UPDATE 3-France readies response to "shock" industry review

* Competitiveness review recommends slashing labour costs

* Socialist government promises ``strong'' action but no shocks

* Business heads say measures must happen now, not next year

PARIS, Nov 5 (Reuters) - French industrialist Louis Gallois called for a patriotic effort to reverse declining competitiveness via shock therapy as he handed in a review on Monday which the Socialist government commissioned and is now under pressure to heed.

Gallois is prescribing slashing 30 billion euros ($38.54 billion) off payroll taxes and loosening labour laws to reverse a long decline in industrial competitiveness that has eaten away at exports and bled factory jobs.

The widely leaked recommendations have set frustrated industry heads against a government reluctant to shift part of the tax burden from employers to households which are already struggling with rampant unemployment and an austerity budget.

Gallois said the 22 recommendations set out in a review to be detailed to media later in the day were tough but necessary.

``The French people need to support this collective effort which could be a magnificent project for our country -- winning back our industry,'' he told reporters as he left the prime minister's office. ``This will require real patriotism.''

President Francois Hollande said ``strong decisions'' would be taken based on the report, despite having lowered expectations for radical reforms by ruling out any ``shock'' measures.

The weekly Le Point reported, without citing its sources, that government plans, as a compromise, to offer temporary tax credits from next year to companies keeping jobs in France that would eventually add up to 20 billion euros.

It would balance that with public spending cuts and a tiny rise in value-added tax to 20 percent from 19.6 percent.

The prime minister's office declined to comment.

Industry leaders, who say shouldering some of the highest labour charges in the world puts them at a disadvantage against foreign rivals and is the cause of a ballooning trade deficit, have joined forces recently to demand a radical shake-up.

Gallois suggests slicing 20 billion euros off employers' social contributions and 10 billion off those paid by workers, and compensating with spending cuts and higher consumer taxes.

Hollande's aides have thus far said raising taxes on households is out of the question as the country grapples with its toughest austerity budget in years to meet deficit goals.

``This report is a contribution. It's the government that governs,'' cautioned Social Economy Minister Benoit Hamon.

Hemmed in by his pledge to cut the 2013 deficit to 3 percent of economic output from 4.5 percent this year, Hollande has limited his language to promising a ``competitiveness pact''.

``A shock causes trauma whereas a pact reassures,'' Finance Minister Pierre Moscovici explained last week.

The government has said its response to the report, due on Tuesday, would focus on measures that do not affect labour costs, like investment in innovation and training, although small business minister Fleur Pellerin said on Sunday some sectors could see labour charges trimmed.

``We cannot simultaneously restore public finances and impose a competitiveness shock - a massive and immediate transfer of employer payroll taxes onto taxes,'' said a government source.


Finding a solution to the lag in competitiveness that has left France trailing Germany in industrial exports, putting a strain on the economic balance between the euro zone's central economies, is Hollande's biggest challenge.

With French growth stalled for three quarters and jobless claims at a 13-year high, Gallois recommends compensating for lower payroll taxes by raising VAT and increasing a social levy paid on pensions, investments and rent income as well as wages.

Leery of angering an already disgruntled public, Hollande has already scrapped a VAT hike his predecessor Nicolas Sarkozy proposed for the same reason.

Michel Didier, head of the Coe-Rexecode think-tank, said industry was on a ``slippery slope'' that could only be remedied by reducing labour costs. Business leaders also weighed in.

``I do not want us to wait until the end of 2013 to take these measures which are essential for business morale and for workers. We need a shock, we need to see a real strategy that is going to benefit companies,'' said Jean-Francois Roubaud, head of the CGPME small and medium-sized business confederation.

Moscovici has argued that shifting more of the tax burden onto households too fast risks choking domestic consumption, a key growth motor. He rebuffed a call by the AFEP business association to raise VAT to 21 percent to enable lower labour costs and said the focus would be on innovation.

Where booming Germany clocked a 2011 trade surplus of 158 billion euros, France saw a record 70 billion euro deficit as its share of euro zone exports has slid to 13 percent from 17 percent a decade ago and its global market share also shrank.

German unemployment is at 6.9 percent versus 10.2 percent in France, which has lost 750,000 industrial jobs in a decade.

French manufacturing margins have slid as Germany's have soared, impacting spending on new technologies and innovation.

Meanwhile, impatience at what many see as a plodding approach to fixing the economy has knocked Hollande's approval ratings to as low as 36 percent from over 60 percent when he took over from the conservative Sarkozy in May.

Grappling with new layoffs in the steel and auto industry, Hollande is working with unions to find ways to increase flexibility in a labour system that makes it hard for firms to hire and fire quickly to adjust to changing business cycles.

He is not expected to tackle the issue of payroll charges before a review on welfare financing in January.

Many economists fear the report by Gallois, ex-chief of aerospace group EADS, could end up stuck on a shelf alongside a similar review ordered by Sarkozy when he took office in 2008. That report, by economist Jacques Attali, also called for an overhaul of labour laws and cuts to labour costs.

``The worst would be for this to end up in our cemetery of buried reports,'' Le Figaro daily said of the Gallois review.