Fillon's economic shock therapy for France risks side effects

By Leigh Thomas

PARIS (Reuters) - On paper, French presidential favorite Francois Fillon's free-market plans to cut business taxes, relax labor laws and shrink the public sector should give corporate France a shot in the arm and boost economic growth.

But his reforms are likely to come at the cost of showdowns with labor unions and public-sector workers who face losing jobs in a country where strikes can often drag on for several weeks if not months.

He could also clash with Berlin over a ballooning budget deficit, while a sales tax hike that would help pay for his other plans risks dampening consumer spending.

Fillon, an admirer of late British Prime Minister Margaret Thatcher, is the center-right candidate for the presidential election in May, when he will go up against far-right leader Marine Le Pen and a yet-to-be selected Socialist opponent.

If victorious, he would have a popular mandate to enact his free-market reforms following deep disenchantment with Socialist President Francois Hollande's failure to fulfill pledges to slash high unemployment of about 10 percent and deliver growth.

Fillon says he would introduce 50 billion euros ($53 billion) in tax cuts - worth about 2.5 percent of GDP - with most of that targeting companies' payroll tax.

The loss of state revenue would be partially offset with a 2 percentage point increase in value-added sales tax, by far the government's biggest source of tax revenue.

Economists liken the move to a currency devaluation - something outside French authorities' power as a member of the euro zone - because firms could sell at more competitive prices abroad while importers face higher prices, thus improving the overall terms France trades on with the rest of the world.

"The aim is to rebalance France's growth model towards exports and away from solely relying on consumption," said economist Emmanuel Jessua at Coe-Rexecode think tank.

There are precedents in France, notably when conservative former President Nicolas Sarkozy, with Fillon as his prime minister, tried to cut payroll taxes in the final months of his term in 2011.

Sarkozy's successor Hollande unpicked the program once he came to office and introduced instead a tax credit scheme to reduce the payroll taxes companies pay.

Fillon would turn that scheme into a permanent reduction in payroll charges, while also going further than Sarkozy's plans by also cutting the corporate tax rate to 25 percent, from 33 percent currently.

'BOSSES BACK FILLON'

Fillon, a former labor minister, would also reduce the complexity of the labor code, make firing workers easier, and also axe France's 35-hour legal cap on the working week and raise the retirement age to 65 from 62-63.

"He's taken on board all of our concerns," the head of the MEDEF employers association, Pierre Gattaz, told journalists. "There's a lot of bosses backing Fillon."

With proposals to shrink the public sector and spending by cutting 500,000 civil service jobs and reducing unemployment benefits, critics have characterized Fillon as a man who threatens France's cherished welfare system.

Fillon's plans to cut public spending to 49 percent of output by 2022 would still leave it well above the current OECD average of 45 percent.

Nonetheless the conservative, who lives in a Loire valley chateau, makes an easy target for hardline unions eager to show that they remain relevant after years of declining influence.

"When workers are not happy, and retired people are not happy, they go on strike, factories have to shut," the head of the CGT union Philippe Martinez said. "When a majority of workers are on strike the economy suffers."

Though he insists he will not water his plans down, on Monday, Fillon retreated on prime time television from a suggestion he would privatize basic healthcare.

FISCAL FUDGE

With spending cuts coming gradually after the tax cuts, Fillon accepts that the initial strain on the budget means he will have to tear up the current government's plans to cut the deficit to less than 3 percent of output next year.

Instead, his program would let the deficit balloon to as much as 4.7 percent of GDP next year before gradually coming down as tax cuts gradually lift the overall growth rate.

France's partners in Berlin have not forgotten that a similar fiscal strategy by Sarkozy at the start of his term left the French finances vulnerable when the financial crisis struck in 2008-2009.

EU Economics Commissioner Pierre Moscovici, a French Socialist close to Hollande, has said he would not cut Fillon any slack for overshooting the 3 percent target.

Playing in Fillon's favor is an emerging international consensus, including at the European Commission, supporting looser fiscal policy as long as it helps growth.

The OECD estimates that near record-low borrowing rates mean France like other countries can afford some fiscal slack after years of sweating to rein in the finances.

"They have cash they found on the sidewalk, so they don't have to be budget neutral," OECD chief economist Catherine Mann told Reuters.

(Reporting by Leigh Thomas; Additional reporting by Yves Clarisse and Michel Rose; Editing by Andrew Callus and Pravin Char)

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