French resistance

President Jacques Chirac has long claimed to represent “a certain idea of France,” defending the country’s culture and social traditions while asserting an independent voice in global affairs to rival that of the U.S. At the moment, that vision is more popular than ever to the French. Chirac’s willingness to stand up to the superpower and oppose President George W. Bush’s effort to remove Saddam Hussein by force has united the French nation in admiration. From the Communists on the left to the Front National on the extreme right, politicians who usually criticize Chirac for alleged corruption or bad judgment are lauding his determination in rebuffing the country’s most powerful ally and promoting a multipolar world order instead of American hegemony.

“Jacques Chirac has never been as good as when he is campaigning. And as a candidate for peace, he has been perfect,” an editorialist recently asserted in Le Monde. “A certain idea of France in the world has been defended, and illustrated, by its president.”

Underneath the accolades, however, a palpable concern is growing among France’s business elite. The immediate worry is that Chirac’s bold but risky gambit could backfire economically. With Franco-American relations at their lowest level since Charles de Gaulle pulled France out of NATO’s military apparatus nearly 40 years ago, the threat of boycotts or economic reprisals hangs in the air. The Speaker of the House of Representatives, Dennis Hastert, has proposed slapping warning labels on French wine, and other lawmakers have suggested boycotting this year’s Paris Air Show or barring French companies from any postwar reconstruction contracts in Iraq. For a country that has invested E460 billion ($495 billion) abroad over the past four years, the largest portion of which has gone to the U.S., such threats are not idle.

French officials play down the risk of economic repercussions. Chirac has said that U.S. trade retaliation is unlikely because any measures that singled out France would violate World Trade Organization rules. Francis Mer, the former French steel executive who serves as Chirac’s minister of the Economy, Finance and Industry, is also trying to calm the waters. He struck a quick rapport with U.S. Treasury Department Secretary John Snow, a fellow ex-CEO, at a Group of Seven meeting of finance ministers in Paris in February -- a rare instance of bilateral bonhomie.

“I consider it perfectly normal for countries with extremely long-standing relations to find that they don’t necessarily agree entirely on a given subject, even an important one,” Mer, 64, told Institutional Investor in a wide-ranging interview (see box, below). “So however momentous the Iraq issue may be for the future of the world, I simply can’t imagine that developments in this area over the next few weeks will generate economically irrational behavior between the two countries.”

Some French executives are less sure. “The huge scale of the anti-French campaigns causes real economic damage to our companies,” Olivier Dassault, head of Dassault Group’s publishing arm and a parliamentarian in Chirac’s ruling party, wrote last month in Le Figaro. “Thousands of French enterprises are going to watch helplessly the destruction of years of commercial effort, the weakening of their revenues and the layoffs that will follow.” Dassault called for a full-scale French counterattack that would include everything from a PR campaign to turn around anti-French sentiment in the U.S. to boycotts of U.S. products and the imposition of sanctions by the European Union in the WTO trade dispute over U.S. foreign sales corporations.

An even bigger concern stems from the difference between Chirac’s foreign policy boldness and his timidity on domestic issues. The president’s audacity in opposing George Bush over Iraq -- a posture that has greatly bolstered his popularity -- stands in stark contrast to his unwillingness to confront unions, public sector workers and other vested interests over vital, but unpopular, reforms at home. Despite a massive parliamentary majority, Chirac’s government, led by Prime Minister Jean-Pierre Raffarin, has preferred consensus to tough choices during its first year in office.

The government has cut income taxes by 6 percent and tinkered with two controversial laws from the previous Socialist government -- laws establishing a 35-hour work week and restricting companies’ ability to make layoffs. But Raffarin has eschewed dramatic reforms to slim the bloated French state and improve corporate competitiveness. The reason? Fear of union weapons of mass disruption of the sort that brought down the previous center-right government of Alain Juppé in 1997, when it tried to make savings in the generous pension regime of France’s state-owned railway. “The motto is, ‘Softly. Don’t do what Juppé did,’” says Eric Chaney, an economist at Morgan Stanley and a former French Finance ministry official.

The government has made gestures in the right direction, but “it’s still only a tiny fraction of what is necessary,” says Bertrand Collomb, chairman of cement maker Lafarge. Business executives “always think we can do more, and faster, but in reality, political life is not that easy in France.”

