Cures for the French Disease

Five years ago, Germany was "the sick man of Europe." Three years ago, Italy took the baton. Now France has the highest unemployment rate in the euro area and is underperforming other euro members in terms of GDP and exports. It owns the title now. This somber background makes the presidential election all the more important. Sunday's first round might have signaled a starting point for the long-overdue reforms the French economy needs to regain competitiveness and prosperity.

The good news from the first round, won by center-right candidate Nicolas Sarkozy (with 31% of the vote) and Socialist Ségolène Royal (26%), is that the French have endorsed the necessity of reforms. By voting for young candidates who pledged to change French political habits, they have closed the book on 20th-century politics, recently embodied by President Jacques Chirac and Socialist Lionel Jospin. By rejecting protectionist and isolationist songs from the far right and the far left and by invading polling booths as they had not done since 1965, the French said: We want changes and this is a job for government, not for street demonstrators. And by cutting the wings of the "neither-right-nor-left" third man, François Bayrou (19%), who would have been at the mercy of an Italian-type coalition if elected, they've expressed their will to entrust a strong executive backed by clear parliamentary majority in order to change France.

The less good news is that the French have not yet chosen between two strategies: giving more freedom to businesses and workers, or further regulating the economy to try to reduce the collateral damage from globalization. Before looking at the platforms of the two contenders, let's fully understand the French symptoms.

First and foremost, an "insider disease" is choking the labor market. A majority of French wage earners, civil servants or beneficiaries of open-ended job contracts are protected by labor regulation – the insiders. Here, labor mobility is very low. Elsewhere, a growing minority only gets temporary jobs, short-term contracts or internships – the outsiders. The violence that erupted in the mostly Muslim immigrant projects in late 2005 came from outsiders: Many of them change jobs often and have lost hope of getting a "good" job. Attempts by the outgoing government to implement small or partial reforms miserably failed.

Second, French companies innovate less than their German or Swedish competitors, according to Eurostat. This is due in my view to a low rate of innovation from government-sponsored research bodies and a low return on innovation for private firms.

Third, the size of the government – as measured by the share of public spending in GDP, which goes together with the heavy hand of the state in the management of the economy – is a major hurdle for French companies. As of 2006, public administrations spent 53.7% of GDP, thus preventing an enormous amount of resources from going to high-return projects. The weight of public spending has declined in all EU countries but France over the last 10 years.

As for the labor market, Mr. Sarkozy wants to replace all existing work contracts with a simplified one, allowing companies to lay off employees with severance payments linked to seniority but without legal hurdles. He would also make unemployment benefits conditional on job-seeking. Ms. Royal favors enhanced conditionality for job seekers as well, but she also wants to to increase the net minimum wage to €1,500 a month – a 50% increase, which would price thousands of small companies out of business and dramatically increase structural unemployment.

As for innovation, both candidates pledge to increase public spending on R&D. But only Mr. Sarkozy links this promise to an in-depth reform of French universities and other research bodies. Specifically, universities would become autonomous, including setting their own tuition fees, as early as this year. Both candidates want to make life easier for smaller businesses, but they both miss one point: Small companies need to grow, and helping only smaller firms will not address the lack of innovation.

Finally, Ms. Royal wants more intervention in the economy at the central and local government level. She has made so many spending promises that overall government outlays would almost certainly shoot up under her rule. By contrast, Mr. Sarkozy is determined to cut the tax pressure by four points of GDP over 10 years, which would imply a similar decline in public spending. He would do so by replacing only one out of two retiring civil servants and by closing inefficient bureaucracies. As for interfering with business, both candidates claim that they would protect "strategic" French firms from falling into foreign hands. Le patriotisme économique will remain alive and well.

Ms. Royal's platform, although so far the most reformist platform I have seen from the Socialist ranks, would not deliver the fresh oxygen France needs to heal its triple disease. Of course, like Gerhard Schröder in Germany, Ms. Royal might understand the need for in-depth economic reforms after one or two years of unsuccessful trials. Unfortunately, her massive rise of the minimum wage – a concession to the far left in the last few days of the campaign for the first round – would inflict largely irreversible damages to the economy.

Mr. Sarkozy's platform is the more reformist and pro-market of the two. He has a carefully conceived strategy, such as letting employers and unions negotiate labor-market reforms for a given period of time before government steps in, or starting all the reforms together so that they will reinforce each other. In a perfect democratic world, the debate would be about platforms and strategies, rather than individuals and ideologies. A reading of the first round that the French are ready for reforms would give a clear edge to Nicolas Sarkozy. Of course, we don't live in this perfect world, and Mr. Sarkozy's poll lead is no guarantee of victory on May 6.