Growth in the Euro area continues to stagnate as Europe’s “lost decade” progresses slowly. Dan Steinbock discusses where Brussels and the European Central Bank went wrong, why the business environment is likely to remain dire, and what Europe’s leading companies can do to survive what the coming years hold in store.
European leaders like to say that the combined GDP of the European Union is almost $17.4 trillion, some $600 billion more than in the United States. The former translates to over 23 percent and the latter to over 22 percent of the world GDP. Together, the transatlantic economy accounts for almost half of the world economy.
The impression that is conveyed is that Europe’s economic potential exceeds that of the US. But Europe is not the Euro area. There are significant differences between the two in terms of corporate universe.
And it is the Euro area that is about to face the most severe challenges in its postwar history.[ms-protect-content id=”9932″]
Leading Companies, Declining Business Environment
The market value of the world’s leading 500 companies is estimated at more than $30 trillion, as measured by Financial Times 500 (FT500).1 These are the companies that can make or break entire countries. These are also the companies that contribute to the prospects of global growth.
American corporations account for 41% of the FT500. By market value, their share is significantly higher (45%).
European companies account for 27.4% of the FT500. Measured in terms of market value, their importance is a bit lower (26.9%). However, Euro area companies account for only 16.4% of the total. And measured by market value, their share is significantly lower (14%).
In particular, 30 UK corporates play a vital role in the FT500, accounting for a fifth of all EU companies and more than a fourth of their total market value.
Some two decades ago, Japanese challengers were seen in the United States as the corporate godzillas of the 21st century that could easily buy much of America, just as they snapped up Rockefeller Center. And yet, their share has halved to less than 7 percent of the world’s 500 leading companies. In terms of market value, their share is even lower, barely 5 percent.
Only a decade ago, there were hardly any Chinese corporate giants in the top-500 list. Today, there are almost as many as those from Japan, about 6 percent. Measured by market value, the Chinese companies already account for more than 7 percent of the total and thus have left their Japanese counterparts behind.
Altogether, the four groups – the world’s leading US, European, Japanese, and Chinese companies – account for over 80 percent of the number and over 84 percent of the total market value of the world’s leading 500 companies.
Together, the US and the European companies represent two thirds (68%) of the leading 500 companies and, by market value, their share is even higher (72%). But in the long term, the share of these transatlantic companies is already in relative structural decline, which preceded the global financial crisis. In turn, the severe contractions during the crisis and the lingering stagnation in its aftermath are accelerating that decline.
Interestingly, the share of the US companies in the FT500 has been relatively steady.2 While the role of Japanese concerns has been shrinking, those from China have only begun their ascendance. In turn, the glory days of the leading European companies are now behind them, even if they shall continue to play a major role for years to come.
The real challenge is that as the US business environment remains resilient, Japan continues to suffer from its secular stagnation and growth is slowing in emerging nations, Europe is amidst a “lost decade”.
Europe’s “Lost Decade”
When the 2008/9 crisis hit Europe, its core economies relied on their generous social models, but structural challenges were set aside. Instead of working with European businesses to develop competitiveness and innovation across the region, Brussels has relied on failed regional strategies.3
Initially, the crisis in Europe was seen mainly as a liquidity issue and a banking crisis. That’s why Brussels launched its EUR 770 billion “shock and awe” rescue package to stabilise the Euro area. As the consensus view grouped behind Brussels, I argued that the rescue package was inadequate, the austerity policy too strict and that it ignored multiple other crisis points. Consequently, it was likely to generate substantial protest, even violence in Southern Europe and to split the region. That’s what followed as smaller economies – Greece, Portugal, and Ireland – were swept by severe contractions.
In Brussels, the crisis economies were seen as “exceptions” until the Euro area crisis deepened in Spain, Italy, and
Initially, the European Central Bank (ECB), led by its then-chief Jean-Claude Trichet, moved too slowly and hiked rates instead of cutting them. When the ECB finally reversed its approach, precious time and millions of jobs had been lost. Subsequently, Trichet’s successor, Mario Draghi, cut the rates and pledged to defend the
euro “at any cost.”
Markets stabilised, but not without huge bailout packages, which divided the Euro area between fiscally conservative North and economically ailing South, while Central and Eastern Europe were swept by economic and geopolitical challenges.
As the then-EU President José Manuel Barroso and his commissioners began to argue that “the worst was over” in fall 2011, Brussels hoped to reinforce the trust in the euro and the EU to deter the rise of the euro-skeptics. But hollow promises resulted in a reverse outcome.
What’s worse, both Brussels and the core economies failed to provide adequate fiscal adjustment amidst the global crisis and the Euro area debt crisis, which made bad mass unemployment a lot worse and continues to penalise demand. In such circumstances, business has few incentives to invest. Also, neither liquidity support nor recapitalisation of the major banks has mitigated the worst insolvency risks
in the region.
Moreover, many European economies, including the Nordic ones, began to cut their innovation investments, thus making themselves even more vulnerable in the future.
As the crisis spread to Italy and Spain, which together account for almost 30 percent of the Euro area economy, bailout packages could no longer be used. Now structural reforms became vital but since they were seen as a political suicide, delays replaced urgency.
As the ECB chief Mario Draghi has ac-knowledged, persistent disinflation is driving the ECB away from strict austerity policy. Unfortunately, this recognition came half a decade too late. The unemployment rate remains 11.5 percent and prohibitively high in Greece (27%) and Spain (24%).
