Global competition seems to be turning into a fight between Chinese and American corporate giants. However, structural forces and a changing mindset are challenging the old narrative about antitrust and industrial policy in Europe. Facing the risk of being left behind, Europe is in search of creating its own European champions.
Observations
- We have written before that a new type of digital conglomerate is on the rise, as globalization and innovations in digital technology increasingly advantage the most productive firms in each industry by reducing transaction costs and creating network effects. As a result, the “new economy” is increasingly dominated by very large firms with high profits and a low share of labor. Examples of these so-called “superstar firms” are Amazon in retail, Google and Facebook in advertising, and Apple and Samsung in consumer electronics. In fact, 18 of the 20 the largest tech firms are from the U.S. West Coast (i.e. Silicon Valley) and the east coast of China. Economists and regulators have recently warned that some sectors have an overly high corporate concentration, hindering competition and raising consumer prices.
- Despite the fact that they account for more than 21% of global GDP, the market capitalization of domestic listed companies in the European Union accounts for just 11% of global stock market capitalization. In comparison, the U.S. accounts for almost a quarter of global GDP, while its domestic listed companies for more than 41% of global stock market capitalization. The market capitalization of Chinese domestic listed companies is now almost equal to that of the EU, although China’s share of global GDP is much smaller (15%).
- The size of the median listed EU company is almost half that of the median American one. Chinese firms have almost caught up — the size of the median company there is 94% of the median EU firm — and this figure has been growing rapidly in recent years. As a result, corporate EU has a weak return on equity, which at 9% lags America (13%) and China (10%).
- Following the establishment of Europe’s internal market and the Eurozone, intra-European M&A accounted for almost one-third of global M&A between 2000 and 2005. However, when interest rates rose and liquidity dried up in the wake of the 2008 financial crisis and the subsequent Eurozone crisis, intra-European deals plummeted to an average of 6.5% of global M&A between 2008 and 2017. At the same time, domestic M&A volume in the U.S. and China were respectively four and two times as large in the last four years.
Analysis
In his book Capitalism against Capitalism, Michel Albert distinguishes between two forms or models of capitalism. The European form, or “Rhine model,” of capitalism, represents a “stakeholder approach”, long-term success and public consensus. This contrast with an Anglo-Saxon form, or “neo-American model,” of capitalism, which favors a “shareholder approach”, short-term profits and individual success. To this, we might propose to add a third: the Chinese form, or “Yellow River model” of capitalism, which focuses on private-public collaboration aimed at developing strategically important “national champions”, the controlled testing of new innovations and technologies in Special Economic Zones and centrally planned roll-out of successful prototypes, and incremental reform and protection of the Chinese economy.
With increased global competition from the U.S. and China, as well as an increased willingness among regulators to embrace the idea of European champions, a new phase of European corporate consolidation might dawn.
The American and Chinese types of capitalism, by their very natures, are more conducive to creating large companies. The U.S. has the world’s deepest capital markets which allow companies to fund growth, while regulation is tolerant towards M&A activity (e.g. U.S. antitrust focuses purely on consumer purchasing power) and its tax system stimulates the creation of large companies. The Chinese model of capitalism also stimulates the growth of large companies, but via different means. China’s markets are still heavily regulated, with the initial aim of protecting Chinese domestic markets and companies from foreign competition. Using subsidies and other governmental support (e.g. easy access to financing) Chinas’ government aims to create companies that are “national champions” which are of strategic importance to the government and that lead innovation in their sector. The general cycle begins with restricting foreign access to Chinese markets to let Chinese companies compete between themselves, after which a phase of domestic consolidation follows. The “survivors” of this process then merge into “national champions” which are then, in turn, gradually stimulated to expand their businesses beyond China. We have seen this process occur across several sectors, for example in railways (CRRC) and telecommunication (China Mobile). The same has occurred with China’s “new economy” companies, like Alibaba, Tencent and Baidu.
In contrast to these other two models, the European model of capitalism constrains companies’ growth by embedding private companies and markets in the broader socio-economic contexts. As such, companies have responsibilities beyond those to shareholder or strategic value, translating into more stringent regulation (e.g. tougher labor laws, or safety and health requirements for food and beverages) and less accommodative financial and fiscal regulation (e.g. corporate taxes). Furthermore, the EU’s fragmented internal market means that instead of being the second-largest market in the world, it is instead composed of a myriad of mid-sized economies, each with its own regulatory and fiscal frameworks. As a result, many European companies have their “national champions” (i.e. national railway, postal or telecom operators) that are then disadvantaged by lacking scale, political and financial capital formation compared to their Chinese and American counterparts.
However, in the wake of Brexit and Trump’s hostile stance, the continent is increasingly dependent on itself. As a result, Macron and Merkel are now in serious talks to reform the Eurozone and further integrating the EU, for example by creating a banking union, harmonizing tax rates and insolvency laws and establishing large EU investment to finance technological and scientific innovations. European regulators also seem to be more willing to allow large intra-European M&A. Last year, intra-European M&A more than doubled to $266 billion, compared to $177 billion in 2016, with several high-profile deals: Siemens merging with Alstom (transport), Luxicotta merging with Essilor (eyewear), Thales acquiring Gemalto (cyber security), ACS and Atlantia acquiring Abertis (infrastructure construction), and the asset swap between Boehringer and Sanofi (healthcare). Other industries, like Europe’s fragmented banking sector, are also looking to consolidate (i.e. Unicredit and Societe Generale and Barclays and Standard Chartered are in talks to merge their businesses), as well as in other industries where Europe is experiencing significant pressure from increased global competition (i.e. Bayer’s takeover of Monsanto and Airbus’ acquisition of a majority stake of Bombardier’s C series plant). With increased global competition from the U.S. and China, as well as an increased willingness among regulators to embrace the idea of European champions, a new phase of European corporate consolidation might dawn.
Implications
- The race to lead the development of the new technological revolution is increasingly one between China and the U.S. However, while Europe may not develop or lead these innovations, it is well-positioned to become a global player in the adoption and implementation of these technologies. As these ‘next-gen digital technologies’ (e.g. AI, 5G, quantum computing) are exponential technologies and thus highly disruptive, the European model of capitalism can maintain a middle between the Chinese and American models as by stressing public consensus by involving all stakeholders and aligning social and moral values with private interests. Recently, French President Macron said in an interview with technology website Wired that with respect to AI, “Europe is a place where we are able to assert collective preferences and articulate them with universal values”. Blockchain technology, a decentral, consensus-based government model, also fits in with this way of thinking.
- The West is increasingly challenged by China’s encompassing and long-term industrial (its Made in China 2025) and foreign (its Belt and Road Initiative) policy. As a result, the rise of China and its state-sponsored giants might become a new “Sputnik moment” for both the EU and the U.S. And indeed, the European Commission recently proposed a $20 billion fund to invest in AI, while the Trump administration is prioritizing federal efforts to boost innovation in quantum computing, has set 5G as a “national security priority” and recently appointed an “AI advisor” to the White House.
