Bloomberg BusinessWeek
By Peter Coy
During the Olympics, the ad ran constantly: A red Cadillac ATS speeds through hairpin turns in Morocco’s Atlas Mountains as a wide-eyed wingman yells, “We’ve been going as fast as you possibly can without taking this thing off the side of a cliff!” The disc brakes that make this stunt possible are from Brembo, a company in the Lombardy region of northern Italy. Brembo is not what you picture when you hear people tossing around phrases about Italy like “profligate” and “basket case.” It’s an elite export powerhouse, with €703 million ($871 million) in revenue in the first six months of 2012, up 11 percent from a year earlier. In Germany, its biggest market, Daimlergave it a supplier of the year award in 2011. “The performance of our order backlog allows us to look toward the coming months with confidence,” Chairman Alberto Bombassei said on July 31, when he announced rising first-half revenue and profit.
Overlooked in Europe’s financial crisis is that some of the countries in the biggest trouble have quietly improved their international competitiveness since the crisis began in 2008. They’ve cut back on imports and increased exports. Spain’s trade deficit is a quarter what it was before the crisis. Italy ran a €1 billion trade surplus in May, the last month available. Ireland has lowered its labor costs dramatically. Even Portugal has become less dependent on foreign capital, the International Monetary Fund noted last month.
The great tragedy of Europe is that it’s ever so close to pulling itself together—but perhaps not close enough. International lenders are losing confidence in the ability of debtor nations to earn their way out of indebtedness. They’re demanding higher yields to compensate themselves for greater perceived risk. If they drive borrowing costs any higher, countries that might have made it back into good standing in the international community will be forced into a chaotic cycle of default and devaluation.
For countries such as Spain and Italy to win over investors, they have to make a plausible case that in the long run they will be able to earn enough from exports to pay for all of their imports, with enough left over to cover the interest on outstanding loans. It’s that basic. So in the end, it’s not the diplomats and bankers who will decide the fate of the euro currency and the larger European Union—it’s companies like Brembo.
The ebullience over Europe during the first decade of the millennium was based on some real strengths. Even now, with borrowing costs rising and domestic markets shrinking, many of Europe’s export champions are performing admirably. A Spanish consortium recently won a contract to build a high-speed rail line in Saudi Arabia between Medina and Mecca. Spain’s Zara clothing empire is so successful internationally that Amancio Ortega, who founded its parent, Inditex, just bumped Warren Buffett down to fourth place in the Bloomberg Billionaires Index. An Italian shipbuilder, Fincantieri, won a bid to build a pair of superluxury liners for Viking Ocean Cruises. AgustaWestland, another Italian company, is selling helicopters to Algeria. The list goes on.
That’s not the whole story of the region, obviously. Southern Europe is saddled with less efficient manufacturers and a sclerotic service sector whose high costs drag down exporters. Workers for exporters have to receive high salaries because they have to pay so much for milk, beauticians, and lawyers.
Currency union was supposed to drive all of Europe toward greater efficiency and cheaper hair salons, but it contained the seeds of its own destruction. Prices began to rise to uncompetitive levels in peripheral nations such as Greece, Portugal, and Spain. Without their own central banks, which could raise rates to chill inflation, the countries were powerless to do anything about it, says Muir Macpherson, an economist for Bloomberg Government. The high-cost countries lost their competitiveness and began running trade deficits. Surplus nations such as Germany, the Netherlands, and Finland were willing to underwrite those deficits until suddenly they weren’t anymore, and the Continent’s crisis began.
Parachuting out of the euro is one quick solution, and may ultimately be the best one for Greece, which has problems even deeper than stuck wages. Devaluation is shock therapy that closes the trade gap by putting a country’s goods on drastic markdown and making imports impossibly expensive. But it causes instant misery by putting even basic necessities out of reach, triggering defaults by both the government and private companies and wiping out the banking system.
That’s why for most of Europe’s bigger, healthier economies, the preferable solution is to stick with the euro but narrow the yawning competitiveness gap that caused their problems in the first place. That requires “internal devaluation,” a grinding process of cutting workers’ pay while trying to improve their productivity.
Internal devaluation is starting to correct Europe’s imbalances, albeit gradually, according to a monthly report from the European Central Bank. Germany is the long-term competitiveness champ, having reduced its costs by 14 percent since 1999, according to the central bank’s “harmonized competitiveness indicator.” But over the past year the biggest improvement, 7 percent, was recorded by Ireland.
Private organizations have also spotted competitiveness improvements in Europe’s periphery. A July 27 study from the Conference Board, a global research organization with corporate memberships, gave Ireland top marks for cutting its unit labor costs by more than 6 percent from the beginning of 2008 to the end of 2011. (Hungary topped all countries studied, with a unit labor cost decline of nearly 12 percent, due largely to a big currency devaluation.) Other euro area countries that outdid Germany in cutting those costs since 2008 include Spain, Portugal, Greece, and Italy.
Germany, which cut costs mercilessly for the first decade of the euro, did the rest of Europe a favor by allowing its unit labor costs to rise nearly 9 percent since the start of 2008, according to the analysis by Conference Board economists Bart van Ark and Bert Colijn. With German unemployment at a two-decade low, unions have been pushing for wage increases well above inflation.
Unfortunately for European unity, both halves of this solution—southern devaluation and northern revaluation—have their limitations. In the less competitive nations, costs are falling only because high unemployment has crushed workers’ bargaining power. That’s not a healthy fix. Also, if companies cut wages too much, employees can’t pay their mortgages, car loans, and other debts. The Wall Street Journal recently reported on the dilemma of an underwear factory owner in Greece who said, “If I cut their pay, they can’t survive.”
And while Greece can’t push its wages much lower, Germany resists letting its labor costs drift much higher for fear of losing ground to tough rivals outside the euro region. Macpherson argues that for Germany, allowing more inflation in the core of the euro zone to right the competitiveness imbalance is “the least bad option.” Chancellor Angela Merkel and Bundesbank President Jens Weidmann don’t appear to agree with him.
The logic leads back to Brembo and its world-beating kin—companies that have used innovation and discipline to earn their way in the world without subsidies or diplomatic protection. Brembo was founded as a small machine shop in 1961. It began making auto disc brakes for Alfa Romeo and later expanded to motorcycles and Formula One race cars. Now it operates internationally out of a bright-red headquarters in the Kilometro Rosso science and technology park in Stezzano.
For the EU to survive, entire countries have to get faster, stronger, and cheaper—like Brembo and Zara. They’re beginning to. The question is whether it can happen quickly enough to keep this thing, as the wide-eyed wingman says, from going off the side of a cliff.
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