Europe Closes the Gap

By Henry Muller/Paris

When an American Internet merchant like Jeff Bezos joins Charles Lindbergh and Winston Churchill in the pantheon of TIME's Men of the Year, it's all too easy to assume that the economic future belongs exclusively to the U.S. and that Europe will become a quaint museum dependent on tourism and some luxury niches for its livelihood. Too easy--and wrong. While the Old World is still bedeviled by archaic habits and practices, it enjoys a global lead, possibly unsurpassable, in certain sectors that are at the heart of the technological revolution.

Take the mobile phone. If it's impossible to sit in a Milan cafe without being drowned in competing phone conversations, the reason is not only that Italians like to talk. European wireless technology is simply more sophisticated and user friendly than that in the U.S. Europeans can already check e-mail and get news bulletins on their cell phones, and soon they'll surf the Net and shop online from mobile phones that double as fashion accessories.

Another increasingly ubiquitous, albeit less visible high-tech object is the smart card. Many a European wallet now includes one or more cards embedded with a memory chip, which may hold anything from a cash balance to be spent on small purchases to personal information that reduces the possibility of credit-card fraud--or even, as in France, a complete medical history. Three French companies produce more than two-thirds of the world's smart cards, a $12 billion business set to explode as companies discover the limits of the familiar magnetic-strip card, which can hold relatively little information and is not nearly as secure for e-commerce. Jean-Marc Giry, vice president for strategic marketing at Gemplus, one of three French firms that dominate the world market for smart-card banking applications, expects most U.S. banks and credit-card companies to begin issuing smart cards this year.

Then there's Airbus, long ridiculed by Boeing as a massive pork-barrel project for second-rate aircraft manufacturers. Last year the European consortium captured 55% of global-passenger jetliner sales, outflanking Boeing for the first, but probably not the last, time. Competitive prices and superior salesmanship are factors in the success of Airbus, but so is technology. Airbus beat Boeing to the market with computer-laden "fly-by-wire" technology, which, it says, enhances safety while lowering costs. The flying experience is so similar from model to model that Airbus-equipped airlines save millions of dollars in training costs.

The common thread in these examples is a uniquely European approach to business. While the U.S. has embraced the pure marketplace with ideological fervor, Europeans continue to believe the state has a role to play in guiding markets. Exhibit A is the GSM (global system for mobile communications) standard introduced in the European Union in 1991. Thanks to GSM, a subscriber in Portugal can use her phone from Ireland to Hong Kong. The U.S., in contrast, still allows various incompatible standards to compete like trains running on tracks with different gauges. As a result, a New Yorker cannot use his cell phone in London and, depending on his carrier and his instrument, sometimes not even in St. Louis.

Europe is becoming more competitive just as its economic prospects look better than at any time in a decade. Business and consumer confidence is on the uptick, and there are indications the region is on the cusp of a period of extended growth, perhaps equal to the near decade of good times the U.S. has enjoyed. Most economists predict steady annual growth of 3% for at least the next three years, with no inflation to ruin the party. As in the U.S., technology and its impact on productivity may push Europe's normal economic cycle beyond historic levels. "Some elements of the new paradigm are in place," says William Kennedy, an economic historian at the London School of Economics.

The euro, introduced little more than a year ago, has been crucial in accelerating the pace of change. Those who wring their hands over its declining value in 1999 miss the point. "The euro has allowed Europe to almost completely overcome its historical weakness of market fragmentation," says Albert Bressand, economist and director of Paris' Promethee think tank. "It's created a larger, almost seamless economy roughly the size of the U.S. economy." The euro's undervaluation has, in fact, given European exporters a shot in the arm by lowering their prices in overseas markets. Most experts foresee a rise in the euro, perhaps to the $1.10 level, this year, but by then, they say, Europe's consumers will be generating enough demand of their own to power further growth.

