Even casual observers of equity markets will have noticed how cheap European stocks look compared to American ones: in aggregate, they trade at a discount of over a quarter, relative to profits. But stock pickers seeking bargains on the continent soon make an unpleasant discovery. There are far fewer large European companies to choose from, and their discounts almost always reflect slower growth than American peers. The Europe discount exists primarily because European companies struggle to expand.
Ask European investors, executives and entrepreneurs why this is — and if it can change — and they are pessimistic. Whether it’s over-regulation, a patchwork of languages and traditions, or attitudes towards risk and work, the answer is that problems have existed for decades and nothing will change now. As an American, looking in from the outside, I take a different view: many of the barriers to growth are surmountable, and there are signs of progress.
Europe’s scaling problem can be broken down to three C’s: canons, culture and capital. Europe’s canons — its laws and regulations — are the most discussed problem, amply described in the competitiveness and market reform reports from Mario Draghi and Enrico Letta. Most harmful is the costly replication of national systems for data, public procurement, tax and more.
Culturally, there are forms of European heterogeneity — language, customs, tastes — that can make it hard for some industries to scale across the continent, and which are not going away (and who would want a homogeneous Europe?). But culture also takes less benign forms: behaviours that, while not encoded in law, protect the anti-growth status quo.
Letta notes that Europeans who live and work across national borders find they need local bank accounts and phone numbers in each country to pay rent and set up utility accounts. There is no law that enforces this sort of thing, but it is ubiquitous, and it protects local incumbents against transnational innovators and consolidators. For an individual, this is a nuisance. For a small, growing company that must pay, house, move and connect employees across Europe, it is an anchor that prevents them from going anywhere.
A recent paper finds that the valuation and size gap between US and European businesses cannot be explained by a few very large American companies; nor European businesses listing in the US; nor by the sectoral composition of the two markets. Instead, it is “the gap is concentrated precisely where a firm’s value rests not on today’s cash flows but on the option to grow.” The fragmentation of European markets matters: sales growth and the size of a group’s local market are closely linked — a pattern absent in US companies. And there is a huge gap in the amount of “patient, risk-tolerant capital for young, high-growth firms”, a problem the authors attribute in part to the fact that EU pension schemes do not create large pools of investable capital.
But do European companies struggle to scale because they lack capital, or is less capital invested because they struggle to scale? Both are probably at work; I think investors are looking, but not finding. A history of lower investment means support systems for entrepreneurs are under-developed, expectations are low and the political constituency for pro-growth reform is weak.
But this doesn’t make change impossible. Corporate Europe’s growth problem stands out among geopolitical issues in that there are solutions that don’t involve awful trade-offs. The proposal for a supranational regulatory domicile for businesses within the common market — the “28th regime” — could bring the benefits of regulatory uniformity. Stifling business behaviours that suppress competition can be rooted out. Europe has five major stock exchanges and a litter of smaller ones. Consolidation, which has been blocked by the EU in the past, could reduce this to one or two, creating deeper pools of liquidity. EU companies are more than capable of growing fast when the conditions are right, as Aldi and ASML’s global scale shows.
The consensus is that meaningful change is politically impossible, given the entrenched local interests and hyper-cautious European bureaucracies. Don’t be so sure. In Germany, plans to move away from pay-as-you-go pensions towards a public investment model are under way. The planned takeover of Commerzbank by UniCredit could open a path for the creation of European champion banks. Both changes would have been hard to imagine just a few years ago. Typical American naivety? Absolutely. But maybe a little naivety is just what Europe needs.