After the euro ... now what?

Within weeks, the euro will have arrived. But will the true single market ever become reality?

European economic and monetary union (EMU) is arguably the biggest economic experiment attempted in this century. On January 1, 1999, a new currency, the euro, will be born and is expected to be one of the two most powerful mediums of exchange in the world. Backed by a supranational central bank, ECB, which fiercely guards its independence, the euro will be legal wholesale currency representing an irrevocable fixing of conversion rates among the 11 participating currencies. (The U.K., Sweden, and Denmark are electing not to join the euro at the outset. Greece failed to meet the economic criteria for participation.)

The arrival of EMU signals the coming of age of a single European economy, or the "euro zone." The euro zone is said to be not merely the collection of 11 disparate economies, but an economy in its own right - the second largest after the U.S. in terms of output, the largest in terms of trade. If and when the above four European countries join, the euro zone will overtake the U.S. in all these areas.

EMU will have profound consequences for the financial and business environment in which companies operate in Europe whether or not they are headquartered in the euro zone. Transition costs of around $30 million per company or around $50 billion for Europe's largest companies have been predicted by Harris Opinion Research, which surveyed European companies with more than 5,000 employees. According to London's Financial Times, the total cost of preparing for EMU may be $150 billion - and experts say the final bill could be higher.

Aside from the accounting, treasury, and computing issues that must be harmonized, how are companies preparing for what must seem like a journey into the unknown? (Historically, political union precedes economic union.) To find out, CE, in partnership with Deloitte Touche Tohmatsu, gathered CEOs of companies based in Europe and North America, to examine the intermediate term impact on business.

For example, price transparency will have profound and perhaps unintended consequences. A common currency will tend to level down prices and put pressure on margins. The increased use of the Internet and the advent of e-commerce will compound this. Daimler-Chrysler, for example, plans to publish its price list for all its vehicles in euros on the Net by mid-1999. Loss of competitive advantage based on domestic market dominance will increase competition within the euro zone, though cross-border business will be simpler, allowing for greater distribution efficiencies.

As with any major market restructuring there will be unforeseen threats and opportunities. According to the Economist Intelligence Unit, there will be clear differences among industries. With banks moving early and retailers late, the capital-intensive industries such as finance, tourism, and operations will see the most long-term change, while software and vending machine industries will likely feel the effects earliest in the transition period, which concludes in 2002 when euro coins and banknotes replace national currencies.

Could it all go wrong? Given the lack of precedents on this scale, EMU is a leap into the unknown. Roundtable participants argue that politics, not economic logic, drives the decision making. Considering the commitment and sacrifice among EMU's adherents, the dynamics are such that leaders have reached the point of no return. There is no plan B if it all goes off the rails.

Left unanswered politically in Brussels, but avidly discussed in the following roundtable, is whether or not Europe can ever move to a single unified labor market. How long can differences in cost structure remain, say between Germany and Spain, if both operate in a single economy? The elections of left-of-center governments in Sweden, Germany, and Italy - all of which have made a point of using fiscal policy to boost employment - further complicate the matter. Also left unresolved are the differences in tax policies within the euro zone. The EC's Italian commissioner for tax policy is said to favor tax "coordination" by the respective governments as opposed to harmonization imposed from above.

Euro CEOs assume that the politicians and the bureaucrats will improvise. As Zeneca's Sir David Barnes observes, much will depend on how political leaders deal with EMU's first crisis, whenever that arises. Nonetheless, speculation must now give way to action as the reality of the single market begins to take shape.

EU: THE GOOD, THE BAD, AND THE UGLY

Nicholas Brookes (Bowthorpe): We really need to look at the competitiveness of Europe versus North America and Asia. Britlan on its own cannot compete effectively on a political basis or on a business basis with the other trading regions of the world. We've got to have a central power.