From Contraction to Stagnation
In Germany, the region’s growth engine, annualised real GDP growth is likely to remain barely 1.3 percent and, even in the best scenario, about the same through the rest of the 2010s.
France lingers in stagnation, despite President François Hollande’s pledge of EUR 30 billion in tax breaks and hopes to cut public spending by EUR 50 billion by 2017. The reform-minded Prime Minister Manuel Valls has intensified reforms, which in April included additional EUR 11 billion in tax cuts for companies and households. He also reshuffled a new, more reform-minded government. Nevertheless, the economy is barely breathing and annualised growth is likely to remain less than 0.4 percent as fiscal austerity and falling consumer confidence are preventing domestic demand from rebounding.
In the last elections, Socialists lost their control of France’s upper house Senate to the conservative UMP party, while the radical right established a foothold in the Senate as well. At the same time, investment and jobs languish in the private sector. Pierre Gattaz, head of the largest employers union, has called the economic situation “catastrophic”.
As Paris has all but scrapped the target to shrink its deficit and seeks to soften Euro area budget rules, it is supported by Italy, where economic conditions remain grim. To sustain his bold economic reforms, Prime Minister Matteo Renzi needs a whopping EUR 32 billion to overhaul the labor market, EUR 18 billion for unemployment benefits and EUR 13 billion for infrastructure projects. Nevertheless, Italy’s economy will suffer a mild contraction in 2014 and, even in the most benign scenario, can achieve 0.5 percent growth in 2015. Through the rest of the decade, it hopes to generate 1 percent growth.
In both Italy and France, fiscal adjustment is strangling domestic demand, while exports suffer from deindustrialisation, erosion of competitiveness and the strong euro.
Ever since spring 2010, the reforms and the austerity doctrine in the Euro area have aimed to overcome the rising debt burden. How has deleveraging succeeded? Well, it has not.
General government gross debt as percentage of the Euro area GDP soared from 70 percent to 93 percent in 2013. In Italy, the ratio has increased by a third to 133 percent. In Spain, it more than doubled to 94 percent; in France, by a fourth to 94 percent. In small crisis economies, the debt – Greece (175%), Portugal (129%) – remains at elevated threat levels.
If Athens were to hold early elections, the winner would be neither conservative New Democracy nor the socialist PASOK party, but the radical left’s SYRIZA. And if Rome were swept by a structural crisis, it would cast a long, dark shadow – possibly a fatal one – over the rest of the Euro area.
The Way Out
In view of the dire business landscape, even the largest European corporations suffer from multiple strategic challenges. They do not enjoy the imperial advantages that supported the British multinationals in the pre-1914 era. Nor are they any longer amidst industrialisation, which insulated European multinationals in the challenging interwar era. The years of falling barriers in world trade, which promoted the rise of US multinationals and the resurgence of European corporates in the postwar era, are history.
Similarly, the era of globalisation, which once paced the ascendance of Japanese multinationals and more recently has boosted the rise of the emerging-country multinationals, has been fading to history ever since the crisis of 2008/9 as well.
At the same time, the euro, which many European industrialists advocated so passionately in the past, has become a heavy burden in the Euro area and a massive deterrent against devaluations that could have restored competitiveness in most of the area after the sovereign debt crisis of 2010.
Ironically, the very arrangements of the monetary union, which were initially designed to unleash the dynamic potential of the old continent, have frozen change in the Euro area. Even though the region remains significantly – some 20-25 percent – behind the US in productivity growth, the euro was $1.45 in fall 2008 and $1.38 in April; almost 40 percent higher than the US dollar. Today, the rate is less than $1.25 but the trend line is clear, finally – thanks to the ECB’s quantitative easing.
In 2014, the Euro area’s growth is expected to remain around 0.7 percent but the recovery is fragile and downside risks remain elevated. Ageing Europe is breathing heavily before stumbling up – or falling further down.
If, in these conditions, the West will take the Russia sanctions to still another level, the consequences could prove particularly severe in the key economies. In Europe, it could push the region into a triple-dip recession – and the weakest euro countries into the abyss.
The only way Europe’s leading companies can overcome stagnation in their business environment is to participate in the growth of the emerging economies, but far more substantially than today. That’s the sole viable way European companies can drive global integration and coordination and thus benefit from the economies of scale and scope, as well as factor costs and free trade.
To sustain their edge in worldwide innovation, European multinationals must work far more closely with their own home governments and Brussels to ensure that structural reforms will materialise across Europe.4
In local responsiveness, European multinationals have always had something of an edge, due to Europe’s fragmentation. But sustaining that advantage requires greater cost advantages, which are not viable without significant investments in the emerging world. It won’t be easy, but the alternatives are worse.
About the Author
Dr. Dan Steinbock is an internationally recognised expert of the nascent multipolar world. In addition to advisory activities (DifferenceGroup), he is Research Director of International Business at India, China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore). He was born in Europe, resides in the US and spends much of his time in China and Asia. For more, see www.differencegroup.net
1. Financial Times 500 is based on data from Thomson ONE Banker, Thomson Reuters Datastream and individual companies.
2. In the long term, even US innovation and entrepreneurship must cope with increasing challenges. See Dan Steinbock (2014) The New Landscape of U.S. Innovation and Entrepreneurship (TEKES, the Finnish Funding Agency for Innovation, Helsinki) [Forthcoming]; and the author’’s (2014) The Erosion of U.S. National System of Innovation. (Information Technology & Innovation Foundation, Washington DC) [Forthcoming].
3. See Dan Steinbock (2014). Multipolar Innovation – and Europe. The European Business Review, July-August.