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Paying people in the EC.

Independent pension plans, no-incentive stock offerings, hands-on works councils . . . the many faces of employment in the European Community. How does it add up for EC and North American companies?

With the North American Free Trade Agreement on the horizon, many people are focusing on employment costs, debating whether American jobs will be lost as companies try to boost profitability by moving tasks to Mexico, where employment costs are lower. Some executives say it's the only way to cut expenses and remain competitive. But what about the many U.S. companies that have European subsidiaries? How do employment costs compare there ? Are the issues the same?

January 1, 1993, marked the beginning of free trade within Europe's "single market," which means that a company operating in one European Community country can trade throughout the EC without meeting any other country's regulations. However, it doesn't mean the 12 EC countries are similar to 12 U.S. states.

Though EC law does in many instances overrule national laws, each EC country maintains its own taxation and social security systems and its own occupational practices. So, while a financial comparison of the cost of locating in the United States versus locating in Mexico is relatively straightforward, how do you cost out where to locate in Europe? The single market sounds fine in theory, but how do you make sense of it all?

The social costs of employment vary widely in the EC. We assume social costs -- those beyond an employee's take-home pay -- are the sum of the following:

* Social security contributions for both the employee and the employer.

* Income tax paid by the employee, since this has a direct bearing on the ultimate salary paid.

* Mandatory supplementary benefit plan contributions from both the employee and the employer.

* Private pension plan contributions by both the employee and the employer. Though these are voluntary plans, competitive pressures force employers entering the market to follow local practice. To ignore these would underestimate the overall social cost. (In the United States, this would include health care plans.)

For every $100 of take-home pay to a U.S. employee earning average compensation, the additional cost is $65, for a total of $165. But, in Italy, companies add 106 lira to 100 lira of take-home pay, more than doubling the total employment cost.

Of course, you must factor these social costs into your compensation calculations before you can determine the overall cost of an employee. A bigger question, however, is the difference in currency purchasing power.

As you can see, Belgium, France, Germany, Italy and the Netherlands top the league in cost, while the United States is in the lower half. Of course, no company would locate in a particular country merely because of employment costs. Infrastructure, communications, the local market size and the distance between that country and the population center of the EC all play a part. Being close to the customer is, after all, one of the major reasons to operate in different countries. Nevertheless, the United States compares very favorably to major European economies, such as Germany, France, Italy and the United Kingdom.

But what about the future? What's in store for multinationals already in Europe? And how should emerging multinationals prepare for the single market and the increasing influence of EC law?


Here are some of the compensation issues that companies in the EC, and their parents in the United States, are facing.

Pan-European Pension Plans -- Europeans are covered under socialized medicine, so health care isn't the major benefit European employers provide. Pensions are. This is true in the United Kingdom, Germany, Ireland, the Netherlands and France, while Spain, Italy and Portugal provide extremely generous pensions through their social security systems.

However, even given this broad interpretation, each country operates its pension plans under its own regulations. For instance, a company operating in the 12 EC countries hypothetically could have 12 independent pension funds. Think of the headaches a U.S. company would have if it had to manage a separate plan for each state.

As a result, the EC is advocating a Pan-European pension plan, in part to increase labor mobility and to encourage free capital movement. The EC initiative is currently in the form of a directive, or a discussion document that precedes legislation.

If the plan is accepted in its original form, a company will be able to offer one pension plan to all employees, wherever they're located in the EC. It also will have one investment fund and one manager to control the investments. Companies could see huge savings through economies of scale in administration, investment and actuarial work. However, several problems remain, and the EC countries haven't reached a consensus on how to implement a Pan-European policy.

Of the three parts to this policy -- smembership, investment and investment management -- membership has faced the biggest obstacles, centering around the diversity of tax and vesting qualifications throughout the EC. The individual and corporate tax rates are different in each EC country, and the mechanics to operate one European pension fund aren't in place. So far, these problems have been irreconcilable, and the membership issue has for now been moved to the too-difficult-to-deal-with tray.

Investment and investment management remain on the agenda. However, some EC countries dictate that pension funds invest a certain percentage in government securities. (Belgium, for instance, requires 15 percent in government bonds.) This alone contradicts the objective of capital-movement freedom. Other arguments concern the type of plans to be covered and whether, for example, industrywide or book-reserved plans should be included.

But, since the concept of a Pan-European pension plan is still part of the EC's objectives, several multinationals are beginning to consolidate functions to make investment management more efficient. For example, some have appointed one manager to handle all European equities while they continue to operate different funds in each country.

The insurance directives also are complete. Most multinationals now find cost-effective risk coverage in pooling arrangements (using one network for worldwide benefit insurances). These directives will allow companies to provide risk benefits (for example, death benefits) from one EC insurer and ultimately will mean more competitive local premium rates. Stock Plans -- While offering company stock to all employees, whether as a benefit or an incentive, is widely accepted in the United States, it's not in Europe. Only the United Kingdom, Ireland and, to a lesser extent, France offer tax advantages for granting company stock. And without the taxation incentive, employers are reluctant to establish the plans. However, the EC does encourage employees to take a financial stake in their employers through what the Community calls a "recommendation," which confers no legal power.