The issue to me is the politicians; can they really let go of the power and surrender to a centralized government? My fear is that we're not doing enough. If we count on Britain as we have in the past, taking us 15 years to get into the EC - we're still paying for the common agricultural policy that was formed without Britain's input. We had no say when we came into the EC in 1973; it was already there, and we had to pay a very high price to get in. Britain ought to be in the middle of it, leading Europe, leading the monetary union, and helping change the things that need to be changed. We're very dangerously close to being on the periphery if we continue on this route. And if that's the case we need to be looking towards America and saying: "Why don't we just have the dollar as our national currency and join NAFTA?"

J.P. Donlon (CE): But then it was the EC six or nine; now that it's 15 going on 21, how much greater will Britain's voice be if you join tomorrow? With every new addition, doesn't the voice become diluted?

Brookes: Not necessarily so - but that's still not a case to continue to delay it forever.

Sir David Barnes (Zeneca): Many of us in this room have operations in France, Germany, Italy, and Spain. So, as a corporation, we are already in Europe. Whether the U.K. is wise to say, "Wait a minute, We want to keep in the waiting room and just think about it before we get admitted to the inner sanctum," is a very difficult question. That's why I'm in the "don't know" camp at the moment.

The price for hanging around could be very high. Equally, people have said the whole objective is to increase efficiency, but I think it's actually political union and a single market. Maybe in an ideal world we will get increased efficiency out of it, but just as our children, when they go to school or to parties, pick up the worst rather than the best habits of those they mix with, I suspect that we may have less labor flexibility, higher taxation, more rigid control, and be obsessed with internal politics rather than looking at global competitiveness. If that bad scenario comes to pass, hanging around in the waiting room isn't too bad an idea. [Laughter]

Arnie Pollard (CE): So tying to the common currency would have a negative consequence for the U.K.?

Barnes: It's the economic union that has a negative consequence, not monetary union. The currency is the last 3 percent of the question, quite frankly.

Julian Lee (Allied Carpets): It is the economic union that gives us the freedom to close our factories in Germany and put them up in Greece, because the cost base is cheaper.

Barnes: I don't think the discussion should be about whether the U.K. is in Europe or out of Europe. I am Spanish; I am French; I am Italian; I am Belgium; I am Dutch; I am Swedish. I've got operations in all those countries. And I'm all of these simultaneous. And I'm also English.

We'll be taking those skills, those resources, and adapting them to an evolving set of circumstances. It isn't a case of: "Are we in Europe or not?" We are in. And that is every bit as true about our American friends at this table who have operations in Europe. They, too, are simultaneously French, German, American, and so on.

Bill Hjerpe (Honeywell): One of the frustrating things for me is the constant dialogue about balancing the interests of the various constituencies in Europe, because that suggests that the interests of those constituencies are opposing in nature, and that what you give one, you're taking away from the other. Nothing could be further from the truth. If we can instill in our work force that the objectives of our shareholders, of our customers, and of management are the same as those of employees, we'll have much healthier enterprises.

I'm trying to instill that by making our employees shareholders in the company, by giving them access to stock, and building very attractive economic terms of conditions. By the end of this year, more than 60 percent of our employees across Europe will have access to these plans, and by the end of next year, more than 95 percent will have access.

Jacques de Cock (ICL): I'm always very amused when the English and the Americans talk about global competitiveness when they are the two largest net importers and have lots of raw materials and Europe has no raw material and is a net exporter.

The euro has already improved the competitiveness of European countries on the service side. Multi-national European service suppliers are multi-national, but inside Europe, they are multi-parochial. We are noticing in our company that simply reflecting on the euro and realizing that they're one market hasn't made the French and the Germans and the Dutch and the Belgians work together at creating pan-European services and reallocating roles and responsibilities across Europe. But it has changed the mentality a bit and it will allow us to compete more effectively with those who have been global or international for longer than we have.

Umberto Quadrino (New Holland/Fiat): Having a common currency doesn't mean we have to organize it around a single political system across Europe. This would be a colossal mistake. The U.S. has different laws state by state as far as labor and taxes are concerned. There are differences between the states and competition between states to seduce investors to localize investment in a particular area. There has to be this competition within Europe.

