Can Europe Become More Like California?

Jean-Francois Theodore, chairman of the Paris Stock Exchange, was enthusiastic during a recent visit to Los Angeles and San Francisco. France was organizing a special stock market for small high-tech companies, he said. The aim was to emulate California, with its economy of “entrepreneurs and high-tech companies,” Theodore said.

The momentum of economic change is picking up in Europe, he added. French companies are restructuring, and France will soon have a law mandating corporate pension funds to swell sources of capital for industry. That will alleviate burdens on the state system of social security, which in France covers payments for child support and illness as well as retirement.

Germany and other European countries are likewise reforming their economies, striving to lower government deficits and restructure industry.

To Americans, it looks like a rerun of history. U.S. pension funds arose in the 1940s and have dominated financial markets ever since. Corporate restructuring has transformed industry and sparked anguished debates right through the early 1990s.

Now Europe is anxious about change. Demonstrations protesting cuts in social programs occur daily in the streets of Paris. But that’s part of the cure for systems in which basic taxation has risen to 60% of income and economic growth has been stalled for years.

“Those demonstrations are proof that change is occurring,” says Eugenie Arbillot, research director of Societe Generale Equities, a Paris-based investment company.

Something had to be done. Unemployment in France is 13%, and in Germany unemployment has risen to 12.2%, a 50-year high. Yet attitudes have changed. Where once there was scorn for the U.S. economy, now there is widespread admiration for its job-creating ability.

And there is special regard for California, which is seen, rightly, as having come back from recession and the decline of the defense industry by putting people to work in new industries related to computer and software development, business and financial services, foreign trade and entertainment.

So Europeans now are driving to do the same, talking these days of “shareholder value” and “venture capital.”

Their drive is having ripple effects far and wide. It is one reason for the surging U.S. dollar and weakening German mark, says Norbert Walter, chief economist of the Deutsche Bank. At the Berlin Group of Seven conference this weekend, “Europeans won’t act to stop the dollar’s upward trend because it helps their countries export and ease the strains of reform,” Walter says.

It may well be that the U.S. government is accepting a stronger dollar value to help Europe and Japan get their economies moving, agrees economist John Mueller of Lehrman Bell Mueller Cannon, an Arlington, Va., consulting firm. “And the dollar may go higher--to 1.80 marks, 125 to 150 yen--but not back to the extreme ratios of the 1980s.” It’s simply a sign of international cooperation, something you don’t hear much about these days, says Mueller.

Ironically, changes in Europe are little remarked upon in the U.S., where commentary is dominated by arguments about our own reforms. George Soros, who has made billions speculating in currency markets, has published an essay, “The Capitalist Threat,” saying that financial markets should not be trusted to solve problems. And a new book, “Everything for Sale,” by economist and journalist Robert Kuttner, praises the very economic systems that Germany and France are struggling to change.

Such arguments are abstract and misleading. A look at what is really happening in Europe--and in California--can reveal much more about the true foundations of prosperity and even why you might want to allocate some mutual fund investments to Europe in the next few years.

European corporate restructuring is maintaining its momentum, report economists Gary Dugan and Caroline Meroz of J.P. Morgan Co.’s London office, who have written a report on the subject.

The high German unemployment figures released last week indicate that restructuring is continuing. Companies are shedding operations to focus on core businesses, as U.S. companies have done. “There is anxiety but general acceptance that people have to leave old industries and go to work in new ones,” Dugan says.

But setting up new industries remains a problem. “There is abstract thinking about venture capital, but it will take a change in thinking about risk--a culture shift--for it to develop,” says Dugan. Europeans remain uneasy about backing start-up companies with a high risk of failure.

Yet backing just such companies has made California once again “the leader in most of the nation’s future growth industries,” says economist Stephen Levy, of the Center for Continuing Study of the California Economy in Palo Alto. The state did not develop new jobs in its old standby defense industry, but in new businesses.

But the jobs didn’t develop in a vacuum either, Levy notes. “The foundation of the recovery lies in the University of California system, in Stanford University and in government spending on defense and other research,” he says. In short, it was a cooperative effort of the public sector and private industry and finance, as are all developments in the economy.

That’s an important point. It speaks to the anxieties expressed by Soros and others that the economy and workers are being left adrift on the vagaries of financial markets. They are not. The new global economy actually works better than that.

In Europe, the markets are a mechanism for reforms to open up systems that have left millions of people unemployed. Even if supported by state welfare payments, that is not a healthy or secure economy.

And in the U.S., lest we get smug in our recovery, we should keep in mind that universities and schools need constant reinvestment and renewal, especially now that massive defense spending is no more. Here and abroad, prosperity is never automatic.