• All-in for Europe

09 July 2021

To achieve its economic potential, should Europe move away from its ‘taking part is everything’ stance and compete to win? Deutsche Bank’s Stefan Hoops considers who holds the chips

At the beginning of the 21st century, technological, geopolitical and societal factors, complemented by exogenous shocks and crises such as the Covid-19 pandemic, have brought about rapid structural change in the economy. For most companies across most industries, the pace and scale of the associated adjustments pose a significant challenge.

At the same time, the upcoming transformation is developing into a global race in which market shares are shifting and market structures are being reshaped. It’s clear that, in free markets, the better idea and the successful orientation of the business model should decide the competition. However, this only applies if the framework conditions are as equal as possible for all market participants.

Is this currently the case, or are European companies now confronted with a series of locational disadvantages? Should Europe ensure equal opportunities for its companies, and if so, how? And what contribution can European financial institutions make? What strategic options are there to ensure Europe’s sovereignty in important areas such as data and payments? How should Europe position itself in a bipolar world dominated by the US and China?

In order to ensure the long-term competitiveness of European companies, these questions must be answered swiftly and a decisive game plan for the coming years must be defined. The respective strategies and tactical approaches of the other major economies should be taken into account.

Royal flush?

Imagine a poker game between the US, China and Europe. The US is clearly the chip leader; it has the most chips on the table, which allows it to play with complete confidence. It studies the facial expressions and behaviour of the other two players, uses all the tricks, bluffs, and sometimes goes all-in to force a decision. It does everything it can to keep its leading position.

China, on the other hand, behaves like the successful self-made millionaire who is happy to play a game with friends from former university days. China smiles at fellow players, sometimes it calls and sometimes it folds, and a clear strategy is not always recognisable to outsiders. Above all, China always remains relaxed, because it knows, “I have the deepest pockets, I have the most money – and at some point during the evening, I will win.”

Europe is, in theory, best prepared. Europe has read every book on poker and has absorbed the mathematics behind the game. It knows exactly who bids how much and what (applying the rules of probability) the next move will be. However, Europe never bluffs. What’s more, Europe believes that none of the other players ever bluff either. Europe plays rationally at all times, never misleads and assumes that the other two players behave likewise.

You can probably guess how the poker evening will end. Europe leaves the table as the loser. At home, Europe confesses to its partner that, while it did not win, it always stuck to a mathematically sound game strategy and therefore actually played the best. The others had cheated or simply been lucky − and who would want to win like that anyway?

"China has emerged as the second global superpower, with a gigantic domestic market of 1.4 billion people and a political leadership that is exploiting its economies of scale"

Similarities between the course of this hypothetical poker game and developments in the real world at the beginning of the 2020s are not coincidental. With its economic, technological and military strength and the dollar by far the most important world reserve currency, the US dominates global politics and the world economy just as the chip leader dominates poker. In a massive race to catch up, China has emerged as the second global superpower, with a gigantic domestic market of 1.4 billion people and a political leadership that is patiently, but consistently and adroitly, exploiting its economies of scale. In doing so, China sometimes behaves cooperatively, sometimes adopts a wait-and-see approach, and can sometimes be threatening. At times the leadership goes ‘all-in’ – for example, in the case of Hong Kong, where there are no compromises.

Europe may also behave consistently as a rule, but this is especially true when it comes to adhering to rules, values and agreements. Even when others fail to comply with these rules, Europe does not change its behaviour – at least, it has hardly done so at all to date. This attitude may be due in part to the heterogeneous nature of Europe, or to a lack of unity within the EU27 circle of countries.

However, Europeans have a growing awareness that their strategy and the pace of its implementation so far are hardly fit for the future. Several global trends are having a considerable impact on the economy, shaking up previous structures, questioning traditional behaviours and setting a new course for the coming decades.

Drivers of change

While some influencing factors are unique to individual countries, others impact the future competitiveness of companies and therefore require a significant transformation of many industries. In addition to a permanently low interest rate environment, these drivers include a change in consumer demand, ‘glocalisation’ (semantically, a combination of globalisation and localisation), the influence of digitalisation on business models and the inclusion of environmental, social and governance (ESG) criteria in capital allocation. 

Whether the Covid-19 pandemic has triggered or merely accelerated sustained changes in consumer behaviour can be passionately debated. Combined with societal trends such as the fight against climate change, which has an impact on both the demand for goods and the mode of production, the implications for the development paths of different industries are enormous. 