It won’t get any easier in the months ahead. For one thing, France is on a collision course with its EU partners over its growing budget deficit. By cutting taxes but not spending, France’s deficit widened to just over 3 percent of GDP last year, putting the country in violation of the EU’s Stability and Growth Pact. And with growth slowing, the deficit will widen to 3.4 percent this year, Finance Minister Mer acknowledged last month. The European Commission, the EU agency that enforces the pact, plans to launch an excessive-deficit procedure that would require corrective action, but Mer is resisting any new budgetary restraint before 2004, saying it would be counterproductive at a time when Europe faces the risk of recession. “We should have the intelligence to follow the least dangerous course between a short term that’s difficult for everyone and our medium-term responsibility” to reduce the deficit, he says.

The government is vowing to come to grips with pension reform at long last. Seeking to avert an imminent surge in the cost of the country’s pay-as-you-go state system, Raffarin has launched consultations with industry and unions and promises to propose legislation in June to salvage the system. If he can crack the pension nut, Raffarin intends to move on to broader reforms on health spending and public sector payrolls that would push back the frontiers of the state and enable the government to finance significant tax reductions. But unions sent an early warning shot in February with demonstrations that brought 350,000 people into the streets, and they promise to fight any attempt to increase working requirements for public employees or to raise the retirement age generally.

Will the government maintain its nerve and succeed where its predecessors have failed? Will it use the pressure of its budget problems to scale back the size of the state, or will it once again shirk reform? For French executives and investors alike, the time for answers is drawing near.

“Impatience is growing,” warns Henri de Castries, chief executive officer of Axa Group, the French insurance giant. “No one underestimates the constraints under which they have to operate. But having said that, if the government was intending to give a clear signal that it wants to change things, it needs to be clearer in its talks and clearer in its actions.”

The cost of inaction is clearly rising. France dropped ten places, to 30th, in the most recent ratings of country competitiveness by the World Economic Forum. That, combined with some high-profile plant closings in recent months, has jolted the government. Worse may be in store. A recent survey of 200 multinationals in France by Ernst & Young found that 25 percent of companies -- and fully 43 percent of U.S. corporations -- were considering moving some of their operations abroad. The main complaint? High taxes and social charges and restrictive social legislation, including the 35-hour work week. Given this troubled context, Chirac’s confrontation with Washington poses real economic risks.

“It is true that people do not need another reason not to invest in France, given the many structural problems already facing the economy,” Maurice Lévy, chairman and chief executive of advertising company Publicis Groupe, said at a recent press conference.

It’s not just foreign investors France needs to worry about. A significant amount of its homegrown talent is leaving the country. One big reason is the wealth tax, a leftover from the Mitterrand era that imposes an annual tax of up to 1.8 percent on assets over E715,000. For some entrepreneurs, who have significant wealth tied up in their companies but draw relatively modest salaries, the tax can exceed income. Mer’s secretary of state for small business, Renaud Dutreil, acknowledges the problem. He’s even dubbed the tax -- called the ISF, or impôt de solidarité sur la fortune -- the incitation à sortir de France, or incentive to leave France. But a bill on economic initiative now in Parliament, one of Mer’s key pieces of legislation this year, makes only modest changes in the tax, such as an exemption for private equity investment. Calls to cap the tax at least at the level of income have gone unheeded. Clearly, soaking the rich is popular even for a center-right government, and besides, Mer needs the money.

“The reform is so timid,” says Denis Payre, who co-founded the successful software group Business Objects in 1990 but left France for Belgium in 1997 because of the wealth tax. “It’s a shame. The people who are leaving are very successful, entrepreneurial people, and they’re very young. They’re clearly very important for the country.”

The need for reform is urgent, but the deepening economic slowdown increases the risk of a political backlash from anxious consumers and unions. Investment has slumped over the past nine months, unemployment is 9.1 percent and rising after several years of steady declines, and growth is expected to remain stagnant in 2003 at slightly more than 1 percent for the second straight year. “This is a tough time of the business cycle to take tough measures,” says Jack Anderson, a partner at Ernst & Young.

