The campaign was full of promises of new spending or tax cuts, which, more or less convincingly, were said not to increase the deficit.
The real question is elsewhere. Forget the campaign promises. The question is: how much to reduce the deficit already present ? The answer is that, over time, the government needs to reduce the primary deficit—a concept I will explain later—by 4 % of GDP, around 120 billion euros. This is not insurmountable, but it is far from straightforward. The new government, whatever it may be, will have to explain how it intends to go at it
One should avoid being catastrophist. On debt and deficits, one hears many scarry statements. Like we are on the brink of disaster. That if the debt-to-GDP ratio exceeds 100 %—which is the case in France today—the government will not be able to repay it. But, as many of us know from our own lives, we can perfectly well have debt (for example, a mortgage) that exceeds our annual income without it being a problem. And, a fundamental difference between the government and us is that we actually have to repay our debt, while the government can refinance it practically indefinitely, as long as there is market trust. Indeed, many countries have experienced or are experiencing much higher debt levels than France. In Japan, debt exceeds 170 % of GDP and there is no market panic.
So, there are no reasons to panic; but there are good reasons to worry and to act. To understand why, one needs to take a brief theoretical detour. Suppose the state’s revenues are sufficient to cover its expenses, outside of interest payments. In other words, suppose the primary balance, the difference between revenues and expenses net of interest payments, is equal to zero. And suppose the government finances the payment of interest on the debt by issuing additional debt rather than through higher taxes: the debt will increase at the interest rate. At the same time, GDP will increase at the growth rate. The debt-to-GDP ratio will therefore increase based on the difference between the interest rate and the growth rate. In the current context, and as long as the markets continue to trust the French state, the two rates are very close. The state can therefore maintain a stable debt-to-GDP ratio, whatever it is, without needing to increase taxes.
Can one then conclude that the level of public debt is unimportant ? No. The argument, as presented, is too extreme, for two reasons. First: we cannot be sure that the interest rate will remain close to the growth rate. Either because global interest rates rise (and France must follow), or because investors are worried and demand higher rates. If interest rates rise, the higher the debt-to-GDP ratio, the higher the increase in the fiscal cost of the debt will be. Second: the argument assumes that the primary deficit is zero. And this is not the case today. It is around 3 % of GDP. As long as it doesn’t return to zero, the debt-to-GDP ratio will continue to increase. If investors conclude that it won’t return to zero and the debt-to-GDP ratio will continue to rise indefinitely, they will worry and demand a higher interest rate, thus worsening the situation. Thus, to stabilize debt, the primary balance must go to zero.
Given that the primary deficit is 3 %, why do I propose an adjustment target of 4 % of GDP rather than simply 3 % ? The answer: To be ready to face any major crises, which have occurred recurrently in recent years—the global financial crisis, the COVID-19 pandemic in 2020, and the war in Ukraine in 2022—and be able to respond with “whatever it takes” without jeopardizing the stability of the debt ratio. If, as we have observed in the past, one of these crises increases the debt-to-GDP ratio by an average of 10 %, and assuming a crisis every ten years, this implies setting aside an additional 1 % of GDP every year, thus adjusting the primary balance to 4 % of GDP.
This naturally leads us to the following questions: how quickly should the adjustment be made ? And by what measures ?
The first question has a fairly clear answer. On the one hand, too rapid a budgetary adjustment, which would kill consumption or investment, would have potentially dramatic macroeconomic effects. It is enough to remember the effects on activity of the too rapid budgetary adjustment that followed the euro crisis in the early 2010s. On the other hand, an adjustment that was too slow would have two implications: the first would be an increase in the level of debt as long as the primary deficit remained positive; the second, more important, would be doubtful credibility, the feeling that difficult decisions are being postponed. This would lead investors not to believe the program and to increase the risk premium and the interest rate on French sovereign bonds. Calibration suggests an adjustment plan between five and ten years, thus an adjustment of 0.4 % to 0.8 % of GDP on average per year—or about 10 to 20 billion euros per year. The new European budgetary rules in principle allow for an adjustment over seven years if accompanied by significant reforms, so it falls within this range.
The question of specific measures to be taken is political and therefore beyond my subject in this column. But I can make a few remarks.
First, it is necessary to understand how we got here. The primary deficit was 1.3 % in 2017. Why is it around 3 % today ? A report from the French Economic Observatory (OFCE) gives the answer. Many of the measures introduced to protect businesses and individuals in response to COVID-19 and the increase in energy prices caused very large deficits between 2020 and 2022; most of these measures have now disappeared. But the two crises have slowed growth. GDP is about 5 % below its previous trend, resulting in lower tax revenues. The rest of the shortfall comes mainly from tax cuts: compared to the trajectory planned in 2017, the abandonment of the carbon tax increase in response to the Yellow Vests, the reduction of production taxes, and some other measures can explain a shortfall of about 40 billion, or about 1.4 % of GDP. Expenditures have decreased as a proportion of GDP, but not by as much, leading to the increasing deficit.
Second, it is important to have a sense of the size of the challenge. An adjustment of 120 billion euros can be compared for example to the revenues from the income tax, which amount to about 110 billion euros, to the revenues from the CSG which are similar in magnitude, to VAT revenues, which are around 160 billion. It can also be compared to expenditures: the adjustment is equivalent to about half of the total operating expenses, around 220 billion. These numbers make it clear that it will take more than a “fight against fraud” or minor cuts to reach the objective. It is also clear that the most attractive approach lies in measures that increase the employment rate, particularly for young people and seniors, or in measures that increase the productivity growth rate and, by implication, the economic growth rate. These measures can do more over time, both for the budget and the people, than simple spending cuts or tax increases. But one must be realistic: The former can only bear fruit over time, and the effects of the latter are always uncertain.
Third, it is essential to do what is needed for the green transition and the defense effort, two absolute priorities. The Pisani-Ferry and Mahfouz report suggests a necessary increase in public investment of around 1 % of GDP. Some estimates put the additional defense effort at 0.5 % of GDP. The adjustment should not be made at their expense. Not far behind are the expenditures of sectors necessary to strengthen growth, such as education and research.
Fourth, such an adjustment can only be credible if the government starts taking measures and designing reforms now. Credibility of the adjustment program is particularly hard achieve when the government is the result of a coalition or if uncertainty about the nature of subsequent governments is high. It is obvious that a government appointed today can only commit the state for at most three years and risks having limited room for maneuver. There is, of course, no simple solution, but the clearer the vision underlying the government’s projects and commitments is, the more convincing the initial steps, the greater the chances that the program will be perceived as credible and France will not be penalized.
All these points skirt the essential question of the exact content of the adjustment, in particular the proportion of the adjustment that should come from increasing revenues or from reducing expenditures. This is where political preferences must come into play. While I have my opinions on the subject, my intention with this article was to highlight the constraints that a government will face in making these choices, regardless of its political orientation.
Olivier Blanchard is a professor at the Massachusetts Institute of Technology and at PSE. A prominent French macroeconomist, he was also chief economist of the International Monetary Fund. His article below draws on an upcoming report from the Council of Economic Analysis on budgetary adjustment.