Comprehensive transformation programmes are the result. Industries that have been large and successful, such as aviation, now struggle to survive. All automotive manufacturers and their suppliers are reducing their focus on the internal combustion engine and − following corresponding political requirements and changes in consumer demand − are investing in electric vehicle technology. The automotive sector is probably the most obvious example of an industry that needs to reposition itself. But it is by no means the only one that has to follow a new development path if it wants to operate competitively and profitably in the future. Traditional industries and sectors are no longer guaranteed to survive in this new environment. Painful adjustment processes are sometimes unavoidable. 

Another trend that affects an export-oriented economy such as Germany’s is the so-called glocalisation. In past decades, companies could assume that the world economy would develop more or less in step with ever-increasing globalisation. Some individual world regions may have grown faster, others somewhat slower, but any deviation from the dynamics of the world economy was limited. 

After a phase of deglobalisation, Covid-19 led to a rapid renaissance of the local and regional. This was triggered by the fact that the lockdowns had severely disrupted international value and supply chains, with no quickly implementable alternatives. The very different growth and recovery dynamics in individual countries reinforce the local aspect of glocalisation. It is therefore increasingly important for companies operating globally to understand which local conditions, demand impulses, and also rules they have to follow for international success. 

The fourth globally relevant trend is increasing digitalisation. In many cases, this means much more than just a further sales channel for products and services. In addition to optimising and accelerating existing processes, it is creating entirely new business models or ways of doing business. 

One major development enabled by digitalisation is service-based business models, the so-called ‘Asset-as-a-Service’ (AaaS) offerings. The starting point for AaaS was the behaviour of a rising class of consumer that places less value on owning a car, a holiday home or another product. These consumers prefer to use the asset (and pay for it accordingly) only when they need it. Due to its obvious advantages, this calculation is now spreading in industry as well. If, for example, a company no longer has to buy printers for offices or forklifts for warehouses, but pays for the use of these items, it converts fixed capital expenditure into variable expenditure for business operations. For the providers of these AaaS models, there are a variety of implications; for example, with regard to data management, financing structures, logistics and payment processing.

China has emerged as the second global superpower under the leadership of President Xi Jinping

ESG frameworks

A final overarching trend that is becoming increasingly relevant for business is sustainability. This is often described using the abbreviation ESG, i.e. sustainable business under the criteria of environment (environmental protection), social (socio-politically responsible business) and governance (sustainable and transparent corporate management and supervision). The way in which these criteria are dealt with increasingly determines which companies get access to equity and debt capital and on what conditions. It is now standard practice for most major international capital-gathering institutions to analyse and evaluate a company’s ESG performance before making investment decisions. According to estimates by Deutsche Bank Research, by 2030 around 95% of all investment money managed worldwide will be invested with the help of ESG criteria.1 Companies must therefore develop a sustainability strategy and establish active stakeholder management if they want to attract capital flows.

Banks are challenged by these global trends in a variety of ways. On the one hand, they must adapt to these developments, and on the other hand, the regulatory environment continues to tighten. They must therefore adjust accordingly. More importantly, they have to create financial services for the new economic world and at the same time enable companies to finance comprehensive transformation and restructuring programmes.

Obviously, the free market should determine success and failure in competition. In order for the better ideas and the better management to win the competition, global equality of opportunity must be ensured. But are the framework conditions actually fair, or to the detriment of European companies? In what ways can European banks help to compensate for competitive disadvantages?

The framework conditions for financing in Europe differ considerably from those in the US or China.2 The US, for example, has the advantage of a much broader and deeper capital market through which companies can comparatively easily obtain venture or mezzanine capital, and thus also financing for structural change projects. In China, the state undertakes this task extensively and provides companies with the necessary funds in a variety of ways. But what might work effectively there cannot also be a viable path for Europe from a regulatory perspective due to the negative experience of strong state intervention.

Nevertheless, Germany and its European neighbours reveal a number of weaknesses in the financing of substantial transformations. It is true that state institutions provided capital quickly and abundantly during the Covid-19 crisis. However, this has mainly been in the form of senior secured bank loans, with often conservative guidelines on the use and repayment of funds. While this solves liquidity problems, it primarily maintains the status quo. Genuine venture capital, which could be used to invest on a large scale in research and development or the strategic repositioning of a company, is also necessary.

