Many respected journalists and economists branded Europe’s common currency, the euro, a failure after it declined 30% against the dollar following its 1999 introduction. But they missed the point. As intended, the euro has made much more capital available to help European businesses expand. The surprise for the euro’s creators has been that companies are choosing to avoid the continent’s rigid labor market by investing abroad rather than at home.
The euro was created in the belief that a common currency could break down trade barriers, reduce transaction costs, and allow Europeans to invest their money in all European Monetary Union (EMU) member nations without the risk of fluctuating exchange rates. Economists and politicians envisioned large corporations flourishing across Europe, their rapid growth fueled by cheap and plentiful capital. This era of corporate growth would ultimately raise the general standard of living, as unemployment fell, wages increased, and burgeoning worker productivity, stimulated by technological advancements, resulted in lower prices for goods and services.
Opening The Floodgates
Since the adoption of the euro, European markets for corporate debt have boomed in much the way the currency’s creators had hoped. Before the euro, individual investors and some financial institutions were not eager to make substantial cross-border investments because of currency risk. Investors with pan-European holdings not only had to worry about the quality of the securities and debt they were holding, but also about free-market exchange rates. The euro’s arrival created a common currency for all EMU securities and debt, thus removing currency risk. Now an Italian investor could buy shares of Volkswagen AG on the German Stock Exchange using his local currency.
This led to a fourfold increase in euro-denominated corporate bond issuances to more than 187 billion euros in 2000, according to the European Commission’s Directorate General of Economic and Financial Affairs. The boom has continued even during the recent world economic downturn. According to June 2002 statistics released by the European Central Bank, debt issuance by non-financial corporations in euroland increased 24% in the 12-month period ending in May 2002.
Raise It There, Spend It Here
It would stand to reason that the removal of currency risk within the eurozone, combined with raising massive amounts of capital from new debt issuances, would result in a sudden increase in European economic growth. This, however, has not been the case. Instead of reinvesting the newly raised euro-denominated capital within EMU member states in the form of new factories, new equipment, research and development, and more employees, companies have deployed the proceeds of their eurobond issues mainly overseas. Mega-mergers such as Deutsche Telekom’s $26 billion purchase of VoiceStream Wireless (now T-Mobile) and the acquisition by France’s Vivendi of Canada’s Seagram for $24 billion are good examples.
The outward flow from Europe of foreign direct investment (FDI) skyrocketed from $475 billion in 1998 to $820 billion in 2000, according to the 2001 United Nations Conference on Trade and Development (UNCTAD) report on world FDI. Although inflows have also increased from $273 billion to $633 billion, the EMU continues to leak money, as there is still a net outflow of capital. During 1999 and 2000, EMU net outflow amounted to a total of $205 billion, according to the 2001 UNCTAD report. Meanwhile, FDI net inflows to the United States totaled more than $294 billion over the same period.
The regional money flow statistics reveal a shocking trend: Instead of euro- denominated capital raised within the EMU settling within the EMU, it has crossed the Atlantic to the United States and Canada. This helps explain the fall of the euro’s value against the dollar.
Consider this example. Let’s say Germany’s BMW wishes to open a new plant in Spartanburg, S.C. The American contractors building the facility work for dollars, not euros. If BMW raises the capital for this investment by selling eurobonds, it must then exchange the euros it has raised for dollars. On the world market, this translates into an increase in the demand for dollars coupled with an increased supply of euros. This in turn should cause a drop in the price of euros in terms of dollars, and this is precisely the result the world currency markets produced during the 22-month period between the euro’s initial release and its 30% plunge from $1.18 to $0.82 per euro. The euro has since recovered part of the decline, trading recently at just under one dollar per euro.
Capital Seeks Productive Labor Force
Capital has left Europe in such large quantities because opportunities for growth and profit are better overseas, in areas such as the United States, Eastern Europe and developing Asian markets. This is mainly due to high labor costs in Europe compared with other regions. In Europe, corporations confront mountains of red tape while grappling with union representatives at every step. While some worker protection is undoubtedly good, too much rigidity prevents companies from adjusting their workforces when appropriate. In addition, the average European worker takes six weeks of vacation time a year. Compare this to the average American who receives two weeks of vacation in his first year of employment and four weeks of vacation after 20 years of employment.
The final straw for most corporations that consider investing in Europe is the 35-hour workweek. France has passed legislation, which is also pending in other EMU member states, that limits the number of weekly hours a wage earner can legally work to 35. The results of overly generous vacation time and a limited workweek are stunning. In 1998, Americans worked an average of 1,950 hours, whereas Italian workers averaged 1,650, French workers 1,600 and German workers 1,550. These statistics, which do not fully reflect the French adoption of the 35-hour week in May of that year, demonstrate why corporations must hire more European workers to accomplish the same amount of work that an American worker or Asian worker could during the same week. European corporations have elected instead to minimize expenses and increase productivity by investing overseas rather than within the EMU.
Success Or Failure?
Although the euro has not had a demonstrable impact in stimulating the continent’s economic growth, we can see that the currency has not been a failure. Small and low-rated corporate borrowers, who traditionally have been absent from the European capital markets, have been able to issue bonds and raise money thanks to the euro. That is a pretty big achievement for a currency. Faster economic growth and higher living standards in Europe are going to have to wait for policy reforms that bring the continent’s labor markets in line with the rest of the developed world.