"France is sad and I think the French are fed up. My heart aches for them, because they ended up in such a difficult situation," said French actor, tax exile and recent Russian citizen Gerard Depardieu.
Mr Depardieu is probably right. Europe's second-largest economy is going nowhere and a far-reaching programme of fiscal and structural reform will test the limits of Francois Hollande's socialist administration. Tinkering with the 'French way of life' rarely ends well, and an initial focus on tax hikes threatens confrontation with Berlin. Clearly, the outcome is far from certain, but blindly bashing France helps no one, least of all investors who risk throwing the baby out with the bathwater.
Of course, a lot of the criticism is justified. Unemployment is welded to a 13-year high, public debt stands at a record 90 per cent of GDP, there's been no budget surplus since 1974 and unit labour costs are among the highest in Europe. Having already admitted he'll miss growth and deficit targets this year, it is hardly surprising that Mr Hollande lags far-right leader Marine Le Pen in the popularity stakes. A loose-lipped labour minister who tells the world you’re "totally bankrupt" and a budget minister with a taste for Swiss bank accounts are unhelpful.
Markets were initially sceptical, too. Ratings agencies Standard & Poor's (S&P) and Moody's have already stripped France of its prized triple A rating, causing fury in Paris. Moody's questioned "multiple structural challenges, including its gradual, sustained loss of competitiveness and the long-standing rigidities of its labour, goods and service markets". There's "subdued domestic and external demand" and French banks remain overexposed to dodgy European economies such as Greece and Cyprus.
Latest projections from the Organisation for Economic Cooperation and Development (OECD) are for growth of just 0.1 per cent in 2013. It doesn't expect government debt to meet the European Commission's deficit ceiling of 3 per cent until 2014, either. In the meantime, unemployment will peak at over 11 per cent and a derailing of the cyclical deficit would have serious repercussions for the credibility of fiscal policy.
Both the substance of French reforms and Mr Hollande's ability to enact them have already been criticised as inadequate, and little has changed since François Mitterand backtracked on socialist reforms in favour of austerity in the early-80s. But then politicians here are struggling, too, and the debate about whether austerity or spending will best drive the recovery is fiercely contested. Mr Hollande is struggling with his own economic omnishambles, but will likely get another year to work on the deficit target and get France back on track.
Traditionally, France has excelled at branded goods and consumer products such as those made by LVMH above.
Markets give Hollande time
Since the last ratings downgrade in November, the local Cac-40 index has posted double-digit gains. Not bad, but London and Wall Street have done far better. And there's no masking the chronic underperformance since the post-Lehman sell-off climaxed in March 2009. In the four years since, £100 invested in French large-caps would be worth £141, much less than the FTSE 100 (£175), the Dax (£208), Dow Jones (£217) or S&P 500 (£224). And Paris is one of the few yet to recapture highs pre the eurozone debt crisis and US ratings downgrade in summer 2011.
Equity markets, however, appear not to be punishing Mr Hollande. The Cac is up 16 per cent since he beat Nicolas Sarkozy in last May's election. Bond markets haven't, either. After briefly nudging 3 per cent in the aftermath, the yield on 10-year French government bonds is now less than 2 per cent - a record low and not much more than the US and Britain - and the spread with German bunds has more than halved from over 140 basis points to less than 60.
Rajesh Shant, who runs the Newton Continental European Fund, had been underweight France for a couple of years, but the election marked a "turning point" and began a shift toward its current neutral stance. Mr Shant believes we're past the worst and that the "perception is lagging the reality". A move to overweight could follow in time. Mark Whitehead, a fund manager at Sarasin & Partners, reckons France trades at a discount of 10-20 per cent, a gap he says will eventually narrow.
Clearly, Mr Hollande is getting the benefit of the doubt. French government debt is a deep, liquid market and a safe alternative to German paper. It will remain so. The socialist administration has raised taxes, promised €60bn (£50.93bn) of spending cuts, a €20bn corporate tax break to restore French competitiveness and an agreement with unions for much-needed reform of outdated labour laws. It's also tackling pension and welfare benefits and freezing the defence budget. That's more than Mr Sarkozy ever did.
And let's put things into some perspective. Public debt is running above 70 per cent of GDP both here and in the US, and even the Office for Budget Responsibility (OBR) admits the UK's deficit – forecast to exceed 7 per cent this year - will not fall below 3 per cent until at least 2018. It's 2014 in the US. Experts think France's gross government debt will be less than Britain's this year, too.
"We think that France will deliver, if in a somewhat patchy, 'stop and go' way which may give way to moments of market volatility," says Gilles Moec, an economist at Deutsche Bank. It will need to be "prodded" at times, too; a reminder that "the reformist drive is a matter of necessity, not choice". Mr Shant agrees. "Reform is very much on the German agenda and they probably don't mind speculation about France slipping into the 'Club Med' as it keeps up the pressure on Paris," he says.
La France peut-elle rivaliser?
Mr Hollande is well aware of the urgent need to arrest the decline in French competitiveness. A report from highly regarded ex-EADS boss Louis Gallois called for a "competitiveness shock" to reinvigorate the French economy. Rising pay and non-wage contributions for businesses are the problem, not productivity. Despite US tyre boss Maurice Taylor's racist attack on "lazy" French workers, OECD figures show that while they worked 17 per cent less the European average in 2011, hourly production of $24.59 (£16.15) was 13 per cent more than the UK and not much less than Germany or the US.
Unfortunately, rather than emulate the Germans and use productivity to drive profit margins, the French have tended to divert much of it toward higher wages. Indeed, French companies suffer the lowest margins in Europe and unit labour costs have rocketed since monetary union. Its share of eurozone exports has fallen, too, down from 18.5 per cent to just 13 per cent, according to Eurostat.
Wage austerity, however, will take time to work. Most of the benefit here will come from layoffs, says Mr Moec. Yes, the scent of burning tyres is in the air again, but steelmaker ArcelorMittal has shut plants and both Peugeot and Renault have agreed thousands of job cuts with unions in recent weeks. Others elsewhere will follow suit and the inevitable pressure on household budgets will render the decade-old French growth model, driven by consumption and the housing market, redundant.
Shifting resources from the domestic public sector to exports is crucial to success here. A lack of focus on high-end niche products has been France's undoing in the past and, rather than overdependence on the European periphery, it is success in fast-growing economies such as China and Brazil that France lacks. Over the past five years, Germany has more than doubled exports to China, but in France they have risen just two-thirds. China accounts for a far larger percentage of Germany's total export pie, too.
French policy and its Keynesian twist, however, should help it skirt a major problem with monetary union and stimulate exports. Put simply, cutting payroll taxes will make French goods cheaper for foreign buyers and raising VAT means domestic consumers will find imports more expensive – so-called fiscal devaluation. Research by the International Monetary Fund’s Ruud de Mooij and Michael Keen has found the policy does work most of the time, in the short term at least.
■ That might stiffen Mr Hollande's resolve, and markets are giving his administration time to work through an immensely complicated process of change. On paper, he has until 2017 to get reforms implemented and working, but in reality voters, and Mrs Merkel, will want results much sooner. Only when the benefits are felt and growth re-appears can the French president, and investors, claim success.
Chaud ou froid?
With Mr Hollande managing to keep all the plates spinning – financial markets, voters, European Commission, Berlin – and the French stock market pricing in a huge slice of execution risk, we sort the haute cuisine from the hors d'oeuvre.