After 15 years of calling the shots as a CEO, Mer often appears frustrated by the slow pace of political life, the need for compromise and the intrigue among ministers. He acknowledges that “rightly or wrongly” the government is wary of Juppé's mistakes and is determined not to repeat them. But he insists that by explaining the need for reform to the public and by carrying out less visible day-to-day administrative work, such as establishing tighter spending controls inside ministries, government ministers are laying the groundwork for a change of direction that will be no less profound for being methodical.

“Right from the start we laid our cards on the table in terms of changing economic policy, and we said that private enterprise is what drives the economy, not government,” Mer asserts. France is turning away from two decades of ever-greater taxation and redistribution and ushering in an era of “less redistribution and more freedom of individual choice, meaning more wealth left in the hands of each person. That’s our philosophy.”

It sounds good, but can Mer deliver? Economists and industrialists welcome the presence of a business executive to head the sprawling Ministry of the Economy, Finance and Industry, where Mer’s accent on spending discipline and sound management marks a welcome change from the highly politicized role of his Socialist predecessors. The difference is visible in his glass- and mirror-walled office atop the massive ministry building in the eastern Paris neighborhood of Bercy. Mer discarded the sofa enjoyed by the previous tenant, Socialist Laurent Fabius, and replaced it with a conference table where he spends much of his day working in shirtsleeves with his staff. He refers to Fabius with more than a hint of disdain, saying: “He didn’t work. He ‘discussed.’”

But Fabius, a former prime minister and parliamentary leader with ambitions for the presidency, had real political clout. Mer has no political base of his own, and although he was chosen by Chirac and has close ties to power brokers like Jacques Barrot, leader of the ruling Union for the Presidential Majority party, or UMP, in the National Assembly, he has lost some early battles over spending and civil service cutbacks. “He’s not a heavyweight on the political stage, so he doesn’t have the leverage to get spending cuts,” says Morgan Stanley’s Chaney.

The more important factor behind the government’s cautiousness stems from the bizarre nature of last year’s elections. Chirac won reelection with an unprecedented 82 percent of the vote, and his UMP swept into government with 363 seats in the 577-seat National Assembly. But the landslide was a referendum against extreme-right Front National leader Jean-Marie Le Pen -- who stunned the country by outpolling former Socialist prime minister Lionel Jospin and getting into the presidential runoff -- rather than a resounding vote for Chirac. If the president has a mandate, it’s to deliver on his main campaign pledge of strengthening law and order.

“The government has not been elected with a mandate to really reform profoundly the state,” says Business Objects’ Payre. When the new government was presented at a ceremony in front of the Elysée Palace last May, the first member introduced was Interior Minister Nicolas Sarkozy, the star of Raffarin’s cabinet, who is leading a crackdown on crime and illegal immigration. The order of introduction signals the effective rank in cabinet, and typically the Finance minister is at or near the top. Mer was introduced seventh. The drop in protocol itself didn’t bother Mer. But if rank hampers his effectiveness, that will rankle.

So far Mer’s biggest coup has been the sale last November of the state’s 10.9 percent stake in Crédit Lyonnais (see box, page 55). The Jospin government had dithered over the stake for more than two years despite favoring an eventual marriage between Lyonnais and Crédit Agricole. Mer’s deal to sell the Lyonnais stake to BNP was a masterstroke that reaped E2.2 billion for France, but he can’t count on additional windfalls anytime soon. Although the government wants to sell some or all of its stakes in companies ranging from Air France and Renault to France Télécom, “the market isn’t there,” one Mer aide admits. So if the Finance minister wants to cut the deficit, he will have to do it the hard way, by restraining spending and rolling back the frontiers of one of Europe’s most extravagant welfare states.

Government spending amounts to 54 percent of GDP in France, well above the EU average of 47 percent and trailing only Sweden’s 58 percent. In the U.S., government spending totals 35 percent of GDP. Middle-class entitlement to a wide range of public benefits, from child subsidies to disability benefits and early retirement, is a major factor blocking reform in many European countries. But in France, where Socialist governments have ruled for most of the past two decades, the problem is particularly acute. “The point of view of the middle class is more the point of view of the beneficiaries of welfare than of the financiers of welfare that, indeed, it is,” says Jean-Claude Trichet, governor of the Banque de France. The high level of welfare spending, he says, is “an enormous problem. It’s an incentive to not work, to not grow.”

