingson world
financialmarketsamplytestify.
4.2. Inflation
The inflationdifferentialwithGermany has been more than halved
between 1981 and December 1985. Two broad policies have been put
to work:a setof directwage and pricecontrolsand the moretraditional
strategyof demand restraint.
While price controlsare partof France's tradition,the impositionof
a wage freezeas earlyas July1982 was a greatsurpriseto publicopinion.
This freeze was set for4 months.The policyadopted afterthe freeze
is interestingas it illustratesone of the many effortsby European
countries to achieve effectivede-indexation. There has never been
formal cost-of-living
adjustment in France but in practice,this has
been the rule for a very long time. The existence of a de facto full
indexationmechanismis confirmedbyall theeconometricstudies(Artus
etal., 1981; Oudiz and Sterdyniak,1985; Feroldi and Meunier, 1984;
and themean lag is foundto be betweenone and twoquarters).Similarly
there is a strong,fast,and well-documentedeffectof wage increases
on inflation.
The procedure since 1982 is as follows.At the beginningof each
year, the governmentissues inflationrate targetsand asks the firms
and the trade unions to base theirwage increaseson thesetargets.This
is simplya wish,backed by a carrotand a stick.The carrotis the fact
that the governmentpledges to followthis targetfor its own labour
force and the prices of public servicesand utilities.As for the stick,
prices are not free but resultfromcontractsat the branch level with
theauthorities(in theabsence ofagreementthegovernmentsetsprices).
I
10Data
I
computed by the Ministerede l'Economie,des Finances et du Budget (Sept. 1985). Gross
liabilitiesare definedas borrowingforoverone year; shorterliabilitiesare omitted.Grossassets
exclude exchange reservesand are mainlyexport creditsor public loans. At June 1985, net
externaldebt was estimatedas 5.2% of GDP.
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Table 9. Wage guidelines(%p.a.)
Official
Target
ActualIncreases:
GrossHourlyWage
GrossAverageSalary
SMIC
CPI
1985*
1982
1983
1984
10.0
8.0
5.0
4.5
15.4
12.6
17.6
11.7
11.2
10.1
12.2
9.7
7.6
7.6
9.4
7.5
5.6
5.6
6.9
5.6
Source: Les NotesBleues No. 251.
*Note:official
forecast.
The interestingfeatureof this scheme is that it does not state that
wages must be de-indexed. On the contrary,it specificallyendorses
indexationbut ties it to futureinflation,not to past observations.The
advantagesofa forward-looking
indexingmechanismwhen disinflation
is under wayare obvious.Withtargetssetat the beginningof each year,
the 1 or 2 quartertraditionallag is now replaced (at least in principle)
byan average lead of six months.Whiletherehave been some inevitable
slippages above the targets,Table 9 shows thatwage growthhas been
graduallyconvergingtowardprice inflationsince 1983. Because social
bornebyemployeeshave risen,especiallyin 1984,
securitycontributions
thishas meant a reductionin net real wages (-1.8% in 1984).
At the same time,unemploymenthas been risingquickly,ahead of
our estimatesof a steadilyincreasingNAIRU. The interestingquestion
is whetherthe systemof price and wage restrainthas added much, if
anything,to the normal Phillipscurve mechanism.In its 1985 annual
surveyof France, the OECD reportsan INSEE studywhichhas simulated itsestimatedwage-priceequationsfor1984 findinga 2% difference
betweenpredictedand observedinflation,suggestingthatindeed wage
and price controlsdid work.Our own estimatessupportthese calculations.When we re-estimateour Phillipscurve (Regression(1) of Table
6) over the period 1963-80 and generateforecastsfor1981-84, we find
significantresiduals of, respectively,2.9 and
negativeand statistically
3.6% inflationfor 1983 and 1984.
4.3. Labourcostsand employment
policies
Withreal gross wages roughlyconstantin 1984-85, real hourlylabour
costshave stillincreased by about 4% in 1984 because of a furtherrise
in the wedge. As a result,our measures of wage gaps show a further
worseningof about 3% in the manufacturingsector.Not surprisingly
therefore,while employmentmeasured by the number of registered
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Jeffrey
workersdid not fallin 1984, afterdecliningin the years 1981 to 1983,
the reductionof effectiveman-hoursworked in the competitivesector
has not yetcome to a halt.
Thus it appears thatthe apparentlysuccessfuleffortat curbingwages
has not been mainlymotivatedbythe desire to reduce real labour costs
and promote employment,but by a concern to break the wage-price
spiralin order to fightinflation.Here again we findin 1983-84 a mirror
image of the policies followedin 1981-82: reducingreal wages is now
meant to reduce demand, verymuch as the earlier wage hikes were
stillthe dominatsupposed to raiseit.The demand side is unfortunately
ing concern.
A similarinterpretationapplies to employmentpolicies. In the face
ofrisingunemploymentnumerouspolicieshavebeen designedtoreduce
the number of registeredunemployed,withoutreally increasingthe
numberof employedworkers;earlyretirementbenefits,trainingprogrammes,specialcontractswithfirmsfortemporaryon-the-jobtraining
have been continuouslyexpanding in size, scope and cost. By 1983
thesemeasurestogetherwithunemploymentbenefitsrepresented3.4%
of GDP. These numbers underestimatethe true cost as they do not
include subsidized loans to corporations,but theyare large enough to
prompta change of heart. In 1984, for example, the unemployment
benefits system has been restructured,reducing the number of
beneficiariesand the volume of benefits.Several trainingprogrammes
are being scaled back. The civilserviceand state-ownedcorporations
are no longer called upon to hire. There have been spectacularlargescale firingsin industriessuch as steel, coal and shipbuildingwhich
have long been recipientsof public subsidies,as well as at state-owned
Renault, long a symbolof generous social policies. The government
itselfis now engaged in a processof trimmingits ranks.
4.4. Conclusion
Withobvious successesregardinginflation(the officialtargetof 5% for
1985 has been surpassed) and the external balance (with a current
account surplus in both the second and thirdquarters of 1985), the
major casualtyof the Socialists'policies is paradoxicallyemployment.
The combination of demand expansion and supply side errors in
in 1983-84, has resultedin a
1981-82, followedby demand restriction
continuousrise in the unemploymentrate, in line withgrowingwage
gaps and a growing wedge. Only in 1984 did it emerge that the
Government had realized the importance of the supply side and
profitability.
