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France's President Francois Hollande speaks at a news conference at the end of the first session of a two-day European Union (EU) leaders summit in Brussels October 19, 2012.
Credit: Reuters/Christian Hartmann
By Catherine Bremer
Tue Nov 20, 2012 7:13am EST
PARIS (Reuters) - After six months keeping the world guessing about whether he had a vision for fixing France's sickly economy, President Francois Hollande has unveiled a battle plan "à la française" to ease companies' labor costs and trim public spending.
But the softly-softly pace of adjustment may be too slow to satisfy financial markets after Moody's on Monday became the second credit ratings agency to strip Paris of its AAA rating, citing both a loss of competitiveness and low growth.
Hollande's "competitiveness pact" aims to create 300,000 jobs and lift output by half a percent over five years by granting 20 billion euros a year in corporate tax relief and pruning public spending by 1 percent.
The measures will be funded by modest sales tax rises from 2014, sparing households immediate pain. Tweaks to labor laws will follow next year to make hiring and firing somewhat more flexible while extending the length of job contracts.
The plan is bold for a left-wing French government, yet it falls short of what business leaders wanted and critics say it may be too timid to pull the economy out of decline in time.
Moreover, a key plank - spending cuts of 12 billion euros a year - will require sharp reductions in welfare payments or local government, hard to sell to a parliament full of mayors and civil servants, and an electorate including more than 5 million public sector workers.
"We've taken a big step forward but we've lost time. We should have started two months ago," said a government source. Some in Hollande's team had nudged the president to move sooner but found that "he does not like to be rushed".
"Hollande has not said where the 12 billion euros will come from because he doesn't know. None of us knows. There would be a lot of resistance to public sector cuts," the source said.
Most economists have applauded Hollande's move to embrace reform, despite muttering from Berlin that the measures should be bolder.
But they say success, in the face of stalled growth and rising 10 percent unemployment, depends on Hollande being able to implement all his plans - corporate tax relief, labor reform and spending cuts - to the letter.
That will hinge on acquiescence from a disgruntled public, on the euro zone avoiding further crisis or a deeper lurch into recession, and on investors keeping French borrowing costs low.
"If he can meet all these commitments it would be remarkable and he could really make a difference. If he only partially meets them the results are harder to predict," said Elie Cohen, an economist who advised Hollande during his election campaign.
Cohen sees a risk of France being sucked into the sort of downward spiral that has afflicted Greece, Portugal, Spain and to an extent Italy.
"A euro zone recession could be decisive," he added. "If France misses its growth targets and then its deficit targets, he'll need to do a third austerity plan on top of these measures and that would look seriously like a Mediterranean scenario."
Hollande is under growing pressure from foreign investors concerned at France's strained public finances, flatlining economy and industrial decline that has led to a 70 billion euro trade deficit.
Paris also faces new competition for its exports from Spain and Italy, which have been forced by their debt crises to reform their labor and product markets faster.
Hollande's November 6 announcement of the tax rebates was his response to an independent review of competitiveness that recommended 30 billion euros in direct cuts to labor costs.
The rebates will be linked to payroll size in a way that the government says is equivalent to a 6 percent reduction in labor costs from 2013.
Hollande's economic advisers, who include a U.S.-educated academic and a former investment banker, expect the rebates to have a similar effect to an internal devaluation, raising profit margins, especially for labor-intensive manufacturers and small firms, for a couple of years until prices adjust.
The government reckons this could boost exports by 10-15 billion euros over two years, shaving the non-energy trade deficit.
"All other things being equal, this will improve the current account by quite a bit," said a government adviser, whose position bars him from being quoted by name.
Naysayers note that any trickle of jobs created through the tax rebates will be outstripped by continuing job losses as long as economic growth remains below 1 percent.
A rule of thumb for France is that employment stabilizes once growth reaches 1.5 percent, and it takes 2 percent expansion or more to achieve a net increase in jobs.
"The tax rebate plan may enable us to absorb some of the recession, by adding some jobs, but it won't boost economic activity," said Philippe Ansel, an economist with Fondation Concorde, a business-funded, economically liberal think-tank.
"France remains squashed between Germany, with its high-quality products, and Spain and Italy, which have made bigger efforts to reduce their labor costs."
Like other critics, Ansel says the rebates are worth only a net 10 billion euros to companies since they come on top of 10 billion euros a year in corporate tax rises in the 2013 budget.
His think-tank advocates a 50 percent cut in payroll contributions for companies exposed to foreign competition.
Hollande is also under fire for capital gains tax changes that will penalize investors in start-ups as well as failing to make good on a promise to ease the tax burden on corporate profits that are reinvested.
"You'll see the impact of these measures in 2014 and 2015. There will be less wheat to harvest," said Ansel.
NOT CRAZY, BUT DELIBERATE
French public spending accounts for 56 percent of economic output, second only to Denmark at 58 percent, and the tax take from companies amounts to 17.9 percent of gross domestic product, compared to just 4.3 percent in Denmark.
Departing from Socialist dogma, Hollande questioned at his first presidential news conference this month whether the high spending bill had brought the French a better quality of life.
Hollande sent his prime minister to Germany to tell Chancellor Angela Merkel that France would reform at its own pace and would not be pressured to go faster.
His advisers dismiss accusations of foot-dragging from Berlin and by The Economist magazine.
"Cutting 60 billion euros (from public spending) in five years is anything but timid. The idea it's not ambitious is insane," said Thomas Philippon, a finance ministry adviser.
"Doing crazy things isn't going to work. You have to do things gradually but deliberately and in a sustainable way."
Yet Hollande's economic team knows the pressure is on.
Labour Minister Michel Sapin told Reuters that beyond the labor flexibility accord the government is seeking, it could look at making people pay into the pension system for longer, another topic previously taboo for the French left.
"It's fine to tell the Germans we'll reform at our own pace - but we do have to reform," said the first government source. "Hollande is a very prudent person, and that's fine, but if you spend too much time talking, you risk getting nowhere."
(Reporting By Catherine Bremer; Editing by Paul Taylor)
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