Lee: I don't see how you can run economic union with the disparity you're suggesting. It's my understanding that the majority of U.S. federal legislation regulates businesses at the lower end of the demand scale rather than at the top. You need a central treasury, whether it be for a business, for a country, or for an amalgamation of countries using a single currency.

Hjerpe: As a group, we shouldn't lose sight of the opportunity this provides us as enterprises on the supply side. If you're in the business of adding value, you're most likely going to be buying more commodities than you're selling. You're adding value, so, by definition, your exposure is going to be less than your opportunity.

We looked at our strategic response to the euro on three levels. One was the technical adaptation opportunities; for us, the technical savings - reducing transaction costs and improving financing efficiency - add up to something like $5 million to $7 million dollars a year. Then, from a strategic line of business point of view, we looked at each line of business in terms of price transparency versus the opportunities on the supply side versus what we could do from a redeployment of our manufacturing. Now that the FX environment was no longer an impediment, we could reallocate our assets geographically to the most advantageous business conditions within Europe. The third level of strategic response was in the overall positioning of the company, a set of strategies that transcends all lines of business. If you do agree that the objective of EMU is ultimately to improve the competitiveness of European industry, we found we were exactly in that business in every single one of our lines.

THE SLIDING COST OF CAPITAL

Hjerpe: We don't read enough about new access to capital in business literature. According to ABN AMRO statistics, if you compare U.S. corporate debt portfolios to European debt portfolios, you find European companies depend on bank financing twice as much as U.S. corporates do. The reality here is that there's been no such thing as a corporate bond market because the financial markets have been so fragmented that people are unwilling to take the FX risk in investing in a Swedish Krona-denominated corporate security.

The innovation in Europe has really been starved for capital. And the whole competitive landscape is going to change, because now all the good ideas are going to be funded through new access and lower costs to capital.

John Connolly (Deloitte Touche Tohmatsu): I agree with the thrust. But one of the consequences of a heavily bond-financed corporate sector is - as occurred recently in the U.S. - when all of the sudden bond financing is no longer available.

Frank Cahouet (Mellon Bank): It seems to me - and I'm coming from a U.S. point of view on this - that the longer the U.K. stays out, the harder it is going to be for London to retain its position as a financial center along with New York, one of the U.K.'s core strengths.

Lending to the giant companies is not a profitable business. If you took the U.K. and European banks apart and looked at their numbers, you would see that with every loan, they're destroying shareholder value, not adding to it. They may not realize it, but a lot of them earn well less than 10 percent return on capital.

Sir Martin Jacomb (Prudential): I don't think there's any doubt whatever that the bond market in Europe will be a big beneficiary from EMU. It's going to become an enormous market and already dealers in London are looking at credit risk rather than currency risk. So it will be good for the bond market, it will reduce the cost of capital and widen the availability of capital.

But as to the future of London, I don't think London is finished if we don't join the monetary union. London's strength as a financial market grew from several things: the English language; the tradition of dealing, that the dealer can give you a committed deal as opposed to waiting for the opposite side of the deal; the fact that the U.S. destroyed its own international bond market with the introduction of interest equalization tax in 1963 and drove that market off-shore; and that we have an extremely beneficial regime of personal taxation, which makes this a great place to live.

Bill Mayer (CE): There have been comparisons made to the overlay of the federal government and the state government in the U.S. I'd like to point out that they had a heck of a time putting together the federal government. (Laughter) As a matter of fact, Jefferson, Madison, and Hamilton wrote something called the Federalist Papers - what we could call "spin papers" today - because New York State was the holdout; unless New York ratified the Constitution, the whole thing would fall apart.

Then it was really the Supreme Court, at least in the U.S., that spent the next 50 years arbitrating exactly what that all meant. We are talking about our children's children by the time this thing is truly functioning. By then, I'm pretty sure we'll be out of the waiting room. (Laughter)

THE EU MADE ME DO IT

de Cock: What the continental Europeans are looking for is to be able to have rational debates about competitiveness within their country. Continental Europeans believe that society as a whole needs to evolve correctly and together. That's a very noble aim and it makes difficult decisions more difficult to make.

