France - Robust growth in 2018-2019 despite increased recruitment difficulties
Q1 GDP showed slowing growth. This was expected and was justified by one-off factors; this does not suggest, however, that the French economy has begun a cyclical downswing. Over 2018 as a whole, the pace of growth is forecast to remain robust. France is experiencing increased recruitment difficulties that reveal a level of activity that it now nearing its potential, and a problem of labour suitability.
Growth decelerates in Q1
In Q1 2018, volume GDP rose 0.3% quarter-on-quarter, compared with 0.7% in Q4 2017. Our forecast was for quarterly growth of 0.2%. Growth is thus slowing, consistent with the signals from the leading indicators for several months past, with falls in business climate surveys since the start of the year, a fall in manufacturing production in Q1 (-1.1% q/q) and unchanged household consumption of goods (+0% q/q).
Domestic demand in particular (excluding inventories) has contributed positively to growth (+0.3 of a point). Conversely, contributions from stock variations and foreign trade were nil. More precisely, household consumption saw modest growth (at 0.2%, after 0.2% in Q4), similar to household investment (0.5% after 0.6%), while business investment slowed over the quarter to 0.5% from 1.6%. The slowdown in mainly due to the fall-off in investment in manufactured goods, down to -0.9% from +1.7%. In addition, exports and imports were virtually stable over the quarter.
This slowdown does not presage a downturn in the French economy in 2018. It was partly predictable after a 2017 year-end, which saw very strong growth. Moreover, activity surveys for April suggest that agent confidence levels have become more consistent with developments in the real economy. At year-end 2017, the surveys were pointing to far higher activity rates than the effective activity data, even though that activity was extremely sustained, especially in the manufacturing sector. The fall in Insee’s composite PMI and business climate index since the start of the year should therefore not be read as an early sign of a cyclical downswing but rather as adapting expectations to reality. The reality is that of an activity cycle which, after seeing a period of acceleration, is now in an expansion phase.
Towards an uneven quarterly profile in 2018
In 2018, the quarterly growth profile is likely to be uneven, however, due especially to the calendar of tax measures rolled out by the government. The measures will affect household consumption, even if changes to the personal savings ratio may help to smooth their profile.
Purchasing power was cut in Q1 due to the 1.7% increase in the CSG solidarity tax, partly offset by a reduction in social security contributions and higher taxes on energy products and tobacco. Purchasing power should recover in Q2 and Q3 on the strength of tax cuts (reform of the ISF wealth tax and extension of the tax credit for domestic employment). As a result, consumption, which saw a modest increase in Q1 of 0.2% over the quarter, looks set to grow by 0.4% in Q2 and by 0.5% in Q3. It is forecast to accelerate markedly in Q4, by 0.7% q/q, due to a further cut in social security contributions and the deployment of the first tranche of the cut in the taxe d’habitation (council tax).
Business investment, for its part, is forecast to continue rising for the fifth consecutive year and is likely to be the second most important driver of growth. Resilient corporate margins and profits, combined with an increase in the production capacity utilisation rate, point to a further marked increase in investment spending of 5.2% in 2018. Following a sharp recovery in 2015, linked to the roll-out of the CICE tax credit, the level of margin ratios for non-financial companies has remained fairly stable. In 2017, it dipped slightly, to 31.7% from 31.8% in 2016. The change was justified by a slightly larger increase in real wages than in productivity and by a rebound in energy prices. Margin ratios should be more or less unchanged in 2018. Conversely, the rate of growth in household investment spending seems likely to be less dynamic than in 2017, largely due to the rejigging of the Pinel buy-to-let scheme and of the PTZ interest-free housing loan in areas of housing shortage, and to a modest increase in lending rates. It is also worth noting that public investment should rise in 2018, largely on account of the gradual deployment of the government’s Grand Plan for investment. Last, the contribution from foreign trade is likely to remain slightly negative in quarterly terms given that imports could be slightly more dynamic than exports.
Overall, therefore, the pace of quarterly GDP growth looks set to accelerate steadily over the year, from 0.4% in Q2, to 0.5% in Q3 and 0.6% in Q4, with growth reaching an annual average of 1.9%, close to the 2% growth recorded in 2017.
Sharp rise in recruitment difficulties: where do we stand in the cycle?
