☆ Can a country like France « go bankrupt » (2/2), and when?

In our previous insight, we explained that the concept of « bankruptcy » is not, strictly speaking, appropriate for a country. In this context, it is more accurate to talk about « default » or « cessation of payments. «  Can a country such as France declare itself in « cessation of payments »? The answer is obviously yes. While it is clear that a state has many options before declaring itself in default, this does not prevent such an event from occurring, as was the case in Argentina in 2001 or more recently in Greece in 2012, where the default affected part of the debt. So when does this event occur?

In theory, a country has many ways to reduce its debt before defaulting (see our insights on this topic here): raising taxes, cutting public spending, inflation (via monetary policy), stimulating economic growth, financial repression, etc. In practice, these tools are automatically used when budgetary difficulties arise (certainly the first two). It would therefore seem logical from an economic point of view to argue that a sovereign default only occurs once all possible measures have been applied in an optimal manner: once public spending has been cut to the maximum, taxes raised to the maximum… without the sovereign having succeeded in restoring its solvency.

This reasoning is highly simplistic, particularly because it overlooks the political realities surrounding a state’s default. In reality, therefore, we need to think differently. While it is clear that a state has many ways of improving its budgetary situation (listed above), it may be that, beyond a certain threshold, the economic and, above all, political costs associated with using these solutions [1] are too high compared to the economic and political costs of default [2]. Once this threshold (which is subjective in nature) has been exceeded, a state will choose to default on all or part of its debt or to restructure it (see our insights on this subject here). This is the recent history of Greece: while some observers believed it was possible for Greece to adjust its budget so as not to default (or at least to default to a lesser extent), street protests, the radicalization of certain citizen movements, and growing political instability, coupled with the fact that Greece was more or less assured of support from its European neighbors in the event of default, meant that the costs of adjustment for Greece became too high compared to the costs of default, pushing the latter to « choose » default. We could therefore summarize the situation as follows: a state will default when it considers that the costs of default (political, societal, and economic costs) will be lower than the costs of the economic solutions to avoid it.

Default is therefore theoretically entirely possible for a country such as France. If France has not « chosen » this solution at present, it is primarily because the cost (economic, societal, political) of the budgetary adjustments that are still possible is not considered to be higher than the potentially staggering costs that default would have for France (and for Europe as a whole, moreover). The politicians in charge of these budgetary decisions are certainly aware that a default would lead to a real weakening of the country (both politically and economically) in the long term, greater than that caused by the measures currently being taken.