At the time of writing,there is littlefactualevidence on which to
base a theorythattheSocialistshave now movedthewholecircletowards
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defendingthe virtuesof competitionin a freemarketeconomy.Prices
are being gradually freed, but controls remain extensive. Foreign
exchange regulationshave been eased but remainas extensiveas before
May 1981. The long standing traditionof credit ceilings has been
replaced by a market-basedmonetarypolicy relyingon management
of bank reserves,but this change was probablymotivatedby the very
large amount of unused creditbelow the ceiling (due to the weakness
of demand and highreal interestrates)whichcould be absorbed should
the economypickup. Financialmarketshave been allowed to growand
withthe activesupportof tax incentives,and
develop new instruments,
stockpriceshave soared since 1983,butthebanksare stillalmostentirely
state-ownedand 'selectivefinancing'(i.e. credit allocation by government) does not appear to have fallen.
5. Currentsituationand policy options
In the thirdquarterof 1985, withunemploymentat 10.2%, the budget
for 1986 was being finalizedaround the general objective of further
disinflationand no relapse fromausterity.The argumentsbehind a
strategyof continuingausterityare thatthereis no room forexpansion
because: the external constraintwould again surely undermine any
such attempt;the budget is stillin deficit,thus ruling out any fiscal
policy-led recovery; monetary policy must remain tight in France
because it is tightabroad, expeciallyamong EMS countries;the process
of rationalizationand trimmingof French companies is not yetcompleted, and any expansion would relax the pressure to pursue this
fundamentalstructuraleffort.
We do not findthese argumentsconvincing,since we believe thatif
demand stimulusis combinedwithappropriatesupplymeasures,many
of the adverse consequences of a demand expansion could be avoided.
We now sketchsome policyoptionswhichcan be enacted fairlyquickly
and which,according to our analysis,could deliver sizeable gains in
employmentwithonlymodestcostsin inflationor externaldeficits.The
cornerstoneof the proposal is a reductionin labour costs designed to
reduce the wage gaps and bringthe NAIRU down, achieved through
a decrease of labour taxes and a social contract.This policy must be
accompanied by suitablestrategiesforthe budget and forthe external
constraint.
5.1. A marginal wedge reduction
A central conclusion of Section 3 is that any attempt at reducing
unemploymentthrougha demand expansion alone would quicklyhit
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Table 10. The wedge. (Ratio of employers' real hourly labour costs to
employees' real take-homepay)
1963
1968
1973
1976
1980
1982
1983
1984
1.34
1.41
1.41
1.50
1.60
1.62
1.65
1.69
Source: INSEE, ComptesTrimestriels.
Note: The wedge is (T1/T2)(PCIPV)where T, is the ratioof totallabour coststo
the wage bill, T2 is the ratio of net to gross take-homepay when employees'
social securitycontributionsare deducted, and Pc and Pv respectivelyare price
indices for consumptionand value added. As in Table 6, we ignore income tax
rates,whichchanged littleover the period.
the inflationthreshold,withthe attendantexternalcrisis.The immediate implicationis thatthe firstpriorityshould be to reduce the NAIRU
and the wage gap. One way of doing thatwould be to reduce hourly
eitherthroughnegotiatedconcessions,
wages relativeto productivity,
or through'surpriseinflation'.The required reduction,10 to 15% is
such that the inflationsolution is untenable, while the reduction in
hourlywages via concessionsis likely,by itself,to lead only to small
progress achieved over a protractedperiod. A differentapproach is
required.
Our analysisof the Phillipscurve directsattentionto the wedge, the
ratio of total real hourly labour costs to net real hourly take-home
salaries.The evolutionof the wedge is shownin Table 10. Cuttingthe
wedge at constantreal take-homesalaries will reduce real labour costs
in the same proportion.Thus a 15% reductionin the wedge, which
bringsitback slightlybelow its 1976-78 level,would probablyeliminate
mostof the prevailingwage gap. The strategyof achievingwage concessions should be combined witha strategythatreduces the taxation
of labour income.
A 15% cut in the wedge would not immediatelyreturnthe NAIRU
to its 1976-78 level of around 5%, since in the meantimeseveralother
factors(rising social protection,an increase in the targetwage, new
labour regulations)have taken theirtoll. Our estimatesshow that,in
the shortrun,the NAIRU would onlyfallby a bitmore than 2%, which
would leave it in the range of 6 to 7%. However, as we have stressed
earlier, we believe that the Phillips curve estimatesof the NAIRU
probablyunderstatethe long-termbenefitsof a reduced wedge.
Most of the wedge correspondsto labour taxes used to financesocial
securityexpenditures,whichat presentamount to almost25% of GDP
(Table 2). A 15% reductionin the wedge, if achieved by an across-theboard reductionin payrolltaxes,would then contributeto a deficitin
the social securitybudget of 3.75% of GDP, a very large amount to
recoup through spending cuts. However, if the cuts in payrolltaxes
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can be placed more on the margin,to apply mainlyto new workers,
and not to existingworkers,the budgetarycosts of wedge reduction
would be very substantially reduced." As a very rough
example, if a 15% marginal wedge reduction succeeds in bringing
employmentup by 5%, the shortfallin social securityreceiptswould
amount to about 0.5% of GDP.
It must be stressedthat in order to achieve the long-termbenefits
from payroll tax reduction, and to get those benefitsas rapidly as
possible,firmsmustbe convincedthatthe lowertaxes willbe sustained
witha marginaltax reductionis that
for several years. One difficulty
firmsmay be able to manipulatethe systemto theiradvantage without
creatingmore jobs in total. For example, faced witha subsidyon new
workers,firmsmightbe induced to make dismissalsforthe purpose of
subsequent hirings,or to create new businesses to replace, for legal
purposes,existingbusinessactivities.One possibilitywould be to relate
the reductionin payrolltaxes onlyto new workersthatraise the firm's
total labour force above the size at the startof the new policy. Thus
dismissalsby a given firmfor the sake of re-hiringthe same number
of workerswillbe pointless.It mayalso be advisable to plan to make a
gradual reductionin the level of labour taxes on existingemployees,
so thataverage tax ratesare ultimatelyaligned withthe lower marginal
taxes,thusalleviatingthe incentiveto close down one businessand start
up another to take advantage of the marginalwedge reduction.