French spending and taxation goes a long way toward explaining the irony of French economic performance. The burden of taxes and regulation has forced French companies to become extremely efficient to survive. French output per hour worked is among the highest in the world, at 97 percent of U.S. levels, according to the OECD. The problem is that not enough people are working. The country’s employment rate stands at just 63.1 percent, well below the EU average of 65.5 percent and far from the EU’s own target of 70 percent by the year 2010. By contrast, more than 70 percent of the U.S. working-age population is employed. As a result, French output per capita is just 65 percent of U.S. levels.

“The business community has done what it had to do over the past 20 years to reform itself,” says Axa’s de Castries. “The people within these companies are now slightly tired of hearing civil servants and politicians giving them advice. They would prefer to see the public world reforming itself.” Or as Patrick Artus, chief economist at CDC Ixis puts it, “If you want to fix anything in the private sector, you have to fix things in the public sector first.”

For Mer, that’s no small job. The Socialists increased spending commitments instead of reducing the deficit during France’s good growth years, from 1999 to 2001, and Mer entered office with a commitment to carry out Chirac’s tax cut pledge, not impose austerity. So last summer, just as the European Commission was instructing France and other high-deficit countries to trim their deficits by half a point of GDP a year, Mer introduced a supplementary budget that cut income taxes by 5 percent. The move, which lowered the country’s marginal income tax rate below 50 percent for the first time since 1959, was welcomed by business leaders and economists as a boost for growth at a time of economic weakness. But Mer angered many of France’s EU partners and the European Central Bank, which regarded his budget as violating the spirit, if not the letter, of the Stability and Growth Pact. In September Mer ratcheted the tensions by drafting a budget for 2003 that projected an unchanged deficit of 2.9 percent of GDP. He even clashed openly with Trichet at the annual IMFWorld Bank meeting in Washington, when, at a joint press appearance, he dismissed the central bank governor’s appeal for deficit reduction.

Since then Mer’s budget problems have only worsened. The deficit for 2002 turned out to be 3.1 percent of GDP, well above the original government projection of 1.4 percent. The minister also conceded that the economy would grow by just 1.3 percent this year, far short of his initial target of 2.5 percent, causing the deficit to widen to 3.4 percent. Many private economists think he’s still being too optimistic. Morgan Stanley’s Chaney forecasts growth of just 0.9 percent. Regardless of who’s right, European Commissioner for Economic and Monetary Affairs Pedro Solbes is expected to launch an excessive-deficit procedure against France this spring and recommend corrective measures in June. The move puts France in the EU dock alongside Germany, which is already implementing austerity measures to comply with EU recommendations.

Mer has changed his earlier confrontational stance on the Stability Pact to one of resigned acceptance. He shows no sign of opposing Solbes’ excessive-deficit procedure, and talk of reforming the pact to put more emphasis on debt than on deficits, which swept Paris last fall, has faded as officials acknowledge the practical difficulty of getting unanimous EU agreement on treaty changes. But in reality Mer is simply playing for time. He has frozen E4 billion in discretionary spending this year, but he has no intention of following German Finance Minister Hans Eichel in imposing tax increases or big spending cuts, which he says would choke the weak economy. The strategy appears to be aimed at winning leniency from the commission and France’s EU partners in the short run in the hope that an economic recovery will help him trim the red ink in 2004.

France may yet find EU sympathy. Finance ministers last month discussed the possibility of effectively suspending the Stability Pact’s rules because of exceptional circumstances if an Iraq war leads to a recession. But Mer’s problem lies in Frankfurt as much as in Brussels. ECB officials continue to criticize the lack of economic reform and big deficits in France and Germany, and many economists believe that those concerns explain why the bank has been so slow to cut interest rates. Trichet makes the point subtly but no less clearly, telling II, “The government has a great interest in reducing public spending as a percentage of GDP.”