European competitiveness has also been spurred by a continuing trend toward corporate restructuring and by further deregulation of a true single market where prices are increasingly denominated in euros rather than in marks, francs or pesetas. Hardly a week goes by without the announcement of a major consolidation--the $198 billion proposed takeover of German mobile-phone provider Mannesmann by British giant Vodafone AirTouch will surpass the AOL-Time Warner/deal as the largest merger ever. The most auspicious development of the past year, given Europe's historic fragmentation along national lines, is the cross-border merger. Aventis is the new, conspicuously neutral name for what used to be Germany's Hoechst and France's Rhone-Poulenc. Nor are Europeans confining their targets to the Old Continent. Even a few years ago, it would have been hard to imagine Renault buying Japanese carmaking giant Nissan or Daimler-Benz acquiring Chrysler.

These mergers are creating a single global-business culture in which national interests no longer determine corporate behavior. Shareholder value is the new mantra in Europe, where corporate control has long been clubby, and the shareholders of an Aventis or a DaimlerChrysler are now as likely to be a California pension fund as a bank in Austria. This new business culture cares little whether its products are manufactured in Stuttgart or Shanghai; and it is as likely to find an executive or a new idea in Buenos Aires as in Brussels. "The economic imperatives behind such consolidation bring about a mixing and altering of business cultures that no one can impose or ignore," says French economist Jean-Marie Chevalier. "It requires larger, global-thinking vision and management. What nationality is a DaimlerChrysler or a Hoechst-Rhone-Poulenc? The markets certainly don't care, and neither, at the end of the day, does the consumer, if product quality and price are roughly the same."

No sector will have more impact in the years ahead than wireless. The adoption of the common GSM standard gave Finland's Nokia and Sweden's Ericsson a home market of more than 300 million, counting only Europe, and many times that if one includes Asia, which also adopted GSM. Europe's lag in traditional telecommunications helped too, of course. Until Jan. 1, 1998, most European telecoms were still overregulated, state-owned entities, gouging their customers for services that were less efficient and less innovative than in the U.S. Local calls were essentially free in the U.S., so when mobiles came along, they seemed comparatively expensive.

In Europe, however, mobiles came into being in a deregulated wireless market in which cutthroat competition ensured low prices, speedy market penetration and innovations such as pay-as-you-go phones. Operated by prepaid cards, they do away with the need for credit checks, deposits and other ornery paperwork that inhibited customers. In addition, Nokia and Ericsson showed huge creativity in making cell phones fashionable, ensuring quality and keeping up with fast-paced technological change. "In Italy the must-have fashion accessory is a WAP [Wireless Application Protocol] phone in chartreuse," notes Marie Wold, manager of the communications-industry practice at Deloitte Consulting.

That said, the GSM standard offered Europe a one-time advantage. Wireless companies around the world are preparing to adopt the so-called 3G standard (for third generation). Although the phones will eventually work all over the world, there will be three variants of 3G: European (already adopted by Japan and most of Asia), U.S. and Chinese. Acceptance by Japan means the European version already has a head start, so there is a good chance that it will be the one to win out with customers. Says Falk Muller-Veerse, head of European research activities at Durlacher, a research and investment group: "Nokia will continue to be in the driver's seat because they are not following the market, they are making the market."

In addition, the precursor WAP phones, which can handle short data transmissions, are already taking off in places like Finland, where users can download such short messages as weather reports and market updates. Wold points out that because U.S. companies have just completed expensive investments in networks for current-generation mobiles, there will be no great appetite for massive new spending.

Europe's wireless revolution is having an impact well beyond the phone industry. By making all commerce--business-to-consumer and business-to-business--more efficient, quicker and ubiquitous, wireless technology "will give the [European] economy another kick in the right direction," says Hugh Jagger of Ernst & Young. Moreover, by freeing up the Internet from PCs, wireless will make e-commerce genuinely mobile, increasing its penetration in Europe.

Europe Unlimited, a Brussels-based research firm, tracks the growing number of European companies that are winning shares in the global-technology markets, creating jobs and wealth with innovative products, aggressive acquisitions and smart niche strategies. Its latest list shows that 127 of Europe's 500 fastest-growing companies are from the tech sector. These companies boast an average annual growth in revenues of 42% and in employment of about 36%. Among the strongest sectors are smart cards, encryption software, e-commerce software, electronic games and digital television.

