The Chief of the Mutual Security Agency
Mission in France (Labouisse) to the Assistant Director for Europe of
the Mutual Security Agency (Cleveland)
Dear Harlan : We are extremely disturbed by the recent measures which France has taken in the external economic field,2 not only because they do not appear to offer any hope of a real solution to the problems at which they are aimed, but also because they represent a definite step away from the goals of an integrated Europe of which the French have been the most vocal advocates up to this time.
In our view, the retreat of the French into a system of import restrictions and what are in effect export subsidies or a system of preferential exchange rates is a greater blow to the ideal of the creation of a harmonious and unified economic system to cover all of Western Europe, and of eventual political federation than the defection of any other country. If this ideal of an economic and political union in Western Europe is ever to be reached, the French will have to play a leading part in its achievement. With Great Britain keeping herself at arm’s length from Europe, with the fear that exists in Western Europe of a resurgence of German power, only the leadership of a France strong enough to provide an effective counterweight to Germany would appear to offer the possibility of reaching the goal. Thus the spectacle of a French economy caught up in a morass of difficulties from which its efforts to disentangle itself seem ineffectual and without direction, and finally adopting emergency measures which intensify the economic barriers in Europe is doubly disquieting.
The French have insisted that the recent measures are only temporary, and that their extreme character (with regard to the reimposition [Page 1181] of import quotas) is an indication of their temporary nature and a guarantee that other solutions will be found. We are not as optimistic as they are, in their statements at any rate. In order for the present measures to be temporary the French would have to adopt a firm line of action unpopular with powerful pressure groups. It was their inability to do this which led to the current difficulties. The present crisis has been considerable time in the making. In the spring and summer of 1951, it was already clear that inflation in France was much greater than in other countries. The deficit in foreign trade, the French position in EPU, and official foreign exchange assets all began to and continued to deteriorate. In October the deterioration became very acute; then it let up somewhat but was still very rapid if compared with the situation during the spring and summer months. Until the measures taken at the beginning of last month almost nothing was done to arrest the decline, and indeed many policies followed by the Government only served to enhance it.
Credit policy is a case in point. Following the economic lull in the latter part of 1949 and the first part of 1950, the French liberalized their credit policy in May 1950 to encourage an expansion. Conditions, of course, changed drastically after the outbreak of the Korean war. During the last quarter of 1950, it was clear that production was expanding satisfactorily and that the major problem was to stem the inflation. Nevertheless, it was not until October 1951 that anything was done to restrict bank credit, which under the impetus of speculative pressures, as well as the expansion in production and the rise in prices, was three times as large in 1951 as in 1950. Even so, the measures taken at this time to tighten credit were more apparent than real and the expansion during the remainder of 1951 was just as great as previously. We have been told that under the pressure of complaints of businessmen the French financial authorities evolved a whole series of devices which made it possible to extend credit outside of the rediscount ceilings and thereby in effect to negate the publicly announced intentions of the Bank of France.
The Government wage and price policy has equally aggravated the inflation. One of the most contradictory aspects of this policy has been the legislating of price increases for the public utilities, for wheat, and other controlled commodities or services. Thus, within a brief period, the price of wheat was raised 30 per cent, the price of coal 20 per cent, steel 21 per cent, electricity 25 per cent, gas 12 per cent, and freight rates 15 per cent. It is true that each of these price increases was based on some rationale of increasing production (wheat), eliminating the deficit (SNCF), or obtaining funds for desirable investments (electricity and gas); but almost all [Page 1182] of these commodities and services enter directly into the cost of living and therefore increases in their prices only serve to nourish the inflationary spiral in which wage increases compensate for increases in the cost of living and in turn serve as the justification for further price increases. The Government’s attempt to lower the price of meat resulted in confused disorder, the main results of which seem to be a temporary brake in the price of more expensive cuts at the expense of a rise in the cheaper cuts.
During the year and a half following Korea, hourly wage rates rose considerably more than consumer prices, and while weekly earnings did not rise as fast as wage rates, they were still higher in real terms at the end of 1951 than in June 1950. Twice in 1951 the Government boosted the legal minimum wage, which has a kind of “pilot” effect on wage trends, once by 11.5 per cent and the second time by 15 per cent. Probably because of the 1945–49 experience, when large-scale increases barely enabled wages to hold their own with prices, French labor could not now be satisfied with increases of a smaller magnitude which it might have been possible to absorb fully into the existing cost structure, thereby avoiding a large increase in the general price level and perhaps leading to a greater increase in real wages.
Government-inspired wage increases and government-directed price adjustments were transmitted rapidly throughout the price structure. Each economic pressure group succeeded in more or less maintaining its relative position. The financial authorities saw fit to let credit outstanding rise accordingly. As a result of these factors, the French wage and price structure moved upwards faster than that of its principal trading partners. By September 1951, the increase in French wholesale prices since the pre-Korean period was 4–5 per cent greater than in Belgium, Germany, and the UK, and 15 per cent greater than in Italy and Switzerland. During the last quarter of 1951, the gap was intensified and in December the increase in French prices was 11 per cent greater than in the first group of countries mentioned above and 25 per cent greater than in the second.
