Cover Story -- The New Economy
Europe: Work in Progress (int'l edition)
Signs abound of a nascent New Economy
Barcelona boasts a new generation of fast-growing technology startups. Helsinki is the world's cutting-edge market for wireless Internet banking. Ireland ranks second only to the U.S. in global software exports. Munich has become a hotbed of venture-capital investing, with some $10 billion of funds under management.
Surprising signs of economic vitality are popping up around Europe, long known for sluggish growth, restrictive labor practices, and unwieldy government budgets. After stagnating for years, growth in the 11-nation euro zone is expected to top 3% this year. Unemployment, the Continent's chief social scourge, has finally dropped below 10%. Private-sector job creation in France, the euro zone's second-largest economy, is at its best point in 30 years. And companies from Helsinki to Lisbon are spending a fortune on new information technology.
No wonder that across the Continent a debate is raging: Could the Old World actually be developing a U.S.-style New Economy? Is Europe headed for an extended period of higher, noninflationary growth, fueled by rising productivity and heavy technology spending? Economists, businesspeople, and politicians are divided. "There's no doubt that a New Economy is developing" in the euro zone, declares Thomas Mayer, chief economist at Goldman, Sachs & Co. in Frankfurt. He cites the rapid growth of knowledge-based businesses and sweeping deregulation of markets such as telecoms as clear indicators. "This should raise the productivity of capital and labor as it did in the U.S.," he adds.
Other seasoned economists are skeptical. They figure that the current upswing is largely a cyclical phenomenon, driven primarily by the recent relaxation of tight fiscal policies in most euro-zone countries and the export-enhancing weakness of the euro. "It's just what you'd expect after all those years of sustained deflation when Europe was preparing to introduce the single currency," says Charles Dumas, research director for Lombard Street Associates in London. Still others claim that Europe's markets are too fragmented, its labor markets too inflexible, and its regulations too restrictive to allow surging growth without inflation.SAME MISTAKE? So far, neither the statistics of the European Union nor individual countries confirm that Europe is benefiting from the same technology-driven productivity gains that spurred such growth in the U.S. The latest European Union-wide data show that the growth rate of labor productivity per hour stagnated for the past four years. In 1999, labor productivity rose an estimated 1.9% in the 11 countries that make up the euro zone, down from a 2% increase in 1995.
Yet, it just may be that beneath the surface--beyond the reach of the statisticians--a New Economy is gradually taking shape in the Old World. "We think something is going on, but we can't yet see it from the data," ventures Graham Vickery, a specialist in e-commerce at the Organization for Economic Cooperation & Development in Paris. Indeed, he and other experts believe that government statisticians may give insufficient weight to information-technology--just as their U.S. counterparts did until recently.
Moreover, anecdotal evidence from manufacturers and service companies alike suggests that productivity is increasing faster than the official figures show. "Companies are finding their own way to the New Economy. It's happening despite the rigidities," says David Cotterill, chief strategist for Europe at Cambridge Technology Partners.ISSUANCE IS SURGING. Certainly, Europe enjoys some of the key elements necessary to start a New Economy. Until recently, the Continent's capital market was small and fragmented. But the introduction of the euro has fused it into a single, dynamic whole. It's now far easier for companies to bypass traditionally cautious commercial bankers and go straight to investors. "Europe lacked a financial sector to invest in new technology and lure capital away from old industries into new ones," says Luc L. Soete, head of the Maastricht Economic Research Institute on Innovation & Technology.
Now it has one. Frankfurt's Neuer Markt and other European stock exchanges that specialize in fast-growing stocks are bringing record numbers of companies to market. Altogether, companies in the euro zone raised $222 billion by issuing new equities and bonds last year, 10 times more than in 1995. Initial public offerings totaled $55 billion last year, three times more than in 1998.
Venture capital is surging, too. Atlas Venture, Amadeus Capital Partners, and other firms poured an estimated $5 billion into 400 Internet startups last year--volumes unthinkable a year or two ago. The amount of venture capital raised in Europe in 1999 topped $20 billion.
Almost as important, the arrival of the single currency has sparked a big wave of merger, acquisition, and restructuring activity. That in turn has sharpened the Continent's once dull appetite for creative destruction. U.S. financial institutions are playing their part: They now own large stakes in many European companies and are pressuring CEOs to maximize shareholder value.
