European Affairs

After all, currency volatility is nothing new. The U.S. technological lead is confined to a few narrow areas such as the Internet, while Europe is ahead in others like mobile communications. And who knows how the economic cycles will compare in a year's time as the United States is forced to reduce its huge trade and current account deficit?

The EU is tackling many of the rigidities that have slowed its adjustment to the emergence of an economic model driven by knowledge and services. European labor markets, for example, are now much more flexible than most Anglo-Saxon observers admit. But the realization has dawned that there is one vital area in which the pace of change needs to be accelerated: the development of Europe's capital markets.

Werner Seifert, Chief Executive of the Deutsche Börse (the German Stock Exchange) is one of many capital market experts who have concluded that the vitality of the American economy is primarily due to the productivity of capital, not to the productivity of labor or even to technological superiority.

Like others, Mr. Seifert worries that unless the EU tackles this fundamental economic weakness, the United States will continue to exploit technological innovations more successfully, and Europe's efforts to achieve higher growth rates will be undermined.

But how can this be? Isn't the single currency supposed to lead inexorably to an integrated European capital market? The answer to this question is "maybe." And even if an integrated capital market does eventually emerge, it looks today as if it will be an awfully slow process, during which the EU's relatively inefficient use of capital will continue to be a heavy, perhaps crippling, burden.

Take, for instance, the hoary issue of Europe's stock markets. For almost three years, the London, Frankfurt, and Paris stock exchanges have been brawling over how to create a single trading platform for the shares of the biggest or fastest growing European companies.

Early last November, the latest chapter in this unseemly struggle came to an end when the London Exchange was forced by the "little Englander" constituency of its owners to call off a deal for joining with Frankfurt.

In the meantime, the Paris Exchange had linked up with Amsterdam and Brussels in a half-hearted federation that will create an organization, Euronext, that is to be managed by three independent chief executives. So much for efficient stock markets.

Factors behind the failure to agree include legitimate fears that a deal favoring a stock exchange located in one EU financial center could weaken the whole financial services industry of a rival nation, and the huge costs - to both the exchanges and their members - of implementing any changes.

Bear in mind, too, that there are a not just six, but a couple of dozen stock exchanges in Europe, which need to be integrated in some way. As a symbol of the difficulty of creating efficient pan-European capital markets, the wrangling amongst Europe's stock exchanges takes some beating.

But while the battle over the creation of a pan-European stock exchange has attracted the most public attention, it is in fact the least important of the many weaknesses of Europe's capital markets.

The cost of trading individual shares is, after all, only a small part of the total cost of capital market activity. And it will not be long, anyway, before alternative electronic exchanges of one sort or another will be eating into, and threatening to replace, the traditional bourses in Europe if they fail to reach an agreement.

It is not the trading of shares, but the fragmentation of Europe's pools of capital and the resultant inefficient use of savings that are the underlying problem. This weakness has recently been highlighted in a report prepared by Alexandre Lamfalussy, the former General Manager of the Bank for International Settlements and head of the European Monetary Institute, the precursor of the European Central Bank.

The report was commissioned last July by EU Finance Ministers, in a decision that was itself the clearest signal so far of the growing unease amongst Euroland's political leaders that Europe is failing to take quick advantage of the opportunities offered by the creation of the single currency.

What the Lamfalussy report said in essence, was that it was all very well to create the single currency, but if it was not matched by a single financial market, many of the most important longer term benefits of the euro would materialize only slowly or even be lost altogether.

To improve the efficiency of the EU economy and make the most of Europe's innovative and technological capacity, companies must be able to issue - not just trade - their shares as easily in one EU country as in another. That is not the case today.

Companies need to be able to mount a takeover bid, complete a merger, or sell off a subsidiary across EU borders, just as easily as they can within their domestic markets. And what is true for companies must also be true for investors.

If Europe is to make the most of its own savings, and the savings it may import from other parts of the world, investors must be able to invest freely around the EU, without falling foul of all sorts of national regulations including discriminatory tax rules and arcane legal procedures. This is especially true for seed and venture capitalists.

The Lamfalussy report points out, for example, that since 1984, U.S. pension funds have earned a far better rate of return than their heavily regulated European counterparts - 0.5 percent compared to 6.3 percent - and that America has five times as much venture capital available per head of the population as the EU.

The availability of venture capital is increasingly seen as a vital factor in the competitiveness of the European economies because of its crucial role in the growth of innovative high-tech companies.

Multiple clearing and settlement systems for the securities markets alone, the report suggests, are burdening users of the EU's capital markets with an extra ó1 billion ($940 million) a year of unnecessary costs that have no equivalent in the United States.

At a summit meeting in Lisbon last year, EU leaders called for an acceleration of initiatives to improve the functioning of Europe's financial markets, so that major changes could be introduced by 2005. At the time, that was seen as a brave step forward.

The Lamfalussy Committee, however, now wants an agreement at the planned summit meeting in Stockholm in March that a new system for regulating and integrating Europe's capital markets should be in place much earlier, by the beginning of 2002. That is a clear sign that the efficient use of capital has moved swiftly to the top of the EU's agenda for economic reform.


This article was published in European Affairs: Volume number II, Issue number I in the Winter of 2001.