French President Francois Hollande addresses at the lower house of Parliament in Tokyo, Japan, on June 7, 2013. Hollande is on a three-day state visit to Japan. UPI/Keizo Mori | License Photo
PARIS, June 24 (UPI) -- It is starting to look as though France might be the country to watch this fall as the next phase of the European crisis unfolds.
Hitherto, conventional wisdom said that the German elections in September would be the pivotal moment but opinion polls suggest that Angela Merkel is likely to remain German chancellor, though she may well have to govern in a grand coalition with the Social Democrats, so no sweeping policy changes seem likely.
That isn't the case in France, where the Socialist government of President Francois Hollande is committed to bringing forward a reform of the French welfare state, starting with the pension system.
This is the toxic "third rail" of French politics, which destroyed the conservative government of Alain Juppe in 1995. No government has dared tackle it since. And yet there is little choice.
There are two reasons for this: The first is that the European Union has given France until 2016 to get its budget deficit under control. Reining in social spending will be the biggest challenge since it consumes just more than 32 percent of France's gross domestic product, compared to 24 percent in Britain and 19 percent in the United States.
The second reason is the French social system is broke. The French pension system, which is largely funded by the "cotisation" procedure under which employees and employees pay into a social insurance fund each month, is $20 billion in the red and the annual deficit will reach $26 billion within six years.
This is the estimate of the advisory board tasked with reviewing the system and recommending changes. Board members suggest that the problem will get much worse over the next two decades as France's population ages. There are now 2.6 people of working age for everyone over 60; by 2033 there will be 1.5 people of working age for everyone over 60.
The board recommends cutting benefits for wealthier pensioners and increasing the payments by employers and employees by a modest 0.1 percent each month. The main recommendation is to increase the years of paying into the system required from 41.5 years to 44 years.
The problem is that the official French retirement age is 60 and only a fraction of the population starts work at 16 these days. For some protected jobs, like train drivers and police, retirement can come as early as 50. So in effect, the age at which a pension can be collected will be raised, even if the nominal retirement age is unchanged. A lawyer or doctor who qualifies at age 26 wouldn't receive a pension until age 70.
Nor does the problem stop with pensions. The social insurance funds that finance unemployment pay and family benefits are also technically bankrupt and they will also need reform and almost certainly some cuts. Currently unemployment pay is linked to the last salary earned which means some jobless executives can receive more than the average French employee earns.
The system for financing the generous healthcare system is also broke but that problem is being shelved for the moment as France gears up for the pension challenge, and Hollande gears up for his biggest political test.
So far, he has ducked major issues and gained time by appointing commissions and review boards but not acted decisively. (The French constitution, enacted to strengthen the role of Charles de Gaulle, gives the president very wide authority, including the right to sack governments and call elections.)
Hollande's supporters, and he still has some even though the IFOP opinion poll, published Sunday, says only 26 percent of those asked said they are satisfied with his performance, defend his approach. They say he is trying to reshape France by consensus, rather than by confrontation in the manner of Britain's Margaret Thatcher in the 1980s.
They have a point. To enact some important reforms in the labor laws, Hollande made the labor unions and employers' federations sit down and hammer out a deal.
He is trying the same trick with pension reform, hoping for a deal to be reached by September.
But a deal looks unlikely. The CGT, the largest union and under strong Communist influence, is vowing strikes and mass demonstrations this fall.
This is where the danger lies and both government and labor unions know it. Failure to reach a deal or TV images of angry demonstrations marching through Paris, puts at risk the French state's ability to continue borrowing money to finance its budget deficits. The bond markets know France's weakness and investors know the vulnerability of French banks.
Last month, the respected Center for Risk Management at Lausanne, Switzerland, published a survey of banks at risk from a new financial crisis. Most in danger was France's Credit Agricole, followed by Deutsche Bank, followed by France's BNP-Paribas. In case of trouble, French banks would need a $300 billion bailout, the report said.
Hollande's belief that he can bring about fundamental reform through reasoned discussion and consensus is about to face its crucial test. If he fails, the crisis of the euro currency will come roaring back as the eurozone's second-largest economy goes critical and its banks go into panic mode.