François Villeroy de Galhau, Governor of the Banque de France, which is one of TSE's long-standing partners, came to Toulouse on December 8, 2022, to give a Business Talk to TSE students.
Here is an extract of his speech.
Today, in commodity-importing countries, the prices of imported products, especially energy products, are rising much more than the prices of exports. This is a net cost for commodity-importing countries, including France. In economic terms, the terms of trade, i.e., the ratio of export prices to import prices, are falling for those countries, thus reducing their purchasing power.
The magnitude of the external tax: the energy and terms of trade shocks
This observation has been made in a context of peaks on gas and electricity prices since the summer of 2021 (global economic recovery after the beginning of the pandemic, Russian invasion in Ukraine, …). As regards non-energy industrial goods, the first blow to European import prices was caused by disruptions in global production chains following the post-Covid recovery. The next blow was the gradual spread of higher raw material prices to all manufactured goods traveling to Europe.
This triggers what we call an “external tax” : when a country experiences a more rapid growth of its import deflator compared to its export deflator. This constitutes a negative shock on the real income of both households and firms.
Looking at the “gross” external tax, i.e., the amount of extra energy bill, for energy importing countries, we notice that there is an important heterogeneity among European countries. Both lower fossil energy dependence and a smaller share of the manufacturing sector mitigate the magnitude of terms-of-trade shocks in France. Conversely, the shock is of larger magnitude for Spain, which is more dependent on energy imports and does not benefit from the rise in prices of transport service exports.
Parallel with the 1970s oil crises
The terms of trade shock in France this year is expected to be the second largest since 1974, the first oil price shock. In 2022, for the whole year, the shock would amount to -1.4 GDP percentage point versus -2.8 GDP percentage points in 1974 during the first oil shock.
Though this shock is related to import prices of similar magnitude, its composition is different: in 2022, the increase is not only about the price of energy but also the prices of many other imported goods.
The terms of trade shock mean a decrease of real income for the French economy and hence is a key driver of the slowdown in GDP growth expected in 2023.
Looking precisely at the energy shock, the extra energy bill for France is of 1.9% of GDP in 2022, compared to the previous year, or 47 billion euros.
An important point is that the energy bill considered here does not include electricity, though electricity prices have also risen considerably. The shock related to these prices is harder to determine since European countries, such as France, produce electricity. It is therefore more difficult to isolate the external component of the electricity price increase.
The ex-ante and ex-post distribution of the external tax
Let me now turn to the second key issue: the question of the distribution of the external tax, or in other terms the burden sharing of the shock. The fist element that needs to be considered is how the increase in the energy bill is distributed “ex ante” among households, firms and the general government. Households would bear more than one third of the bill according to this estimate, while companies would bear a bit less than two thirds. However, the burden distribution is considerably modified after the government compensatory measures: the share for households goes down to around 5%, while that of the general government goes up to at least 35% of the overall burden.
Then, in a second step, we need to take into account the fiscal measures put in place in 2021 and 2022 by the Government, in order to limit the energy bill of households and businesses. The third step should involve taking into account all the macroeconomic adjustments, in particular the pass-through of cost increases by firms in their sales’ prices and the response of wages to prices.
As for the ex-post distribution, the final distribution process after macroeconomic adjustment is difficult to evaluate: it depends on the degree over time of wage adaptation, and the firms’ capacity to increase their prices given their financial situation. This evaluation should be assessed “over time”, let’s say as a minimum over a forecast horizon of around 3 years because some short run losses or gains can be mitigated in subsequent years.
The ex-post distribution: some tentative recommendations
It would likely be too ambitious to attempt to pin down an optimal burden sharing among economic agents. But we can define a number of conditions to be met. For instance, government policies cannot durably suppress the real income loss suffered by the domestic economy: it can only reallocate it across categories of households and firm. For this reason, government measures must be as much as possible temporary: the share born by public finances must decrease after the peak of the shock. Nor should these measures run counter to the incentives to reduce our energy consumption.
I believe it is normal that the public sector has stepped in in France and in other European countries in the face of this very significant economic pain. But let us be at the same time be honest with ourselves, use of medications must be temporary. We all have to share with fairness the “external tax”, and also pave the way to reduce our vulnerability by saving energy and by enhancing our domestic production of energy.
France has in the past decade made significant progress in a number of areas, notably employment and training. In the present shock, too, I am confident that we can emerge collectively stronger.
Find out more on the Banque de France's website.