Behind the scenes, Mer and his Budget minister, Alain Lambert, have lobbied hard to restrain spending, but so far they have had little success. One of Mer’s key objectives is to take advantage of a looming surge in retirements among civil servants to pare back the state. The number of civil servants due to retire each year will jump to 142,000 by 2006, up from 112,000 in 2002. Simply holding hiring steady would produce significant cuts in head count and spending. But in 2003 the budget calls for reducing the public sector payroll by a grand total of just 1,089 employees. In fact, the real total may rise. Mer’s pressure to cut education spending, however, prompted a union backlash. In January Education Minister Luc Ferry announced plans to maintain hiring at 30,000 teachers this year, slightly more than the number due to retire, and to hire 16,000 teaching assistants, 5,000 more than originally budgeted.

Mer hopes to do better in 2004, beginning with his own ministry. The Finance ministry employs more than 170,000 civil servants, many of them staffing the country’s hundreds of tax collection centers. France is advanced on commercial payments systems, including smart cards, but at the start of the 21st century, it still doesn’t have payroll tax deduction. Christian Sautter, the short-lived Socialist Finance minister, tried to introduce payroll deduction in 2000 but was thrown out of office when his proposals incited mass union protests. Mer raised the idea briefly after taking office but quickly shelved it as politically impractical. Since then he’s focused on more modest reforms, including merging two tax collection divisions, but so far they haven’t produced real savings.

Christian de Boissieu, an economist recently named to head Prime Minister Raffarin’s Council of Economic Analysis, believes that Mer’s industrial experience will eventually pay off at Bercy. “He’ll handle reform differently,” he says. “He believes in social dialogue. He has a priori the confidence of the unions, which his predecessors, even on the left, didn’t have.” But Jacky Lesueur, the powerful head of the Force Ouvrière union at the Finance ministry, warns the government to go slowly on administrative reform. It’s not an idle threat: Lesueur orchestrated the opposition to Sautter and is known to colleagues as the “deputy minister.” He says, “Mr. Mer has to be very careful.”

Future reform hopes depend on the government’s ability to overhaul the state pension system. Chirac identified pension reform as his top domestic objective this year, and Raffarin has ordered his Social Affairs, Employment and Solidarity minister, François Fillon, to produce a legislative proposal by June. The stakes couldn’t be higher. A botched attempt at pension reform brought down the Juppé government and could do in Raffarin despite his majority. But the fact is that France can’t afford its pay-as-you-go system much longer.

The number of workers hitting pension age is set to soar almost overnight to some 800,000 per year in 2006, compared with about 500,000 annually at the moment, as the wave of babies born after the end of World War II turn 60. And that’s only the tip of the problem. The minimum retirement age may be 60, but with many companies taking advantage of early retirement schemes to shed workers older than 50, the average retirement age is just over 57.

The big obstacle to reform on pensions, as in other areas, lies once again in the public sector. Public employees can retire after 37.5 years of work and draw a pension pegged to their salary in their last six months. Under reforms pushed through in the early 1990s, by contrast, private sector employees have to work 40 years and draw pensions pegged to their average salary over their last 25 years of employment. This being France, égalité is the watchword of reform, but for Fillon that means everyone working 40 years. For the unions, however, the rallying cry is 37.5 for everyone. “You don’t make progress by backtracking socially,” says Bernard Devy, chief pensions negotiator at Force Ouvrière.

Even égalité is only a first step. With French life expectancy now about 80 and growing by more than two years with every generation, the government should be talking about raising the retirement age, reducing pension benefits or increasing payroll deductions to guarantee the system’s solvency. “It’s too late to respond to this problem simply by saving,” says Daniel Bouton, chairman of Société Générale. But the unions vow to take to the streets to oppose any such measures.

The government is likely to carry through some pension reform. After all, union members are getting older and can do the math themselves. Devy acknowledges that “opinion is rather favorable for reform.” Will it be deep enough to satisfy Mer or his former colleagues in industry? That’s less likely. But for now Mer, and business, have no alternative but to hope that Chirac’s slow, steady approach to reform will work.

“The benefit of going slowly is that at least a debate can occur in society and French people can understand why this has to happen,” says businessman Payre. “The government has very smart people. I just hope they’re smart enough.”

Mer’s vision: Less redistribution, more freedom During his 15 years as CEO of Usinor Sacilor, Francis Mer transformed a nearly bankrupt company into the world’s largest steelmaker by making tough decisions without alienating his workforce. Today, as minister of the Economy, Finance and Industry, he must engineer a similar transformation of France’s public sector to contain a rising budget deficit and stimulate growth. He laid out his vision in an interview with Institutional Investor European Editor Tom Buerkle.