The French are looking to be able to force change while appearing collegiate. We're looking for that lack of restraint and that excuse - a greater force that we cannot control. Nobody in Europe wants radical free market capitalists. They have a structure where the cost of restructuring is absorbed by the whole society and they want to keep that. But they want to be able to justify one's economic worth.

Pollard: Do you believe Chirac is just waiting for the European excuse to promulgate the changes?

de Cock: Absolutely. Because it's a win-win. If France becomes more competitive, France will be richer, but Chirac can't say "we had to do it" without having a greater force that he can't control. Otherwise they'll tell him to control it.

Ian Harvey (BTG): At the World Economic Foram about three years ago, Jean-Luc Dehaene of Belgium said, "Of course we understand that we should deregulate but if I say that, I'll be thrown out at the next election. So how do we go about it?" Then, last year, France's Jean-Claude Trichet - in a debate with then Minister of Finance of Germany and Minister of Finance of Italy - said, "The main reason France needs to get into Euroland is because it will force the government to make the changes that are otherwise politically impossible for us." When a process has been set in place, there is more recognition at the political level that change is needed than is actually made clear to the electorate.

You just have to look at the case of Japan, where they've been set on a course of not wanting to adjust very rapidly, and they're still heading downwards. My feeling is that Japan is in for a decade of really major problems and it will be a generation before it can dig itself out.

Lee: Japan's period of sorting out its problems will be nothing compared to the period of time it takes to bring in appropriate legislative control across a combined Europe - and we don't have a very good track record over the last 15 or 25 years in European legislation to show we are capable of actually making us a single economic unit subject to single control and direction. And that's what you need if you're going to have the freedom of choice to allocate your resources where they are most economically, productively, and efficiently allocated.

Donlon: Are you saying there are key strategic decisions one cannot make in the absence of this legislative infrastructure being in place? What happens when the euro becomes reality?

Lee: Personally, I believe that we are going to find in not too long a time - that we've suddenly hit a brick wall because we are incapable of managing Europe as a single entity. It needs to be as strongly managed from the center as the U.S. is. We can have the equivalent of the U.S. states with their relatively minor legislative ability, but we have to bring together the control of all the economies and we have to do that very quickly. I don't think we'll have the capability or the desire to do that.

Hjerpe: We've been demonstrating that capability since the advent of the master criteria in the early '90s. Countries have been perfectly willing to forego their monetary policy control for the sake of convergence.

Lee: You see a different world than I see.

Jacomb: I don't believe in the brick wall theory, but I do think there is a fundamental problem that this whole enterprise faces. When the monetary union is here, it's going to work and it's going to lead to price transparency and a huge increase in competitive pressure on prices, which is happening anyway because of global trading. And assuming - and this is an assumption - that the WTO continues to make progress toward free trade. Nevertheless, we are left in Europe with a terrific problem: an inflexible labor market.

In any currency area you can think of, there are two countervailing forces always at work: one is the rich centers magnetizing economic activity; the other is the government, collecting taxes and equalizing conditions by paying money to the poor areas through government expenditure. In Europe, the governments spend not much less than 50 percent of GDP on average in that way and this gives rise to the difficulty, for the EU collects less than 2 percent of GDP and therefore cannot redistribute resources to the poorer parts of the EMU area. As a result, the rich parts of Europe will prosper and the poorer parts will suffer. And that will lead to an even greater unemployment problem than the one Europe now faces, which is huge already.

Unfortunately, the governments we've got believe the problem of unemployment is curable by socialist type clauses and it cannot be solved that way. We're going to have to resist calls for taxation harmonization. We must preserve competitiveness in tax - it's an essential way to create wealth.

Connolly: If you look at the surplus labor that is going to be created from the fallout in the financial sector, theorists suggest that could increase productivity by about 6 percent. But there is going to be a timing issue between when the resource becomes available and when it is utilized. The theory might be correct - one day in the long term, the resource will be more productively and valuably utilized and the economy will grow. But somebody has to control that process.