5.2. A Social Contract
A reduction in labour taxes will lead to a distributionalfightover
sharing the benefitsbetween employersand employees. The union
wage model suggeststhatunions willtryto capturea part,thoughnot
the entire benefit,of tax reduction. To make certain that the tax
intoreduced labour costsforthe firm,
reductiontranslatessignificantly
it is worthwhileattemptinga social compact betweenthe government,
trade unions and employers'associations.We envisage an agreement
to splitthe reductionin labour taxesaccordingto a formulaof one-third
to the employees(in the formof highertake-homepay),and two-thirds
to the employers,(as a reductionin labour costs). Note that initially,
the employees'average benefitswould be verysmall,to the extentthat
the tax reductionapplies on the marginonly. If the average tax rate is
I
I
Our proposal for a marginal employmentincentivediffersfromthat of Steinherrand Van
Halperen (1983) in three respects. Our proposal is designed to be permanent rather than
temporary;it acts via a reductionin the wedge ratherthan an explicitemploymentsubsidy;
and we do not insistthatitsbudgetaryincidenceis offsetby changes in unemploymentbenefit.
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304
reduced over time, the average rise in wages would become larger.
Also, negotiationsshould be opened to deal withissueslikeproductivity
incentivesand labour marketregulations(e.g. hiring-firing
restrictions,
overtimework or part-timejob regulations,various unemployment
programmes),reductionsin subsidiesto ailing corporations,and price
and wage moderation.
5.3. The need for a demand expansion
Fixing the supply side creates the necessary conditions for a nonincrease in employment.But unless demand is presentto
inflationary
absorb the increased supply,a fallin the NAIRU will,in the shortrun
withoutdentingunemployment.The government
onlyreduce inflation,
could instead aim for a gradual reduction of actual unemployment,
trailingbehind the reductionof the NAIRU (see e.g. Blanchard etal.,
1985). Whatis theamountof demand expansionthatwould be required
to achieve a gradual reductionin unemployment(assuming a falling
NAIRU), say at a rate of 1% a year?
For this purpose, it is useful to turn to Okun's Law, which relates
GDP growthto reductionsin theunemploymentrate.Using simulations
of demand expansion performedwith METRIC model (Artus et al.,
1981) we find that real GDP must grow about 2% faster than its
underlyingtrend (a proxy for supply expansion) if unemploymentis
to be reduced by 1% a year.12
to say how much demand stimulusshould accompany
It is difficult
the supply side measures,in order to achieve the targetgrowthrates.
In essence, both monetaryand fiscalpolicies will have to operate on a
feedback basis, by settingnominal GDP targetsthat are sufficiently
expansionaryto allow forthe desired real growthof the economy.The
supply measures will of course themselvesraise demand, via higher
take-home pay, higher investmentdemand as labour costs fall, and
higher internationalcompetitiveness.However, the precise details of
such an induced demand expansion will require separate study. It
should also be pointedout thatany precisionin the size of the necessary
demand expansionis vitiatedbytheuncertaintiesin theworldeconomy.
5.4 The external constraint
As has been amplydemonstratedbythe 1981-82 experiment,no policy
measure is likelyto succeed unless it pays due attentionto the external
I
12
l
As a rough estimateto fixan order of magnitude,if trend annual growthis estimatedat 3%
the growthrate the governmentshould targetis about 5% a year over the fiveyearsfollowing
the wedge reduction.
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constraint.This constraint,in turn has two components: the current
account and speculativecapital flows.It should be clear that supplyfriendlymeasuresof the typeenvisionedshould boostthe stockmarket,
build up confidenceand therefore,at the veryleast, leave the capital
account neutral.
As for the currentaccount, we already noted that a reduction in
labour costs has the importantadvantage of creatinga stronggain in
competitiveness.Yet simulationsperformedwithFrenchmacromodels
(METRIC or OFCE) concerningreductionsin employers'socialsecurity
contributions,find that the currentaccount slightlyworsens because
This result
such policiesgeneratefastergrowthand a rise in imports.13
(of which we are a bit sceptical)should at least be taken as a warning
thatany expansion has a potentialforcreatingcurrentaccount difficulties. The best wayto resolvethe externalpressuresfroman expansion
would of course be forEurope as a whole to undertakemeasuressimilar
to the ones that we are outlining.Afterall, France's difficulties
are
shared in various degrees by all EEC countries,where one also finds
severelabour marketrigidities,large wage gaps, and low ratesof profit
(see Bruno and Sachs, 1985; Bruno, 1986; Dornbusch et al., 1983;
Layard etal., 1984). If theotherEEC countriesrefusesucha coordinated
expansion, the second best would be a devaluation withinthe EMS.
Our estimatesindicatethatthe Franc is currentlyovervaluedby about
6% vis-a-visthe Deutschmark.Of course with a reduction in labour
costs,the extentof the overvaluationis considerablyreduced. Yet, with
an anticipatedgrowthdifferential,
a devaluationis inevitable.
5.5. Fiscal and monetarypolicy
The proposed wedge reductioncould result in significantbudgetary
costs,especially if the reductionis generalized to all workers,rather
than applyingonlyto marginalworkers.A general cut in payrolltaxes
of 15% would cost the governmentrevenues of about 3.75% of GDP,
as we noted earlier. Of course therewould be large associated savings
in unemploymentsupport programmes,that could be as much as
1.5-2% of GDP if the unemploymentrate drops from10 to 5%.M
Assumingthattherewould remaina significant
budgetarycostto the
tax reductions,the question is whetherthat cost should be made up
I
I
' Artus et al. (1981) and Sterdyniaket al. (1984). In the OFCE model a 10% cut in employers'
social securitycontributionsleads afterone year to a 0.8% increase in outputand a worsening
of the currentaccount by 0.1% of GDP.
14 We assume
thatthe cost of unemploymentprogrammes(4.5% of GDP in 1985)
conservatively
would be cut by onlyone third,giventhe fixedcost of bureaucracyneeded to administerthese
programmes.
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306
throughcutsin spendingof varioussorts,or byincreasesin othertaxes,
or by somewhatlarger deficits.
We have repeatedly stressedthat the supply-sideconsequences of
any other tax increases should be scrupulouslyexamined, and not
underestimated.If thereis a major conclusionof our analysis,it is that
cutting deficitsvia tax increases and spending cuts have different
macroeconomicimplicationsforthe French economy.Aftera decade
and a half of tax increases,withthe attendantsupply-sidedifficulties,
it is probably time to stress spending cuts as a way to resolve the
budgetaryproblem.