Above and beyond this, we need to ask about the mature character of the ongoing economic expansion and the French economy’s relative position in the cycle. The answer to that question lies in an analysis of the gap between potential GDP (1) and observed GDP. Several indicators testify to tightness in the French industrial base, suggesting that the economy is now close to potential GDP.
One such indicator is the capacity utilisation rate as measured by Insee. According to data from January 2018, manufacturers are using their machinery and equipment more and the capacity utilisation rate reached 85.8%, well above the trend level of 82,9%, and its highest level since January 2008. We can make the same observation when we look at production bottlenecks, ie, the proportion of firms reporting that they cannot produce more, being back at their 2008 peaks.
However, all these indicators apply solely to the manufacturing sector, which accounts for only a fifth of the economy. Another indicator of tightness is that concerning recruitment difficulties, which is more representative insofar as it applies to all the main economic sectors: manufacturing, services, and construction.
Since early 2016, the findings of Insee’s monthly economic climate survey point to a marked increase in recruitment difficulties. These are now above their trend level calculated over the 2000-2017 period. They are now back at their 2008 level in manufacturing, but are still below their 2008 highs in services and construction. In addition, they are still below their all-time record observed at the beginning of the noughties.
How to interpret the marked acceleration in recruitment difficulties in France ?
In the Insee survey of recruitment difficulties in manufacturing, 57% of firms have flagged up obstacles to hiring; the proportion stands at 47% in services. Among other factors, firms point in particular to the lack of availability of skilled labour (32%), uncertainties as to the economic situation (25%), employment related costs (22%) and the regulatory framework (17%) as the main obstacles to hiring. The fact that non-availability of skilled labour is cited as the prime obstacle to hiring, even when the unemployment rate is high (8.9% for all of France at end-2017, according to the ILO), may surprise, and suggests that the structural unemployment rate (2) is itself high and has increased. The OECD estimated it at 9.2% in 2017, as against 8.5% in 2007. The observed unemployment rate stood at about one percentage point lower in 2007 for an identical indicator of recruitment difficulties.
How can this convergence of marked recruitment difficulties and a high unemployment rate be explained? Since the 2008 crisis, the unemployment rate among the long-term unemployed has been rising (an annualised 4.0% of the workforce in 2017, compared with 2.5% in 2008). The skills levels of the long-term unemployed, which have been unused for a long time, had almost certainly tended to deteriorate in an environment of rapid technological change. Second, the existence of a population group with few qualifications, who are less employable, may also have contributed to increasing the structural nature of unemployment. In France, the unemployment rate among people aged 25-64 with no qualifications is 16% compared with 10% in Germany: a six-point difference. Conversely, in the category of those with higher education qualifications, the gap is only three points (2% in Germany, 5% in France).
To the low employability of a part of the workforce should also be added a number of uniquely French features, and in particular, the historically less flexible labour market than in other adjacent countries such as Germany, which can create obstacles to hiring. From this viewpoint, the recent labour market reforms may contribute to minimising the effects in the mid-term. Moreover, even among the population of young people with qualifications, there is a relative mismatch between their skills and the needs of businesss. This is a global phenomenon, but is more marked in France, partly due to the lesser development of apprenticeships compared with other countries such as Germany. Furthermore, some sectors are deemed to be relatively unattractive, such as construction or catering, or suffer from a somewhat negative image among job seekers, such as manufacturing.
These recruitment difficulties therefore mainly reveal a level of activity that is now close to its potential and which is hampered by a lack of skilled labour. It is worth noting that the firms reporting a dearth of skilled labour are also often those that show a marked trend in job creation, with higher balances of opinion about past staffing levels than the average of other firms. This may suggest an increased training requirement and/or a lack of skilled labour in high-growth sectors in, eg, digital, engineering, new technologies, and electronics.
These recruitment difficulties should, however, be put in their proper perspective. While it is true that firms say they are experiencing greater recruiting difficulties, this does not mean that they will not hire, and hiring intentions in the private sector remain upbeat. In light of Insee’s latest forecasts, job creation in the non-farm commercial sector is estimated at 129,000 in the first half of 2018, compared with 114,000 in the second half of 2017. In another indicator from Pôle Emploi, between 200,000 and 330,000 job offers by firms were not filled in 2017, a fairly limited figure when compared with the 3.2 million job offers published during the year. Of these unfilled positions, 97,000 were cancelled due to the removal of the need or the lack of a budget at the firm concerned, and in only 150,000 cases was the recruitment dropped due to a dearth of job applicants.