As with Pan-European pension funds, offering stock plans isn't widely accepted. Only a few of the largest U.S. companies have extended stock ownership to all their European locations, though many have extended their plans into the United Kingdom, Ireland and France. But even European companies are moving to more performance-oriented remuneration, albeit slowly. This no doubt will pressure governments to offer more tax advantages on stock plans.

Works Councils -- In Europe, employees are very involved in corporate matters that affect the workforce. Indeed, eight of the 12 countries in the EC have a statutory obligation for works councils, and the remaining countries set up voluntary or collectively agreed arrangements.

Statutory works councils are made up either entirely of employees, as in Germany, Greece, Portugal and Spain, or of both employees and management representatives, as in Belgium, France and Luxembourg. Their work revolves around their legal right of information, especially about their respective companies' social, economic and financial position; in some countries -- Germany, for example -- the councils also have rights to negotiate and co-determine.

The EC has drafted a directive that calls for EC-wide works councils for multinational companies that have at least 1,000 employees within the Community and at least 100 employees in each of two or more countries. Under the directive, these councils will have specific rights to, at the least, information on key workforce matters. And, since the original draft was written, the EC has amended it to include the works councils in "developing information, consultation and participation."

Although the Europewide employers' organization is basically against any such directive, its members anticipate the introduction of EC-wide works councils through various forms of voluntary action. In any event, the main thrust is toward employees getting more involved, and U.S. management should be aware of the trend if you want to avoid industrial conflicts. Social Security -- One trend in the EC is a gradual cutback in benefits, which many feel have been too generous. For example, Italy and France recently cut government-provided retirement benefits -- but didn't reduce social security taxes.

To understand the process, look at the population trends throughout Europe. People are living longer. This means benefits are paid for longer. And the population is shifting. A larger percentage of people are moving into the retired bracket, and this trend will continue. This means two things: First, proportionately, more people are claiming benefits from the already generous systems. And, second, the working population -- which pays the taxes to meet these benefit promises -- is shrinking.

The result? Governments are looking ahead, cutting back now and shifting the burden of any shortfall on to employers wherever possible. Recently, the Netherlands severely cut back state disability benefits. What happened? Most employers ended up improving their plans to make up the difference.

Part-Timers -- Currently, part-time employees often are excluded from benefit plans. But in the EC, as in the United States, the number of part-time employees is increasing. In the United States, this workforce is growing in part because companies are downsizing and hiring contract workers or part-timers to do specific jobs. Many of these workers would prefer full-time jobs, with the attached security of income and benefits, but companies are saving money by not providing benefits.

The EC, however, is driving legislation to make these employees eligible for company benefit plans -- in part because if part-timers are excluded from private plans and the majority of them are women, this may be construed as sex discrimination, which, of course, is illegal. So part-timers are being included in plans more frequently.


The picture is very clear. Legislation, either from the EC or from local governments, whether direct (for example, for part-timers' benefits) or indirect (as in cutbacks in state benefits), is shifting the cost burden on to the employer. At the same time, increased employee awareness, thanks to stronger legal rights, is making employees more vocal about improving their benefit plans.

So what are U.S. multinationals doing to manage their employment costs with so much legislation coming their way? Corporate treasury departments are playing a bigger role. Companies that run their treasury on a centralized basis and have established cost controls at home are extending the practice overseas to encompass all employment costs, particularly benefit plans. And they're establishing financial controls to assess both current costs and projected costs, so they don't wind up with benefit plans that escalate in cost. This is close to the hearts of U.S. financial executives, who first wrestled with the problem of getting out of domestic defined benefit retirement plans and are now doing their best to control their health care costs. With this in mind, you know the importance of understanding what's going on in Europe.

The first step may be to audit your European plans to assess your existing liabilities. For the more sophisticated multinationals, this means updating information (since you've most likely audited your plans before). For those new to the process, it may involve some diplomacy, as overseas subsidiaries often resent corporate involvement at first. But you have to overcome this hurdle if you're serious about understanding all of your liabilities.

The next step is to establish an organizational structure that forces local subsidiaries to go through the corporate treasury department with any local proposals, including a financial analysis, before amending any plans. Again, mature firms probably already have this structure in place; newer firms must build one.

In short, to manage employment costs efficiently, companies need to be aware of the financial costs of benefit plans, local legislation affecting the plans and the potential impact of overriding EC legislation. Companies that choose to ignore these costs run the risk of being in "agreement by default" and, somewhere down the road, may encounter major surprises as creeping legislation pushes costs onto the employer.

Mr. McKay is a senior actuary in the international division of Noble Lowndes in Chicago.
COPYRIGHT 1993 Financial Executives International
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Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:The European Community; employment costs in Europe
Author:McKay, Jim
Publication:Financial Executive
Date:Sep 1, 1993
Previous Article:No more wasted meetings.
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