Discussion
WillemBuiter
Yale University
The authors'thesisis thatFrance,under PresidentMitterrand,undertook a modest fiscalexpansion in May 1981 whichhad adverse supplyside effects.There was some increase in the growthof output,but the
economy soon ran into both internaland external constraints.First,
and more importantly,
the non-acceleratinginflationrateof unemployment (NAIRU) was too high to permitcontinued expansion without
an increase in inflation.The authors argue that Mitterrand'spolicies
raised the NAIRU and theycitea numberof contributory
significantly
in the minimumwage; employers'payrolltaxes
the
increase
factors;
were also increased; there was an extension of employee protection
legislation;workinghours were reduced increasingmarginal labour
costs; and finallythere was nationalization(although its effecton the
NAIRU is ambiguous).
Second, the economyalso ran intoa twofoldexternalconstraint.The
currentaccount deterioratedowingto the world recession.There was
also a lack of confidencein the Socialistadministrationon the part of
the financial markets. This produced increased capital outflows.
Together these placed the Franc under pressure and raised doubts
about the continued participationof France in the EMS.
The authorsargue the originalMitterrandprogramlastedlittlemore
than six months.The firstcrackswere showingby the timeof the first
devaluation in October 1981. Furtherdevaluationsin June 1982 and
March 1983 put the finalnails into the coffin.The fiscalstimulus(as
measured by the cyclicallycorrectedbudget deficitwhich is not the
correctmeasure) was reversedas earlyas June 1982.
I will firstexamine their claims about the increase in the NAIRU.
such as increasedjob or skill
The authors'dismissalof frictionaleffects,
are difficult
mismatch,is perhapsa littlehastysincemanyoftheseeffects
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The economicconsequences
Mitterrand
ofPresident
307
to measure adequately. They are probably neverthelesscorrectthat
their impact was small. Instead they focus on what has been dubbed
'household-involuntary,union-voluntary'unemployment.Oil price
increases, reduced growthin technicalproductivity(relativeto wage
aspirations)and increases in the tax wedge have all raised unemployment.However, I do not findtheirparticularmodel, withcompetitive
firmsfacinga real wage set by a monopolisticunion, eithernecessary
or useful.A more plausiblestoryis to assume unions setthe moneywage
and imperfectlycompetitivefirmsset prices and hence also the real
wage. The optimizingfoundationsof the model disappear completely
when their purely staticmodel is embedded in an 'error-correction'
mechanismto obtain the Phillipscurve. The finalmodel looks like a
standard expectations-augmented
Phillips curve where the difference
between the target and warrantedwage drives inflationand unemployment.
A crucial missing link in the storyis why the extra involuntarily
unemployed union memberscannot find,or choose not to find,work
in the non-union sectorof the economy. Is thisbecause wages in this
sectorare too low relativeto unemploymentbenefitsas has been suggested by PatrickMinfordforthe UK? Or is it because relativewages
are rigid across the two sectors?The mechanismat work here needs
to be spelt out.
The estimatesof the Phillipscurvein Table 6 providethe centrepiece
oftheanalysis.However,theseare equationswithrelatively
low explanatorypower estimatedon only twenty-oneobservations.While there is
some attemptin Appendix C to examine the robustnessof the results
withrespectto dynamicspecification
and theinclusionofotherplausible
determinantsof the NAIRU, theystrikeme as a veryslender basis on
which to make the very importantpolicy conclusion that France was
supply constrained at the beginning of the Mitterrandexperiment.
of the equationsover 1981-84 would be one useful
Testingthe stability
testthe authors could carryout.
Turning now to the wage gap calculations,theseare potentiallyuseful
to assesstheirstatistical
althoughI finditdifficult
significance.However,
the authors make a crucial non-sequiturin assuming that a positive
wage gap impliesthe absence of a significant
marginof unemployment
due to deficientdemand. The real wage can be too high withoutthis
being the bindingconstraint.The findingof a positivewage gap merely
impliesthatone cannot get back to fullemploymentwithoutan accompanyingreductionin real wages.
More generallyI do notthinktheauthorsexamine sufficiently
closely
the possibilitythat producers in France were constrainedby a lack of
demand in the early years of the Mitterrandexperiment. Data on
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308
Sachs and CharlesWyplosz
Jeffrey
capacityutilizationand vacanciescould give some clues here. Is it the
case that if France was in a demand constrained regime any fiscal
expansionwould neverthelesshave failedbecause ofa lackofconfidence
by the financialmarkets?In other words did the external constraint
bind even if the internalone did not?
Finallytheauthorssuggestthata crucialrolewas playedbytheFrench
commitmentto the EMS. This is interestingbut not altogetherconvincing. Why did the authoritiesfeel constrainedto staywithinthe EMS?
They also argue thatMrs Thatchercould tie the hands of a futureUK
Labour governmentbyjoiningtheEMS. I findthisimplausible:a future
Labour governmentwould just leave the EMS in order to be free to
pursue expansionistpolicies.
GerhardFels
Institut
der DeutschenWirtschaft,
Cologne
From the French Socialists'experimentof the early 1980s one can
learn an importantlesson on economic policy.This episode is highly
instructivefor other countries as well. At least in Germany it has
disillusioned many advocates of a 'soft approach' which unions and
Social Democrats stillfavouras an alternativeto the presentconduct
of economic policy.To be sure,Germany'sperformancewas not much
better,and was actuallyworseon employment.But theexternaldifficulties faced by France demonstratethat Mitterrand-style
policies cannot
solve internaleconomic problems.Sachs and Wyploszprovidean interestingevaluation of these policies,though I should have preferreda
greateremphasis on comparisonwithother countries.
I feel much in sympathywiththe basic analyticalapproach of the
paper. I do, however,have some reservationswithrespectto the policy
recommendations.In substance,I do not thinkthatthe recommended
policy option currentlyexists in France. In particular,the external
constraint,whichwas responsiblefor France's U-turnin March 1983,
mustbe given more attention.France's experience highlightsthe fact
that in an open economy,it is impossibleto conduct an autonomous
economic policy independent of conditionsin the rest of the world,
unless one revertsto trade restrictions
and capitalcontrols.I thinkthis
also has implicationsforthe therapyproposed by the authors.
I think the authors may overstatethe degree of success on the
employmentfront.One reason for France's moderate employment
decline in the period 1980-84 may be a substantialamount of hidden
unemploymentor unemploymenton the job. Table 3 lends supportto
thishypothesis:there was a substantialincrease in employmentin the
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The economicconsequences
Mitterrand
ofPresident
309
sheltered sector. But this was not merely a feature of the Socialist
administration;it had already occurred during the seventies.
