By Cait Murphy

These [French] people are like that. Imagine all possible contradictions and incompatibilities. You will see them in the government, in the law courts, in the churches and entertainments of this absurd nation.
--Voltaire, Candide, 1759

(FORTUNE,June 12) -- Twenty-first century France is a fair distance from Voltaire's classic novel. Nevertheless, the place remains a bewitching, infuriating tapestry of contradictions and incompatibilities. Nowhere are these starker than in economics. Consider: The French have bought some 350,000 copies of The Economic Horror--the kind of sales that require the name of John Grisham or Harry Potter on the cover in the U.S.--a deeply paranoid and almost unreadable antimarket rant. Where is the intellectual counterblast to such works? "It doesn't exist," says U.S. Ambassador Felix Rohatyn, who notes that when he gives a speech, "I always get questions like 'Doesn't globalization entrench American hegemony?' "

But at the same time, France exports twice as much in terms of GDP as the U.S. From 1990 to 1998, years that were mostly dull and difficult economically, France attracted $178 billion in foreign investment (second in Europe, after Britain) and itself invested $257 billion overseas (third, after Britain and Germany). International investment accounts for 30 percent of French jobs and 40 percent of exports. The current account has gone from a deficit of $9.8 billion in 1990 to a surplus of $34.3 billion in 1999. The contradiction is clear: For a country where no one in polite society would be caught dead defending the economic horror of globalization, France does awfully well at it.

Here's another incompatibility to mull while sipping an unpretentiously robust vin rouge. This is the country that gave us the word "entrepreneur" but has often made life systematically miserable for anyone trying to be one. And another: While Prime Minister Lionel Jospin campaigned against privatization, since his election in 1997 he has sold $30 billion of French industry. The most fundamental contradiction of all is that France has always claimed for itself the distinction of being different. But in fact it has less and less scope to assert the "French exception." More than 30 percent of the stock exchange is in foreign hands. France is back in NATO. It is embedded in the EU. Because it is bound to those and other institutions, France's destiny is not entirely in its own hands. (Don't mention this in polite society either.)

That is a momentous change. The first French revolution fostered the idea that the country had a special mission to the world and created the strong state as a focus of national cohesion. Now, because of its allegiance to Europe, France is undergoing a second revolution in which the state is becoming weaker and less distinct. This helps to explain a final larger contradiction: While French elites still talk the talk of capitalist disdain, the pressure of European integration has forced France to walk the walk of economic liberalization.

The single market, for example, compelled France to open its borders in ways it would have found difficult to justify on its own. Competition rules required the dismantling of monopolies. EU regulations forced France into compliance with wider standards. The French can still be dirigiste, of course, as regular rows over British beef, Spanish oranges, or American pension funds make all too clear. But such anomalies are much less prevalent. "I think the French nailed themselves to the cross" of economic and monetary union, says Suzanne Berger, a specialist in European politics at MIT, "as a way of getting external discipline at home to make the kind of sacrifices they had to make."

Economic revolution wrought by EMU

The start of this second revolution can be dated to 1986, when France linked the franc to the deutsche mark as a sign of its commitment to Europe. The franc fort helped to kill inflation, but as Jean-Paul Fitoussi, a member of Jospin's economic advisory council, points out, it also meant that in the 1990s France had "abnormally high" short-term interest rates at a time when the economy was stagnating, the opposite of what one would normally see. Low growth meant lower tax receipts, which led to higher deficits. To reduce the deficit--a requirement for EMU--the government increased taxes, depressing economic activity. Eric Chaney of Morgan Stanley in London figures the strong franc cost a million jobs, and in 1997 unemployment hit 12.6 percent. Now, notes Fitoussi, the vicious circle has turned into a virtuous one. From 1990 to 1997, France grew 1.5 percent a year; this year it could grow as much as 4 percent. Growth is raising tax receipts and thus allowing the government to cut tax rates. That has raised the confidence of business, and unemployment has fallen to 10.2 percent. There is a cheerfulness and optimism afoot that has not been a Gallic hallmark for some time.

