BusinessWeek: July 6, 1998

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 International Business: EUROPE

LESSONS FROM THE EUROPEAN TIGERS
They're growing so fast it could cause trouble

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LESSONS FROM THE EUROPEAN TIGERS

TABLE: Where the Sizzle Is


When Connie van Kints was laid off last year from Ovis, a Dutch bakery company, it took her only four months to find a new job at the same pay. The 53-year-old grandmother now reconfigures hard-disk drives at United Parcel Service Worldwide Logistics' high-tech warehouse in the small eastern city of Roermond. Opened in 1996, the UPS facility employs 60 people, is hiring four more per month, and will increase its space by one half by yearend. "We're having a hard time finding enough workers," says senior sales executive Theo de Vlieger. No wonder: Unemployment in the Netherlands has fallen to 4%, a 17-year low. Meanwhile, four miles away across the border, German joblessness tops 10%.

Europe's big economies have a lot to learn from its smaller ones. While France and Germany will be lucky to turn in gross domestic product growth between 2.5% and 3% this year, Finland, Ireland, the Netherlands, and Portugal are growing faster--in some cases much faster. It's not dumb luck, either. Eager to qualify for the first round of European monetary union in 1999, Europe's little tigers have done more than just wrestle down their budget deficits and interest rates. They also have tackled politically sensitive, structural economic reforms that most core countries have scarcely started (table).

FLEXIBLE. Now their efforts are bearing fruit. Building on its 10% corporate tax rate for manufacturing and international services, Ireland has attracted dozens of foreign multinationals and nurtured a boom in technology and finance. After a wrenching recession in the early 1990s, Finland boasts a restructured manufacturing sector that is among the world's most competitive, plus a thriving electronics industry, with global cellular star Nokia Corp. at its center. Flexible labor laws and wage restraint have turned the Netherlands into a low-cost exporter. And tiny Portugal, thanks in part to a sweeping privatization program, grew faster than any other Continental European Union country last year, at 3.5%.

As the EU prepares to adopt a common currency, the tigers' strong growth is raising some concerns. When the new European Central Bank begins setting monetary policy for the entire euro zone on Jan. 1, it will look at the zone's average economic strength. That means Europe's fast-growing tigers could get stuck with interest rates too low to keep inflation in check. "There is some danger of overheating," warns Pedro Braz Teixeira, head of fixed-income research at Spanish bank Banco Santander de Negocios Portugal.

For Europe's small economies, the trick will be holding the line on wages and applying taxes judiciously. Ireland's steamy growth rate and the punt's 15.1% drop against sterling over the last year could push inflation above 5% for 1998, from 1.5% in 1997. Yet experts say that with prudence on wages and taxes, Dublin can keep the party going. That will mean offsetting election-year demands for cuts in sky-high income taxes with national wage agreements that keep labor costs competitive.

What may help is that the tigers have made huge progress toward flexible, competitive labor markets. Ireland, Denmark, Finland, and the Netherlands permit overtime, weekend work, and even layoffs to be negotiated between unions and their employers. In core Europe, by contrast, national regulation still governs such issues and keeps costs high. Hourly total compensation in Germany is $31.87, vs. $14.12 in Ireland.

In addition, the smaller economies have seen the benefits of modest pay increases. Explains Dutch Prime Minister Wim Kok: "Workers have said, `O.K., we will abstain from wage increases, but in return we get jobs.' My job has been organizing this trade-off."

STOCKS SOAR. The tigers also have core Europe beat when it comes to supplementing old-line manufacturing with high-growth services. In Finland, cellular technology has spawned not just $10.5 billion Nokia but a host of job-creating startups. Finnish industry has revamped, cutting costs and shedding marginal businesses. In 1997, industrial operating margins averaged 12.6% of revenues, compared with negative numbers in the early '90s.

Portugal, meanwhile, is pushing aggressively into financial services. In the banking sector, growth has been fueled by privatization of all but one state-owned bank over the past few years. Their profitability is impressive. The top three private banks posted returns on equity of 19% to 25% in 1997. And the privatization boom has powered the Portuguese stock market, up 78% in 1997 and 43% year-to-date. For newly private companies, that has meant a pile of fresh capital to grow in emerging markets such as Brazil. "I will pay for my expansion from cash flow," beams Miguel Horta e Costa, vice-chairman of Portugal Telecom, which intends to bid for a chunk of Brazil's Telebras.

As the tigers race ahead of France and Germany, pessimists fear Europe isn't ready for monetary union yet. Brendan M. Walsh, economics professor at University College Dublin, worries that Ireland's boom will raise pressure for income-tax cuts--the last thing a fast-growth country needs. Yet others are sanguine. Robert A. Mundell, economics professor at Columbia University, for one, believes improved productivity in Europe's hot economies will let wages rise faster than prices. "It sounds foolish for the Irish to be complaining," he adds. For the moment, Europe's tigers should probably be boasting instead.

By Joan Warner in New York, with bureau reports

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TABLE

Where the Sizzle Is

FINLAND

Has lowered taxes on all income levels. Underwent massive industrial restructuring that boosted average operating margins in manufacturing to 12.6%. Follows a strict fiscal and monetary policy. Estimated 1998 growth: 4.5%



THE NETHERLANDS

Allows companies to hire temporary and part-time workers. Held wage increases to 0.3% a year from 1990 to 1997. Cut social security taxes from 47.5% to 44%. Estimated 1998 growth: 3.5%



PORTUGAL

Privatized several state-owned banks, Portuguese Telecom, cement and electricity giants, and others. Created private pension funds that are fueling a boom in financial services. Estimated 1998 growth: 4% to 4.5%



IRELAND

Cut corporate taxes to 10% for manufacturers, some services, and software. Has kept a lid on public spending. Estimated 1998 growth: 8.25%



DATA: BUSINESS WEEK

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