France's successagainstinflationalso seems overstated.It is truethat
the inflationdifferential
between France and Germanyis substantially
smaller today than it was in 1982, but in both countriesthe inflation
rate in 1985 is only about one thirdof what is was in 1982.
There are differingviews about what caused inflationto subside.
Sachs and Wyploszmaintainthatthe main factorwas wage and price
controls.If that is true, the success may only be temporary.But this
explanation does not seem to be very convincing since all major
countries experienced a sharp drop in the rate of inflation.This
phenomenon has to be explained by monetaryrestraintabroad. Paul
Volker successfullyreduced monetarygrowthin the US, and Germany
followedsuit. Hence France, too, was forcedto adopt a policyof tight
money. Otherwise,she would have been forced to leave the EMS. So
again it is the externalconstraintwhich has to be given creditfor the
improvementafter 1983.
The paper suggeststhat a macroeconomicstrategyfor overcoming
the problemsstillexists.I agree withthe argumentthata reductionin
labour costsof about 10% would be warrantedand useful.But I doubt
whetherthis can be achieved by a significantcut in labour taxes, i.e.,
in compulsorysocial securitycontributions.Can we reallyexpect a shift
of the wedge burden - of whatevermagnitude- fromemployersand
employeesto the public sectorto overcomethe rigiditiesof the French
economy? It seems to be more importantto reduce the burden than
to shiftit to the public budget. Although the rationale of the US tax
cut policy is differentfrom that of the Sachs-Wyplosz analysis,the
structureof theargumentis quite similar:more incentivesto the private
sectorat the expense of an increased public debt. If any countryat all
can affordto have a significant
increase in public debt relativeto GDP
it is the United States,due to favourableconditionswithregard to its
labour market,profitrates,equitycapital and the like. By contrast,the
French economysuffersfromso manyrigiditiesthatthe fiscalstrategy
recommendedby the authorswould be highlyriskygiventhe external
constraintand the budget situation.I thinkthe same is, in principle,
also true in the case of Germany.
To reduce the wedge burden, the authors propose a social contract
and a gradual reductionin public spending, especiallyin subsidiesto
corporationsand individuals.But has a social contractever been more
than a dream in France? Even the Socialistgovernmenthas not been
able to establishit. And the level of subsidies is as much a subject of
the debate over income distribution
as wages and salaries.The financial
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310
Sachs and CharlesWyplosz
Jeffrey
supportwhich is given to decliningindustrieshas more the character
of social policy than of industrial policy. And what about a large
devaluationof the Franc as a complementarymeasure?My guess is that
accelerated inflationwould be the most likely result. If the unions
respond to increased inflationthe burden will be shiftedback to the
businesssector.
What is the alternative?Austerityis no solution.But in the environmentofa scleroticEuropean economy,privateconsumersand investors
have lost confidencein macroeconomicpolicieswhichlead to a higher
budget deficit.Under European conditions, supply policy must be
geared towards improvingtotal factor productivity,which will also
bridge the wage gap. In the French case I would propose to continue
and reinforcethe course of economicpolicywhichthe governmenthas
been pursuingsince 1983. This would mean; furthereffortsto reduce
the budget deficitby maintainingonly a modest growth of public
spending; continuationof monetarydisciplineto ensure low inflation
rates; combatingmajor legislativerigiditieswhich constrainand discourage employersfromhiringadditionalworkers;deregulationof the
servicesector to increase competition,and the privatizationof public
service activities; easing of the constraintsimposed on small and
medium-sizedfirmsin the formof workerparticipationand additional
social changes; and finallythe introductionof tax sheltersfor newly
establishedenterprises.
Of course, such a strategypromises only a gradual improvement.
However,ifsupplyconditionsare improvedthefreedomformanoeuvre
in fiscalpolicy will become greater. The greater freedom should be
used to lower taxes on investmentand high-riskactivities.My beliefis
thatsuch a strategywould enable the Frencheconomyto growat a rate
of about 3%. The German economy may serve as an example. It is
about to recover and will accelerate its growthmeasures to improve
supplyconditionswhichallowed the economyto overcome stagnation
withoutan increase in the budget deficit.
Georges de Menil
Ecole des Hautes Etudes en Sciences Sociales, Paris
Afterthe legislativeelectionsof March 1986, the new Frenchgovernmentwilltryto learn fromthe errorsof the precedingfouryears.Why
did thisSocialistexperimentfail?My commentswillconcentrateon the
authors' three principal and most provocative conclusions: budget
deficitswere not the most important problem; reductions in the
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Mitterrand
The economicconsequences
ofPresident
311
and competivenessof Frenchenterprise- in short,supplyprofitability
side disturbances- were the most seriouslydisruptiveaspects of the
Socialist programme; and Mitterrand'spolicies exacerbated these
supply-sideproblemsbut did not constitutea fundamentaldeparture
fromthe previoustrends.They were in essence a ripple on the rising
tide of Eurosclerosis.My discussionis organized under threeheadings:
the demand side aspectsof the programme,itssupply-sideconsequences, and the implicationsfor presentand futurepolicy.
The importance
of relativedemandstimulus.
In theirclaim for the relative
unimportanceoftheKeynesianstimulusin 1981-82, Sachs and Wyplosz
make a myopicerror.They pointout thatthe increaseof the structural
deficitof the French governmentbudget during 1980-82 (1.4% of
average GDP) was smaller than in the United States during 1980-83
(1.8% of GDP) and about the same as in Germany(1.2% of GDP during
1977-80) followingthe Bonn summit(see Muller and Price, 1984). It
is not budgetaryexpansion perse whichdisruptsexternalbalance, but
expansion relativeto the policies being followed by major trading
partners.In 1981 these partnerswere simultaneouslymoving in the
direction of restraint.The substantial divergence between French
stimulusand foreignrestraintwas neitheran accident nor a surprise:
the French governmentconsciouslydecided to expand when others
were contracting.