George Burnett (Ashlead Group): The problem with what we're talking about is the overall culture. From the U.S. market to the British market there is an ability to learn; people speak the same language. But that will not work in the European environment because people are nationalistic; the culture is so fundamentally different. We have our own 3,000-year-old traditions across the whole of Europe that are not easily subsumed into some form of nationality.

PROOF IN THE PRICING

Connolly: What we've seen is that the range of prices when converted to the same currency in different markets - where there is not necessarily a significant reason for such a difference - can be anything from par to par plus 50 percent, and in some instances, even twice the price for the same product when sold in a different market. Historically, industry has been able to get away with this because it wasn't so transparent.

There will always be a range of price differences, and perhaps there could be a tolerance of up to par plus 10 or maybe 15 percent. But beyond that, it will not be possible to sell your goods at excessive prices. The consequences of this will be that some more efficient and perhaps more visionary companies will move their production operations to the lowest cost areas and will benefit from this. Those not quick or sharp enough to identify this problem could suffer very badly. It's happening in the airline industry; an air ticket from Paris to London doesn't necessarily cost the same as from London to Paris.

Brookes: Transparency is going to be one of the biggest issues but it's not new to those companies that have been operating globally. It might hurt a lot, but the sooner we face up to these issues, the sooner we can get our industry more competitive in these markets. Those that can't compete probably ought to be somewhere else.

Hjerpe: If price transparency doesn't represent a threat to the industry here then the whole objective of unification - to lower the cost basis of our products and make them more competitive on a global basis - isn't working.

Denis Cassidy (The Oliver Group): As far as moving the source of production to the lowest cost point, if it's outside Europe, then that's not about competitiveness driven by the unification of the European currencies, but a fundamental underlying restructuring of the whole economy. That's about facing up to global competition. And I think that's a very, very different issue and not easily given by what we describe as pricing transparency.

Cahouet: As the European markets come to be one market, you'll pick the place to manufacture. If you have the brand name, the products, and the channels of distribution, you'll be able to cover a wider area and you won't have to be indigenous in each market that you're selling into.

Barnes: I agree that if you're going to move your manufacturing base, then you're going to find the most advantageous position from which to serve the global market. The textile industry is a clear example, having migrated from Europe to Asia and India.

At the moment there are very different prices across Europe. There is an opaqueness, because people don't know whether 973 Belgian francs is more expensive or less expensive than 8,946 Italian life. Well, they probably do, actually. (Laughter) That's a bad example, but that will become much more transparent.

But the impact on the service sector may well be greater than the impact on manufacturing. For pharmaceuticals, the price difference is par plus about 150 percent across Europe. That's not because the pharmaceutical industry is stupid; it's because different governments set different prices. If you believe that manufacturers' price control is going to have to come down to the common denominator, what's government going to do in the pharmaceutical sector about price control?

Carl Symon (IBM, U.K.): My view is that the single currency is a means to an end, not an end in itself. When it happens, it will be cheaper and simpler to do business. But what are we doing, what is the government doing, and what is industry doing to prepare the environment for a more efficient way of doing business? I'm sure you've read the McKinsey studies that say we're 30 percent or 35 percent less productive than the U.S. How do we close that gap?

CONCERNS ABOUND, OPTIMISM REIGNS

Jacomb: The consumer is going to have a period of deflation and lower prices and all the advantages of competition. For businessmen, the challenges are enormous, but we can rise to them.

de Cock: When we did an analysis of what the challenges were, we found more opportunity to be more efficient, to save costs, to put out new businesses. And, because we will report European numbers, the apparent disparate size of the markets of America versus Europe will disappear. And the European opportunities will look as big as the U.S. opportunities - and that will attract capital and thinking.

Hjerpe: I'm very optimistic about EU - so optimistic that we're investing heavily in Europe, because of the future that we see here. We've, in fact, made 50 acquisitions since 1992 five of which we've made this year alone.

But the worst thing the politicians can do is try to sell this as a short term panacea for job creation. By definition, you need an investment for long term prosperity. There's a price to pay, and lower costs by definition mean no job creation, and maybe some job losses.

