From Our European Bureau: Consequences of the American Slowdown on the European Economy and Stock Markets By Francois-Eric Perquel August 10, 2001

The slowdown in the United States has caused some notable repercussions on the European continent. There are many reasons for the strong ripple effect, including market correlation, the impact of fully globalized industries, and the lack of pragmatism on the part of Europeans.

It is well known that European stock market activity slows down before Wall Street opens. This enables European investors to take the pulse of the U.S. market and follow developing trends during the rest of the day. The availability of information and the rapid speed of international transactions have caused secondary markets to become increasingly dependent on Wall Street. In a negative climate like the current one in the States, market correlation almost always increases. The slide in the U.S. markets has therefore replicated itself in European equity prices.

The American slowdown has primarily impacted industries like telecommunications and information technology, which are more globalized sectors. As a result, a reduction in sales of mobile phones anywhere in the world directly hits European companies like Nokia, Ericsson, and Alcatel. This has caused many European companies to begin restructuring in anticipation of the effects of the slowdown. For example, Alcatel has declared its willingness to become a company without production plants.

Generally, Europeans tend to lack pragmatism. Unfortunately, the European Central Bank (ECB) has proven even more rigid in the way it is run. Some analysts feel this lack of flexibility has been exacerbated by the mismanagement of the ECB communication system by its first president, Wim Duisemberg. These factors have increased the impact of the American financial recession by creating uncertainties in the market about the European monetary policy, and by increasing the cost of financing for European industries in general.

Despite these problems, Europe can take steps to limit the effect of the U.S. slowdown. When the euro does become an accepted currency, money could flow back to Europe from America. During the past two years, close to $1 trillion moved from Europe into the States. Among the reasons why so much money crossed the Atlantic are:

• The hope of better returns in a country that is more investor-friendly than the European Union. The investors who have chased strong U.S. returns need to be convinced that the European market will turn around before that capital returns. This process will be very deliberative, to say the least.
• The fear of not being able to change from local currencies into euros. This money can come back rapidly once the euro bills are circulating, potentially creating an inflow of capital in Europe of hundreds of billions of dollars.

Europe also needs to follow the U.S. in terms of being more supportive to its business community and trimming the weight of its state bureaucracies and social security programs. Some parts of Europe have made progress in this much-needed restructuring in recent years. There is still a long way to go, and unfortunately it appears that most of Europe isn't willing to push ahead with the necessary changes. Perhaps a real economic crisis could force Europeans to embrace reform.

The strong effect of the U.S. slowdown was not anticipated by most Europeans. If anything, Europe hastened the effects with the rigidity of the ECB policy makers. The current crises in emerging markets have also had an effect. However, there are still two factors that could help Europe recover- the potential for a huge investment flow in the short run, and the implementation of overdue fundamental economic and structural reforms.