* Welfare currently financed by firms and workers
* Current financing considered to harm competitiveness
* PM also flags pension reform for next year
By Leigh Thomas
PARIS, July 10 (Reuters) - France's new Socialist government said on Tuesday it would reform the funding of the generous welfare system, which weighs heavily on companies and wages, to try to increase the competitiveness of Europe's second largest economy.
After two days of talks with unions and employers on everything from wages and working conditions to pensions, Prime Minister Jean-Marc Ayrault also announced the appointment of the former chief executive of aerospace giant EADS Louis Gallois to head a taskforce on improving France's flagging competitiveness.
President Francois Hollande, who took office in May, has pledged to reverse an industrial decline which has seen France bleed 750,000 manufacturing jobs over the past decade. Its exporters have lost market share resulting in a record 70 billion euro trade deficit in 2011.
"We have to rapidly find ways both to guarantee the durability of our welfare protection and improve the competitiveness of our companies," Ayrault said in a speech after the talks.
Ayrault's government is scrapping a reform by its conservative predecessor that would have cut companies' welfare contributions by shifting the cost onto an increase in value-added sales tax, saying the rise would have hurt consumers.
The government will commission a study in September on diversifying the financing sources of the welfare system, Ayrault said.
After the report is submitted in the first quarter of 2013, the government would hold talks with unions and employers to agree on legislation to be introduced in the rest of the year.
His government has signalled that it was open to alternative ways of financing a cut in companies welfare contributions but has not indicated how it might do so.
Advisers to Hollande have suggested he could increase a broad tax that covers everything from wages to corporate tax to capital gains, or increase taxes on polluters.
The Medef employers' association and some unions are also in favour of shifting the cost of the welfare system onto a broader tax base than just companies and workers.
Ayrault said the government would launch talks in the first half of 2013 on overhauling the creaking retirement system. One of Hollande's first moves was to partially roll back a 2010 pension reform, meaning the retirement age will return to 60 from 62 for those who have contributed for 41 years.
The move did little to help Hollande's popularity ratings which have fallen 7 percentage points from last month to 56 percent, according to an Ifop poll for weekly magazine Paris Match released on Tuesday.
Hollande, who beat his predecessor Nicolas Sarkozy in a presidential runoff in May, announced a package of 7.2 billion euros in new taxes on the wealthy and big companies last week to plug a hole in the budget for this year.
Ayrault's announcement came after Bank of France Governor Christian Noyer urged France's leaders on Tuesday to reform the labour, services and product markets to regain lost competitiveness.
France has long resisted such measures favoured by financial markets and risks increasingly standing out in the absence of major reforms such as those under way in Italy and Spain.
The Socialists have also expressed the desire to move toward German-style corporate governance, in which unions negotiate with management to adjust salaries, allowing firms to reduce their wage burden in a downturn instead of laying off workers.
This could effectively circumvent France's 35-hour week and binding collective agreements but allow unions access to strategic and economic decisions via a seat on the board of directors, as is the case in Germany.
A senior union source said that steps in this regard could be announced in the coming weeks.