That, at least, is the party line that the Socialists are talking up as they get ready to launch Jospin for the presidency in 2002. The second economic revolution wrought by EMU has in fact served the country well. The strong franc meant that France could no longer devalue its way out of trouble. Industry had to get competitive, and it did--with fewer strikes, modest wage growth, higher productivity, and resurgent exports. In particular, big businesses like Vivendi, Danone, and AXA have seized the new opportunities unleashed by the single market with relish. And privatization, even when the government keeps a stake, has enforced accountability. The state, for example, still owns 44.2 percent of Renault, but the company today is ambitious, competitive, and dynamic, a far cry from the inward-looking manufacturer of clunky cars it was in the 1980s. France Telecom, 75 percent state-owned, is undergoing a similar transformation. Privatization is also unwinding the incestuous system of cross-shareholdings that used to characterize the upper reaches of French industry--and in which little people like shareholders were routinely ignored. "Corporate governance," concludes Paul Desmarais, who watched it happen from his perch at the Albert Frere investment house, "is evolving nicely."

Now a third revolution may be brewing. There is a burgeoning class of rebels with an outlook that embraces the globe, not just France or Europe. These rebels favor individual enterprise. They are skeptical about the idea that centralization, as the first revolutionaries argued, is the best way to foster liberte, egalite, and fraternite. They question authority. They are independent. And they are using the new economy to upend the traditions of French business.

Meet Loic Le Meur. All of 27, Le Meur is a young man in a hurry who walks fast, talks fast, and starts businesses fast. His career began conventionally enough when he graduated in 1996 from Ecole des Hautes Etudes Commerciales (HEC), the grandest of business schools. But while most of his classmates went off to join French blue chips, Le Meur struck out on his own. "At least 15 to 20 of my fellow students," he recalls, "told me I would fail." With that generous sendoff, he went on to start B2L, a Web agency that eventually had 120 people building Web sites for the likes of Chanel and Twentieth Century Fox. In 1997 he founded RapidSite.fr, a Web-hosting agency for small business. He sold the businesses in December 1999 for a total of $15 million and started Business Pace, a company that starts companies, the same month. Two businesses are already up and running--Marketo.com, a Web site that aims to put small businesses in touch with suppliers, and Actibox, a messaging system. And Le Meur has had the last laugh on his ungracious classmates. A couple of months ago he went back to HEC to participate in a seminar on the Internet--and was mobbed. "It is crazy, actually," he muses. "The new economy is changing very fast the way people react."

How fast? Well, in November, Erik Albou's wife had a baby son. Not two hours after the birth the proud papa put the infant's image on the Web, where friends like Errol Cohen could view the wonder boy. Two weeks later Cohen and Albou were working out a business plan to create Web sites for new parents. Less than three weeks after that, they were in talks with Leonardo Finance. About a month later they had their capital, and two months after that, the business was up and running--or at least toddling. Log on to a specific baby's site at babyintheworld.com, and you can read notices from parents, buy gifts, see (and post) videos and pictures, set up diaper deliveries, and so on. An English version will be added this year, and ones in other European languages in 2001.

To meet the needs of entrepreneurs like Le Meur, Cohen, and Albou, France is fast developing the familiar infrastructure of the new economy. There are more than enough venture capital funds and angel investors to get ideas to market. And the Nouveau Marche, France's version of Nasdaq, is coming into its own. It ended 1999 with a market cap of about $14 billion, compared with $4 billion a year earlier. The number of listings has risen from 55 in 1998 to 130. By 1998, IT easily outdistanced cars as the industry that attracted the most investment and created the most jobs.

Who needs a third revolution?

The nagging problem is that the promise of the third revolution is at odds with the heavy-handed way France does things: This is a country, after all, that regulated the price of a baguette well into the 1980s. Because no government has made the principled case for a retreat from state intervention, regulation, and general meddling, no one really wants to go there. "A fundamental part of the identity of the right, not just the left, is state-led modernization," notes Jonah Levy, a professor at Berkeley and the author of Tocqueville's Revenge. "It's not easy to turn around and say, 'We believe in markets, and free trade is wonderful.' "

Well, one could argue, so what? Who needs a third revolution, anyway? France does. Yes, the economy, helped by the embarrassingly weak euro, is growing. But that's hardly surprising. So is most of the world--Europe, Britain, Asia, America, and Latin America. "What has gotten better is that we have expansion," says Ernest-Antoine Seilliere, head of Medef, the French employers' federation. "But will we be able to say that in a few years?" That is the right question. In three important ways, France is offering the wrong answers.

