BUSINESSWEEK ONLINE : FEBRUARY 5, 2001 ISSUE
INTERNATIONAL -- EUROPEAN COVER STORY Continental Lift (int'l edition) Europe could become the world's most dynamic economy Maurice Levy, the powerful head of Paris-based multinational advertising giant Publicis Groupe, noticed that the news from the U.S. started getting choppy last October. It began with unexpectedly poor housing starts. Then the first earnings warnings from New Economy stalwarts such as Apple Computer Inc. and Intel Corp. started slamming into sky-high stock valuations like guided missiles. And now Levy, who visits his U.S. operations at least once a month, is starting to have a first-hand look at the economic distress. Some clients in the U.S., which accounts for 40% of the group's $8 billion-plus in billings last year, are slashing their ad budgets with a swiftness Levy hasn't seen in years. ''Americans have always had the quality of making rapid but firm decisions,'' says Levy from his ultramodern office on the Champs Elysees. ''But I wonder if the decisions now will not only be firm but brutal.'' With a mixture of awe and concern--not to mention a smidgen of schadenfreude--executives, policymakers, and investors across Europe are watching the unfolding drama of the U.S. economic slowdown and wondering what it will mean for them. For the past five years, America's economy has been the envy of the world. Its unprecedented growth fueled a record runup in U.S. equity markets, commercial real estate, and the value of the dollar. European companies from Vivendi and Deutsche Telekom to Bertelsmann and Danone raced to lay down stakes in the booming U.S. A New Economy was coming into being--and it had ''America'' written all over it. With the collapse in the value of the euro over the last two years, U.S. triumphalism seemed justified. ALTERED VIEWS. Now all of a sudden, the view from the Continent looks different. With the U.S. slowing, Europe looks all the stronger. For the first time since 1991, Europe has a chance to outperform the U.S. Falling oil prices, hefty tax cuts, and rapid job creation are driving up consumer confidence and consumption. Euro boosters are cheering the U.S. woes, saying it exposes the contradictions of the American system--a boom, yes, but one that depended on over-leveraged consumers, stingy public spending, and sweatshop imported goods. But another group of European executives and policymakers take a more sober view of the U.S. slowdown. They know that a recovery in Europe always goes more easily when a prosperous America is hungry for European imports. And European companies now derive billions in profit from their beefed-up U.S. subsidiaries, profit that will diminish in an American recession. ''There'll definitely be a slowdown in revenues coming from the U.S.,'' says Daniel Bouton, chairman and chief executive of Societe Generale, France's No. 2 bank. These realists aren't celebrating America's troubles. Instead, they see the next year as a crucial test for European economic progress. The Continent's companies and governments must prove Europe can grow without brisk demand from their American trading partner and booming profits from their subsidiaries. READY EXCUSE. More important, Europe faces a psychological test. For the last five years, America's performance forced European companies and governments to shed their old ways to compete better. Europe responded to the challenge, not with complete success, but more vigorously than it ever had. Now, with the U.S. humbled and Europe rebounding, the temptation to slack off on reforms and postpone hard moves to improve productivity and investment will be strong. ''Europe's relative strength may cause celebration in Brussels, but it has a sting in the tail,'' says Roger Bootle, managing director of London-based Capital Economics. ''Governments could use it as an excuse to avoid reform, which would be very unfortunate.'' Any such backtracking would be a deep disappointment, since Europe has not been this strong in a generation. Jobs are being created on a scale not seen for more than a decade. The economy is performing well at last, and it's already evident that any slowdown will be far less severe than America's. Most economists predict that the European economy will move up a gear in the second half when tax cuts, worth some 0.8% of gross domestic product, and an expected tumble in energy prices will put more than $500 billion into consumers' pockets. And the recent stock market carnage has not scared European households, since they own fewer shares than their American counterparts. Direct holdings of listed equities and mutual funds total 160% of annual household disposable income in the U.S., compared with some 50% in Europe. Thus the euro zone looks set to be the developed world's most dynamic economy this year and next. With growth of 2.5% to 3% on the cards this year, Europe will probably outperform the U.S. for the first time since 1991. ''The euro-zone economy is holding up well,'' says Jean-Claude Juncker, Prime Minister and Finance Minister of Luxembourg. ''I'm not worried we'll be hurt by the slowdown in the U.S.'' Nor are Europeans feeling cowed by American high tech. Europe now leads the world in mobile telephony, putting it in a strong position to dominate