French President Emmanuel Macron has dissolved France’s National Assembly, the lower house of the French Parliament. Macron has called elections for late June and early July because France’s far-right party, National Rally, did much better than expected in the June 9 elections for the European Parliament.
National Rally won about 31.4% of the vote, while Macron’s Renaissance party trailed badly, winning only about 14% of the vote. Macron is forcing the French people to decide between the center or far-right populism. France’s real problem is that its economy is moribund. The French people are polarized over economic and social reforms. Financial markets understand that France faces likely unsolvable challenges that won’t be fixed by elections.
Following the EU elections, yields on French sovereign debt soared relative to yields on German sovereign debt. The gap between the two increased by 50 basis points, 0.5%, the widest since 2017. France has a debt-to-GDP ratio of 110%. That deficit ratio is rising. An increase in borrowing costs of 0.5% will consume over 0.5% of French gross domestic product. France faces the specter of a financial doom loop, debt service consuming an ever-growing share of the economy. France is already running a fiscal deficit of 5.5% of GDP. Nominal GDP growth in France does not exceed 4%. France has a problem.
Under the constitution of the EU, France must reduce its budget deficit to 3%. Financial markets are rightly concerned that the French economy and its government face a Sisyphean task. Government consumes over 55% of the French economy and is just too big. Markets and economists know that France must cut spending. Further tax increases will only make the growth and productivity problems worse.
But the French people are sharply divided on where to cut spending. Entitlements are a major problem for the United States’s fiscal situation, and are an even bigger problem in France. The French people rioted about raising the retirement age from 62 years to 64 years. To restore fiscal sanity in France, the retirement age must be raised to 70 years, but the French people won’t stand for that.
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Increasingly, France and all of Western Europe are becoming a sideshow in the global economy. In France there is effectively no dynamic technology sector. The champion of French innovation is a new company, Mistral AI, a business focused on artificial intelligence. But Mistral AI only has a market capitalization of $6 billion. It does not have a supertanker balance sheet. Mistral AI does not have the database necessary to develop large language models. Mistral AI will be competing against American companies with trillion-dollar market capitalizations, almost unlimited sources of capital, and enormous databases. France’s DGSE intelligence service, renowned for its economic espionage against allies and foes alike, will be unable to steal enough intellectual property to boost Mistral AI’s prospects.
Globally, the economies of the EU are losing market share. The U.S. economy is gaining market share. U.S. GDP is over 50% larger than the GDP of all of the EU and approaches $30 trillion. France and Europe are an economic sideshow. But France offers a warning for U.S. voters about what can happen when the state gets too big.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society.
