The political economy of the Breton upheaval. II: A symptom of collective mad cow disease.

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I will continue my discussion of the Breton upheaval by discussing its economic, or rather mad-cow-nomic, roots.

Over the last two decades French public opinion has become increasingly vocal against globalization. All political parties have to some extent a protectionist stance, if only a nominal one. The “extreme” parties are outright protectionists. The ruling parties’ platforms include a cosmetic industrial policy agenda to make-up for the fact that they will abide by international treaties and therefore are in no position to close frontiers.

The arguments of the opponents to globalization are simple. How can a French firm with high labor costs compete with a Romanian firm with low labor costs? The French firm will have to close and its employees will be out of jobs. If globalization puts people out of jobs, why does the European Union write reports saying it is good for the economy? And why is it imposed upon the French people, increasingly against their consent?

At the same time, there is much less support for protectionism in other countries with similar levels of developments, such as the U.S., the U.K., Sweden or Germany. These countries seem to adapt better to globalization, in fact they are more globalized than France; the Bolkestein directive has been implemented to a greater extent in the UK and then Germany than in France, and yet their population is more sympathetic to trade. Indeed, in Germany the unemployment rate has constantly fallen throughout “the worst crisis since the great depression” and is now at a minute 5 %. (According to a French magazine, this is “the example not to be followed”.)

We could believe that the French are brainwashed, and that may be true to some extent, but facts seem to confirm their views. Every day a prominent firm announces that it will close or downsize, and the Breton food and agricultural industry is one of the most exposed ones. Could it be that globalization is good for Germany and bad for France? And what differences between these economies could account for that?

To answer those questions, we need to understand why wages are low in Romania in the first place. And we need to understand why we may gain from trading with them despite that some firms can’t compete with their low wage producers.

Suppose we only trade with countries with a similar level of development. Then, clearly, no firm would have to shut down because its foreign competitors have lower costs. Consumers would gain not because they would import cheaper products, but only because they would consume a broader range of products. Yet even in such a situation, some firms would have to close, because they are less productive than their German competitors; and some German firms would have to close, because they are less productive than their French competitors. This should be no problem; because France and Germany have a comparable distribution of skills, trading between them does not impact the distribution of wages. So if lose my job because some German firms are more efficient than my employer, I can expect to find another job at a similar wage elsewhere. In fact, reallocating resources to the most productive competitors increases the productive capacity of both economies and makes everybody better-off.

Yet if you describe this scenario to a French, he will object that once he has lost his job, he won’t find another one. The scenario only works if the economy is sufficiently flexible to smoothly reallocate labor between firms. And that is not the case of the French economy.

Suppose now that instead of trading with Germany, we trade with Romania. These people earn much lower wages. Yet that must be for a reason. If they were as productive as the French in all sectors, they would have the same real wage and real living standards. Any differences in nominal wages would then just be a matter of exchange rate misalignment. The Romanians must therefore be less productive than the French. But if they were uniformly less productive than the French, they would not be able to undermine the competitiveness of French firms. A French firm which pays 100 to workers who produce 100, can sell its good at the same price as a Romanian firm which pays 50 to workers who produce 50.

The problem comes from the fact that the Romanians are not uniformly less productive. They may be far less productive at making airplanes, but equally productive at producing poultry. They only earn 50 because of their low productivity at making airplanes, but their poultry firms pay 50 to their workers who produce 100, while the similar French competitor has to pay 100 and needs to sell its production at twice the price. When forced to compete with the Romanian firm, the French firm has to close unless its own wages fall down to 50. If that happens, its workers will become much more attractive to hire for the aircraft industry and will relocate there. The aircraft industry will grow and indeed it would attract all the former workers of the poultry industry if workers were identical. Given that the aircraft industry does not suffer from competition from Romania, eventually no worker has suffered a wage loss and people are better-off because they can consume cheaper Romanian chicken that is financed by exporting aircrafts. But perhaps workers in the poultry industry are not so productive in the aircraft industry because they are  “unskilled”, and through trade they have to indirectly compete with Romanian unskilled workers who are relatively more abundant. Then the unskilled workers end up with lower wages, but their wage losses are smaller, the better their ability to relocate.

Then, you might ask, why would the unskilled accept trade with Romania if their wages fall? The answer is: they wouldn’t! But in theory we may design the shift to globalization in such a way that they are compensated for the wage losses. We could levy a tax on the consumers, who benefit from cheaper imports, and finance a transfer to the unskilled, who also benefit from cheaper imports but not enough for this to offset the effect of their wage losses, in such a way that everybody is better-off. This is because free trade generates global net gains at the aggregate level.

Of course, one does not have to do it. It is written nowhere that the losers from public policies have to be compensated. In fact most public policies are zero-sum (or even negative-sum) redistributive ones such that compensating the losers is impossible because the policy does not generate any gains. Its legitimacy comes from “consent” of at least a majority of voters. But, as we have seen, that kind of “consent” has been denied to the French in the case of the Eastern enlargement of the European union.

But the central issue is that the French economy does not work as described. In fact it has been designed in such a way that participation in a free-trade zone with low wage countries has catastrophic consequences.

On the one hand, market rigidities make the adjustment to foreign competition more painful, and magnify the losses for the social groups exposed to it. Workers who can no longer compete with their Romanian counterparts have to lose their jobs, because minimum wages and collective agreements make it impossible for them to have a wage cut. Regulation makes it harder for them to relocate to another industry or location. For example, they would have to buy a costly license should they want to become a taxi driver, or to spend years getting a degree should they want to open a hair salon. They would lose their order of priority in access to social housing should they want to accept a job elsewhere.

On the other hand, participating in a global market increase the economic distortions associated with taxes and regulations. For example, in a closed economy, an increase in social minima would make unskilled labor more expensive to hire, and firms that employ lots of unskilled workers could adjust by raising prices. This would generate some employment losses and welfare losses for consumers. But these losses would be smaller than in an open economy, where those firms could no longer raise prices, since their customers would then shift to foreign competitors. Instead they would have to close and their workers would become unemployed.

Many other handicaps compound those issues, such as the working time regulation, the gradual piling up of safety and environmental regulations, the ever crawling up payroll taxes, and the Euro.

With a rigid economy, losers lose more, and gainers gain less, from globalization. It is no longer obvious that there are aggregate gains from trade. To compensate the losers one needs a greater tax hike than in a flexible economy, and it may be impossible for everybody to gain.

The  inherent contradiction in French economic policy is to insist on implementing ideologies that hamper markets, while at the same time participating in globalization, which makes flexible markets more necessary. French politicians live under the delusion that they can survive that contradiction by making it up with subsidies. Last week only the government spent 5 billion Euros of taxpayer money to appease interest groups, including the angry Bretons. They hope that they can find some more malleable people willing to remain silent while they have to pay more taxes to finance the subsidies that the more vocal, connected, or violent groups managed to get for themselves.

Suggested reading: Saint-Paul, Gilles (2007) Making Sense of Bolkestein-Bashing: Trade Liberalization under Segmented Labor Markets.Journal of International Economics, 73 (1). pp. 152-174.

Suggested movie: Que la fête commence, by Bertrand Tavernier, with French actor jean-Pierre Marielle at his best in the role of Breton dissident Pontcallec.

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