The two companies on the list from the smart-card sector are Gemplus and a smaller German firm, ASG. They are both well positioned to cash in on the mobile-commerce craze, says Caroline Martin, an e-commerce analyst in the London office of Datamonitor. So-called SIM cards are already present in all European mobile phones to identify users for billing purposes. Once new phones with wireless Internet access come on the market, these smart cards will be used to encrypt a consumer's credit details and send them securely to merchants over the Internet.

The smart card was invented by a former French journalist and technological autodidact, Roland Moreno, in the 1970s. Initial applications centered on ID cards, but by the 1980s--in another example of state-led adoption of new technology--France Telecom introduced prepaid telecartes that rendered coins in phone booths obsolete. Applications quickly blossomed as the association of Carte Bleue debit cards ordered their banks to fight fraud by issuing only chip-embedded cards, and as France Telecom issued the Minitel with smart-card readers to enable online purchase of everything from opera tickets to train reservations--well before anyone had heard of the Internet.

Gemplus' Giry anticipates a global explosion in the use of smart cards. "The potential applications are innumerable and provide almost total security and reliability of identification," he says. Giry explains that the cards themselves are inexpensive to produce, so that the only brake on use has been unwillingness of merchants to invest in readers and communications devices. The countries that have not adopted smart cards have been waiting until losses from fraud and theft start to outweigh the costs of updating hardware.

He believes the U.S. has reached this point, and anticipates that finance companies like Citibank and First USA will follow the recent move by American Express to issue smart cards to their clients, as well as readers for their PCs at reduced prices. Noting Motorola's decision last year to pull out of an already tight global smart-card market, Giry expresses confidence that new players will not be able to take on the three French companies that have more than 70% of the global-production market: Gemplus, Schlumberger and Bull.

European governments are also playing a positive role by helping to jump-start high-tech companies. Germany, for example, held a competition to identify the three top bio-tech "clusters"--areas specializing in the field. The winners were Munich, Heidelberg and Julich, each of which received $25 million to give to start-up companies for pure research. In addition, both the German national government and state agencies pushed start-up financing that matches the risk taken by venture-capital firms. They also encouraged the creation of the Neue Markt, a sort of German NASDAQ. As a result, there are more than 80 bio-tech firms in Munich, including Morphosys, which has a library of 10 billion human antibodies.

In spite of such successes, Europe's promise will be fulfilled only if its political leaders continue to enact the reforms necessary to make the Continent more competitive. Much has already been done. Governments are ridding themselves of state-owned monopolies, liberalizing trade and slashing national budget deficits. Germany has promised to cut corporate taxes from 55% to 38.5% in 2001. Likewise, France plans to remove a tax surcharge that will reduce the corporate rate from 41% to 39%.

France, which had made it virtually impossible to fire anyone, now allows limited-duration contracts, a measure that is credited with creating some 300,000 jobs. But there is still a need for more measures to loosen sclerotic labor markets and junk regulations that inhibit entrepreneurship and the flow of capital. France's 35-hour week, while not as bad as many had predicted, was an unnecessary reminder that the country's bureaucrats still believe they should mandate everything down to the cafeteria menu. German Chancellor Gerhard Schroder's decision to bail out the bloated, bankrupt construction company Philipp Holzmann also sent a confusing signal.

As the successful application of the GSM standard shows, European governments can clearly play a role in guiding the Continent's economic future. But they will be most effective if they avoid regulations that limit what people can do and instead focus on creating an environment in which some of the world's most innovative people can prosper by taking smart risks and working hard.

--Reported by Bruce Crumley and Jennifer L. Schenker/Paris, James Graff/Brussels, Thomas Grose/London and Charles P. Wallace/Berlin

With reporting by Bruce Crumley and Jennifer L. Schenker/Paris, James Graff/Brussels, Thomas Grose/London and Charles P. Wallace/Berlin