Institutional Investor: French companies have heavily invested over the past few years, especially in the U.S. Do you foresee any negative economic fallout from the political discord over Iraq?

Mer: I personally don’t think so. I consider it perfectly normal for countries with extremely long-standing relations to find that they don’t necessarily agree entirely on a given subject, even an important one. So however momentous the Iraq issue may be for the future of the world, I simply can’t imagine that developments in this area over the next few weeks will generate economically irrational behavior between the two countries.

The economy is a world that seeks to be as rational as it possibly can. That is its very raison d'être.

Everyone’s talking about confidence, or rather the lack of it. What can the government do to raise confidence?

I believe that beyond the current geopolitical events, which none of us can control, what really is at issue here is that we have discovered that certain more or less reprehensible kinds of behavior are possible, in the U.S. and perhaps in Europe as well. There is no guarantee that the basic rules of the game and principles of conduct governing the way our economic system works will be upheld. If we fail in short order to restore a climate of confidence around the world, we’ll be endangering the very foundations of the system.

It is the responsibility of governments, working in cooperation if possible, to lay down basic, simply stated principles. Companies should know that they are required to abide by these principles and that if they don’t, there will be someone capable of inflicting penalties.

You have referred to a new philosophy for managing the economy, including tax cuts and reducing the government share in GDP. But details are lacking. What exactly is your philosophy?

In the economic system we’re living in, where things are no longer compartmentalized, where freedom is the basis for consumer and investor behavior, freedom of choice and freedom of establishment suggest that what may be good for one country for part of its history, things like strong central government and major compulsory deductions, becomes counterproductive once the rules of the economic game change. Two decades ago French investors were under the control of the Finance ministry, with no possibility to turn elsewhere. But today we have a whole financial network whose job is to capture all these savings and invest them where it seems they’ll get the best returns. So we in France have to adjust to the new situation, giving these stakeholders in the economy back a larger share of the wealth they create, of the value they add. This goes against the historical trend in France, which was for the government to say, “You do the producing; we do the distributing.” That vision seems to me to be less conducive to growth than a system with less redistribution and more freedom of individual choice, meaning more wealth left in the hands of each person. That’s our philosophy.

Considering that you have such a large majority and a five-year mandate, why is the reform process going so slowly?

It isn’t merely a question of majority, because we have one, and it isn’t a question of time, because we have enough. The challenge is to explain our program clearly to the French population. Right from the start we laid our cards on the table in terms of changing economic policy, and we said that private enterprise is what drives the economy, not government. We’ve already started putting this idea into practice in a number of areas, including labor regulations, simplifying business start-up procedures and providing tax incentives to those who want to invest in equity.

Is it a safe bet for your administration to make reform of the retirement system a priority?

I don’t know if it’s a safe bet, but we are fully determined to attempt it and successfully carry it through in the next three or four months.

What is the minimum you must achieve for it to be a real success? How far can the government go in reforming the retirement system?

We have to reassure the French, because they’re worried. They sense that the retirement system doesn’t offer the guarantees they were expecting. So our goal is to say to them, “Look, here are the changes you’ll have to accept if you want to be reassured, the changes that will enable us to rebuild the retirement system in an open, straightforward way for the coming 20 or 30 years.”

In France the 60-year mark has symbolic value. So that probably means saying that at age 60 everyone is entitled to retire, but not necessarily with the same benefits as those who retire later. Likewise, we will be increasingly faced with the objective need for people to rediscover the urge to work until age 60. In the past we handled a number of unemployment problems with a statistical sort of approach, which amounts to declaring artificially that such and such a person isn’t jobless because he or she has retired. From an economic standpoint, that doesn’t make much sense.

A few days ago you admitted what private sector economists have been saying -- namely, that the 2.5 percent growth target for this year will not be reached. What would be a more realistic forecast?

Our current forecast for GDP growth is 1.3 percent.

It seems that crossing the 3 percent public deficit threshold entails considerable risk.