Supply-side
consequences.The mostappealing aspectofthe Sachs-Wyplosz
studyis the crucial emphasistheyplace on the effectof the Mitterrand
programme on supply. The heart of their studyis an application to
France of the wage-gapanalysiswhichhas gained prominencein recent
years.A numberofeconomistsfollowingGiersch(1981), includingmost
recentlyBruno and Sachs (1985), have argued thatexcessivereal costs
of labour are the major reason manyWesterneconomies,particularly
in Europe, have experienced steadilyrisingunemployment.'Natural'
unemploymentis largely determined in this view by the difference
betweenthe effective
cost of labour and itsmarginalproductivity
when
all resourcesare fullyemployed.This discrepancyis the wage-gap.The
authorsthen estimatea Phillipscurve whichrelatesshort-runchanges
in inflationto the differencebetween actual and 'natural' unemployment. Whilst inflationand actual unemploymentare observable the
unobservable natural rate of unemployment must be modelled
Whereas forthisI believethatwage-gapanalysisis required,
implicitly.
Sachs and Wyploszstressonly one aspect of thisanalysis,the so-called
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312
Sachsand CharlesWyplosz
Jeffrey
'wedge' between gross labour coststo the firmand net take-homepay
is not warranted.'5
receivedby workers.In myview thissimplification
the
of
in
the
authors'
role
Moreover,
key
supply
analysisis deficient
fortwo reasons. First,inadequate attentionis paid to considerationsof
competitivenessand external balance. It was not inflationor rising
unemploymentbut the deteriorationof the currentaccount, and the
consequent speculativeattackon the Franc, whichforceda reversalof
budgetarypolicyin the Springof 1983. It is regrettablethattheauthors,
in contrastto their careful studyof inflationand unemployment,do
not bring this same detailed analysis of supply and demand to the
externalposition.
The second deficiencyis more fundamental.In theirintroduction,
the authors recognize the long-runstructuralreformswhich,in the
eyes of both the Socialistsand the opposition,constitutedthe heart of
the programme. In many areas these were major departures. The
nationalized sector increased by one quarter, to 18% of total nonagriculturalvalue-added. Marginal tax rates were increased,reaching
up to 75% in 1982, and a new annual wealth tax of up to 2.5% was
introduced. New labour laws enhanced trade union power, private
rented housing was subjected to rent controls,and privatemedicine
was curtailed.
Whilstbudgetarypolicyhad been reversedby 1983, and some incentives for enterprisehad been restored,by 1985 the full array of the
structuralreformswere essentiallyleft untouched. What were their
effectson productivityand competitiveness?Sachs and Wyplosz are
silenton the question.Having emphasizedthe importance
surprisingly
of supply-sideconsiderations,theauthorshave givenus Hamlet without
the Prince of Denmark. Of these omissions,the most glaring is the
neglect of nationalization,especially in the banking sector. Given
exchange controlsand the underdeveloped nature of French capital
markets,bank loans constitutethe most importantsource of external
funds for privateinvestmentin France. The argumentthat the 1981
l
I
15The wage-gap, in Sachs-Wyplosznotationis
(h + t,- pv)-_
whichmay be rewrittenas
(h - t2-pc)+(tl
+ t2+ P -pV)-
q
The firstterm is the log of real take-homepay, the second is the log of the wedge. Having
made this decomposition,the authors implicitlyassume in their estimationthat changes in
NAIRU are caused exclusivelyby changes in the last two terms,and since the data will not
supporttheirimplicitomissionof the firstterm,take-homepay, theyare obliged to introduce
an ad hoc time trend whichonly partiallycapturesthisomission.
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Mitterrand
The economicconsequences
ofPresident
313
banking nationalizationwas of secondary importance because twothirdsof the industryhad previouslybeen nationalizedin 1946, misses
the potentiallydecisive influenceon the entire industryof the threat
of competitionfromthe privatesector.Similarcommentsapply in the
manufacturingsector.
Not onlyis the reductionin competitionlikelyto reduce productivity
and efficiency,each nationalizationcreates a precedent for future
nationalizationsand may significantly
reduce incentivesforinnovation
and risk-taking
in the privatesector.If StephenJobsor KennethOlson,
the foundersof Apple and Digital Equipment,had been French,they
mightwell have emigrated.
Of course these are long-runeffectsand difficultto measure. But
they should not be neglected on that basis. By concentratingtheir
analysison short-runphenomena which can be discerned quicklyin
nationalstatistics,
Sachs and Wyploszgivean unbalanced accountof the
Socialistprogramme,and may miss more than half the story.
Implicationsforpolicy.The messageoftheSachs-Wyploszstudyforfuture
Frenchpolicymakersis clear: reversesome of the measuresof 1981-82,
but do not merelyrevertto the policies of the previous decade. The
relentlessincrease of structuralunemploymentover that period is a
tellingtestimonyto the cost of social rigiditiesand misguided policies
whichpush labour costsever higher.This trendmustbe reversed.Sachs
and Wyploszpropose a 15% cut in labour coststo reduce the NAIRU
to 5%. This radicalsurgery,whichwould implythatthesumofemployee
and employertaxes on labour fell from60% to 35% of wages, could
notbe implementedovernight.And anyattemptto achievecoordinated
reductions throughout Europe could only take longer. Given the
authors' premise that there is little current slack in French labour
markets,neitherrapid demand expansion nor a quick solutionto the
unemploymentproblem is feasible.
An alternative,and in my view more promising,way to reduce the
wage-gap is to erode rigiditiesand distortions,improve competition,
and thusmake marketsworkbetter.Examples of such measureswould
include privatizationand the abolitionof controlson prices,rents,and
and competitiveness,
this
foreignexchange. By increasingproductivity
offersa more durable solution. It would be a radical departure from
trendsin France over the last twentyyears.
General Discussion
Jacques Melitz believed the comparison with the experience of the
Giscard administrationwas instructive.The Chirac expansion was also
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Sachsand CharlesWyplosz
Jeffrey
short-lived,but the Barre plan stabilizedthe currentaccount and the
Franc relativelyquickly.Inflationwas allowed to rise over the period
1977-81. By contrastthere had been three successive devaluations
under the Socialistsand even in 1984 the currentaccount was stillin
deficit.This forcedMitterrandto maintaina contractionary
fiscalstance
feltthe
continued
downward
on
inflation.
He
also
exerting
pressure
model of union behaviourwas inappropriateforFrance. Union membershiphad been fallingrapidlyunder the Socialistsand the preservation of union membershipratherthan the pursuitof higherwages was
probablymore importantto union leaders.