The first is that while EMU has substantially improved the climate for big business, France is still a tough place to be a small business. The director of a 100-employee manufacturing company in Burgundy can hardly contain himself as he ticks off the various indignities he suffers: the impertinent works; inspectors who can enter his factory at will; the high taxes; the 35-hour week that will force him to replace low-wage workers with machines. Don't get him started on how difficult it is to fire people: "It can take months!" Or maternity provisions. Or paperwork. "If it were not for the food," he concludes over a sublime Provencal dinner, served in a tiny and unpretentious neighborhood joint whose ambiance New York designers would kill for, "who would stay in France?"

Startups have the same list of complaints, and add more: collecting VAT refunds, for example. Or just getting legal. It typically takes a month to six weeks to fill out the paperwork to register a business; in California, it takes about six minutes. "Everyone was very helpful," recalls Errol Cohen of his treks to various ministries when he was getting started. "But it was still too complicated." According to the OECD, France requires 15 procedures to open a business, compared with three in Belgium, four in Britain, and eight in Germany.

None of this is news to Olivier Cadic, the French founder and owner of Info-Elec, a computer electronics business that has grown to 14 employees--all of them in Ashford, England, just an hour away from France on the Eurostar rail line that links the two countries. Cadic is forthright about why he is in Ashford rather than, say, Avignon: "The French system does not support entrepreneurs," he says. "Explain why it is better to pay 36 percent corporate tax rather than 20 percent." Cadic is an irritant to the Paris ministries but has become something of a poster boy for French emigre entrepreneurs, whom he urges to come to Britain. They're listening. Ashford alone has 315 French-owned companies registered, including a baguette company that imports the dough and bakes it on-site so that French locals no longer lack that crusty essential.

The friendly French invasion of Ashford is just one aspect of a troubling issue. Didier Lombard, France's ambassador-at-large for international investment, likes to point out the strength of the country's technical education. In Silicon Valley alone, he estimates, there are 50,000 French working. But wouldn't France be better off if they were using their talents at home?

Concerned about this brain drain, the French Senate convened an informal dinner with entrepreneurs to find out why so much homegrown talent goes overseas to seek its fortune. The scene can readily be imagined: austere, older, status-conscious, and exquisitely dressed and mannered career politicians trying to find common ground with scruffy, aggressive, egalitarian dot-com types. "The young people were not that impressed by the politicians," recalls Yves Delacour, director of Leonardo Finance, who put together the event. "There is a huge discrepancy between the world-view of politicians and the world-view of entrepreneurs." The entrepreneurs have won a few important skirmishes of late, particularly when Dominique Strauss-Kahn was Finance Minister--"He was perfect," says Delacour, his eyes agleam with the remembrance of a lost love. But it is the politicians who set the terms of battle. And many of them just don't get it.

Studies by French researchers have confirmed that innovative firms, particularly those in IT and high tech, create jobs fastest. So you might argue that France is doing everything possible to enable such firms to thrive. Not exactly. The 1999 OECD economic outlook ranked France 20th (out of 21 countries) in barriers to entrepreneurship, 16th in economic regulation, and 21st in administrative regulation. In a perverse way, this might account for the excellence of French management, which has to be very good indeed to prosper under the circumstances. But these hurdles also keep people from trying to strike out on their own. There were more new businesses started in 1999 than in 1998. But the number was still less than in 1993, which was not a particularly good year for the French economy. According to the London Business School, France has a business startup rate of 1.8 per 100 people, compared with 8.5 for the U.S. and 4.4 for Germany.