Moreover, the French economy is not alone in experiencing growing recruitment difficulties. European Commission surveys point to more marked recruitment difficulties in Germany and the United Kingdom, which is consistent, given the relatively low levels of unemployment (respectively 3.5% and 4.2%) and their more advanced position in the economic cycle. The difficulties are, on the other hand, less marked in Spain and Italy, where unemployment rates are higher (respectively 16.1% and 11%). In the United States, the difficulties are extreme. As shown in particular by the NFIB survey of small businesses, 47% report that they have few or no qualified applicants for the jobs they were offering. These levels are close to the peaks observed in the noughties.
Wage pressures are still moderate, however
In view of these recruitment difficulties, we might expect to see more pronounced pressure on wages. But wage pressures are still very modest, no doubt due to the presence of structurally deflationary factors such as globalisation and competition, the “Uberisation” of the economy with the rise of temporary jobs with flexible pay and hours, and with average per capita wage increases of around 2% a year in France. This weak pressure on wages tends to strengthen the idea that the economy is not going to come up against supply-side limitations in the very near term. Other countries, that are further ahead in the cycle, such as Germany, where the output gap has been in positive territory for several years, are continuing to see growth.
After accelerating in 2017, growth looks set to settle down to a robust pace in 2018-2019, although against a more uncertain international environment
Our diagnosis is that after seeing a period of acceleration in 2017, the French economy is now in an expansionary phase (ie, mature growth). In this phase, we can see a slow deceleration in the rate of growth in activity, but this is still higher than the potential rate, estimated at around 1.3% a year by volume. After 2.0% GDP growth in 2017, we expect to see 1.9% in 2018 and 1.8% in 2019. This would nudge GDP towards its potential level in 2018 before rising above it.
Moreover, reaching potential level does not mean that a downswing is imminent, as GDP theoretically fluctuates around its potential level (3). At domestic level, for example, despite their recent slowdown, lead economic indicators have confirmed the persistence of a cyclical upswing. Although lagged, especially relative to the United States, a virtuous sequence of production, profits, investment, employment, incomes and domestic demand now seems in place in France. Despite increased pressures on production capacity and recruitment, this cycle, whose fundamentals are strong, is likely to continue given further sustained global demand for manufactured goods, improved corporate profitability, and renewed investment and job creations, all against a backdrop of a slow return to inflation.
We should point out that the international and financial assumptions that we use suggest an environment conducive to the continuation of a strong recovery, even if the support factors will be slightly less marked than in 2017. Global growth is expanding at a pace close to 4% a year, unseen since 2010, with the growth spread across all regions. This pace is likely to continue through to 2019. With respect to the financial assumptions, the per-barrel oil price looks set to remain relatively high in 2018, at 65-70 dollars, before falling back to 55 dollars by end-2019. Financing conditions for agents are also likely to continue very favourable, with short-term rates close to zero and a slow, gradual rise in 10-year OAT rates (1.55% at end-2019, compared with 0.8% at end-2017). Last, the euro should continue to appreciate while remaining modest, with the euro-dollar exchange rate at 1.30 at end-2019 compared with 1.19 at end-2017.
Around this central scenario, major risks may arise, in particular because of a more uncertain international environment. In the recent period, downside risks have increased, especially in the US. Although our scenario can take the US fiscal stimulus easily in its stride, especially in the short term, it nevertheless assumes that the fundamental condition is borne out, namely that the Fed’s monetary policy will not be excessively tightened. In addition, the resurgence of Mr Trump’s protectionist leanings has added an extra factor of instability.
Ludovic Martin, Group Economic Research
(1) Potential GDP is the GDP an economy generates on a lasting basis when using its capacity to the full without creating inflationary pressures.
(2) Structural unemployment rate: the equilibrium unemployment rate obtained when GDP is at its potential level; its determinants are directly linked to the operation of the labour market and the policies applied to it, as opposed to cyclical unemployment.
(3) By definition, in the methods most widely used, notably by the French Treasury, the output gap (GDP-GDPpot)/GDPpot is assumed to be zero on average over long periods containing several economic cycles, such as 1991-2011.