the wireless Internet, which many telcos are betting will revolutionize the Web. European auto makers produce and sell cars more efficiently than their U.S. counterparts. Airbus Industrie has more plane orders on its books than Boeing Co. In finance, Europeans now have the scale, skills, and clout needed to take on the Americans. Deutsche Bank, which acquired Bankers Trust in early 1999, and UBS, which bought Paine Webber last year, are both global institutions. Both now have a serious chance of making it into the top league of investment banking alongside the giants of Wall Street. Just two years ago, Wall Street took neither bank seriously. UBS is sixth in the league table for advising on global merger-and-acquisition transactions. Deutsche is the leading underwriter of euro-denominated securities. Credit Suisse Group, which already owned CSFB and last year bought Donaldson, Lufkin & Jenrette, is a major player in the U.S. The strength doesn't just lie in finance. Analysts at London-based IBES International, which tracks analysts' forecasts, are predicting an 11.3% jump in euro-zone corporate earnings in 2001. That's ahead of the 5% or so likely in the U.S.--which should encourage European investors to repatriate some of the $500 billion of portfolio investments they have made in the U.S. since the beginning of 1999. Meanwhile, national governments are finally trying to improve fundamentals. With the advent of the euro, the nations of Europe can no longer compete by pushing down exchange rates or manipulating monetary policy. Instead, they have to cut taxes and social security contributions. Witness the major tax cuts due in Italy, France, and Germany. The nominal tax burden on retained corporate earnings in Germany was 56% in 1998. This year it will be just 38.6%--below the U.S. level of 40.8%. Not surprisingly, interest in joining the euro is reviving in both Sweden and Britain. BOLDER POLITICIANS? Adding to the feeling of revitalization is the imminent expansion of the European Union to the south and east. Up to seven new members--including Poland, with its 40 million consumers--look set to join by 2005. Just as happened in Spain in the 1990s, the economies of those countries will boom as they converge with core Europe. This is the kind of cycle that, if sustained, can prove virtuous indeed--more growth attracts more investment, more investment fosters yet more growth, and politicians and voters grow bolder about the final stage of reforms the Continent needs to embark on. Economists say Europe is likely to import up to 7% more this year than last. Japanese Finance Minister Kiichi Miyazawa hopes brisk European demand will benefit Asian exporters hurt by the U.S. slowdown. ''This is Europe's year,'' he told a meeting of Asian and European finance ministers in Kobe on Jan. 14. ''We hope it will play the role of locomotive for the world economy.'' All glorious stuff--but what about that big test that Europe must pass? One part is political. Eight of the European Union's 15 member states--including the four biggest--face voters in general elections during the next 18 months. At this stage in the political cycle, governments usually get cold feet about serious reforms. Don't expect, for example, Germany's reformist Chancellor Gerhard Schroder to try and liberalize the country's restrictive labor laws anytime soon. But if he can stay the course on his much-needed but unpopular pension reform, that should be enough to keep the momentum of reform going. ''FEET OF CLAY.'' Another part of the test is how to keep up the pressure on governments to coordinate economic and fiscal policies. The Euro 11 meeting of finance ministers lacks the teeth to set up a real European Finance Ministry to push through Continental measures to cut subsidies and liberalize capital markets further. ''Europe is an economic colossus with political feet of clay,'' says Stanley Crossick, head of the European Policy Center in Brussels. So far, governments have acted prudently enough in gradually reducing the burdens of the welfare state. But if France or Germany decided to backtrack on reform, no institutional force can stop them. Then there's the test the European Central Bank is facing. The fledgling ECB has never had the job of keeping a party going: Its inclination is to jack up rates at the merest whiff of inflation. ''The ECB will be much more hawkish than the Fed,'' points out Schroder Salomon Smith Barney strategist Michael Saunders. The central bank has to learn how to ease interest rates as well as ramp them up. There's plenty more Europe must do to creep out of America's shadow. European companies, for example, probably have to double their spending on information technology to boost productivity to U.S. levels. Labor reforms, budget tightening, further tax cuts--the list of things to do is still dauntingly long. Europe has made huge strides. Now it must stay the course. By David Fairlamb in Frankfurt _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Europe's Big Test (int'l edition) COVER IMAGE: Europe's Big Test CHART: What's Helping Europe CHART: What's Hurting Europe Continental Lift (int'l edition) TABLE: The Honchos Hold Forth INTERACT E-Mail to Business Week Online

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