The power of the public sector

Which brings us to the second way in which France is hobbling itself. While the private sector is more optimistic, forward-looking, and creative than it has been in decades, these are not words that can plausibly describe the public sector. French government employees, through their unions, seem to regard any change as for the worse, and they are not shy about using their considerable power. In recent months they have taken the scalps of a Finance Minister (Christian Sautter) and an Education Minister (Claude Allegre) and hobbled health reforms. The size of the public sector, which employs a quarter of the work force, is a clear impediment to the economy--and no one dares to touch it.

The larger brief against the French state is a familiar one. It is that heavy social charges depress employment, that taxes are too high, that pensions are a debt-ridden mess, and that civil servants are often irritating fussbudgets. (Medef's Seilliere points out that the regulations implementing the 35-hour week are 157 pages long: "I call this textual harassment.") Unless you're a former French communist, you cannot look at the state, which spends 54 of every 100 francs French workers produce, and wish for more of it. To an extent, the Jospin government agrees with this critique, and it has presented plans to cut taxes and social charges--all the way back to the level of 1997. This is considered rather bold.

"Will we be able to accomplish real structural reform? People say, 'Yes, it is necessary,' " notes Jean-Claude Trichet, governor of the Bank of France and chief-in-waiting of the European Central Bank. "But the public is not backing structural reform in the labor market." True enough, but neither the government nor the opposition is making the case for it either. And in some ways France is going into reverse. A series of reforms starting in the early 1990s, for instance, liberalized the rules governing part-time and temporary work and cut the costs of hiring low-wage workers. The happy result was more jobs; and when France grows, it now creates more jobs than it used to. But instead of doing more along these lines, Jospin looks likely to do the opposite. There are laws under consideration that would fine firms that fire people over 50 (who will then, of course, no longer get hired), make layoffs more difficult, and penalize companies deemed to be abusing short-term contracts. The 35-hour week will effectively raise the minimum wage and therefore depress low-wage employment. That will be devastating to young people, among whom unemployment is still extraordinarily high (near 25 percent), and to the long-term unemployed.

Another way that France is keeping its third revolution at bay is difficult to define. It is that there is a certain je ne sais quoi missing from the place, the buzz that makes investors hearts go pitapat. This goes beyond the usual moans and groans about high costs. In fact, it's surprising how many French business people shrug off burdens that would drive Americans to distraction (or at least to Mexico). "I don't complain about paying taxes," says Jean-Pierre Arbon, founder of an online publishing firm. "But what I get angry at is a system that prevents me from creating wealth. Why does it do that?"

Marc Reeb sees the answer to that question in the negative perception that business still carries in France. Reeb, who is about to launch Netcrawler, a way to track advertising campaigns over the Internet, may have a clipped British accent and a very American directness, but he would never dream of starting his businesses anywhere but in France: "I love my country," he says simply. Since 1988 he has launched and sold several enterprises and has taken stakes in almost a dozen more. All told, he has created perhaps 200 jobs. Nevertheless, he flinches at what he sees as French society's disdain for what he does. "Starting a company is not something natural for French people," he says. "If you succeed on your own in France, you are someone different, and that is not good. Should I say, 'I'm an entrepreneur and I drive a Ferrari?' I can't say it."

So, does he drive a Ferrari?

Reeb looks around theatrically, closes the door, and puts up two fingers. "Two," he laughs. "I am not sure I would say that to a French journalist. With you, an American, I take a risk!"

Ambassador Rohatyn is a bull. "The evolution of France," he reflects, "has really been quite remarkable." True. It was not that long ago that French executives never left home and that the state occupied the commanding heights of the economy. France's economic landscape has been transformed in the past 15 years. There is more creativity, more accountability, more energy, more opportunity for more people to play. And yet it is not enough.

The promise of a third revolution is that it could complete the first two. The result would be a strong (but less greedy) state, a core of successful global businesses, and a frisky small-business sector creating jobs and operating with a certain postmodern savoir-faire. But to chase that opportunity, France must really believe in its exceptionalism. It has to have the confidence to let its entrepreneurs and institutions test themselves against the rest of the world. It is time to take that leap of faith.