Europe and “Locusts”, What is at Stake?

The economic benefits of free trade in goods and services, and more widely of free movement of capital, both portfolio and direct investment, and labor are well known. Specialization on the ground of comparative advantages, wider range of product availability, more efficient allocation of resources, economies of scale and scope, enhanced cost effectiveness. In most sectors a higher degree of competition results in lower prices, increased supply, higher output and employment. Not surprisingly, the EC, the IMF, OECD and others have provided on several occasions estimates that confirm the positive impact of market friendly reforms on growth. On top of this, reforms that improve the flexibility of the economy should be welcomed in the context of a monetary union where individual member countries have lost their own monetary and exchange rate policies. Unfortunately the experience of Euroland countries has often disappointed. There are of course exceptions but reforms tend to be partial, and sometimes are followed by a step backward. The high level of structural unemployment and low participation rates in several big countries give a clue of what remains to be done. The Bolkestein directive episode, a project that has finally been significantly watered down, is a perfect illustration of that failure. Why then is it so difficult to implement reforms and especially to achieve the goals of the “common market” regarding services, capital and labor? The benefits take time to materialize and are not always perceived as a certainty. Besides, they are generally distributed over the population at large, while their costs are immediate, more precisely known and fall on well identified parts of the population. So there is a clear asymmetry between the incentives to support reforms and the incentives to reject them. The consequences in terms of political costs are obvious and hence the appetite to implement reforms. Over the last two years cross border mergers have become at the center of the debates in several countries as France, Italy, Spain, Poland…Politicians interfered at different degrees with various success: names such as Arcelor Mittal, Enel Suez, Danone Pepsi, Antonveneta ABN AMRO, Eon Endesa, Abertis Autostrade, are in all memories. All this is nothing else than a special case of protectionism, which does not target goods but foreign direct investment. It aims at pushing away the risk of foreign control presented as extortion, but ultimately puts sand in the wheels of the market for capital control. Curiously, foreign investment from home companies doesn’t seem to raise such concern, nor does the risks of retaliation. As often in France, this comes with pompous theories and concepts: it gave birth to the so-called “economic patriotism”. Does it make sense? On purely economic grounds, that is highly debatable to say the least. Consider first the perimeter issue: opposition becomes really vocal in the case of unfriendly takeovers, they attract media attention, even though they represent a tiny fraction of the M&A activity. Second, it is impossible, when relying on statistics or facts to exhibit any significant difference of performance on various grounds between nationally owned and foreign owned companies. That conclusion is easy to establish whatever the criteria selected: growth in turnover, in profits, in jobs, in investment efforts in the field of R&D. It is not obvious that workers are not as well treated in foreign-owned companies. In that respect, compensation depends on the conditions of the local labour market and have little to do with the nationality of the shareholders. Besides, when a company, say company A, declares that it intends to buy another one, say B, then the price of B shares goes up. The rationale is that a new management would generate better profits for B, so its price, that is the present value of expected future incomes, would increase. The rise in the price of the target shares could be seen as stronger in case the buyer is a foreign company. One might suspect that the potential for boosting profitability can be higher in that case, since the acquirer is supposedly less constrained by local considerations, political pressure… which could mitigate its willingness or ability to restructure the target, to extract higher productivity gains. In fact such a view can be questioned in a context, in which a significant part of the capitalization is held by non-residents, obviously the case of France. Besides, cost effectiveness is not the whole story, very frequently cross border investments aim at generating higher income (cross selling…). More important, whatever nationality involved, the final target is always to create value i.e. ensure a proper level of profitability. The structure of the management compensation is aimed at achieving that objective, whatever the nationality of a company. In fact in case of a takeover, the winners are usually the owners of the target who benefit from an appreciation of their shares. It should not surprise that the opposition to cross-border mergers is especially strong in countries where savings are only marginally invested in shares. Obviously, in that case, higher equity wealth that follows the announcement of a possible merger doesn’t benefit fully the nationals. The fact that the distribution in share ownership is skewed at the top of the incomes / wealth distribution doesn’t help. When pensions financing relies at least partially on equity investment and not only on PAYGO mechanisms, the opposition to M&A could be expected to be less vocal. Political posturing against foreign ownership, including inside Europe, may be perceived as effective in terms of winning votes, hence the reference to investment funds as “locusts” for instance. That is probably even more so in places where the public shows reluctance regarding free market mechanisms or lack economic awareness. That creates a favourable ground for ideological positions that hardly makes sense when it comes to economic logic. Obviously a wider diffusion of share ownership would help especially in a world where the potential for cross border M&A is on the rise. There are more and more big companies in the emerging markets not to speak about sovereign wealth funds that are eager to spread their operations out of their home country, and there is a lot of savings particularly in dynamic Asia that is invested in very basic instruments (deposits, treasury bills…), there undoubtedly a huge potential in the future for diversification of these investments both in terms of instruments and in terms of geographical orientation.

2 Responses to "Europe and “Locusts”, What is at Stake?"

  1. Guest   October 31, 2007 at 11:29 am

    Your analysis is spot-on: Germany plans law against foreign takeovers[fr] Published: Wednesday 31 October 2007″Germany plans to introduce a law preventing takeovers of strategic industries, in a move directed against sovereign wealth funds orginating in countries such as Abu Dhabi, Saudi Arabia and China. The law also targets hedge funds and state holdings from non-EU countries, such as Russia’s Gazprom.Roland Koch, minister-president of Hessia and one of the most influential CDU politicians, was quoted recently as warning that Russian and Chinese investors “would be in a position to buy the whole DAX” (the stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange).”

  2. Guest   October 31, 2007 at 12:50 pm

    Any ideological considerations aside, it seems obvious today that many of the celebrated LBOs and mergers fuelled by the “liquidity glut” in the recent past would better not have occurred from an efficiency point of view. Could the same eventually be said in the future when looking back at emerging market’s currently inflated pockets?