Well, if we compare ourselves with our American counterparts, a 3 percent figure isn’t much to worry about, because if you apply the Maastricht criteria to the U.S. deficit, it would be more like 4.5 percent this year. But still, for 2002 our deficit stands at 3.1 percent. In 2003, given the economic downturn generated by world events, the figure will reach 3.4 percent.

But the 3 percent ceiling established in Maastricht doesn’t apply to the Americans.

The treaty states that if your deficit exceeds the 3 percent mark, you’re allotted a time limit to provide information on the corrective action you intend to take to bring the deficit back under 3 percent the next year. So if need be, we will supply this information, because, like the other member countries, we are convinced that the 3 percent rule makes sense. I don’t mean in absolute terms, but in terms of basic guidelines.

Isn’t it kind of stupid to enforce the rule in a mechanistic way?

The rule isn’t being enforced mechanistically. The thinking underpinning it is that if we make a habit of exceeding the 3 percent limit, we Europeans, with our European cultural framework, will eventually find it harder and harder to get back to more reasonable levels and move gradually down to roughly zero percent. So the European Union countries agreed on this mutual rule of conduct, which signifies that if you exceed the 3 percent limit, you have to act promptly to avoid drifting off into uncontrolled behavior. Each member country applies this rule at home, so there’s nothing mechanistic about it. Americans can afford to overshoot various limits, because they know that it’s part of their culture to return to acceptable levels by changing their behavior. In Europe we have “smoother” behavior patterns, so we can’t allow things to go too far.

Is your government determined to respect the Stability Pact this year?

We intend to proceed as we did in 2002, pursuing a policy that takes both the short term and the long term into account. That means that while we accept a number of things in the short run to prevent an economic situation that’s far from rosy anywhere in the world from getting worse, we’re committed to returning to more exemplary policies as soon as the situation

So even budget cuts to stay under the 3 percent limit would be too much in such a climate?

Given the current situation, we should have the intelligence to follow the least dangerous course between a short term that’s difficult for everyone and our medium-term responsibility.

The European Commission is compelled to try to enforce the rules itself, but are the various finance ministers going to act differently?

The Commission is there to remind finance ministers of the rules that the member countries voted for themselves. It’s not there to invent new ones. I don’t criticize the Commission for playing its part. I believe that all Europeans are convinced of the need for intelligent management of this pact, which I call a sustainable growth pact rather than a Stability and Growth Pact. And that means pursuing growth policies that can be sustained, in other words, that don’t lead to the debt-fueled growth of the kind we used to have in Europe.

Is reforming the pact an option?

No. Reformulating the pact would serve no purpose. What matters is to reaffirm that we have an objective -- that together we are pursuing a sustainable growth policy and that we’re not planning to shift our priorities to some vague notion of stability, which in practice means price stability. Besides, maintaining stable prices is no problem now.

The challenge for all of us in Europe is working out a responsible, sustainable growth policy, since the backdrop to all this is the aging of the population. It’s therefore a vital necessity to increase the growth capacity of our economic system, which will soon have fewer active members and more people who depend on their performance than ever before.

Everyone is wondering about the outlook for Banque de France chief Jean-Claude Trichet [who is awaiting a court verdict on charges that he participated in false accounting at Crédit Lyonnais]. Do you expect to see him as the next European Central Bank president?

I’m waiting for the June 18 court ruling, which of course I hope will be in accordance with my convictions, although I’m not the one to judge. The decision will be made on the basis of the verdict. My own objective is for Trichet to be Duisenberg’s successor as was agreed upon years ago.

Will France propose another candidate if Trichet is blocked?

I’m sure it will. But that’s not a question today.

Duty bound When duty calls, Francis Mer doesn’t hesitate. In 1986 the government of thenprime minister Jacques Chirac asked the glass industry executive to run France’s state-owned steel companies, Usinor and Sacilor, which were nearly bankrupt. Mer proved to be just the man. With relentless determination over the next 15 years, he cut costs and capacity and oversaw a restructuring that merged the two companies, slashed payroll by nearly two thirds and privatized the group. Then, seeking global scale, Mer championed a three-way merger with Luxembourg’s Arbed and Spain’s Aceralia Corp. Siderúrgica in 2001 to create Arcelor, the world’s largest steel company.