Patrick Minford supported Buiter's criticismof the lack of an
adequate storyabout behaviourin the non-unionsectorand whyunemployed union memberscould or would not findjobs there.Even if the
whole economy were treatedas unionized the storycould not be sustained because the shadow wage of displaced workerswould fall to
zero. He thoughtthat the unemploymentbenefitsystem,the 'Aide
Sociale', early retirementschemesand the like played a centralrole in
underpinningthe model of labour marketbehaviour.
Torsten Persson suggested the distinctionbetween internationally
between
tradable and non-tradablegoods could help in distinguishing
and 'confidence'explanations for the fall in investthe 'profitability'
ment. If firmsin the tradable sectorfound it less easy to pass on cost
increases on account of foreigncompetitionthan firmsin the nontradablesectorone would expectto findthe share priceof the twosorts
of firmsreactingdifferently
to increasesin labour costs.On the other
hand fear of nationalizationwould affectboth sectorsequally. He also
thoughtthe distinctionwas relevantto the specificationof the Phillips
curve which implicitlyassumed prices were a mark-upover costs: this
would not be valid forthe tradable sector.
MervynKing found the estimatedinvestmentequation a peculiar
hybridbetween 'accelerator'models which stressedthe role of output
and 'Tobin's q' models whichstressedthe role of the stockmarket.
Paul Krugman pointed out a peculiar propertyof the estimated
Phillipscurve, which implied thatunions were perpetuallyseeking to
returnto thetrendvalue ofthetargetwage irrespectiveofdevelopments
in productivityor the wedge in the interim.This did not seem very
plausible over time spans of a decade or more.
Giampaolo Galli noted thatneitherunemploymentnor the NAIRU
was higherin France than in mostother European countriesand that
the somewhatlaterdecelerationin inflationcould be attributedentirely
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Mitterrand
The economicconsequences
ofPresident
315
to the later increase in-interestrates. Monetarypolicyseemed capable
of explaining most of the differences.
Appendix A. Computation of wage gaps
For each sectorwe assume a CES productionfunction
Y = A[SK-P + (1 - )L-P]-'P
(Al)
where Y is real value added, K the stockof capital and L is labour in
units
efficiency
t
L = L (1+i)
(A2)
i=l
withyi the rate of labour augmentingtechnologicalprogressin year i
and L, is labour (in man-hours).
If SL is the share of labour in value added and H represents(hourly)
labour costs,SL = HL/ Y. Let small lettersdenote logarithms.Then an
approximationto (Al) and (A2) is
Ay,= (1 - SLt)Akt+ SLt(Alt +
(A3)
yt)
From (A3) it is easy to obtain estimatesof Yt since all of the other
variablesare observed. In practice,we smoothSL by takinga two-year
movingaverage of the originaldata.
Next we normalize Y, K and L to 1.0 in the base period so thatA = 1.
Maximizingprofitgiven K yieldsthe usual relationship
SL=(1 - 8)
t
I ( +7)
_i=1
-P
(Yt/Lt)P
(A4)
Withthe above normalization,we findthatin the base period S? = 1- 8
so that parameter 8 is directlyobtained as the share of capital in the
base period.
We can now express (A4) as a demand for labour aftersubstitution
of (Al) (up to a constantterm)
i=l
P
Thus the real wage rate ensuringfullemploymentLf giventhe stock
of capital is (up to a constantterm)
h*y=
i=l
.
t 1+p
In [8(K,/f)P
P
+(1 -8)]
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(A6)
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Sachs and CharlesWyplosz
Jeffrey
The wage gap is then simplyh,-h* where ht is the (log of the)
observedreal labour cost. It is computed foralternativevalues of p = 0
and p = 1. A similarprocedure is followedforthe case of Hicks-neutral
technologicalprogresswhere Equation (A2) is replaced by an equation
in whichA growsover time.
Appendix B. The union wage model
1. Firms' demand for labour
We assume that the technologyis representedby a CES production
functionwithHicks-neutraltechnologicalprogress
Y = A[SK-P + (1 - S)L-P]-P
(B1)
whereA = A(t) is the productivity
factor.The unitcostof labour is the
gross nominal wage H, divided by the value added deflatorPV, witha
mark-up T1 foremployers'taxes.
C=v
H
(B2)
TI
The firms'soptimizingconditionis
C = a Y/aL = A-P(1 - 8)(Y/L)'+P
(B3)
With lower-case letters denoting logarithmsand omittingconstant
terms,(B2) and (B3) imply
c = h - p+ t = -pa+(1 +p)(y-l)
(B4)
(B1) can be log-linearizedas
y = a +(1-
SL)k+SLl
(B5)
where SL is the share of labour in value added.
of substitutiono = 1/(1+ p), (B4) and
Denotingthe constantelasticity
(B5) yield the demand forlabour:
1= k-p(h -pv + t- a)
with /3= /(1 - SL).
(B6)
2. Trade union's wage setting
FollowingMacDonald and Solow (1981) we assume thata singleunion
maximizes the expected utilityof the representativeworker (or,
equivalently,the weighted average of employed and unemployed
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The economicconsequences
Mitterrand
ofPresident
317
workers):
E (u) = (L/L)u( W) + [(L- L)/L]u(l)
(B7)
where L is the labour force,L the number of employed workers; W
the real take-homewage, f real unemploymentbenefits.Real takehome wage is;
W=
(B8)
PcT2
withPC the consumptiondeflatorand T2 the employee tax mark-up.
The trade union maximizes(B7) withrespectto the gross salarylevel
H, given the firm'sdemand for labour in (B6). If the union is able to
impose its optimal salary level, it acts as a monopolist,leaving to the
firmthe decision to hire labour accordingto (B6).
The union's optimizingconditionis;
L au aW
-+ u-u?
_ aL aC =O
L aC aH
LaW +H
(B9)
where u = u(W) and u?= u(fl).
This can be shown to become
W au
u uaW.+
u-u0C
u
dL
LaC
0
(B 10)
If the utilityfunctionhas constantrelative risk aversion, u=
W'-Y/(l- y), and with(B6) we obtain
1-, =3P
U-U?
(Bl 1)
U
or
W" =
l withO =
y
(B1l')
Iftheunionisabletoenforcethisrealtake-home
wage,theemployment
levelis givenby
lu= k+3(a-x-wu)
where w" = 0+
(B12)
from (Bll') and x is the logarithmof the wedge
separatinglabourcostsand take-home
wages:
pCT T,
C PT,
PCT
PV
W
=
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(B 13)
318
Sachs and CharlesWyplosz
Jeffrey
The union sets the salary level as a mark-up over unemployment
benefits,withthe rate of mark-updepending inverselyupon the elas- SL) = as in a standard
ticityof the firm'sdemand for labour r/(1
monopolypricingmodel. In the Cobb-Douglascase 3 is exactlyconstant
and the targetreal wage is constant.