The French sometimes seek to attribute their difficulties to the post-Korea increases in the prices of imported raw materials. Although this undoubtedly had some effect in starting the inflation, the fact that imported raw material prices have fallen appreciably since the spring of 1951 has not prevented French prices from continuing to rise. In December 1951, the weighted index of imported raw material prices was 40 per cent above the level of June 1950, whereas the index of domestic raw materials was 94 per cent above.[Page 1183]
The most common explanation that the French give of their present predicament, both popularly and in official circles, is that it is due to the burden of financing rearmament. However, this has not yet had a serious impact. In both 1950 and 1951, the Government budget was in a better condition (i.e., the percentage of expenditures which had to be covered by borrowing was smaller) than at any other time since the end of the war. Thus, the budget and defense expenditures cannot be held responsible. It is true to a certain extent that the defense effort has absorbed resources of the economy, in the sense that basic production and capacity in the heavy industries has increased under the stimulus of foreign orders, anticipated domestic orders and speculative increases in inventories. Thus, practically all of the industries concerned with producers’ goods have experienced a particularly sharp increase.
A complaint constantly made in official circles is that the low level of foreign exchange reserves makes it impossible to have any flexibility in external economic policy. But the French were in a relatively good reserve position in the spring of 1951, and even if, as the French maintain, the rapid loss of dollars thereafter was partly due to the postponement of United States economic aid, the loss in EPU credits and in credits with other areas of the world cannot be attributed to this cause.
In the case of their EPU position, the French are certainly correct in attributing a part of their present difficulties to the import restrictions previously imposed by the Germans, the Dutch and the British. The German and Dutch import restrictions have probably played as important a part in the deterioration of the French position in EPU as the French internal inflation. The British restrictions undoubtedly played a part in the sharp drop in sterling exports in December and will weigh heavily on the French trade balance as long as they are continued. The improvement in the Dutch external position has made it possible for them to eliminate progressively their import restrictions to the point where they have almost reached again the 75 percent stage of liberalization. The German external position has improved spectacularly and though they are still far from the 75 per cent stage, they have increased the percentage of liberalized imports from its low level following the February crisis, and it is to be expected that both their situation and degree of liberalization will continue to improve. As far as the British are concerned, it is difficult to say now what the future prospects are; improvement in their external position will depend on the effectiveness of their internal measures and particularly of their budget policy.
In a sense, the French were pushed to take the expedient of restricting imports by the similar previous action of their main customers [Page 1184] in Western Europe. A number of French finance officials, however, consider the recent measures taken by their Government without having previously endeavored to change internal policies to be inadmissable. They nevertheless hope that the French action will force all the EPU countries to recognize that liberalization must be maintained and that constant changes in trade policies should not be relied upon to correct payments difficulties. Indeed, the French action may force a more searching examination in OEEC and the EPU Managing Board of what has to be done in order to make the multilateral trade and payments system workable. The French themselves are now pushing in OEEC for a deeper approach to the problem of creating a single European market, notably through the creation of a European investment bank which could encourage the specialization of production in those countries where it can be carried on most cheaply, by lending funds for the conversion of industries.
Another line of action which both the French and other OEEC countries have urged is a broadening of the functions of the EPU to take cooperative preventive action instead of being confined to remedial action for a single country once a crisis has arisen. Everyone could see how the French situation was developing months ahead of time, but under its present mandate EPU could take no steps to force corrective measures on France (or the other participating countries to the extent that their policies were contributing to the French difficulties). Indeed, the problem could not even be discussed in EPU because France had not yet abandoned 75 per cent trade liberalization. Thus, EPU had no choice except to sit by and watch the French slide downwards at an increasing rate.
The progressive liberalization of imports by other countries which are France’s customers, and the broadening of the EPU function, may have a favorable effect on the French position. But it is doubtful that these developments by themselves would be enough to solve the French external problem. Even if other countries’ actions had been the major cause of the present French external position, it has reached such a point, taking into account also the atmosphere of disorganization and inflation internally and the upward adjustment in the price and wage structure, that it appears that only a devaluation may be able to set things right again. Deflation is out of the question. As was the case in England in the months preceding the devaluation in September 1949, the expectation in France of devaluation is leading to a flight of capital of such proportions that it may be possible to stem it only by the fait accompli. However, the sine qua non of devaluation’s having anything more than a temporary salutary effect is that internal prices are kept from rising as a result. Otherwise, the cycle will only [Page 1185] begin over again. The problem of keeping prices from rising after devaluation will not be an easy one, and will depend upon a credit and price and wage policy which will force sellers to absorb a large part of the increased cost of imports instead of, as usually occurs after any increase in costs in France, of over-compensating for it.
We have discussed the entire problem of corrective measures with French financial officials. We have also considered the problem with the Finance and Trade people in MSA/E and have reached agreement with them that the four following considerations should be stressed both in the EPU hearings on the French problem and in any further bilateral talks:
- How will the restrictive measures just taken by France affect the various projects for European integration in which she has been a leader: the coal and steel community, the common military budget, and the common military procurement program?
- What evidence can be offered to buttress the belief that France is able or has the will to handle her domestic economic and financial affairs in a manner conducive to the creation of the type of economic conditions which are necessary for integration?
- What steps are being taken by the French to ensure that the restrictive measures will really be only temporary?
- What did the French do before the fact to try to head off the crisis which has descended upon them?
The implementation of the Lisbon decisions may provide the French with an opportunity to work out the type of economic and financial program needed to restore some measure of stability to the situation. It is only upon the basis of such stability that we can hope to move forward towards our broader political objectives in Western Europe.
In view of the delicate nature of many of the subjects discussed in this letter, I should greatly appreciate your limiting its distribution to a few key persons.
- Upon receipt of this letter, Harlan Cleveland drafted an interim reply dated Mar. 19 and circulated copies of his reply and Labouisse’s letter to several officials of the Department of State, including Martin, Nitze, and Cowan. (740.5/3–1752)↩
- Information concerning French foreign economic policies was regularly transmitted to the Department of State in “Quarterly Economic Reviews” drafted by Embassy officials; copies of these reviews are in file 851.00.↩