WASHINGTON, Jan. 9 (UPI) -- The European Union has been a catalyst for economic growth policies, both among its core members and to its neighbors hoping to get in, for most of its evolution and operation. Investors have regarded entry into the EU -- and, before the EU, the EEC -- as an unambiguously good thing. And for most of its history, it has been.
In 1985, for example, when the G-7 began currency coordination with the United States, a key step in the EU's evolution, Europe needed and was able to combat nascent American protectionism through a managed decline of the dollar. This was a victory for EU diplomacy even before the EU reached its current level of development.
In the years that followed, lower and falling tax rates in America and parts of Europe (Switzerland, Britain) helped compel Germany, France, and others to adjust their own rates downward. During the 1990s, sweeping welfare-to-work reforms in parts of the continent, similar to such a shift in the United States, helped spur countries in the EU to raise incentives for work and lower the subsidies for non-work.
In recent years, though, the composition of the EU itself has changed, not to mention the world economy around it. The World Trade Organization has formed, with further multilateral tariff cuts. Alternative trade blocs have taken root, and grown, from the Americas to Asia. The euro has established itself, and performed impressively against the U.S. dollar and the Japanese yen. But the price of that effort has been high.
Most important, the nature of policy competition within the EU has subtly altered, and towards a not-so-subtle force.
Politically, governments are not encouraged to flourish in their own separate and federalist ways. Instead, in recent years, when the voters in Austria, Latvia, the Ukraine, and other EU entrants and would-be entrants had the temerity to elect leaders or adopt policy that the EU leadership didn't like, they were the object of a high degree of private and public pressure to bring their countries in line.
To be sure, a union, to be a union, must have some common standards and policies. But note: that standard was in one place in the early 1990s, and is headed in a different direction today.
On economic policy, when such countries as Poland, the Czech Republic, and a group of other states joined the European Union in recent years, the main issues had to do with how large a budget subsidy they could get, how few willing workers they would allow to emigrate to other EU states, and how much their policies on farming subsidies could be made to resemble those of France and Germany and the existing EU group.
In short, what began as a system that at worst allowed economic experimentation to bloom -- and, in some cases, was pulling EU members, and would-be members, towards economic liberalism -- has become a kind of exclusive fraternity or sorority that frowns on policy experimentation and meritocracy. The president and social chairman, Germany and France respectively, define "harmonization," in practical terms, as meaning that other countries within the EU must adjust their policies to match Franco-Prussian economic malaise and keep the euro strong. With the benefits of a common currency, it turns out, comes a large burden -- that of maintaining it.
The question is worth asking, whether investors looking for exposure in the European area are better off focusing inside the EU club, or outside.
If someone had applied this admittedly unorthodox view, say, one year ago, he might have focused his Euro-area (broadly defined) investments in such non-EU countries as Russia (not yet taken seriously for entry, but longing to be considered), Turkey (slowly gaining access to the club, but well outside now), Switzerland (outside by the choice of its own voters), and Britain (not participating in the common currency). How would such an investor have done, compared to someone investing in the recently joined members (Poland, Hungary) or the old core group (Germany, France)?
Well, on average, a portfolio invested in the EU core group mentioned above (France and Germany) declined 28 percent in the 12 months that ended in December. For the EU group as a whole, markets declined 25 percent. In the non-EU group of Switzerland, Britain, Turkey, and Russia, the decline (as a country average, non-capitalization-weighted) was minus 6 percent. And that average takes in Turkey, which plunged in the first half of 2002, but has emerged as one of the hottest markets of all since voters elected of a Muslim government several months ago -- one that France and Germany object to.
The tentative hypothesis performs fairly well if we take a more long-term, fundamental view of the same economies. Unemployment in the EU-area today stands at 8.4 percent. In the EU core of Germany and France, the average is higher, 9.5 percent. In the ex-EU group of Switzerland, Russia, and Britain, the average is 6.5 percent. Only in Turkey, 9.9 percent today, has unemployment risen substantially since 1997, when it stood at 6.5 percent. And unlike the EU members, Turkey's jobless rate has fallen in recent months.
And the trend is better. In Russia, unemployment has declined from 11 percent five years ago. British (5.2) and Swiss (3.3) unemployment rates have risen in sympathy with the European slump, but not as badly as within the group of full EU participants. Absolute inflation rates are higher in the ex-EU countries, but are trending down rapidly. Yet real wage growth in the ex-EU countries is approximately double the average rate in Germany and France since 1998.
It's unlikely that being in, out, or some mix, was the single factor that accounts for these differences. In fact, it's almost certain that those countries outside the EU would be performing even better if they had cracked into the EU trade union, but without having to alter their domestic economic policies on taxation and transfer payments in particular.
Evidently, however, on at least this superficial glance, whatever the costs of being outside the EU are, there are some benefits. The ex-EU countries with non-EU policies performed better than the members and the joiners that had EU policies. This is something for investors to keep in mind.
Normally, this is where come to a bottom line, along the lines of "buy Russia, Switzerland, and Britain," or "don't cover your shorts on Germany yet." This is far too big a leap to make, however, merely on the basis of the general analysis above. At this stage in wrestling with such large questions, my advice is simply a caution: It's imprudent to assume, merely because certain states have made it into the club, that their economies are necessarily going to turn up. Conversely, it's not prudent to assume that countries outside the EU, whether by their own choice or by non-admission, will under perform.
If you invested in the EU entrants or members four or five years ago, you invested in a bear market in Poland and Germany, and missed a great bull market in Russia. Likewise, you preferred the decline of 24 percent in France to the fall of 19 percent in Britain or 14 percent in Switzerland. (December 2001 to December 2002 prices.)
No doubt, in the coming months, the U.S. economy will turn up, and pull France and Germany, at least somewhat, out of their doldrums. Perhaps, given how far their markets have fallen, they'll have farther to go to the plus side. There is something to be said for what goes down must come up, in the long run.
But it may be that the real turning point for the EU awaits the day when the it gets back on its former course.
Until the voters in France, or Germany, or some of the other inner-core states show some Swiss-British-American-Russian style independence, or until Brussels and the other members of the EU consensus are willing to tolerate (or even imitate) the results of a little economic and political diversity -- well, until then, the European Union may remain as much a wet blanket than a growth catalyst. And the investment gains merely for EU entry may stand for "Essentially, Un-compelling."
(Gregory Fossedal is chief investment officer of the Democratic Century Fund, managed by the Emerging Markets Group, dcfund.net. His firm may hold some of the securities mentioned his articles. Individual investors should contact their own professional advisor before making any decisions to buy or sell these or any related securities.)