Ian Henderson (Hyperion Solutions): It's interesting that just about everybody around the table has been optimistic. I think partly that's due to the psychological make-up of a group of chief executives. If you weren't generally optimistic folk, you wouldn't be here in the first place. Speaking on behalf of my business, I am optimistic because times of great change, in my industry, result in great opportunity. But I think we should not delude ourselves; it's going to take a very long time before we reach European nirvana.

Barnes: My concern is that the regulatory tendency, and therefore the bad habits of children, will prevail, and we will get an inward looking Europe. But you have to be optimistic. I'm optimistic. And the younger generation are going to suffer far less from the prejudices; they see themselves as citizens of the world, so they are much more open minded, more positive. And remember, they've never seen a war or felt those sorts of tensions, so they are much less inhibited than are we.

Harvey: I'm optimistic about the benefits of the European enterprise, but this country will have to have referendum before it enters, and I am pessimistic that if you took a vote now, they won't make the sensible, right decision. We need to engage in that debate because our jobs, as chief executives, are all about managing risks, about ensuring that the positions we take have a good outcome. And in this case, we should be sitting at that table, to help bring about the benefits and to minimize the chances of it going wrong. Because if it does go wrong, it will damage all of us.

A WHO'S WHO OF ROUNDTABLE PARTICIPANTS

Sir David Barnes is chairman and CEO of London-based Zeneca Group, an $8.7 billion drug and agrochemicals firm.

Nicholas K. Brookes is CEO of Crawley, U.K.-based Bowthorpe, the $929.1 million parent company of an international technology group focused on specialist electronic products.

George Burnett is managing director of Surrey, UK-based Ashtead Group, a $338.4 million supplier for outsourcing of equipment for use throughout industry.

Frank V. Cahouet is chairman, president, and CEO of Pittsburgh, PA-based Mellon Bank Corp., a banking corporation with more than $300 billion in assets under management,

Denis Cassidy is chairman of The Oliver Group, a Peterborough, U.K.-based footwear retailing business with nearly 300 stores.

John P. Connolly is CEO, U.K., of Deloitte Touche Tohmatsu, a $9 billion global professional services firm.

Jacques de Cock is managing director-Europe of London-based ICL, a $4.08 billion supplier of IT systems and services.

Ian A. Harvey is CEO of London-based BTG International, which patents and markets intellectual property rights for companies and universities.

Ian A. Henderson is managing director of northern Europe operations, based in London, for Sunnyvale, CA-based Hyperion Solutions, a $375 million financial management and analysis software products firm.

William M. Hjerpe is president of Europe, Middle East, and Africa operations - based in Brussels, Belgium - of Minneapolis, MN-based Honeywell, an $8.03 billion provider of control technologies for buildings, homes, industry, space, and aviation.

Sir Martin Jacomb is chairman of Prudential Corp., a London-based life insurance company managing almost $200 billion for customers in the U.K., Asia, and the U.S.

Julian F.K. Lee is chairman of Orpington, U.K,-based Allied Carpets Group, a brand retailer of carpets, with turnover of $452.6 million.

William Mayer is chairman of the Chief Executive Group and managing member of New York City-based Development Capital LLC, an active value investment company.

Ian Menzies-Gow is chairman of U.K.-based Geest, a food and food products distributor with turnover of $710.7 million.

Umberto Quadrino is CEO of Amsterdam-based New Holland, a $7 billion unit of Fiat, which manufactures agricultural and construction equipment.

Simon Reuben is co-CEO of Trans-World Group, an approximately $6 billion diversified global conglomerate specializing in metals and mining, as well as trading, marketing, engineering, shipping, and financial services.

Carl G. Symon is chairman and chief executive of the U.K. and Ireland operations of Armonk, NY-based IBM, a $78.5 billion computer hardware, software, and peripherals company.

Richard Vissers is president and CEO of Wilmington, DE-based CTS Corp., a $500 million software company specializing in bulk fare, business-to-business travel.