Broader support

One of the most urgent tasks for European financial institutions is therefore to develop a much broader and more innovative set of debt and equity options and make them available to companies. A fully integrated capital and banking union in Europe is needed to strengthen the clout of European financial players. However, the final establishment of such a union will still take some time due to the large number of issues involved. In the meantime, a collaboration of private and public capital can make a much-needed start and improve the supply of debt and equity options. One approach here is cooperation via support programmes that enable targeted transformation investment, while at the same time using market mechanisms wherever possible.

Additional requirements and opportunities for banks also arise from the phenomenon of glocalisation. In this changed environment, multinational companies can only exploit economies of scale if they also meet local framework conditions. In doing so, they must comply with a multitude of regional specifics, which often also affect specific types of finance, such as supply chain and trade finance. Banks have the task of serving as a global ‘Hausbank’ for companies by combining local knowledge with a global understanding of customer needs through their presence in many countries.

Increasing digitalisation is creating entirely new ways of doing business

Rules and structures

A particular challenge for the European economy is the issue of payment infrastructure. For simplicity, this is understood broadly here to include both technical infrastructure and the ‘provision’ of a currency to enable payment flows in the first place. While the former, in our perception, is mainly offered by private companies, payment flows in its own currency allow the state to exert influence. Since much of international trade finance, commodity trading and a high proportion of capital market issues is denominated in US dollars, these payments fall within the territory of US regulators. The US can therefore pick and choose who uses its currency and in recent years has increasingly exercised this power of intervention.

The area of technical infrastructure, defined here in simplified terms as the range of payment options, is also dominated by American companies. In most cases where European consumers make digital payments, they use US-controlled payment systems, either one of the popular credit cards or, increasingly in recent years, PayPal or Apple Pay. China has not accepted such US dominance and has long since established its own payment options, such as WeChat Pay and Alipay. Europe, on the other hand, has no payment system of its own for private individuals that can be used Europe-wide, apart from individual national offerings such as the German Girocard.

Theoretically, this could work, at least in a world where everyone abides by the rules and fair play is the highest priority. In reality, however, the current payment infrastructure set-up has long since proved to be a weighty disadvantage to the bloc. As in poker, Europe is becoming more vulnerable to bluffs and all-ins. After all, whoever controls the payment infrastructure also has, in effect, sole authority to interpret critical issues such as money laundering. It would be better to have a close international exchange to establish a common understanding and a coordinated approach.

Europe’s weakness became apparent during the US sanctions against Iran.
While the European Commission (EC) encouraged companies to do business with the country, the Americans prohibited this and threatened sanctions for anyone that did so. The result was clear: Europe’s economy complied with the American instructions and not with the recommendations of the EC.

The power to set the rules for international payments has become a potent geopolitical tool. China is placing great emphasis on a digital central bank currency in order to be able to offer an alternative to the US dollar, at least in the digital world. Europe, on the other hand, still seems to trust that this strategy should not be necessary between friends. However, giving up our own pipelines through which financial resources flow is comparable to a situation in which our domestic water and electricity pipes are controlled by our neighbour. Would we really take the chance that they would not cut off our electricity in the event of a neighbourly dispute? Or would we prefer to have sovereignty over our pipelines?

Europe’s building blocks

To ensure Europe’s sovereignty, three building blocks are key in the area of payment infrastructure:

  • The digital euro;
  • A usable European and Europe-wide alternative to American credit cards and online payment options; and
  • The denomination of global flows of goods − i.e. trade and trade finance − in euros.

This will only be possible through concerted action by politicians, regulators, commercial banks and businesses. In this way, the digital euro can help Europe retain sovereignty and autonomy over the use of currency and data. To make this possible, the focus should not only be on the necessary rules and regulation, but also on the potential future benefits for end consumers and trading companies. The EC has set itself the goal of strengthening the international role of the euro and making it more resilient. It therefore calls for and promotes euro-denominated investments and trading contracts, commodity derivatives and reference indices.

A highly developed technical infrastructure is needed for another reason. The increased digitalisation of the economy and the emergence of new business models such as AaaS are generating enormous amounts of data. While the digital linking of products (the Internet of Things) is still in its infancy, one can already guess what insights the resulting data will offer. But one central question remains unanswered: who actually owns the data generated by the Internet of Things? And who can use it, and for what purposes? Europe has accepted that American big tech companies have a near monopoly on collecting and analysing consumer data. But should Europe also give up the data generated by AaaS business models without a fight? Some joke that while the US has the ‘Internet’, Europe has the ‘Things’. Yet this is actually a starting point that can be built upon, or – to stay with the card game analogy – a pretty good hand.