Now, at an age when most French have long since retired, Mer, 64, has answered the call of duty once more. Chosen by President Chirac to be minister of the Economy, Finance and Industry after last year’s center-right landslide victory, Mer has the tough job of delivering Chirac’s promised tax cuts while containing a budget deficit that already exceeds the European Union limit for countries using the euro. Even more challenging, he must instill private sector efficiency and discipline in France’s bloated state administration without sparking the kind of unrest from public sector unions that brought down the country’s last center-right government in 1997.

Mer is not one to duck a challenge. As the first business executive to serve as France’s Finance minister, he brings a blunt and determined optimism to the task that is as refreshing as it is unusual in French politics. “The challenge is to explain our program clearly to the French population, to the economic agents, to say, ‘This is why things have to change, and here is how we’re going to do it.’ We have five years to accomplish these changes, and we will,” he says in an interview with Institutional Investor (see box, page 50).

Mer has been destined for high places since he obtained an engineering degree from the Ecole Polytechnique in Paris, the grande école that produces the bulk of France’s corporate chieftains. After a few years as a civil servant, he joined Saint-Gobain, a glass and industrial materials company, in 1971. He rose rapidly through the ranks, but in 1986 he lost the contest to become chief executive to the group’s current leader, Jean-Louis Beffa.

Later that year Finance minister Alain Madelin, one of the few French politicians to regard “Anglo-Saxon” as a compliment rather than an epithet, asked Mer to take over Usinor and Sacilor. Crucially, Mer effected sweeping changes not through confrontation but with labor support. When the group shut a big steel plant in Caen in northern France in the early 1990s, Mer searched for other employers to move into the site and gave job-seeking assistance to laid-off workers, an effort that has since become a model for French industry.

“He was willing to negotiate with the unions so that the restructuring took place in the least painful way for the workers,” says Marcel Grignard, head of the mining and metallurgy division of the Confédération Française Démocratique du Travail union. “He’s a man of his word.”

Mer’s reputation as a caring capitalist may be his best weapon as Finance minister. Unions like to portray the government as a tool of Mouvement des Entreprises de France, the big-business lobby. Medef campaigned actively for Chirac and the ruling Union for the Presidential Majority party last year and drew up a list of demands at a spirited rally in Lyon. After a series of executives took the stage to demand urgent reforms to bolster French competitiveness, Mer, a devout Catholic, struck a different note, telling fellow bosses they should worry not just about their profits “but about their employees too.”

An impatient man who can’t tolerate delays, Mer rises before dawn at his home in the Bourg-la-Reine suburb south of Paris to beat the morning rush hour and is in his office by 7:00 a.m. He has little regard for the pomposities of French public office: One of his first moves upon arriving at the ministry was to tell the huissier, the morning-coated attendant that precedes a French minister anywhere, to leave him alone when he went to the toilet.

Mer acted decisively in November when France sold its 10.9 percent stake in Crédit Lyonnais. His team began preparing the sale in September and started discussions with Crédit Agricole aimed at cutting a deal at a minimum of E44 ($43) a share. Agricole stalled, underestimating Mer’s impatience. He ordered aides to announce a snap auction after the market closed on November 22, a Friday. The move stunned bankers; BNP Paribas’s president and COO, Baudouin Prot, called the ministry to make sure the announcement wasn’t a joke. Far from it. BNP trumped Agricole with a bid of E58 a share the next day and won the stake.

Mer’s decisiveness paid double dividends. The premium paid by BNP generated an extra E500 million for the Treasury, and Mer forced the deal he preferred: BNP’s strike prodded Agricole to make an offer of E56 a share for all of Lyonnais. The merger, which was approved by French regulators last month, creates much less overlap and threat of job losses than a BNP acquisition would have.

The Finance minister is showing similar determination to improve corporate governance. The ministry is pushing a financial security bill through Parliament that will prevent accounting firms from providing audit and consulting services to the same company and that will require companies to rotate auditors every five years. Mer regards corporate governance as first and foremost a matter of personal integrity and honesty. He dislikes the detailed, rules-based approach of the Sarbanes-Oxley Act in the U.S. “As I come from business, and so I’m supposed to know a little about how it works, I think rules of behavior are much more important than rules imposing a certain kind of organization on a company,” he says. -- T.B.