French President Nicolas Sarkozy’s S&P downgrade counter-offensive

PARIS — French President Nicolas Sarkozy met with labor and business leaders on Wednesday, in what was hyped as a crisis summit to deal with Standard & Poor’s downgrade of the country's credit rating — a dramatic development that not only affects France, but also the conservative politician's chances for reelection three months from now.

"The gravity of the crisis forces us to do something," said Sarkozy. "Hiding from the situation will only benefit those who say politicians and trade unionists are powerless to act."

But there was much talk and little action at the summit. Sarkozy ushered in a series of ad-hoc measures to cut unemployment, earmarking $550 million for youth employment schemes and training for jobless workers.

However, the French president did announce vast — if vague — reforms to France’s generous welfare system, and measures to boost businesses and industries.

"It’s a radical change from the policies deployed in the first four years of Sarkozy’s mandate, when fiscal policies were devised to support demand. Here they are working on boosting supply," says Jean-Christophe Caffet, economist with French bank Natixis.

In 2007, the French government introduced controversial tax breaks for France’s wealthiest, and exempted workers from paying tax on overtime work to boost consumption and demand.

Read more: Sarkozy does damage control after S&P downgrade.

Many say Sarkozy, much like his predecessor President Jacques Chirac, neglected France’s manufacturing sector, letting the competitiveness of businesses slide.

Sarkozy now wants to reduce welfare contributions paid by companies and increase value-added tax to boost exports.

France’s foreign trade deficit has increased to record heights in 2011, reaching more than $92 billion. Exports have dropped over the past decade, falling from 5.8 percent in 1995 to 3.8 percent in 2008, according to a ministry report.

According to French business daily Les Echos, the government wants to increase VAT by 2 percent, from 19.6 to 21.6 percent, which would generate an estimated $15 billion to fund social security.

The move would allow the government to cut the welfare contributions made by French businesses, boosting their competitiveness.

"These measures go in the right direction," says Caffet, "Standard & Poor's had warned against new budget restrictions that would drag down growth."

But with an outstanding debt of $1.6 trillion, France is the world’s fourth-largest sovereign borrower. And increasing VAT is hardly going to solve that.

"A VAT increase will have a minimal impact on decreasing the cost of labor in France," says Agnes Verdier, director of the Paris-based think-tank Ifrap. "A 2.5 percent [hike] will only bring in a mere $18 to 20 billion.

"We need a profound reform of our social system," Verdier adds. "The French are paradoxical, they want to maintain their welfare system even though they know it is very expensive, but at the same time they want to increase their buying power."

Read more: The secret reason why Germany may be forced to keep the euro.

Caffet agrees a VAT increase is not enough and says a cut in labor costs can easily be compensated if the euro increases.

Caffet warns that if France wants to tackle foreign trade deficits, it must take drastic measures to boost its industrial sector, and like Germany, encourage the manufacturing of high-end products.

"Our problem today is that France manufactures middle-range products," explains Caffet. "Take France’s car-makers: their small cars don’t punch in the same category as German cars.

"We are competing against emerging countries where production costs are much lower."

On Wednesday, Sarkozy also announced the creation of a public bank for France’s industrial sector, an organization that would continue lending to businesses despite the economic downturn.

But some economists dismiss Nicolas Sarkozy’s action so far as irrelevant, political gesturing to salvage his bid for reelection in April.

“France has structural problems and needs to reform its inefficient public sector, its retirement policies,” says Harald Hau, professor of economics at the University of Geneva. "But none of this will be seriously tackled before a new president is elected.

"The real plans are in the drawers."

Read more: IMF needs more money; Europe roundup.

In the past months, Sarkozy has worked on his reputation as a fighter, best placed to save France’s AAA rating. But the downgrade risks diminishing Sarkozy’s rock-bottom popularity ratings even further.

"It is very probable that voters will hold Nicolas Sarkozy and his policies over the past five years responsible for the downgrade," says Yves-Marie Cann, head pollster at French polling institute CSA.

He says that while more time is needed to evaluate how the downgrade has affected voter intentions, he believes Socialist candidate and frontrunner Francois Hollande will benefit the most from the loss of AAA status.

"Hollande started campaigning on reducing deficits in 2007. Now he can say that he warned people against mounting debt."

Cann says the timing of the summit might benefit Sarkozy’s bid to show he is still fighting to boost growth in France.

Read more: Greece: Pimco calls for bigger haircuts.

But France’s powerful trade union leaders walked away from the summit on Wednesday with muted enthusiasm for Sarkozy’s battle plan. They slammed plans to increase VAT, dismissed other reforms in the works as "woolly."

Francois Chereque, head of the CFDT union, admitted the summit yielded "some interesting measures," but that Sarkozy couldn’t push a VAT increase in a rush.

"It’s regrettable that structural reforms of the French economy are being ushered in so late. You can’t build popular support for such reforms in a couple of weeks," says Caffet.

"The risk is that talks will fail and trade unions will refuse to sign proposed agreements."

Sarkozy however has set himself a deadline, and insists he will deliver concrete proposals before the end of January.