June 10, 2002

Europessimism

The Washington Post's Steven Pearlstein reveals himself to be a Europessimist: Europe's structural rigidities coupled with the approaching demographic crisis of the social insurance state give it a bleak future--unless it can reform itself.

I still don't know what I think of this argument. The contrast between the United Kingdom today and over the past decade and the major states of continental Europe lends force to the claim that continental Europe must reform or stagnate. However, the contrast between Scandinavia (including Ireland) and the major states of continental Europe seems to me to teach different lessons. I wish I knew what those different lessons were...


washingtonpost.com: Golden Moment Eluding Europe

Golden Moment Eluding Europe: Resistance to Reform Stymies Bid To Become Economic Rival of U.S.
By Steven Pearlstein
Washington Post Staff Writer
Tuesday, June 4, 2002;
Page E01

In Italy, an economist working on a government proposal to allow companies to lay off employees in select instances was gunned down in front of his home in Bologna. When the government announced it would move ahead with its plan anyway, unions in April shut down the country in the first day-long general strike in 20 years.

washingtonpost.com

Golden Moment Eluding Europe
Resistance to Reform Stymies Bid To Become Economic Rival of U.S.

By Steven Pearlstein
Washington Post Staff Writer
Tuesday, June 4, 2002; Page E01

In Italy, an economist working on a government proposal to allow companies to lay off employees in select instances was gunned down in front of his home in Bologna. When the government announced it would move ahead with its plan anyway, unions in April shut down the country in the first day-long general strike in 20 years.

In France, the flow of investment capital out of the country in recent years has been three times the flow of capital into it.

In Switzerland, headquarters for much of the world's pharmaceutical industry, the giant drugmaker Novartis AG announced this month that it was moving its research headquarters to Cambridge, Mass., to reap higher profits and take advantage of less restrictive regulations and an environment that nurtures risk taking and entrepreneurship.

And in Germany, the number of unemployed workers has remained stuck at more than 4 million, half of whom aren't even looking for jobs, according to a recently leaked government report.

This was supposed to have been Europe's golden moment -- a time when economic union, privatization and deregulation would revitalize the European economy and make it a genuine rival to the United States. But it hasn't turned out that way.

Outside of Britain, European companies and unions have been slow to embrace the kind of free-market flexibility apparently required to be successful in the kind of fast-changing industries that generate most of the new jobs and economic growth.

European government officials have been reluctant to take the political risks necessary to reform rigid labor laws that discourage job growth by making it difficult and expensive to fire workers in response to changing business conditions.

Control of all but the biggest corporations remains largely in the hands of company managers, unions, large banks and an elite group of interlocking directors that remains proudly unresponsive to the demands of shareholders and financial markets.

And in the largest economies on the continent -- Germany, France and Italy -- the public remains reluctant to embrace a form of "shareholder capitalism" that it associates with American cultural domination, widening inequality and a kind of cutthroat competition incompatible with the European lifestyle.

As a result, despite a workforce that is highly productive when it works, the euro zone remains a high-cost, low-growth economy that not only is losing ground to the United States but also is increasingly unable to finance the social programs it cherishes.

"We wanted the 1990s to be the European decade," said Juergen Kluge, partner in charge of the German office of McKinsey & Co., a leading management consultancy. "It seemed possible. Now it looks like we missed the chance because our structural reforms didn't progress that fast."

Not that there hasn't been change.

In Britain, which so far has resisted adopting the euro, the regulatory environment, business norms and power of the financial markets have become so indistinguishable from those in the United States that critics now refer to it as the "Anglo-American" style of capitalism. Britain posts some of the highest growth rates in Europe, and London has emerged as the leading financial center in Europe.

In France, the recent Socialist government managed to privatize more nationalized companies in the past seven years than all six of its predecessor governments combined, including defense electronics firm Thomson CSF, Air France, France Telecom SA and banking giant Credit Lyonnais. Capital gains taxes were lowered on stock options and investments in new high-tech firms, spurring development of a second, Nasdaq-like stock market and a new mutual fund industry. And just this year, the country's constitutional court struck down a law that would have prevented French companies from laying off workers unless they were unprofitable, declaring for the first time a right to entrepreneurship.

In Germany, the top tax rate for wealthy individuals and corporations was reduced to American-like levels (38.5 percent). And the first steps were taken to break the cozy relationship between German banks and corporations when the government recently decided to allow the banks to avoid capital gains taxes when selling their minority stakes. Meanwhile, increasing numbers of German companies have opted out of industry-wide collective-bargaining agreements that have blocked the emergence of a low-wage sector that could employ many of the country's unemployed workers.