Still another sign of a New Economy in the making is the surge in technology spending. European companies shelled out $200 billion on new information technology in 1999 and are expected to spend up to 30% more this year. Productivity gains from those investments might add up to half a percentage point to the annual growth of the EU economy by 2003, estimate economists at Salomon Smith Barney.
Examples abound of productivity driven by info tech. French auto-parts supplier Valeo plowed $300 million, or 3.5% of sales, into productivity-gaining improvements last year and is moving rapidly to put supplier bidding on the Net. That kind of spending is a must for CEO Noel Goutard, who has to shave up to 10% off parts prices annually to hold on to hard-nosed customers such as General Motors Corp. and Ford Motor Co.
The productivity gains may be filtering through to the service sector, where they are notoriously difficult to measure. MeritaNordbanken, the cross-border Nordic commercial bank, and Deutsche Lufthansa, the German airline, say that recent information-technology investments are clearly improving revenues per employee, a sign that productivity is increasing. A full 62% of the equity trading done by MeritaNordbanken customers is now over the Internet. Analysts calculate that the productivity of the bank's stock-broking business is rising by a hefty 5% a year. And Lufthansa notes that the growing use of Internet bookings has boosted its labor productivity by 4% over the past year.
Meanwhile, after years of lagging behind, Europe seems to be developing its own job-creating tech sector. Technology companies and industries are springing up in surprising places (map, page 36). Oulu, Finland, enjoys economic growth of 9% a year, thanks to mobile startups and plants operated by cell-phone giant Nokia, now Europe's most valuable company. In Catalonia, where high-tech companies employ 51,000 workers, unemployment is 6.5%--less than half of Spain's 15.4% jobless rate. Lured by skilled graduates from nine local universities, Hewlett-Packard Co. and Nokia have set up research and development centers near Barcelona.
Europe's smaller countries have been the most successful in creating high-growth economies. GDP in Finland and Holland is expected to grow more than 3.5% this year. Ireland's economy surged more than 9% last year. Each of these countries is creating jobs in record numbers, partly because they have led the way in structural economic reforms.LABOR CONCESSIONS. For Europe's New Economy to get going, though, the bigger countries need to get into the act. France and Germany are still beset by sky-high labor costs, even while many still want government solutions to joblessness that hurt the market: In Germany, employers, unions, and the government are talking about lowering the retirement age from 65 to 60. In both countries, welfare systems burden companies with high social-security levies.
But while Europe's left-dominated governments still spout socialist rhetoric, behind the scenes, Germany and France are fast becoming more business-friendly. "Far from stifling the New Economy, some of the recently, seemingly antibusiness legislation is actually helping to nurture it," says A. Steven Englander, an economist at Salomon in London. Although France has just introduced a 35-hour workweek, companies have been able to wrest greater flexibility from unions as a condition of applying shorter working time.
Tax regimes are also getting less repressive. Having spent nearly a decade squeezing budget deficits in readiness for the single currency's introduction, euro-zone public finances are in pretty good shape. That means governments can afford to cut taxes. In France, almost $7 billion will be lopped off companies' tax bills this year--the equivalent of 0.5% of GDP. In Germany, the corporation tax will be slashed from 40% at present to 25% in January, 2001. These steps will boost the capital available for investment. Coupled with the adoption of the Net, the tax cuts have raised the rate at which growth in Europe typically becomes inflationary by 0.5% or 0.75%, to nearly 3%, calculates Salomon's Englander.
The potential bottlenecks are still there, of course. Europe's governments and labor unions may balk at making the economy more flexible. Much, too, will depend on how the European Central Bank reacts to rising growth. The worry is that the ECB, traditional in its outlook, could choke economic activity by pushing rates up at the first sign that inflation is heading toward 2%. Inflation in the euro zone touched 1.8% last month.
Whether in the corridors of the ECB or Europe Inc., the New Economy is likely to remain a subject for hot debate. Still, Christian Saint-Etienne, a Paris-based consultant and longtime skeptic about the chances of real structural reform in Europe, is turning more hopeful. Saint-Etienne says Europe has a good chance of catching up with the U.S. if the economy grows 3% a year for two or three years. "The crucial question is not whether the New Economy is taking hold in Europe. It is whether growth can be strong enough to [trigger] the kind of investment boom that the U.S. experienced," he says. If that investment boom materializes, Saint-Etienne figures, the New Economy will expand rapidly to supplant the Old. Europe may yet have its new age of prosperity.By David Fairlamb in Frankfurt and Gail Edmondson in Barcelona, with Bureau ReportsReturn to top