France; Labour Management Negotiations. They even wanted the shirt on his back
I go to France a couple of times a year and was lucky enough to spend several weeks there over the past month. Last December, I had intended to go to Lyon, a 3 hour train ride from Paris, for the ‘La Fête des Lumières’, but the festival was unfortunately cancelled due to the Paris Terrorist attacks.
To get myself in the mood, I usually bring along a book and this time chose Thomas Piketty’s ‘Capital in the Twenty-First Century’, a book which I had put down shortly after it came out in 2014, when I got bogged down in the detail and minutia after the first couple of hundred pages.
After my first week in Paris, I completed ‘Capital’ and was somewhat shocked by the conclusions. The major theme of the book is that the return on capital r has historically been significantly greater than global growth, so a return of say 5% (assuming limited interest, dividend and capital gains taxes) and only 1-1.5% growth, implies that asset-owning classes find it easy to only consume 20-25% of their income while accumulating the rest.
Of course private capital, has seen periods of protracted contraction, particularly around WWII, with weak markets, asset destruction and high taxation. But what alarmed Piketty, is that over the last 30 years, strong returns and lower marginal income and capital gains taxes, have resulted in private capital rising to almost 700% of national income in the US, with Japan a surprising second at 600% (and 450% among developed countries). He forecasts this to rise a further 50% by 2090. Private assets have consistently grown faster than national wealth, such that wealth gradually became more and more concentrated, peaking between 70- 80% of wealth for the top 10% globally around 1910. Though wealth destruction in Europe during the WWII and a 25% one-time tax in France shortly after the war, saw private wealth as a multiple of national income there and elsewhere decline until 1970, it is once again approaching the extreme of the early 20th century when income and inheritance tax was virtually non-existent.
Mr. Piketty also addresses inheritance as one of the villains in proliferating this inequality. Though he does not include Japan in his inheritance data, while it is impossible to provide meaningful data for the U.S., given the treatment of ‘gifts’. I, however, took Japan inheritance data and was surprised to find what 25 years of value-destruction can do (If the gov’t data is to be believed)
In terms of income, Japan’s top 1% received a little less than 10% of total income, putting Japan at or slightly below Germany, which at 10% was average among the advanced country sample. While the US remains significantly above everyone at 24%.
Mr. Piketty’s solution for this inequality is quite simple, raise the marginal tax rate to 80% on income above $1mn and introduce a wealth tax of 1% between $1mn and $5mn, 2% or more for $5mn and 5%+ for $100mn or more. His data shows that two-thirds of European wealth is actually inherited wealth and though he has nothing against wealth, per se, he is only willing to accept it if it contributes to the greater ‘utility’ and overall growth. His assertion is that the recent trend for the mass accumulation of wealth has done nothing to enhance the overall ‘utility’ for society nor promote growth. Furthermore, he sees government debt as simply benefiting the wealthy class, and as such, it should be reduced by hefty one-time taxes on private assets.
The natural extension of his thesis is that a healthy democracy requires equality, which includes economic well-being and that globalization only helps the higher echelons of wealth while hurting those at the bottom. On this point, I sympathize with his argument, because a society where the poorest paid cannot afford to properly feed their families or offer education opportunities to their children, will eventually stagnate and lead to a proliferation of walled communities. It only makes things worse, when 26% youth unemployment, as in France, leaves people with little hope. Where I disagree is the attitude towards ‘entitlement’, that seeks to protect those already fortunate to have a job, even if it prevents new job opportunities for those on the margin.
Mr Piketty also proposes a progressive wealth tax or one-time tax to cut national debt, the servicing of which he claims unfairly penalizes the poorer classes. His utopian proposal is further stretched when he proposes a pooling of national debts to support poorer nations . He also proposes an international wealth data base to fully comprehend who has wealth and where.
Mr. Piketty’s suggestions are not just pie in the sky. It is suggested that his proposals were the basis for President Holland’s 75% marginal tax. Though the 75% marginal tax rate was later ruled unconstitutional by France’s Constitutional Council, a 0.5-2% wealth tax on assets above 1.3mn euro that was introduced when he came to power in 2012 remains. Mr. Holland’s socialists also raised the capital gains tax on real estate from 25% to 29% for the French and up to 70% on residents of non-cooperative states (read tax havens). Although the book was very thorough, I was disappointed that more examples from Japan, Australia or Canada were not included, where taxes may be more progressive and the phenomenon of ‘old money’ less pervasive.