The vanguard for this new European economy is made up of the large multinational corporations that have developed out of what had been the "national champions" of an earlier era -- companies such as airplane maker Airbus; Axa in insurance; automakers Volkswagen AG and DaimlerChrysler AG; telecommunications-equipment makers Nokia, LM Ericsson and Alcatel SA; Deutsche Bank AG and Credit Suisse Group; oil industry giants such as Total Fina, Schlumberger Ltd. and Royal Dutch/Shell Group; and Lafarge SA, the world's leading maker of cement and building supplies.

To do business on a global scale and tap into global financial markets, these European-based multinationals are now managed and operate largely according to Anglo-American norms. They report their results quarterly, use stock options to motivate top managers, take an aggressive stance on mergers and acquisitions, and, when necessary, sell off less profitable divisions and even lay off workers. In the executive suite, English is often the common language. And while they respect the European tradition of managing for the benefit of all stakeholders -- employees, shareholders and the public at large -- their executives now make it clear that the highest priority must be increasing shareholder value over the long term.

Back home, these global companies have provided the political impetus behind economic liberalization. But at the same time, their determination to achieve global scale, faster growth and a higher return on capital has led most to invest much of their money outside of Europe, with a particular focus on North America. The recent wave of transatlantic mega-mergers reflects both the global ambitions of these companies and their frustration with the slow pace of reform back home.

"Some companies have adopted the U.S. style and expanded aggressively around the world, but they still question whether they can do it in Europe," said Dieter Heuskel, managing partner of the Boston Consulting Group Inc. office in Germany.

Denis Kessler, who heads an association of large French corporations, notes that between 1997 and 2000 the 33 largest French companies created a mere 45,000 jobs in France while adding 1.2 million outside the country's borders.

Equally significant, American and even British firms that are not already established on the continent have been surprisingly reluctant to make direct investments there -- and even many of those that are there have cut back or directed their attentions to the emerging economies of Eastern Europe. McKinsey's Kluge estimates that the return on capital in Europe runs between 50 percent and 65 percent of the U.S. rate.

"I very definitely have seen a slowdown in direct investment in Europe over the last few years because, very frankly, the returns were better elsewhere and companies got frightened by the restrictions," said Felix Rohatyn, an investment banker and former U.S. ambassador to France.

Kevin Ryan, chief executive of DoubleClick Inc., a New York-based software maker, is a self-described Europhile. He has spent half his life in Europe, his wife is French, and he is quite bullish on Europe's economic prospects.

But while Ryan sells plenty of software on the continent, he doesn't make any there. It is certainly expensive and cumbersome enough to do business in Europe "that, at the margin, we'd place someone somewhere else," he explained. He estimates the cost of employing a software engineer is 20 percent higher in Europe than in the United States.

Yet others who have done business in Europe say the problems and costs, while frustrating, are hardly insurmountable if you know how to maneuver through the system, or hire someone who does. And while the process is certainly slower, more time-consuming and more costly, they report, the consensus is that eventually it produces change that is often more durable than the rapid top-down restructurings common in the United States.

"We find that there are very good opportunities to earn good returns -- but we can't do it ourselves," said Glenn Youngkin, who heads the European buyout operations of Washington's Carlyle Group, with $3 billion to invest. "With the right management team, you can execute as aggressive a program of restructuring and change as you do in the U.S."

Often cited is the example of France's new law reducing the standard workweek to 35 hours, with no reduction in pay. Like most French executives, Lafarge chief Bertrand L. Collomb opposed it and warned it would hobble the country's economy. But in the end the company was able to use the negotiations precipitated by the change to win greater flexibility on work rules that offset the negative impact of the law. Now, instead of calculating overtime on a weekly basis, Lafarge calculates it on the basis of hours worked over a month or year, allowing more efficient scheduling of shifts and dramatically reducing overtime.

"Good companies can achieve the desired results in a different way," said Collomb. "Our values and priorities and lifestyles are not the same, and we have to adjust to that."

But even within the business community, there remains strong resistance to Anglo-American ways, particularly from small and mid-size companies that are content with slow growth and reliable profits and benefit from the restraint on competition that results from Europe's maze of regulations.

