A bug-eyed little car known as the deux chevaux (meaning two horsepower) was an icon of the French car industry for more than four decades. Now, PSA Peugeot Citroën (UG:FP), whose Citroën unit produced the deux chevaux until 1990, has become an emblem of France’s deepening economic woes—and a key test for its new president, Socialist François Hollande.
On July 12, Peugeot announced it will close a factory in the Paris suburbs and cut thousands of jobs at other facilities. Including reductions announced last year, it’s set to shed some 14,000 workers, mainly in France. Prime Minister Jean-Marc Ayrault called the announcement “a true shock.”
Peugeot had little choice. It will post a €700 million ($860 million) first-half operating loss and is burning through €200 million in cash every month. The carmaker’s factories are operating at just 76 percent capacity, as first-half deliveries slid 13 percent. To raise cash and cut debt, it’s selling off assets, including its Paris headquarters. “Peugeot is pretty close to bankrupt,” says Nicolas Meilhan, a Paris-based consultant at Frost & Sullivan who previously worked for the car company.
Other European automakers have suffered sales declines during the region’s debt crisis, but Peugeot’s problems go far deeper than its rivals’. Some 40 percent of its production capacity is in France, where high payroll taxes and rigid labor rules clobber its competitiveness, Meilhan says. French unit labor costs, now the second-highest in Europe after Belgium, have increased about 20 percent in 2000 in relation to Germany, benefiting competitors such as Volkswagen (VOW3:GR). French automaker Renault (RNO:FP) is in much better shape than Peugeot, as it has moved 80 percent of production abroad, mainly to low-cost locales.
The news from Peugeot only adds to an increasingly dire economic outlook in France. Unemployment is at 10.2 percent, and the government recently downgraded its 2012 growth forecast to just 0.3 percent. Two other big employers, Air France (AF:FP) and pharmaceutical group Sanofi (SNY), have announced major job cuts since Hollande took office in May.
The president is being pressed to act quickly to restore competitiveness, as the French trade deficit hit a record €70 billion last year. “France has allowed serious weaknesses to develop over the past few decades, which account for the slow deterioration in its economic position in Europe and the world,” Bank of France Governor Christian Noyer wrote in a letter to Hollande on July 10.
Louis Gallois, the former chief executive officer of European Aeronautic, Defence & Space (EAD:FP), whom Hollande named to head a new advisory group on competitiveness, has said France may need to cut taxes and social charges by as much as €50 billion. “We need to create a competitiveness shock,” he said on July 7. “It has to be quite massive.”
The danger is that Hollande may go in the opposite direction. He has already announced plans to raise taxes on large companies, including special levies on banks and oil companies. He also scrapped a plan by former President Nicolas Sarkozy to reduce social charges on employers. Now, Hollande is under pressure from unions to tighten anti-layoff rules that already make it expensive for companies to downsize. Those very rules help explain why Peugeot is now saddled with so much excess production capacity.
“When one of the country’s largest employers and exporters slashes jobs in its home market partly because of high labor costs relative to Germany, this is a warning sign for the government,” says Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “The fear is that this will embolden France’s government to restrict plant closures and enhance job protection.”