I remember when I was looking at real-estate in France, asking the realtor if they thought the seller was flexible on price, to which they often replied, that the seller was from old money (meaning that they didn’t particularly need the money so they weren’t very inclined to negotiate). There also seems to be more a cultural trend towards property ownership in the anglo world where countries like France or Germany have home ownership rates which can be as low as 33% in Paris and 44% in Munich. In Canada home ownership is about 70% in English Canada and 65% in Quebec. In Iceland, where I was born, home ownership has been as high as 85%, labour participation over 80,% and not coincidentally there has always been a general sense of social equality. Obviously, home ownership is a huge factor if one is to feel that they are benefiting from growth.
I am a big believer in the ‘laffer curve’ which states that as tax rates go above a certain level, incentives to work diminish, such that total tax income starts to decline. Some economists have put this level at between 52-55%. Although Mr. Piketty and others have put this a between 72%-80%, claiming that the marginal utility of after tax income above $400,000 for the 1% is so low that it does not rise to that of the median income earner until marginal tax rates exceed 70%. (Peter Diamond and Emmanuel Saez, The Case for a Progressive Tax: From Basic Research to Policy Recommendations, May 2012). However, as the NY Times recently noted, there are several US states where the top 1% account for between 30-40% of income tax, and as such, respective tax departments often keep running projections of expected tax from top earners, where a few people moving to other states can mean a difference of hundreds of millions of dollars in tax receipts.
The importance of growth as referred to by Mr. Piketty and world leaders cannot be understated. Growth feeds mobility! When asked, “do we live in a society that promotes equality”, we should not refer to equality of results but ‘equal opportunity’. However, such opportunity dries up as growth stagnates.
Many studies have shown that the top 1% indeed has a higher savings rate than the median income earners. This can be seen as either a hindrance or support for growth; savings implies reduced consumption though savings is necessity for investment.
One potential pitfall to Mr. Piketty’s argument is that, as all investor today are painfully aware, ROA has declined significantly in recent years as lower discount rates lifted asset prices, making it difficult to get a decent return (unless prepared to increase ones leverage). How many one-percenters would be willing to lend to Germany for 10 years at 0.2% or 0.6% to France. Surely, long term growth prospects are better than this! Unfortunately declining ROA is likely part of a trend as it seems to be affected by demographics.
As for government debt; in the end, when central banks face the back end of their trade and are forced to sell debt at higher rates, it will no doubt be the wealthier class that will have to absorb these losses. Similarly, as social spending climbs, whether for health or pensions, I suspect we will see a much greater focus on ‘needs based’ disbursements.
Back to my trip. After the first week in Paris, I was ready to get out into the country and spent time in Nantes and Dijon in the Loire region. One of the reasons to get out of Paris was to escape several scheduled protests by students and unions against the ‘loi de travail’, Mr. Hollande’s last attempt to salvage legitimacy by introducing more flexible labour laws. Unfortunately, these protests have caused huge traffic jams around Paris and the cancellations of many trains. Nonetheless, Hollande’s Socialists have continued trying to increase work hours and make it easier for employers to rationalize their work force through the ‘loi de travail’ employment laws, which were designed to make it easier to reduce staff with lower payouts, give greater working hour flexibility and reduce overtime rates. All of which continues to be vehemently opposed by a vocal minority, whose past successes against the Hollande government have only emboldened them.
This reminds me a famous strike at General Motors in 1984. At the time, both the American and Canadian branches of the UAW union were negotiating with GM. Though the US side had at least 100,000 unemployed members, Canadian factories were near full operation thanks to a Canadian dollar that had depreciated 35% over the previous years (similar to now). As a result of this, the Canadian UAW insisted on hourly wage hikes whereas the US side avoided a strike by compromising on wages to get more members back to work.
The bottom line is that the Canadian union won an increase, holding US production hostage, at the expense of a schism with the UAW. Though CAW wages are now 30-35% higher than those at US plants (including legacy pension benefits), CAW auto-related membership fell about 35% between 1985 and 1995, and auto-related employment in Canada has declined about 35% to 120,000 since 2000. Between 1998 and 2008, unionized jobs in Canada decreased at twice the rate of non-union ones’ The most belligerent CAW union plant in St. Therese Quebec was eventually closed after producing 4 million cars. The unions have done well at maintaining legacy contracts while new employees come in at completely different pay scales. So any victory on wages and working conditions seems pyrrhic at best. One would think that there is a lesson here for France which finds itself competing against Spain or newer members of the EU.