"The increased digitalisation of the economy and the emergence of new business models such as AaaS are generating enormous amounts of data"

In this context, banks need to enable the execution of AaaS models through a variety of innovations. What is required, for example, are data trusteeships, including the ability to technically record exactly whether and for how long a corresponding product has been used, and by whom. The implementation of payments with very small amounts is also required. Then there is the need for new forms of financing for AaaS providers.

Take a large manufacturer of 3D printers who wants to offer these machines in future, not only for sale but also on a usage basis. Who should then own the machine, which can easily cost upwards of half a million euros? The manufacturer, the end customer or possibly a third party? How should it be financed? And finally, how should the use be recorded and billed?

Banks must find answers to these issues if European companies want to tap into the opportunities of AaaS for themselves.

Similarly, banks are something of a natural partner for companies in ESG management. After all, the more able companies are to convince the capital markets that their supply chains are sustainable, that they produce in an ESG-compliant manner, and that they prepare the corresponding data and information transparently, the easier it is for them to access equity and debt capital. Advice on green bonds and bank loans is an obvious starting point for banks here. In addition, however, an even broader range of ESG-compliant financial services needs to be created by banks to support companies in their individual ESG transformations. Examples of this are financial contracts with ESG-dependent conditions, or options for the verification of sustainability-relevant supply chain data. All this requires an intensive dialogue between banks and companies. This will deepen not only the exchange of data, but also the advisory dialogue.

The structural change and need for adaptation triggered by these global trends is considerable, no question. However, it also offers great opportunities for European companies and their banking partners. The basic prerequisite for this is, of course, that Europeans − to return to the poker game analogy − also play their hand consistently. This should start with us finally going all-in on the subject of the single market; more people live in the 27 EU member states than in the US. But in many areas there is still no real common market. As a result, companies are not achieving the economies of scale available.

Position of strength

The completion of the European single market should therefore be driven forward quickly with harmonisation of patent laws and data standards, and the establishment of a capital market and banking union, to name but a few structural milestones. This would not only boost growth and the integration of economies (which are still largely national) into a genuine European domestic market, but also help the EU to remain attractive to its member states and help it defend its values internationally.

Last but not least, a strong position in the European home market is also the basis for tapping growth potential in other parts of the world. This is especially true when serious changes occur, such as those in the Middle East. The US had already begun to withdraw from this region under President Barack Obama, not least because it is steadily less dependent on oil imports. It can be assumed that the new administration under President Joe Biden will continue this course. Conversely, China is expanding its influence in the Middle East. In the meantime, the government in Beijing has concluded several economic agreements with states in the region and will probably further intensify relations, for example with Saudi Arabia.

China is acting in the Middle East like the patient poker player with deep pockets. The Middle Kingdom is benefiting from the fact that this region is on its way from being a net capital provider to a net capital taker. In recent years, individual countries there have issued government bonds for the first time − mainly due to the comparatively low oil price. The trend is likely to continue in this decade.

The US currently dominates global politics and the world economy

Regional partners

The new constellations formed after the Arab Spring in the Middle East also offer opportunities for European industrial companies and banks. However, this presupposes that Europe does not remain in the previous role of a largely passive poker player, but plays the game more proactively and courageously. The withdrawal of the US has created considerable space, offering opportunities for strategic partnerships.

The same is increasingly true for Africa. China has systematically and adeptly established itself as a strategic partner there over the past decade. In addition, it has secured raw materials from the continent for the long term with many generously financed infrastructure projects, from dams to roads and from railways to ports. One of the reasons seems to be the extremely favourable conditions for project financing. Through various Chinese development banks, heavily subsidised loans are given to African state clients, with the side condition that a Chinese company with Chinese labour carries out the project.

European companies could have implemented these infrastructure projects at least as well in terms of quality and price. However, the financing conditions and the complex requirements to even do business with Europeans are clearly less attractive than the Chinese overall package. Europe has behaved in Africa in a similar way to that described in the poker game I began this article with. Compliance with the rules was the top priority, for business as well as for politics.

Just to avoid misunderstandings: rules in business must be followed. Contracts that come about through corruption, to name just one example, are and remain taboo. Since there are systemic problems with corruption and deficits in the rule of law in some African countries, it is therefore only logical to be extremely cautious when doing business in these states. However, European companies are currently doing this in a way that leads to many African actors being unilaterally cut off from the Western financial system. Consequently, these countries are blocked from economic development − or driven into the arms of China.