"There is a strange split in the business community here," said Norbert Walter, chief economist at Germany's Deutsche Bank. "The medium companies resent the fact that the global companies are always squeezing them. The fact is they like things the way they are and are very resistant to change."

Defenders of the European way of doing business argue that it not only produces a better quality of life but is particularly well suited to important European industries.

Consider the key elements of Germany's traditional industrial model. Companies invest heavily in worker training in exchange for a virtual guarantee of a job for life. Wages are set in industry-wide union bargaining. Management decisions are made by worker-management councils. Financing is provided largely by banks that also own stock in the companies and hold seats on the boards of directors.

According to Bob Hancke, a Belgium-born lecturer in political economy at the London School of Economics, this institutional arrangement has proved particularly effective for sustaining German leadership in mature and slow-changing industries that require lots of patient capital and skilled workers -- steel, autos and precision engineering. And while it may not be beneficial in fast-changing, high-tech industries, Hancke believes such a diversity of systems is crucial to a globalized economy in which companies increasingly are specializing in what they do best.

"The idea that economic institutions must converge at some American model is ridiculous," Hancke said. "It is neither inevitable nor desirable."

Not surprisingly, Americans tend to be skeptical of this notion of comparative institutional advantage.

"If that were true, why is it that Daimler is so keen on having its stock listed on the New York Stock Exchange and building Mercedeses in Alabama and Mississippi?" asked Adam Posen, a researcher at the Institute for International Economics in Washington. "And if it works so well, why are the most ambitious and talented Germans deciding to opt out of the old system and choosing to go abroad or go to universities instead? The fact is these countries are largely succeeding in spite of their institutional arrangements, not because of them."

Whether or not there is merit to Posen's harsh critique, one thing is clear: The mature, stable industries that Europe excels in aren't creating many new jobs or providing the kind of returns that can attract global capital -- nor are they likely to in the future. Rather, much of the growth around the world is being generated in other faster-moving sectors that rely on flexibility, innovation and speed in getting to market -- or providing low-cost consumer goods and services. Europe's institutional structures have proven to be unsuited to those sectors.

A study by the Organization for Economic Cooperation and Development, for example, found that two-thirds of the per capita income gap between the United States and Europe can be explained by the fact that a smaller proportion of Europeans work -- 75 percent compared with 66 percent -- and even those who do put in 20 percent fewer hours per year on average. According to economists, this reflects a self-reinforcing web of European regulations, taxes and social norms that prevent creation of lower-wage, lower-skilled jobs while discouraging women with children from joining the workforce.

"There are real economic consequences that flow from the fact that in Germany you can't get a nanny, you can't get affordable household help and you can't shop at nights or on weekends because all the stores are closed," Posen said.

European political leaders long ago acknowledged these problems and vowed in a general way to push toward "liberalization." But most of the reforms so far have been accomplished quietly, disguised or limited to new companies and industries where there are no entrenched interests to protect.

This "liberalization by stealth," as Brookings Institution economist Philip Gordon calls it, has been developed into an art form in France, where, like marital infidelity, economic reform is widely practiced but rarely acknowledged in public.

Gordon notes that when then-Prime Minister Lionel Jospin wanted to sell off shares of Air France, for example, he described it not as privatization but "opening up" the airline to capital. And while rigid rules on wages and job security remain, loopholes for contract workers have led to explosive growth for Manpower and other temporary help agencies.

So conflicted is the French political establishment on these issues that neither the Socialist Jospin nor the more conservative incumbent candidate, Jacques Chirac, dared to raise them during this year's presidential campaign.

"It remains taboo to sing too loudly the praises of liberalization or globalization," writes Gordon in a new book, "The French Challenge." Gordon notes that more recently, French leaders have begun to play a new political game in which they quietly encourage the European Commission to adopt new liberalizing rules even as they denounce the directives from Brussels in public.

While public employees and labor unions in Europe have agitated loudly against the globalization and Americanization of their economies, however, polls show the public as a whole is more ambivalent.

"The public knows that reform is necessary, that pension levels and job security are not sustainable, but nobody wants to deal with it now," explained Nicholas Veron, a former aide to France's labor minister. "We are a whole society where people don't like to face problems. Its a deep psychological habit."

Lafarge's Collomb agrees.

"If you are going to succeed, I believe you have to be straight with people and explain it," Collomb said. "The rank and file want more things to happen than the politicians think. That's why I'm still optimistic about the European economy."

Posted by DeLong at June 10, 2002 01:52 PM

Comments
Post a comment