April 10 (Bloomberg) -- French President Jacques Chirac scrapped a labor law intended to reduce youth unemployment after the biggest protests by unions and students since 1968.

The law, known by its French acronym CPE, made it easier to fire workers under the age of 26 without a stated reason, bolstering labor market flexibility, the government has said. Unions and students claim it reduced job security.

The failed attempt to loosen labor rules marks a setback for Prime Minister Dominique de Villepin and may spoil his chance to succeed Chirac in next year's presidential election. The government replaced the law with a plan to curb joblessness among young people, which was 22.2 percent in February, more than double the overall rate of 9.6 percent.

``Companies that may have planned to create jobs here are not going to do it,'' said Marc Touati, chief economist at Natexis Banques Populaires SA in Paris. ``If companies don't feel France is going to be reformed, companies are going to go where the labor market is more flexible.''

Touati said in an interview that strikes and protests will reduce economic expansion by at least 0.1 percentage point per quarter this year. The Organization for Economic Cooperation and Development forecasts French growth of 0.5 percent in each of the first two quarters, lagging behind the 0.6 percent prediction for the dozen countries sharing the euro.

Production Decline

Also today, the government said French industrial production unexpectedly fell in February. The 0.9 percent decline contrasted with reports last week showing manufacturing and services in the euro region expanded at the fastest pace in more than five years in March.

De Villepin presented the CPE in January as a way to make the labor market more flexible to promote hiring. Opponents protested the provisions that allow young workers to be fired within two years for no stated reasons. Students disrupted classes or blockaded universities.

More than 1 million demonstrated on both March 28 and April 4 and police used tear gas and water cannons in Paris to disperse gangs of youths who burned cars, broke shop windows and beat up some of the demonstrators.

`Many Losers'

``There are many losers in this whole situation,'' said Francoise Cocuelle, 44, head of an association of entrepreneurs and president of a 15-person printing company in Chantilly, near Paris. ``Companies in this country are the first ones to lose as they need flexibility. In terms of image, this was disastrous.''

The approval ratings of Chirac and de Villepin collapsed as opposition intensified.

The Confederation Generale du Travail, France's second- largest labor union, claimed ``victory'' over Chirac and de Villepin in a statement today in Paris. ``This is the success of the youth and a victory for the unions,'' said Francois Hollande, head of the opposition Socialist party. He spoke at a press conference today.

The government will replace the CPE with government- subsidized job programs and training, and temporary subsidies or tax breaks for companies hiring unskilled young workers on permanent contracts, Labor Minister Jean-Louis Borloo told Le Monde. The cost of the measures will be about 150 million euros ($182 million) for the second half of the year, Borloo said.

``The necessary conditions of trust and serenity don't exist, either among the youth, or among companies, to allow an implementation of the CPE,'' de Villepin told reporters today.

`Fruitless Confrontations'

The retreat may also benefit Nicolas Sarkozy, the head of the governing UMP party and the majority's leading presidential hopeful, who criticized the prime minister's go-it-alone method. On March 27, Sarkozy said labor laws should always be discussed with unions before being pushed through Parliament to avoid ``fruitless confrontations.''

Chirac begins his 11th year as president next month with approval ratings at 25 percent, the lowest in at least three years, according to a survey by Institut LH2.

The Institut LH2 poll showed Chirac's approval rating was the lowest in at least three years at 25 percent and his disapproval rating 64 percent, the most since June 2005 when France rejected the European Union constitution.

De Villepin Slumps

De Villepin's approval rating was 25 percent, half the level in December, and his disapproval rating 65 percent, the most since he replaced Jean-Pierre Raffarin as prime minister in May 2005.

Chirac has caved to street protests in the past. As prime minister in 1986, he withdrew an education bill after a student died in clash with police during demonstrations. In 1996, during his first presidential term, he revoked a law overhauling the pension and welfare system after three weeks of strikes in the transport system crippled the economy.

``The main information is that the government withdrew this law,'' said Jean-Francois Martins, 24, president of the Federation des Associations Generales Etudiantes, a student union that opposed the new labor contract. ``We can finally resume talks with serenity.''

Medef, France's largest business federation, said in a statement today that it ``hopes'' the withdrawal of the CPE ``marks the end of a crisis that dented'' France's credibility.

To contact the reporter on this story: Francois de Beaupuy in Paris at fdebeaupuy@bloomberg.net.

Last Updated: April 10, 2006 12:01 EDT