A new way of doing business

Another financial factor that has made a difference is private equity, which from tiny beginnings only a few years ago has grown into an important force. In 2005 about €72 billion was raised in new capital in Europe, well over double the amount in 2004, according to PricewaterhouseCoopers and Thomson Financial. Most of that, €57 billion, was for buy-outs of existing firms. Of the rest, €10.9 billion was for new ventures and €3.6 billion for high-tech investment.

Different countries had different preferences: in Sweden and Britain 93% of the funds went into buy-outs, whereas in Germany only 43% was used for such transactions and 26% went to high-tech firms. In Switzerland the share of high-tech investment was as much as 87%. Most of this money comes from Britain (29%) and America (24%). Pension funds are now overtaking banks as the main source of finance because they are under pressure to invest some of their funds in something other than bonds and quoted equities.

The total invested by these funds was also a record, at €47 billion, spread over more than 7,000 separate companies. About two-thirds of the money was spent on buy-outs. Venture capital aimed at business start-ups accounted for just over a quarter of total investment, but accounted for three-quarters of the deals.

Critics think that private equity can be dangerous, burdening firms with debt and stripping out cash to pay the new owners a disproportionate return. Private-equity firms are inclined to move uneconomic production offshore, breeding strong resentment about job losses. And although they will probably have a great year in 2007, those critics argue, they may not be able to maintain that performance.

Others are more sanguine, pointing to the improvements in governance and management private equity usually brings with it. It is not afraid to take difficult decisions that family-owned and listed companies often shy away from. For Dominique Senequier, the boss of AXA Private Equity in Paris, it has an important role to play in making European business more competitive. For example, this might be done by “several companies in private-equity ownership getting together and then returning to the stockmarket”, she says.

Europe's politicians may still be talking of fostering champions, but European companies are streets ahead of them. They were already beginning to reform themselves to meet global competition; now the new financial-market capitalism is giving them a further boost. That new financial underpinning will dispense with the need for the old protectionism.

Some analysts think that changes in Europe have not gone far enough and that America will always lead because its open economy provides the best example of what the (European) economist Joseph Schumpeter famously called “creative destruction”. Last year's Nobel prize-winner for economics, Edmund Phelps of Columbia University, thinks that Europe will continue to lag in productivity and innovation because it has stuck to a corporate model of capitalism that takes the wishes of government and workers into consideration. But much of European business already operates outside its home country, far from the constraints of the old corporatism—which is anyway beginning to wane. The changes may not be as dramatic as in America, but they are reforming European industry and producing returns for shareholders to rival America's.

Although Europe will continue to lose old jobs in basic manufacturing, it will gain new ones in high-added-value industries and in services. Germany and France need labour-market reforms to introduce more flexibility, not to save old manufacturing industries but to foster new service ones. Now that global free trade is a reality and the rigid old financial structures are being swept away, things will change for the better. European business is on the move again.

Howard Read

Feb 8th 2007 From The Economist print edition

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