"The new constellations formed after the Arab Spring in the Middle East also offer opportunities for European industrial companies and banks"

So shouldn’t we look for a more constructive approach? A set of rules that will enable Europe to cooperate with those forces ready to act in accordance with the rules in Africa, and thus ultimately advance a free society? Of course, this is more difficult than categorically insulating oneself against potential financial crime risks. However, it would be in the interest of sustainable, democratic African economic development – and of Europe’s strategic weight in the world. A clear Europe-wide commitment to investment in this growth continent, combined with a dialogue at eye level between politics and business on both continents, is called for.

Beyond Africa and the Middle East, a third group of countries offers growth potential for Europe. These are those states that, like Europe, maintain close economic ties with both the US and China. They are thus equally non-aligned in the middle of a bipolar world. Even though countries such as Australia and Japan have joined the Asian free trade agreement (RCEP), they might have a natural interest in developing common rules of the game together with Europe. A third example would be India, which withdrew early from the RCEP negotiations. Elements for cooperation could be common trade corridors or a neutral common payment infrastructure to support each other.

For such regions, Europe’s economy offers a wealth of interesting trade and cooperation opportunities against the backdrop of the global trends outlined – especially since ‘Made in Europe’ has a comparatively strong position worldwide, notably in important categories such as high-quality and sustainability-conscious production.

Sydney, Australia. Europe´s ties with countries such as Australia must be strengthened

Future-proof Europe

Compared to China and the US, Europe also offers its economic partners unbiased equal opportunities. The reason: in the past decades, Europe has established a tradition in which diversity has developed into a strength and a canon of values has emerged that respects other positions. These are unique and have the potential to deliver real competitive advantage. Europe follows rules, remembers established values and norms despite all future-oriented transformation, and keeps its promises. In international cooperation, these pillars of trust are extremely important and stand the test of time.

Europe brings with it strong starting conditions – probably stronger than we think. Among other factors, Europe benefits from a large single market of 450 million consumers and has shown that it can find effective financial solutions, even in a crisis. In addition, Europe is built on a strong foundation of established democracies and the rule of law, and has a large pool of well-educated talent in its workforce.

To realise this potential, it is important to ensure that these strengths are played to the full, that sovereignty is secured in key areas, that any locational disadvantages are addressed and that opportunities for growth are seized. While at first glance this may appear to be a complex and extensive catalogue of tasks, the individual elements are tangible and well known.

The joint approach to financial support during the pandemic demonstrated how quickly Europe can make decisions when it wants and needs to.3 With the same determination, projects such as the banking and capital markets union must be implemented swiftly to develop the full advantages of the community. To preserve European sovereignty in areas such as data protection and payments, a variety of initiatives are being implemented, such as the creation of a pan-European payments infrastructure for consumer payments. These issues should not be seen as desirable projects but as geostrategic necessities and be given appropriate focus.

"The joint approach to financial support during the pandemic demonstrated how quickly Europe can make decisions when it wants and needs to"

In addition, Europe should strive for fair framework conditions for European companies. This is a prerequisite for the company with the best idea to win the competition and not the one with the best location factors. In the short term, for example, the location disadvantage of ‘transformation capital’ must be addressed in order to make the upcoming structural change in many sectors financially possible. This push is not based on a call for ‘more state’. Rather, it is about the state’s own task of setting the right framework conditions for the economy and providing the necessary infrastructure so that companies in the region can develop their full potential.

Furthermore, opportunities for growth must be consistently exploited. Cooperation with the Middle East, Africa and countries such as Japan, India and Australia should be strengthened. In addition, the emergence of true ‘European champions’ should be facilitated. The collapsed merger of engineering corporates Siemens and Alstom was a good example of how Europe is stifling its own potential.4 It needs large companies that can rival the much larger Chinese and American ones in terms of investment resources to defend Europe’s role in the global economic order.

We Europeans must finally compete to win, not just to take part. The next few years will set the course for the second quarter of the 21st century, and standing up for our values can only be done from a position of strength. To play to our considerable potential − the strong cards we hold − we need a combination of pragmatism, courage and confidence in our own strengths. We have it in our own hands: all-in for Europe.

Stefan Hoops is Head of the Corporate Bank at Deutsche Bank


Sources

1 See https://bit.ly/33OsjZD at dbresearch.com
2 See Building ESG investor frameworks at flow.db.com
3 See Germany’s lockdown lending at flow.db.com
4 See https://bit.ly/3tSBhzF at ec.europa.eu

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