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Regional Servey
Wednesday, January 11, 2006
Old Europe's New Shine
As European Union leaders meet today in London to wrangle over EU budgets and the Anglo-Saxon vs. French model, global investors have already voted and been handsomely rewarded.
Many American investors seem to have written off Europe as a quaint low growth low return destination. This sort of attitude has caused them to miss some great opportunities. Let's look at a few.
Ireland was always seen as on the fringe of Europe, its population of 4 million (UK is 15 times larger) was always viewed a bit of a laggard. Into the 1960's citizens still had to pay for secondary education and as late as 1987, Irish GDP was only 69% of the European Union (EU) average. The unemployment rate was a dismal 17%. Suddenly, almost miraculously, its economy took off with average growth rates in the 1990's of 6.9% and by 2003 Irish GDP was 136% of the EU average with an unemployment rate of 4%.
How can we account for this remarkable turnaround? As usual, it is not due to one action but rather to a confluence of policies, timing and action.
In the late 1980's a grand deal was struck, labor would moderate its demands, freer trade was pursued, and corporate tax rates were brought down to ZERO for multinationals investing in Ireland. Education was also noticeably improved for its relatively youthful population, especially in the technology area. Within a short time, Ireland became the low cost production base in Europe and the money flowed in. Foreign direct investment was the key and now 1,100 multinationals, many in the high tech sector, established manufacturing and R&D operations in Ireland. More than 25% of all American investment in Europe goes to Ireland and Dell is its largest exporter. This, in turn, led to an export boom. The stronger economy also sharply increased labor participation including many more women.
The resultant rise of Dublin as a major city and financial hub also led to a tourist boom with more than 6 million annual visitors. Instead of talented Irish migrating to the US for opportunities, they were coming home in droves.
You can see how every action spins off and helps build sustained growth and momentum. Every action led to another in a virtuous cycle but the key ingredient for success was undoubtedly massive inflows of capital. Capital from foreign direct investment, from EU subsidies, from the exports, from stronger domestic capital markets, and from migration. Good open pro-growth market policies together with sizable amounts of capital can lead to economic miracles. The challenge for Ireland now is to maintain its competitiveness and momentum in the face of greater competition and higher costs plus a potential property bubble. Congestion in Dublin, which represents 33% of the population and 40% of GDP, is a bottleneck on growth.
The New Ireland Fund (IRL) is a closed-end fund that has done quite well. Over the last ten years it has an average annual return of 13% and during the last year was up over 35% It trades at a 10% discount to its net asset value and is managed by the Bank of Ireland.
Next, let's take a quick look at the host of this weeks EU summit, the United Kingdom which has benefited greatly for its openness to the world. London has grown in the last twenty years by 800,000 to reach almost 7.5 million. There are 300 languages spoken in London and the number of nationalities is approaching 100. The UK is one of only three European countries together with Sweden and Ireland that have given workers from Eastern Europe free access to its labor markets. Since last May 175,000 have accepted the invitation. The MSCI United Kingdom iShare (EWU) is up 12% over the last twelve months.
While Americans discuss the flat tax in Starbucks, many of the countries of Eastern Europe have already adopted one and this together with its low cost base, access to new EU markets and strong work ethic has led to a surge in growth. Because their stock markets are thinly traded, why not use the Austria iShare (EWA) as a proxy? Austria serves as a gateway to Eastern Europe and serves as its financial, transportation and logistical hub. Austria has also cut its corporate tax rate from 34% to 25%. The MSCI Austria iShare is up 40% over the last twelve months.
Germany's GDP growth has been anemic but its iShare (EWG) is up 16% during the past year. The reason, firms such as ABB and Siemens are not waiting for the politicians to tell them what to do. They are searching the globe for opportunities and winning big contracts.
Even the broadest European indexes are doing well. The MSCI EMU (EZU) iShare is up over 15% and the S&P Europe 350 (IEV) is up almost 16% during the past year while the S&P 500 is up 6.5%
Don't buy into the media's no-growth no-opportunity label for Europe. It has some of the world's best multinationals and controls 40% of the world's wealth.
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