PARIS (Reuters) - Mass layoffs at Peugeot are piling pressure on France's new Socialist government, which can't afford to bail out the auto sector, to cut social welfare levies instead as a way of easing labor costs and making French industry more competitive.
President Francois Hollande, elected in May on a pledge to reverse France's steady manufacturing decline, faces public expectations for him to reduce the 8,000 job cuts announced by the country's largest car maker last week, opinion polls show.
But with his government struggling to find 33 billion euros ($40 billion) in deficit cuts for next year, it cannot afford the billions of euros in subsidies and cheap loans thrown at the sector by the previous government to stave off jobs cuts after a worldwide economic slump in 2008-2009.
The Socialists on Tuesday repealed legislation which would have shifted some of the burden of social welfare charges from labor onto a rise in VAT, a measure passed by ex-President Nicolas Sarkozy to give French industry some breathing space.
But Peugeot's massive layoffs are stirring calls for Hollande to quickly find other ways of easing the burden on companies, such as a rise in the CSG levy that individuals pay on nearly all income to help finance a generous welfare system.
"This is the demonstration that there is a problem of competitiveness in France," Bank of France Governor Christian Noyer said on Wednesday. "We need to attack this problem. The government must reform the cost of labor and lessen welfare charges on salaries."
Before tackling the underlying problem of competitiveness, Hollande knows he must be seen to stand up to Peugeot's redundancy plan. An Ifop poll published on Sunday showed 28 percent of voters expect the government to block Peugeot from making the layoffs while 21 percent said it should use public funds to avoid them.
While Hollande has ruled out a return to costly and ineffective scrappage schemes, he has vowed to do everything he can to ensure all Peugeot workers are offered voluntary redundancy or alternative jobs.
With Europe oversupplied with cars, Hollande cannot stop the closure of the Aulnay assembly plant. The government does not have a stake in Peugeot as it does in Renault.
However, it is not powerless: the state can limit its co-financing of partial layoffs or block access to cheap credit from state banks, which would make the adjustment plan much more expensive for Peugeot.
"Hollande knows that in the short term, he needs a face- saving deal to minimize the number of firings. And there are lots of ways he can bring pressure to bear," said Elie Cohen, an economist who advised the Socialist leader during his campaign.
"In the medium term, though, the government needs to act on labor costs to make France more competitive. It knows this."
France has bled some 750,000 manufacturing jobs over the last decade - reducing its level of industrialization to amongst the lowest in the Western world - as traditional industries have succumbed to low-cost emerging market competition.
As part of an auto sector rescue package due on July 25, the government will provide incentives for environmentally friendly vehicles such as electric cars where Peugeot and Renault (RENA.PA) are market leaders, Industrial Renewal Minister Arnaud Montebourg says.
It may also increase tax incentives for research and investment in a bid to improve the quality of French cars and industrial goods in general, following Germany's example.
"Going upmarket is the only possible way out of this crisis," said Aurelien Duthoit, analyst at brokerage Xerfi. "But that's a long-term policy. Supply side reforms will take years."
Such measures will come too late to shore up Peugeot's manufacturing unit against 200 million euros a month in losses. With 44 percent of its production in France - twice Renault's level - the carmaker has said it urgently needs a cut in welfare levies.
"We have the highest labor costs in Europe," Peugeot chief executive Philippe Varin told RTL radio on Friday. "We need to massively lower the charges weighing on labor."
French unit labor costs, which were once a competitive advantage, have risen steadily over the last decade to top those in neighboring industrial powerhouse Germany. Half these costs are social welfare levies, according to the MEDEF business chamber, twice the level in Germany.
After talks with unions last week, Prime Minister Jean-Marc Ayrault recognized that France needed drastic steps to regain competitiveness and alluded to the possibility of shifting some welfare financing from wages onto the CSG social levy.
While a VAT increase would weigh more heavily on poorer households - which consume a higher share of their income - the Socialists favor an increase in CSG because it is proportionate to income. It also applies to revenue from capital.
Louis Gallois, the former CEO of aerospace giant EADS EAD.PA named by the Socialists to head a task force on reviving industry, has said France needs "a competitiveness shock" involving cuts in taxes and social charges of up to 50 billion euros. "It has to be massive," he told a conference.
Gallois is due to present a report early next year as the basis for welfare funding legislation before the end of 2013.
($1 = 0.8154 euros)
Additional reporting by Gilles Guillaume, Marc Joanny, Guillaume Frouin, Julien Ponthus; Editing by Brian Love/Ruth Pitchford