Quite logically,(B12) shows thatthe equilibriumemploymentlevel
and labour costs
depends on the differencebetweenfactorproductivity
as measured by the sum of the wedge x, the unemploymentbenefitsw
and the mark-upimposed by the trade union 0. Importantly,it also
depends on the stock of capital k. While k is taken as exogenous, it
should properlybe related to labour costsvia the factorprice frontier,
and is another channel throughwhich high labour costs may reduce
employment.
3. The Phillips curve
Whilethe previoussectionpresentsthe labour marketequilibrium,the
Phillips curve is intended to describe how this equilibrium is
approached. It requires some lags in the adjustmentmechanism.We
adopt two standard assumptions:first,unions are not able to achieve
their target real take-homewage but work towards it; second, gross
nominalwages are set at the beginningof the currentperiod when the
CPI inflationrate wrc
is not knownand approximatedby last period's
rate rc_-(eitherbecause of the indexation mechanismor because of
myopicexpectations).Using (B8), the resultingrate of increase of the
gross hourlynominal wage is;
Ah = Aw + r_In+At2+ a(l- IU)
(B14)
where Az = z - z- and wu is the (log of) real wage targetof the unions
given in (B 11') as w = 0 + o. From (B6) we derive the rate of change
of the value added deflator;
Tv = Ah+ At - Aa - (Ak-Al)/3P
(B15)
If pm is the price index for imported goods, Pc =(Pm)A(PV)l-A
plugging(B14) into (B15) gives (assuming 0 constant):
Xrv=
rl+A(7rl-7t1)-
a(U-
U*)+A(w+tl+t2
+
)- AU/1
and
(B16)
of labour
where: i = a + (k- 1)/,1is the log of the marginalproductivity
evaluated at fullemployment(see (B3) and (B5))
U = I- I is the rate of unemployment.
U* = l- u is the union's targetunemploymentrate.
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Mitterrand
The economicconsequences
ofPresident
319
This definitionof unemploymentassumes that hours worked have
remained unchanged, which is grosslyinaccurate. We returnto this
issue in the followingsection.
(B16) is the Phillips curve referred to in the text. The NAIRU
ANh4, i.e.
corresponds to 7rv= 7r1, 7rm= 7Tr,AU = 0 and A(w + tl+ t2)=
when inflationand unemploymentstabilize and labour productivity
gains are exactlyabsorbed by labour cost increases.Then the NAIRU
is the union's targetunemploymentrate and is given by
U* =p(w
+ x- /)
(B17)
4. Hours worked
In the above formulationthe number of hours worked is taken as
exogenous. A proper treatmentof thisissue would requireintroducing
three changes in the model: leisure should enter the representative
worker'sutilityfunction;the productionfunctionshould recognizethat
there may be costs in operating given equipment withmore workers
workingless hours; the numberof hours worked per workeris in the
end a decision taken by the firmgiventhe extra cost of overtimework
beyond the normal workweek(39 hours in France since 1982). The
resultingproblemhas been studied in Wyplosz(1985) and in a similar
model by Calmfors(1985). Its implicationsare discussed in the text.
Appendix C. Alternativespecificationsof the Phillips curve
Table Cl augmentsthe tworegressionsreportedin Table 6. Regression
(3) augments Regression (2) by adding furtherlags in 7r,U, (i-x),
contemporaneousA(pm-p) and separate currentand lagged values of
x. Individually, their t statisticsare very small. An F test on the
hypothesisthat the additional variables are jointlysignificantis also
comfortablyrejected. (F(6, 8) = 0.33).
to improve
Having checked that it is not possible straightforwardly
on the dynamic specificationof the equations shown in Table 6, we
then investigatethe consequence of omittingcertaincontemporaneous
variablesfromtheseequations.(Ideally,ofcourse,one would investigate
both extensions simultaneously,but with annual data we exhaust
degrees of freedom veryquickly.)Regressions(4) and (5) investigate
the consequences of augmentingRegressions (1) and (2) of Table 6
withthree variables (all in logarithms):
B: real unemploymentbenefits,the ratioof totalunemploymentoutlay
to the product of the numberof unemployedand the consumerprice
index.
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Sachs and CharlesWyplosz
Jeffrey
320
Table C1. Augmented Phillips curves (Dependent variable AlT,
annual data, 1963-1984)
Variable
Regression(3)
Regression(4)
Regression(5)
Constant
U
A(pm-p)(i+-x)
Ar-1
e_l
t
DV1
DV2
201.38
-4.34
0.07
-40.28
-0.33
200.65
-3.83
0.06
-49.00
242.14
-4.46
0.06
-53.90
-0.32
IT-2
U_1
A(pm p)
($1- x)-_
x
x-1
B
RR
UV
Standard error
(0.90)
(1.42)
(1.62)
(1.93)
(2.15)
2.69 (0.98)
1.92 (3.69)
-0.01 (0.02)
0.07 (0.04)
0.02 (0.39)
-2.01 (0.05)
22.82 (0.77)
-12.25 (0.29)
(3.64)
(4.28)
(1.79)
(3.54)
-0.65 (3.89)
2.87 (4.32)
1.98 (2.80)
-5.39 (0.81)
6.90 (1.13)
-1.51 (1.54)
0.72
(5.88)
(6.82)
(2.57)
(6.22)
(3.97)
3.22 (7.07)
1.95 (7.69)
-3.17 (1.05)
3.15 (1.24)
-0.66 (1.21)
0.96
0.62
(t statisticsin parentheses)
RR: the replacementratio,definedby
(1- U (total unemploymentoutlays\
U
/k
totalgrosswages
J
ratio.
UV: the unemployment-vacancy
t
statistics
and the F testson the 3 variables
individual
both
Again,
1.15
for
jointly, (F(3, 12)=
Regression (4), and F(3, 12)=0.62 for
regression (5)) indicate that their omission from Table 6 is not the
source of any serious specificationerror.
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ERRATA
Readers attentionis drawnto thefollowingerrata:
p. 264. Nine linesfrombase lineshouldread "to 6% in 1985"
C
(T P'_\
p. 317. Equation on lastlineshouldread: X = W= T2
(p
p. 379. Two linesfrombase lineshouldread "under2% per month"
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