All the promising signs that EU economy shows are just fluff with very little stuff inside. The fundamental problems which are the root cause for EU’s decline, while the rest of the world (excepting that perennial underachiever Africa) seem to be speeding ahead, remain unsolved. Worse, there is no light visible at the end of this tunnel. Of course with ECB bent upon raising rates, it is almost a shoo in that the growth rate will slow down.

The recent article in Economist (sub required), raises this cautionary flag.

There are three short-term reasons to expect slightly choppier waters in the euro zone. The easiest one to exaggerate is the slowdown in America, where growth tumbled to (an annualized) 2.5% in the second quarter and where consumers will surely be less willing to snap up German plastics and French perfumes. In fact, the euro area’s growth increasingly seems to be being pushed along by its own consumers’ spending rather than exports. The zone as a whole depends on exports much less than its individual countries do: the 43% of Germany’s exports going to other members of the club count as domestic demand at the level of the euro area. And America is less important as an export market for the zone than you might expect. Britain counts for more; so, combined, do other European Union countries. And when it comes to recent additions to exports—which is what really matters for growth—China is buying an ever bigger share. On the other hand, a slowing America is plainly no help to Europe’s exporters.

The second reason to expect a slowdown is that some euro-area countries, notably Germany and Italy, are due to tighten their budgets. That their public finances need repairing is not disputable; the timing and style of the repairs is, especially in Germany. Just when German consumers seem to have recovered their confidence, after years of low wage-growth and worries about jobs and pensions, the government wants to raise value-added tax by three percentage points next January. Paradoxically, this may boost growth in the second half of this year, as spending is brought forward to beat the tax increase. But it will surely hold the economy down at the start of 2007.

Third, the European Central Bank (ECB) is providing less of a following wind than it did. It started raising interest rates last December and is expected to keep doing so at least until the end of this year. So far, there is little sign that these rate increases are holding the euro zone back, but eventually they will have an effect. And the second-quarter spurt makes further rises in interest rates more likely.

The key structural issues of unemployment, labor laws, healthcare remain unsolved. The key social problems of low enterprise formation, stigma of failure, stigma of success remain unresolved. Unless some deep and committed reform happens in these areas, I fear EU will continue to become marginal.

tags: EU+Economies

1. Fear of failure
2. Fear of success
3. Risk aversion
4. The mirage of the single market
5. The VCs’ lack of experience
6. Shortage of funds
7. Expertise is scattered
8. Lack of openness
9. Official ignorance
10. Out of touch

The interesting point about the above list is the neat way in which falls into the 3 critical categories that need to come together to help entrepreneurship succeed: culture, institutional structures and regional economics.

Reasons 1, 2, 3 & 8 lie squarely in cultural aspects of Europe. Europe, which was the torchbearer for renaissance 300 years ago is now sliding into the morass of conformity and consensus becuase of past policies and EU expansion.

Factors 5, 7, 9 & 10 are primarily due to institutional weaknesses that abound in the multiple, diverse and often conflicting systems prevalent across the countries of EU.

Factors 4 & 6 are the economic realities which institutions, governments like to ignore while singing paens about EU’s success in economy & innovation.

Unfortunately, this is nothing new. I have posted about this here and here. I have been involved with Europe and business here for the last 5 years and I have seen practically no improvement in the structural, cultural or economical factors that drive and determine innovation in Europe. In fact, I believe that the problem is not innovation. Innovation can happen irrespective of what the external macro climate is like; it is the support that a country or region provides to bring that innovation successfully to market that is the problem.

Europe ignited renaissance by freeing individuals and allowing them to take risks and make bold moves. Can the modern Europe emulate medieval Europe and ignite a modern renaissance in entrepreneurship and innovation? I believe this is one challenge that Europe cannot afford to ignore. Failure to get the innovation/entrepreneurship juices means that it will face a real danger of becoming irrelevant in the modern world.

While I don’t expect HP to win this particular fight, I hope this will encourage other companies to come out of the woodwork and renew their fight against this law. 

“France not only offers generous compensation, but it has yet to organize an efficient network of job training and placement centers. So in practical terms, the most an out-of-work person has to do to maintain benefits, is to call in every six months to confirm that no new job has been found.”

When I was living in France about 5 years back, the Government took a brave decision and reduced the work week to 36 hours. In fact, there was some discussion about lowering it further to 32 hours per week; that means roughly 6 hours per day.

Germany was no better till Hartz IV came into effect early this year. Before that, an unemployed person is eligible to receive 60% of annual salary for the next 3 years without any compulsion to find a job.

“Germany has historically catered to both those in and out of work. Thanks to its still-powerful labor movement, job protection laws here are among the strictest in Europe. As for taking care of the unemployed, the generosity was epitomized by the notorious 2003 case of “Florida Rolf,” a former banker found living in Miami in an apartment near the beach that he paid for with $2,200 a month in German welfare checks.

In Germany, people who lose their jobs receive 60 percent of their salaries for 12 months to 36 months. Following that, they previously were able to draw long-term assistance and other benefits that could total 53 percent of their wages.

