– Adds Details From Gallois Report In Paragraphs 4 and 5

By Stephen Sandelius

PARIS (MNI) – The French government’s gradual approach to restoring
competitiveness is likely to disappoint everyone and fuel growing doubts
that it has any real strategy to pull the economy out of its slump.

Since last year’s record trade deficit of nearly E70 billion, the
loss of industrial jobs has only accelerated. That, in turn, has
prompted union demands for protection, on the one hand, and business
pleas for relief from rising labor costs on the other.

Prime Minister Jean-Marc Ayrault will present his Socialist
government’s battle plan on prime-time television Tuesday after
analyzing the remedies proposed by the respected industry executive
Louis Gallois. But Gallois’ key proposal to lower labor costs is too hot
a potato for most Socialists to accept without the risk of alienating
their electoral base.

In fact, Gallois proposes in his report several options to lighten
payroll taxes by “around” E30 billion, leaving the government room to
maneuver. Roughly two thirds could come from the broad-based CSG tax on
personal incomes and investment revenues. Hiking the intermediate VAT
of 7% for certain products could net another E5-6 billion. Several
billion in total could also be drawn from taxes on CO2 emissions, real
estate and financial transactions and by reducing certain tax
write-offs.

The report argues that by cutting employee payroll by E10 billion
as part of the E30 billion total, the impact of these tax hikes on
households’ purchasing power would be reduced significantly.

The business world and the economists close to it are calling for
an initial “shock” to kick-start the economy. Nearly 100 top corporate
leaders issued a manifesto last week calling for a E30 billion reduction
in payroll charges for social programs, to be financed over two years by
a 1.4-point VAT hike for half the sum and by public spending cuts for
the other half.

Numerous other studies over the years have highlighted the link
between low business profits, insufficient investment and innovation,
and the loss of market share. The Rexecode think tank has called for a
5-10% reduction in production costs to stem the hemorrhaging in French
industry.

The president of the employers’ association group Medef, Laurence
Parisot, has been working the media and lobbying lawmakers with dire
warnings about the financial plight of business, comparing the situation
of the economy to that of the Titanic.

Everyone recognizes that cost-competitiveness is only a part of the
problem, and most concede that moving upscale is a long process
involving education and training, research and development, investment
and export aids. However, such initiatives “will only bear fruit in the
very long term,” writes BNP Paribas economist Dominique Barbet. “So more
immediate action is required.”

For Jean-Paul Betbeze, chief economist at Credit Agricole,
“cost-competitiveness is extremely important” for the kind of
middle-range goods most of French industry produces. “It is by gaining a
bit of price-competitiveness that we will be able to innovate,” he says.

Citing the examples of Italy and Spain, Betbeze warns that “it is
going to hurt: you can’t absorb E30 billion without feeling it.” But the
alternative of going it slow “won’t produce anything” but zero growth
“for years and years,” he warns.

A convenient focus for labor cost cuts is the part of payroll taxes
that finances social programs, such as family supports, which are
unrelated to employee protection. The argument is that these should be
borne by society as a whole and financed instead by taxes on consumption
(VAT) or personal revenues (CSG).

“Unfortunately, there is no miracle financing reform that would
improve the competitiveness of French firms without degrading
households’ purchasing power,” writes economist Henri Sterdyniak of the
Keynesian think tank OFCE.

Finance Minister Pierre Moscovici has rejected a massive shift of
employer payroll charges to households on the grounds it would throttle
consumption and tip the economy into recession, thereby endangering the
government’s overriding goal of slashing the public deficit to 3% of GDP
next year.

On the left wing of the governing Socialist Party, some members are
openly questioning the relevance of the deficit target during a phase of
economic stagnation and are wary of undermining household earnings with
even more tax hikes, this time to boost business profits.

A recent Viavoice opinion poll showed that 62% of respondents were
already unwilling to sacrifice even “a bit” of their real incomes to
help consolidate the budget.

One strategy floated over the weekend by Christian de Boissieu,
former head of the government’s Council of Economic Analysis, would
lighten payroll charges by hiking both the VAT and CSG by 1 percentage
point to net nearly E20 billion. The VAT hike and concomitant reduction
in payroll charges would have the effect of a “mini devaluation” by
trimming domestic production costs and making imports costlier.

“We have to restore competitiveness without creating a shock for
consumption,” de Boissieu argued.

Yet boosting profits in itself does not guarantee that firms will
necessarily invest more, Sterdyniak warned. One solution reportedly
proposed by Arnaud Montebourg, the minister in charge of reviving
industry, would be to limit the payroll tax cuts to half the amount a
firm invests in innovative goods or production processes.

Montebourg’s plan, according to the business daily Les Echos, would
spare households by financing the payroll tax cuts for mid-income
employees by tapping protected sectors like banking, real estate and
restaurants, imposing CO2 emission tariffs and trimming social programs
for the middle class.

The financing of measures adopted to lighten payroll charges is a
key issue the Socialist ministers will grapple with when they convene to
wrap up the competitive package to be unveiled by Ayrault on Tuesday.
The Gallois report is expected to propose a combination of VAT-CSG and
environmental taxes to finance a E20 billion cut in employer payroll
charges, as well as a E10 billion cut in employee charges.

A majority of the French are aware of the competitiveness problem
of the economy, according to an Ifop survey released this weekend. And
they do not understand why the government has been putting off decisions
on the matter for weeks, Ifop director Jerome Fourquet told Les Echos.

This uncertainty about the future course of economic policy is no
doubt one factor behind the rapid erosion of the government’s
credibility. The prime minister’s approval rating has skidded to only
34%, according to a TNS Sofres survey.

Ayrault’s gaffes in recent days and conflicting positions among his
ministers have certainly contributed as well. Some of these divisions
are directly related to the issue of competitiveness – for example,
whether the ban on prospecting for shale gas should be lifted in favor
of cheaper energy and whether the 35-hour workweek should be abandoned.

Many observers are now asking whether Ayrault has the authority to
control his government and keep renegade members of the Ecologist
coalition party from breaking ranks.

While the prime minister is carrying the bag on competitiveness,
the policies he adopts will also determine the credibility of President
Francois Hollande, whose own approval rating after six months in office
has sunk to a record low of 36%, the TNS Sofres poll showed. More and
more people are asking whether he realizes what straits the economy is
in and has the capacity to turn it around by 2014, as he promised.

Having blasted the previous government’s proposal to hike the VAT
in order to finance payroll tax cuts, Hollande would have a difficult
time selling a policy reversal after a brief period in office and would
further alienate voters on the left wing.

However, the international investors France depends on to finance
its debts are not only eying the government’s budget consolidation but
also its ability to generate growth in the coming years. They are
unlikely to be satisfied without the kinds of structural reforms other
Eurozone countries are adopting.

“The baby-step policy is politically and socially more acceptable,
so more likely,” writes Barbet of BNP Paribas. “The corporate sector and
European authorities, though, are likely to be disappointed with the
outcome.”

–Paris newsroom +331 4271 5540; e-mail: ssandelius@mni-news.com

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