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Why Paul Krugman is wrong about France

November 12, 2013: 12:24 PM ET

The New York Times columnist argues that the country's leaders have charted a brave path to prosperity. But the very policies he praises are hobbling the French economy.

French President François Hollande faces a struggling economy.

French President François Hollande faces a struggling economy.

FORTUNE -- While living in Paris as Fortune's bureau chief for eight years in the 1980s, I wrote a piece on a prominent CEO (or PDG en Francais) who liked to skewer his nation's philosophy of business. "The British had the industrial revolution," quipped this connoisseur of industrial history. "The French just talked. They had the verbal revolution."

Today a lot of outsiders are talking about France. But some of the rhetoric doesn't adhere to the facts. Everything about France now, from the huge jobless rate to the widespread malaise, defines an economy in crisis. However, certain pundits would have you believe that things are just fine and poised to get better.

Specifically, I'm referring to New York Times columnist and Nobel Prize winner Paul Krugman. It's worth asking if the 25% of young people who can't find jobs in France would agree with Professor Krugman's view that France is following a courageous, enlightened course that should be a model for competing nations.

He presented his views on Monday in a Times column headlined "The Plot Against France." I took a special interest in the piece because Krugman criticized a story I wrote here in January, titled "The euro crisis no one is talking about: France is in free fall." He lumped it in as part of a campaign of "incessant negative propaganda."

MORE: Europe likely to get worse before it gets better

Krugman brands France's critics as folks who are unwisely promoting an agenda of austerity -- chiefly spending cuts and deregulation -- that, he argues, has miserably failed in other countries. For Krugman, France is doing just the right thing by keeping government spending at high levels, ignoring deficits, and favoring tax increases over reductions in spending. He concludes that France is being vilified for "the unforgivable sin of being fiscally responsible" and is "performing as well or better than most of its neighbors."

My story emphasized France's dramatic loss of competitiveness over the past several years, causing a severe drop in its exports and, as a consequence, years of sluggish growth. Contrary to Krugman's argument, the benchmark for France's performance shouldn't be Greece, Portugal, and Spain, but Germany, the U.S., and the Asian nations that are both its biggest customers and rivals in world trade. It's highly instructive to compare France's performance over the past several years with that of its biggest trading partner, Germany.

Let's go back even further. In the mid-1980s, France made an economic "right turn" under Socialist President Francois Mitterrand -- I was there at the time -- into spending discipline, reductions in the federal workforce, and an end to nationalizations. The austerity program made France a formidable competitor to Germany and led to years of strong growth. In the early to mid-2000s, France demonstrated its powerful potential once again under conservative Jacques Chirac and his finance minister Thierry Breton. In the mid-2000s, France was, believe it or not, beating Germany on most metrics. Its jobless rate was lower, its debt-to-GDP was about the same at a modest 65%, and its growth rate matched its northern neighbor in the 2% range.

MORE: Why New York is (still) the center of the business universe

What's happened since, under Presidents Nicolas Sarkozy and François Hollande, is a shocking reversal of fortune. France's unemployment rate stands at 11.1%, vs. 6.7% in Germany. France's ratio of debt-to-GDP will hit 95%, a dangerous number, in 2014. That's 15 points above Germany. France grew at 0.1% in 2013 after posting 0% expansion in 2012. Germany's not growing much either at 0.4% for 2013. The difference is that Germany's industries are highly competitive on world markets, and France's are not. That's why, contrary to Krugman's arguments, France's future looks bleak.

Since 1998, France's share of global exports has fallen from 7% to 3%. The number of companies selling goods abroad has declined from 124,000 to 117,000 since 2004, compared to a big increase in Germany, which now boasts twice as many exporters as its neighbor.

For France, the problem is costs, and that problem divides into two categories: expensive labor and old plants. Since the mid-2000s, the cost in wages and benefits of making a car or computer, unit labor costs, have risen 25% in France and 7% in Germany. French workers are also somewhat less productive than German workers. But French workers earn more than their German counterparts, around 35 euros an hour in wages and benefits versus 34 euros for the Germans.

It's important to note that French workers are quite productive compared to their global counterparts. The research firm Flash Economics points out that the main reason the productivity numbers look good is that French workers toil fewer hours than those of any other industrial nation. Companies are reluctant to hire workers in good times because of the high costs of laying them off in recessions. Hence, they tend to operate with lean workforces.

The real problem is that the plants, supply chains, warehouses, and computer systems are antiquated. The reason is that overtaxed corporations lack the earnings to invest in new capital equipment. As a result, France's total productivity -- output for its use of labor and plants -- has shown no increase whatsoever since the late 1990s.

The cost problem is especially serious because France is heavily concentrated in commoditized industries, including inexpensive cars and steel products. Germany sells Audis and Mercedes; France sells Peugeots and Renaults. Because French products are so ordinary, they're far more sensitive to higher prices than the luxury cars and machine tools that are Germany's specialty. Hence, higher costs, and rising prices, hit France's exports hard.

In the past, France's competitiveness issue never careened into disaster because it could always devalue its currency. Today, under the euro, that option is gone. The solution is reducing taxes on business and lowering benefits costs to make labor competitive and restore the profits that would allow companies to build state-of-the-art plants. Unfortunately, that's a course of action of which Krugman wouldn't approve.

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About This Author
Shawn Tully
Shawn Tully
Senior EDITOR-AT-LARGE, Fortune

Shawn Tully has been writing feature stories for Fortune since 1980. He's covered stories as varied as the Vatican's finances, the exile of fugitive commodities trader Marc Rich, and the disastrous merger between Guidant and Boston Scientific. He specializes in banking, federal budget and spending issues, and health care. Tully holds a B.A. in English from Princeton University, an M.B.A. from the University of Chicago, and a master's in Applied Economics from the Universite Catholique de Louvain in Belgium.

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