When I was in Nantes, about 200 police in riot gear, suddenly locked the doors to the train station as we waited for the TGV. It turns out that there were 4,000-5,000 students marching towards the station and they had actually blocked some trains in other cities by sitting on the tracks. Hearing a few warning shots and seeing the tear gas cannisters was a bit unnerving and I started to appreciate how much the student unions and labour unions were working hand in hand to protect their vested interests. I came across more peaceful protests in Dijon the following week.
Though I believe that minimum wages need to be raised to promote hiring more regular workers, which would in turn encourage employers to invest more in training their labour force; I can’t help but feel that these students are undermining themselves where employers are even reluctant to give them training apprenticeships because the labour/social costs seem excessive or they are afraid that once hired, new employees will be impossible to rationalize if necessary in the future.
The minimum wage in Paris is already around 10.50 euro (Y1295 compared to Y907 in Tokyo). And it is said that obligatory social costs nearly doubles the true costs for employers. France, unfortunately seems to have only created about 350,000 new jobs with stagnant wages since the GFC, whereas Germany has created 1mn and UK close to 2mn. Labour participation rates are also much higher in the UK and Germany than in France. This is why it is highly unlikely that the Socialists will make it past the first round in the Presidential election next year and that is why the Socialists will likely pass a sharply watered down version of their reforms in the end.
One potential hope for the Socialists is former Socialist economic minister Emmanuel Macron, an investment banker in another life, who having supported a longer work week, is seen a quite progressive. However, I am cautious given that Mr. Macron was the person who engineered the French government’s increased share ownership in Renault (partly to protect jobs and partly because Renault has received more dividends in the last year from Nissan than it has paid out itself). The same law also doubled long-term (ie. Over 2 years) shareholders' voting rights. Mr. Ghosn, who was called to the Élysée Palace in 2012 to explain himself when Renault decided to build the new Clio in Turkey, established a truce with the Socialist government earlier this year when he unsuccessfully tried to role back the increased French government’s interest in Renault, that was far from satisfactory for either Nissan employees or shareholders.
I decided to take a look at how French companies with government ownership have performed since the adoption of the Florange Law in April 2014, which in addition to doubling long-term shareholders voting rights also made it more difficult to rationalize or sell under-performing business units. The answer is 29% underperformance. Now we see why neither Mr. Ghosn nor myself is comfortable when all shareholders interests are not necessarily aligned.
Government ownership in crucial industries is not entirely bad. It certainly makes more sense for partial government ownership in a utility that has a 30 year investment horizon for nuclear plants and needs debt guarantees, than it would for private equity (ie. TXU) . However, it’s pretty clear that government investors and private investors rarely share common interests. I learnt this several years ago when talking to a consultant for Petro China who claimed that some of his advice against non-commercial investment had been ignored in favour of securing strategic energy supplies.
It was thus disappointing to see the CFO of 85% government- owned French utility EDF resign in March, over government insistence that the $27bn EDF-funded Hinkley Point nuclear plant in the UK was going ahead as planned. The plant currently makes no commercial sense, requiring a 35-yr wholesale supply contract with the UK that is 3x the current price given recent energy price declines. Corporate governance also took a hit in April when the CEO of Air France stepped down after very public rebuffs against attempts for reorganization in 2014, . The airline had been trying to shift traffic to its subsidiary Transavia and Hop to compete with low price rivals Ryanair and Easy Jet. With much lower load factors than its sibling KLM, 13% higher costs per ASK and 35% lower revenue per employee than British Airways, Air France needs further rationalization despite recording its first profit in 7 years last year (thanks to lower fuel prices). However, pictures of HR managers scrambling over fences to escape attacking union members last October triggered ugly memories of previous strikes at Moulinex and Michelin, revealing a difficult mood for concessions.
Though only representing 8% of the workforce, France’s unions remain unfettered in their determination to protect what they see as their inherent rights. Unfortunately, I fear that this view of ‘entitlement’ will simply serve to proliferate the growing chasm between the British, German and French post-GFC recoveries.
Despite all this, I still enjoy my biannual treks to France, particularly as I spend more time enjoying the culinary and cultural richness of the remote regions. I also feel a need to show support to the French by visiting while tourism is depressed after the horrible terror attacks. However, my preparation now includes consulting cestlagreve.fr, a web site that gives the latest on planned strikes around France. I hope to bring along some lighter reading for my September trip.
 The effective inheritance tax in Japan was 13.2% with 4.3% of estates paying taxes, despite raising the marginal tax rate to 55% last year (the highest in the world).
 For example, the working age population of Japan peaked in 1992 at 62.7%, at 63.6% in the US in 2000, at 53.2% in Europe in 2008 and will peak at 58% in China in the next year. All suggesting that the natural rate of interest and expected ROA has declined over the last 25 years.