The Fall of France

Welcome back to the Economic Echo! In this week’s special edition, we dive deep into the dramatic collapse of the French government. We explore the unfolding events, the historical context that led to this crisis, and its economic implications, breaking it all down the Economic Echo way.

Overview (TL;DR)

French PM Michel Barnier resigned on December 7th amid political and economic turmoil. The crisis stems from Barnier’s proposed €60 billion austerity package to tackle France’s fiscal deficit. However, opposition from Marine Le Pen’s far-right party and other parliamentary members created significant instability.

France's escalating debt burden has become a growing concern, casting doubt on its fiscal stability. Investor confidence is beginning to waver, which is reflected in increasing borrowing costs and the widening spread on bond yields. These signals suggest market skepticism about France’s ability to address its financial challenges effectively, amplifying fears of a looming economic crisis.

Now, lets explore the political missteps, economic factors, and future challenges for France as it faces pressure from both domestic political opposition and European fiscal stability requirements.

Background and Build Up

French Prime Minister Michel Barnier, leading a minority government under the liberal-conservative party The Republicans, proposed an austerity budget aiming to tackle the nation's growing fiscal deficit. The budget included:

• €60 billion in savings, with:

  • €40 billion in spending cuts

  • €20 billion in tax hikes

France’s fiscal deficit currently exceeds 6% of GDP, the total value of goods and services produced by a country. This deficit is more than double the 3% limit mandated by the European Commission. A deficit occurs when a government spends more than they can afford and often leads to increased debt. Austerity measures are often a response for governments, they aim to tackle high debt levels though increased revenue generation through taxation, reduced government spending or both. This proposed budget comes at a time where Frances national debt is projected to reach 115% of GDP in 2024 and potentially 124% by 2029. Such high debt levels can have negative impacts on government, preventing their capacity to implement fiscal stimulus to the economy or to bail out failing institutions.

Fiscal stimulus is a type of government spending which can be implemented to boost economic growth, such as building a new railway which provides both jobs in the short term and boosts future output capacity. Bail outs can be used to prevent economic distress - e.g. in 2008 when governments bailed out failing banks to prevent further crises.

The worsening economic conditions meant the French minority government were already positioned weakly to put forward a budget. Aiming to address these issues, Barnier proposed an unanimously unpopular electricity tax hike which became a focal point of public and political ire. This controversy led to the far-right leader, Marine Le Pen, threatening to topple the government with a vote of no confidence.

So What Happened?

Realising his mistake and under heavy pressure from Le Pen, Barnier withdrew the electricity tax hike. However, there still remained many questions whether this concession would be enough to get the budget through. Markets reacted with French government bonds being priced 90 basis points above German bonds the highest difference in 12 years. Government bonds are debt securities where investors can essentially lend to governments at a secured rate of return - they are paid by the loan with a reward. The difference between French and German bond yields indicates an increase in the perceived riskiness of loaning to the French government - investors require a greater rewards for the loan.

Ignoring market sentiment and the opposition’s views, Barnier tried to force the budget through using Article 49.3. This angered even his own party members and subsequently, Le Pen and others in parliament signalled readiness to initiate a vote of no confidence, creating a volatile political landscape.

Without sufficient parliamentary support, Barnier resigned on Thursday, December 7th, leaving the future of The Republican party and French governance uncertain.

French President Emmanuel Macron is now under pressure to appoint a new prime minister, and a special legislative measure is being implemented to prepare a ‘stopgap budget’—essentially rolling over the current budget into the next year. Barnier warned that this would result in higher taxes for 18 million households and fail to reduce the budget deficit, which is projected to remain above 6% of GDP.

Despite this political turmoil, since the collapse of the French government, bond yields have recovered and financial markets have remained relatively calm. According to sources like Politico, markets have factored in political risk and continue to view the French economy as stable, despite the significant debt levels.

Economic Implications

France's fiscal and political instability highlights broader concerns:

1. Rising Debt and Borrowing Costs: A higher deficit worsens debt servicing requirements, impacting government spending on essential services.

2. European Stability Risks: With France as a core EU economy, its financial health directly influences broader European economic stability.

3. Investor Sentiment: Increased borrowing rates reflect reduced market confidence, complicating France's recovery trajectory.

What’s Next for France?

The collapse raises urgent questions about the political and economic future:

• Reforming Governance: Without a majority coalition, stabilising leadership remains a critical challenge.

• Economic Recovery Strategies: A new administration must propose actionable, balanced reforms to curb deficit growth without sparking public unrest.

• EU Stability Rules: France’s breach of the EU fiscal stabilisation rules places it under potential scrutiny from the European Commission.

Unless France demonstrates a clear commitment to reducing its deficit, the European Central Bank (ECB) may find it difficult to intervene by purchasing French bonds. If the spread on French debt—the difference between the yields on French bonds and those of its European counterparts, such as Germany—continues to widen, ECB policymakers could face significant political challenges. This issue could become even more complex, given that France is just one among many European nations grappling with economic difficulties and fiscal strain.

Sources such as The Financial Times and Politico have indicated that ongoing challenges to fiscal consolidation and investor confidence are central to the ECB’s strategic dilemma in these circumstances.

The Big Picture

The political and economic uncertainty surrounding France’s collapse underscores how interconnected governance, fiscal policy, and investor sentiment are within the EU. All eyes are now on how France will respond to these challenges and whether it can re-establish political cohesion while addressing mounting debt pressures.

Thanks for reading! We’d love to hear your thoughts—whether it’s feedback on this edition or ideas for stories you’d like us to cover in future issues. Your input helps us make The Economic Echo even better.

Best wishes,

Harry and Reika

Co-Founders, Echonomics