European business folks are green with envy. Their U.S. competitors came back to work after the yearend festivities to news that President George W. Bush plans to stimulate the economy with massive tax breaks and increased government spending. All the European bosses found waiting for them were rafts of worse-than-expected economic data and reports that their governments were more inclined to raise taxes than cut them. "Absolutely, we're jealous," says Dieter Rampl, new CEO of HVB Group, the large German bank.
To intensify the feel-bad factor, many European executives spent the first days of the New Year cutting their forecasts. Louis Schweitzer, CEO of French auto maker Renault, for example, says demand for cars in Western Europe could drop as much as 6%. "It's clear that the U.S. is going to grow more than Europe," adds Pierre-Alain de Smedt, Renault's executive vice-president.
Things looked gloomy enough before the Europeans headed off for their long holiday break. In the face of crumbling business confidence and lackluster retail demand, economists had already reduced their 2003 euro zone growth forecasts from an average of almost 2% to less than 1.5%. But over the Christmas season, the outlook suddenly deteriorated. The increasing likelihood of a war in Iraq prompted already cautious Continental consumers to trim spending even further. As if that wasn't enough, the depressed German economy, which accounts for 30% of euro zone gross domestic product, took a turn for the worse. Joachim Fels, co-head of the European economics team at Morgan Stanley (MWD
) in London, expects the zone's $7 trillion economy to contract by 0.1% in the first quarter. He doubts it can grow more than 1% over the year. By contrast, the U.S. could grow by 2.5%.
One of the biggest drags on the European economy is the strength of the once-sickly euro, which has appreciated more than 16% against the dollar over the past year. Admittedly, the currency's strength makes imports cheaper, keeps inflation in check, and allows the European Central Bank to justify interest-rate cuts. But it also makes many euro zone goods more expensive abroad, thus depressing exports. "We are definitely feeling the impact in our daily sales activity," says Frederic Weishaar, vice-president for sales and marketing at Pechiney (PY
), Europe's largest aluminum company. Merrill Lynch & Co. (MER
) analysts, anticipating a further 10% strengthening of the euro this year, have cut estimates of Pechiney's operating earnings by 18.8%, to $470 million.
A strengthening euro also depresses the value of repatriated earnings from foreign subsidiaries. Many companies--for instance, aerospace giant European Aeronautics, Defence & Space Co. and mobile phone goliath Nokia Corp.--hedge their currency exposure. But few are fully hedged. On Jan. 7, the $76 billion-in-sales Dutch grocery chain Royal Ahold (AHO
) announced that currency movements would have a "strong negative impact" on 2002 earnings, which could slump as much as 8%. Sales figures for its U.S. subsidiaries, Giant Food Inc. (AHO
) and Stop & Shop Cos. (AHO
), will drop when converted from dollars into euros.
The recent surge in oil prices is adding to business woes. Most corporate planners in Europe expected the cost of a barrel of oil to average $25 over the coming year. But it had already topped $30 by Jan. 6--a rise of nearly 50% since the beginning of 2002. Rising energy costs have erased any benefit from the 50-basis-point interest-rate cut that the ECB made on Dec. 5, because the extra money consumers and companies spend on oil and gasoline isn't available for other activities.
Meanwhile, the prospect of a Middle East war has frayed shoppers' nerves. European Union surveys show that consumers in the 12 euro countries were more pessimistic in November than at any time since 1997. "The outlook is decidedly unfavorable," says an executive at German retailer Metro.
There is probably worse to come. With unemployment rising, tax receipts falling, and workers threatening to strike, Germany's recently reelected Social Democratic-Green government may have to increase taxes further. Meanwhile, Berlin is making little effort to achieve the structural reforms business says are essential. "The government doesn't seem to have a program," says Riedel.
So how about a nice, fat stimulus plan--a la Bush--in France, Germany, and the Benelux countries? Sorry. The Growth & Stability Pact, which was designed to impose limits on spending and so prop up the euro, now gives policymakers little room to maneuver. Of course, the pact allows member countries to spend more if they've built up budget surpluses. But when was the last time Germany and France had leftover money? "Europe has to address the fact that we've got some of the basics wrong," says Gordon Stewart, a Glasgow-based director of PRTM, a U.S. tech-consulting firm.
The one hope is that the situation is now so dire that politicians, in particular those in Berlin, will embrace real change. "The combination of an economy slipping back into recession again, social security contributions spiraling out of control, and additional tax hikes is a harbinger of economic and political crisis," says Elga Bartsch, an economist at Morgan Stanley in London. "Such a crisis is exactly what Germany needs."
Maybe. But turning crisis into opportunity is not going to happen in the short term. It could be years before euro zone businesses stop envying their U.S. counterparts.
By David Fairlamb in Frankfurt, with Carol Matlack in Paris and Christine Tierney in Detroit
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