Raising wages and lowering consumption taxes are among the flagship measures of the New Popular Front to boost the purchasing power of the French. The National Rally’s program included similar measures. Unsurprisingly, raising wages is popular in the polls, with the issue of purchasing power having become the number one concern after the price increases caused by the post-Covid recovery and the invasion of Ukraine. Are prices too high? No problem, just raise wages and lower taxes, that will solve the problem.
If only things were that simple. Those who advocate these solutions seem to have forgotten historical experiences and ignored the fact that since 1992 we have been in a fixed exchange rate with our partners in what has since become the eurozone. Unilaterally raising wages or lowering consumption taxes amounts to revaluing the national currency, which we could call the French euro. To understand this better, let us go back to the time when a government could decide on the exchange rate of its currency.
At the end of the Grenelle negotiations concluded on 27 May 1968, the guaranteed minimum wage (Smig, indexed to inflation) was increased by 35%. On 1 December, the VAT rate was raised from 20% to 25%. On 8 August 1969, Jacques Chaban-Delmas authorised an 11% devaluation of the franc against the dollar. Less than three months later, the Deutsche Mark was revalued by 9% against the dollar and therefore against the franc.
The trick was done: the loss of competitiveness caused by the increase in wages, then indexed to prices, was offset by the devaluation of the franc against other currencies, but also by the increase in VAT rates. Of course, the consequence was a loss of purchasing power of wages which cancelled out most of the increase in the minimum wage, but this did not alarm the unions too much.
The German “fiscal devaluation” of 2007
The sequence was repeated after the election of François Mitterrand in 1981: the 10% increase in the minimum wage, which became the SMIC (which, unlike the old SMIGC, increases faster than inflation) and the high wage inflation that price indexation fuelled, were absorbed by a series of devaluations of the franc, from 1981 to 1987, sometimes disguised as a revaluation of the Deutsche Mark.
Another episode, this time German, is also worth a look: the “fiscal devaluation” of 2007 – a strange term that deserves some explanation. The fall of the Berlin Wall and unification caused a historic overheating of the German economy, solicited beyond its capacities by the frenzy of consumption of the East Germans, suddenly solvent by the one-for-one conversion of their salaries. This was followed by wage inflation so strong that the loss of competitiveness caused a massive increase in unemployment to the point that employers, unions and political parties concluded an implicit pact to save the post-war social model by regaining the lost competitiveness. After the Schroeder reforms of the labor market, the final touch consisted of increasing the VAT rate (from 16% to 19%) while lowering employer contributions (from 6.5% to 4.2%) – an operation called in France TVA sociale.
How does it resemble a devaluation? First, the reduction in social security contributions reduces the cost of labor, while it remains unchanged for competitors, which is equivalent to a devaluation. The effect of the VAT increase is more subtle: products imported by Germany see their prices rise, which reduces demand, while those exported from Germany remain unchanged. The country’s trade balance is improved, which makes the operation similar to a devaluation.
Measures “similar to an appreciation of the French euro”
Let’s go back to France in 2024. If lowering the cost of labor or increasing VAT rates is akin to a devaluation, the opposite movement is equivalent to a revaluation. A massive increase in the minimum wage and a reduction in certain consumption taxes would therefore be similar to an appreciation of the French euro. Knowing that any currency devaluation is now impossible, can the French economy afford the luxury of such a revaluation? Foreign trade data and the constraints reported by companies show that this is really not the case.
In 2023, after three years of strong recovery in exports, the balance of trade in goods remained in deficit of 67 billion euros (-2.4% of GDP), weighed down by a large deficit in industrial products (-101 billion). As France’s current account balance is much less degraded (-35 billion, or -1.2% of GDP) thanks to the surplus in services and the income of French companies abroad, the external imbalance is not in itself a problem for our country. But the deficit in trade in goods indicates at least low competitiveness and/or excessive domestic demand, compared to those of our partners. Revaluing the French euro would only aggravate the difficulties.
There are two counter-arguments. On the one hand, since employees paid the minimum wage work mainly in services and commerce, sectors considered to be sheltered from international competition, increasing the minimum wage would have no effect on competitiveness. On the other hand, boosting consumption through higher wages would stimulate economic growth according to a pattern often heard: more consumption leads to more production and therefore more jobs.
Increase in unemployment and prices
None of these arguments stand up to analysis. A sharp increase in the minimum wage would result in an increase in unemployment – according to the best experts on the subject, job losses would be between 100,000 and 200,000 – and an increase in prices, the only possibility of survival left to companies employing minimum wage earners. In turn, the increase in prices will lead to an increase in wages in general and will therefore not be limited to the sheltered sector. Furthermore, the temptation to finance the automatic increase in tax exemptions on low wages and additional unemployment benefits by higher contributions, or increased tax pressure, will be strong. In the first case, the cost of labor would increase even more; in the second, the excess of levies on the most productive employees would reduce productivity by discouraging efforts. Ultimately, the cost of labor per unit produced would increase. In any case, the French euro would be revalued.
As for the knock-on effect on the economy of a boost in consumption, it would be activated if the French economy suffered from a proven demand deficit and underutilization of its capacities. As we have seen, the results of foreign trade do not indicate a demand deficit. In addition, any stimulation of demand would come up against the supply constraints reported by companies in INSEE surveys. Questioned last April, 29% of manufacturers reported production bottlenecks, not due to insufficient material capacities, but recruitment difficulties: more than half of companies said they could not produce more because they were unable to hire! A stimulation of demand through consumption would then be an excellent deal for Chinese, German, Italian, Spanish manufacturers, etc. but would hardly increase national production. This is exactly the effect that we would expect from a revaluation of the currency.
Revaluing the French euro through wage increases or VAT cuts could certainly create a feeling of euphoria in the short term, but the economic reality would quickly become apparent: gains in purchasing power would be eroded by inflation or shortages in the event of a price freeze, and job losses would be high. And, as the painful experience of competitive disinflation led by Pierre Bérégovoy from 1984 to 1992 showed, it would be long and painful to get back on track.
* Eric Chaney is an economic advisor to the Montaigne Institute