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Sanctifying Eurocapitalism

 Salomons Judgement

Some people say that American companies are better than the European as they are more profitable. Those who dig deeper see that the American businesses have competitive advantages and that Europe is faced with true capitalism.

The big difference in equity valuations and profitability of American and European companies has been the subject of lively debate for years. I stopped counting the number of times I was told that American companies are simply better than European companies. And every time this statement was substantiated by the higher profitability of Americans.

Why bother looking at European companies to invest? More and more economists and strategists have put an end to it, as they think the old continent stands no chance of survival. But those who look beyond these assumptions see that Europe is actually doing much better than the United States.

Recent research shows that American companies are more profitable because their competition is less fierce. In June, the NBER (National Bureau of Economic Research) published an article with the beautiful title: “How EU markets became more competitive than the US markets: a study of institutional drift”. In this article, the authors look at the integration of the European Union in the last two decades when supervision increasingly became a Brussels affair. Since then, the benchmark for competition – the Herfindahl-index – in Europe has fallen below the level of the United States. The lower the score of the index, the more providers an industry has. This also applies to the individual European countries and is the case in almost any industry.

So, Europe is the market economy at its best. Why is that? The authors of the article point out that there is less pressure on the United States to break down cartels and also less attention is paid to the abuse of a dominant market position by companies. The graph in the article on the difference in expenses to lobbyists is illustrative in that respect. The explosive spending on lobbyists in the US keeps pace with the lesser competition. The consequences are worrying, as the lack of competition makes shares more expensive, keeps labor costs low and causes investments to lag behind. There is a lesson for EU policy makers because here too, the spending on lobbyists is slowly increasing.

Due to the lack of competition the Tobin’s Q – the ratio of market value versus the replacement value – of American companies has gone up a lot more in the last five years than it did in Europe. In other words, the valuations of US stocks have gone up faster. Business investment in the United States lags behind, as does income growth. The lack of competition is therefore also a social problem.

In practice, investors are not always concerned with (de)regulation and monopolistic behavior. The research however shows that this is wrong. It seems that a shortage of market forces causes growth in the United States to lag behind its potential and inequality increases. Other research corroborates this view. In the capitalist Valhalla, companies are more profitable due to the lack of competition, but they don’t invest. That is good in the short term, but in the long haul. In Europe, we understand the principle of a well-functioning market economy better. True capitalism is here on this continent. But – putting on my investment hat – can that please be reflected in somewhat higher valuations?

The author

Roelof Salomons

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