But Chancellor Gerhard Schröder cut back the long-term payments, and as of next February, Germans who are out of work for more than a year will be entitled to benefits similar to ordinary welfare – about $414 a month, plus money for rent and utilities.”

Now, many governments in EU are trying to reduce this unhealthy dependency through a “3 strikes rule”. Basically, if the aid receiver rejects more than 3 job offers, he will no longer be eligible for unemplyment benefits. But, this rule does not count on the lethal cocktail of structural problems and human ingenuity. Since the labor laws are so rigid, big companies hate to recruit in a big way; on top of this, the general economic malaise affecting EU means that most of job creation happens in micro and small businesses rather than big companies. Work in a small company is much more demanding and stressful than a job in big company in EU. So many people prefer to be employed a big company in a nice, secure 8–to-4 job or remain on unemployment roles than work their butts off in a small company. However, they do not have much choice in attending job interviews; if the local unemployment agency informs them to attend an interview, they have no choice but to. So how do they avoid getting a job? When my company wanted to recruit field sales people, we had some people who were referred by the local unemployment agency. During the interview, almost every single person told us they are not interested in the job and that they will not perform if we hire them! Instead of working hard to do good in a job interview, they try hard to do bad in the interview. All they want is that we put a sign on their interview book and send them on their way so they can wallow happily in unemployment.

This attitude is so rampant that every company, big or small is vulnerable to a critical level. We have an field sales person who stays at home more than 4 days in a 7–day week since he wants to spend more time with his family.

The problem facing Europe (or more specifically, EU) is not just the legal, welfare focused system; it is the people themselves. Unless, a significant, grassroots change begins in all dimensions, I am afraid that EU will become an irrelavant institution when it comes to innovation, business growth and sustainable job creation.

More evidence? The recently released Global Competitiveness Report shows (pdf link) that the biggest economies of Europe have lost ground again. As WSJ writes (sub required),

Western Europe’s slip in competitiveness from the beginning of the decade – though from fairly high levels — reflects the region’s economic development of late. Gross domestic product in the 12-nation euro zone that forms the bulk of the region’s economy is projected to have expanded on average at just 1.3% during the first five years of this decade, compared with more than 2% during the previous decade. The euro zone is forecast to grow just 1.2% this year, behind 3.5% growth in the U.S. and 4.3% growth globally, according to recent forecasts by the International Monetary Fund. The region’s budget deficit has risen to 2.7% of GDP in 2004 from 1.9% of GDP in 2001.

One of the biggest structural problem facing EU is the overemphasis on consensus and safety. According to the Eurobarometer survey of public opinion,

“almost 60 per cent of EU citizens have never considered setting up a business and 50 per cent of Europeans agree that ‘one should not start a business when there is a risk of failure’ (compared with 33 per cent in the US).”

Take a simple example of language. Instead of moving towards a common business language, so much money is wasted on delivering multiple languages for EU meetings that it staggers one’s mind. On the other hand, the member states are so militant about national pride and national language that it would be funny if it weren’t so tragic!
As a small company in EU, we always find it tough to generate significant inter EU business because of the multiple language requirements, channel differences, price differences and market access costs. This unfortunate lack of scale economies means that very few small companies stand the chance to grow fast in a pan-European market. Without such success stories, I do not see how entrepreneuralism, taking risks becomes ok among people and thus contribute to a culture change from safety and consensus to risk taking and enterprising.

Does EU really constitute a single market? I was taught that you have a single market when the opportunties for price arbitrage within the market are zero or negligible. I was also taught that we have a single market when customers in one part can reference customers in another part of the market. In such a case, EU is definitely not a single market. An internal study by EU shows that prices can vary by as much as 178% for oranges and by 56% for video cassette recorders within EU. Now usually, if there is such a huge difference between prices, there definitely are price arbitrage opportunites. So why are the prices not equalizing as people exploit these arbitrage opportunites? I believe the reason to be quotas and protection within EU. This is similar to US government mandating that a business in Florida cannot export oranges to New York or can market only a fixed quantity per year. Now, I do not know if such a rule exists, but if it does, I for one, would find it very funny.

Secondly, EU is not a single market because the product adoption rates vary significantly across countries. In a paper published by Gerard J. Tellis, Stefan Stremersch and Eden Yin, they argue that the adoption rates vary across countries in Euro Zone. For example, most of the companies prefer to launch a product in the bigger economies of France or Germany. For marketers who are under pressure to quickly ramp up penetration and recoup the marketing costs, these countries could prove to be graveyard given their history of slower adoption behavior. A new product launch in these countries takes on an average 6 years before it takesoff. Marketers under pressure to build momentum quickly can pull the plug on new products too early because they see the adoption rate not rising quickly enough. What are the worst countries when it comes to launching new products? The mediterranean area earns that dubious distinction. On average, the mediterranean countries take twice the amount of time required in scandinavian countries to takeoff.

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