Rising Stocks and Changing Germany

Construction cranes, dotting the horizon of Berlin as Germany builds its once and future capital, reflect the confidence that is rising throughout Europe these days.

As the Continent moves toward the January introduction of a single currency--the euro--experts are counting the superlatives. Having all the stock markets trade in a single currency “will create the world’s second-largest equity market after the U.S.,� says a research paper from the Deutsche Bank.

That is likely to increase investments across Europe and further push up already high stock prices. Professional money managers in Europe and the U.S., turning away from the troubles and uncertainties of Asia, continue to see Europe as an attractive place to invest.

European companies, goes such thinking, when compared with U.S. companies, are at an earlier stage of the cycle of merging, downsizing and splitting off operations that is called restructuring. So the pros expect that cash will be freed up for stock buybacks and acquisitions as the Europeans adapt to the competitive demands of the global economy and the Information Age.

But there are big ifs about Europe’s economies. Unemployment remains high--11.2% in Germany, 12% in France and 14% in Italy. Yet many European workers and political leaders recoil at words such as “restructuring.� They don’t want Europe to, as they say, “go the way of America� with job uncertainties and social changes.

Nonetheless, change is going to happen in Europe, and nowhere more importantly than in Germany, the Continent’s clear leader with more than 80 million people and an economy totaling $2.4 trillion in total output.

Germany’s problems are high taxation, underfunded pensions, lagging technology and uncompetitive cost structures. Those are problems shared by other Europeans and countries in many parts of the world. So the way Germany reforms its economy will have implications for the global economy.

The troubles begin with high taxes and payroll deductions for social security. For average wage and salary earners and their families, taxes--income taxes at 35% and social security at 19%, plus consumption taxes--add up to more than 60% of income.

Taxes on corporations run at 45%, and entrepreneurial taxes are higher, at 47% to 53%, which explains why there are few entrepreneurs.

Regulatory restrictions--for example, on experiments in biotechnology--have also held down entrepreneurial initiatives in Germany and elsewhere in Europe.

Germany is uncompetitive even with other European countries, but it has avoided being penalized on that score because it has operated as the lead economy in a partially closed system, the Common Market. The average German wage, $27.81 an hour, is one-third higher than the European average and 56% higher than the U.S. average. That’s why major automobile firms, Daimler-Benz and BMW, set up manufacturing in the U.S. five years ago.

The taxes and social security deductions are so high because the government pays old-age pensions and is responsible for much of medical care.

But there is a looming crisis in pensions that will force the reform of the German economy. As the German population ages and people live longer, the future pension debt of the government will be overwhelming.

The government and much of German industry recognize that today’s system won’t be able to pay the future pension bill. So Germany has begun to encourage private pension funds, which in turn will increase the size of stock markets and the spread of stock investing.

Private pension funds in Germany and most of Europe have never reached the importance of such investment funds in the U.S. and Britain, where retirement savings have built up giant capital markets.

In Germany, companies traditionally have been financed by banks. The German stock exchange has fewer than one-twelfth the number of companies on U.S. stock exchanges and one-fourteenth the total market value.

Now all that will change. Pension funds and the ease of investing across borders with the euro will increase the size of markets and encourage individuals to invest in stocks and mutual funds instead of bank savings accounts.

It won’t take much to encourage the German people. They are already investing in Frankfurt’s neuer markt, or new market, which was set up only two years ago to encourage start-up companies. Venture capital is in its infancy in Germany, but funds are organizing.

In other countries, too, stock markets are being organized and private pension funds are being urged to seek greater returns in stock investments. France has a nouveau marche for small companies. Morgan Stanley, the U.S. investment firm, foresees pension funds shifting from focusing on separate countries to investing by industry across Europe and around the world.

The growth of an “equity culture,� as German bankers are calling it, will dictate changes. Companies will be judged on return on investment and stock price performance. Companies will adapt technology and outsource operations to reduce costs. There is pressure from industry to reduce taxes.

None of this is without controversy. Workers have demonstrated against restructuring. A leader of the Social Democratic party, which may win the chancellorship in the September national elections, advocates greater government use of tax money, not less. Change is not universally welcome.

“I am not concerned about Europe’s corporations being willing to change, but I worry about Europe’s societies,� says Stephan-Gotz Richter, president of Transatlantic Futures, a Washington-based economic consulting firm.

But change is inevitable, as leading German companies have been saying for years. Daimler-Benz, the maker of Mercedes cars, decided three years ago that it needed a broader capital market to finance its business. So it changed its accounting system to meet the regulations of the U.S. Securities and Exchange Commission and listed its shares on the New York Stock Exchange.

Since then, 10 other German firms, including the chemical firm Hoechst, Deutsche Telekom and Pfeiffer Vacuum Technology, a supplier to the semiconductor industry, have registered with the SEC. In fact, more than 1,000 companies from all around the world have registered with the SEC to gain access to U.S. equity markets.

The meaning of such U.S. stock listings is not that business is being disloyal to Germany or to any other country, but that business leaders recognize that global capital markets are the only hope for financing industry and creating jobs.

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Pensions in particular are a worldwide concern--whether it’s fear about the Social Security system in the U.S. or worries about inadequate pension returns in Japan. But in the U.S. and Britain, private pension funds, tax-deferred savings plans such as 401(k)s and other mechanisms have funded an enormous resource for paying pensions and financing industry.

And those retirement savings have funneled investments to small, technology companies in the U.S., the “Silicon Valley� phenomenon that is the envy of European economic planners in particular.

So Europe is changing. After a half-century of development of the European Union, young people are moving easily across borders to get better jobs. The coming of the euro and multinational investing will facilitate such movements. That’s why investor confidence is rising.

And in Berlin, where 50 years ago U.S. and British planes airlifted food and supplies to a blockaded city, building cranes herald a new era.

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James Flanigan can be reached by e-mail at [email protected].

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Comparing U.S., Germany

Population

Germany: 81.6 million

U.S.: 270 million

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Gross domestic product

Germany: $2.4 trillion

U.S.: $7.4 trillion

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Avg. hourly wage

Germany: $27.81

U.S.: $17.73

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Unemployment

Germany: 11.2%

U.S.: 4.3%

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Avg. individual tax and Social Security payment

Germany: 54% of income

U.S.: 37% of income

Sources: OECD Economic Survey; U.S. Bureau of Labor Statistics; Morgan Stanley Dean Witter

Small Street, Not Wall Street[

Despite the size and importance of its economy--$2.4 trillion in gross domestic product--Germany has comparatively few companies financed by public stock. That has hurt the economy’s ability to earn a return on retirement savings. Pensions are underfunded, so public offerings are on the rise. As the table of international equity totals shows, Germany’s stock market culture has a long way to go.

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Country No. of publicly traded cos. Market capitalization United States 8,559 $19.5 trillion 11 countries in 2,769 4.9 trillion the European Monetary Union* Britain 2,456 3.8 trillion Japan 2,334 3.7 trillion Germany 699 1.4 trillion

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*France, Belgium, The Netherlands, Germany, Italy, Spain, Luxembourg, Ireland, Finland, Portugal, Austria

Sources: Federation of European Stock Exchanges, Deutsche Bank Estimates; Tokyo and New York Stock Exchanges.