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It's Payoff Time (Int'l Edition)

International -- European Business: THE ECONOMY

IT'S PAYOFF TIME (int'l edition)

But high taxes and rigid labor laws threaten the nascent recovery

A funny thing happened this summer to Franco Tato, chief executive of Italy's giant electric utility Enel. In May, Tato noticed an upward spike in electricity demand, a mirror of economic activity and one that had been depressed in Italy for more than two years. At first, Tato suspected a statistical fluke. But each month since then, demand has been up sharply. The Enel head now predicts that by the end of this year, Italy will be consuming over 4% more electrical power than it did in 1996--the largest jump in years. "The recovery is here, and it's a lasting one," says Tato.

Across Europe, economies are turning on the juice. After the most intransigent downturn since World War II, companies and consumers can finally see brighter times ahead (chart). From German car sales to Swedish home prices to Spanish consumer confidence, almost all economic indicators point north. Says Jean-Paul Hologne, economist at Brussels' Banque Bruxelles Lambert: "After years of austerity, people are seeing light at the end of the tunnel."

DEREG DIVIDEND. So far, surging exports from France and Germany have been the main engine of recovery, even as domestic demand has stayed stubbornly depressed. Those export earnings, combined with aggressive corporate restructuring, are paying off in healthy profits. If companies begin to invest in home markets, the crushing 11.2% jobless rate on the Continent will ease, and stronger consumer demand will give the recovery more muscle.

That's a big if, to be sure. The record postwar unemployment numbers in Germany announced on Sept. 9 show just how intransigent long-term joblessness has become. Much will now depend on whether Europe's leaders have the political will to reform rigid labor laws that discourage hiring even in good times. And companies are still waiting for corporate tax rates as high as 54% to fall. Since politicians in Paris and Bonn seem more obsessed with keeping their budget deficits down in anticipation of monetary union than with goosing economic growth, corporate chieftains are keeping their fingers crossed. "It's the next few months that will really be crucial," says Marco Tronchetti Provera, CEO of Italy's $6 billion tire and cable giant Pirelli.

But European governments have clearly done a few things right. Already, in Spain and Italy, unemployment has slowly begun to drop--in large part thanks to deregulation. From the liberalization of European air transport last April to next January's opening of the Continent's $103 billion telephone market, once-sleepy sectors are starting to boom. This year, for example, the Association of European Airlines expects the newly competitive European air travel market to grow by 10%. In telecommunications, Salomon Brothers Inc. estimates the total number of European cellular-phone subscribers will top 50 million at the end of this year--up from barely 14 million just three years ago.

As new entrants arrive in expanding markets, so do jobs. Italy's Rome-based Air One, which sprang up in late 1995 to challenge flag carrier Alitalia, is growing 100% a year and has an expanding workforce of 400. Other airline startups, like Britain's easyJet, Debonair Airways, and Virgin Express, are also hiring. "Liberalization means competition, which means new markets and new consumers," says Paolo Rubino, Air One's commercial director. "And that means more jobs."

Even in Europe's depressed industrial heartland, layoffs may finally be leveling off. Although the auto sector--the biggest employer--faces overcapacity and a mature market, "profitability in the industry is on the mend just about everywhere in Europe," says John Lawson, European auto industry expert at Salomon Brothers International Ltd. in London. Thanks to stronger growth in most of its European markets, Swedish truckmaker Scania is planning modest hiring next year, after shedding 10% of its workforce since 1996.

The ongoing restructuring among Europe's carmakers and other industrial giants could give Europe a competitive advantage over the U.S. in the next few years. From German giant Siemens to Italy's Fiat, many European companies are lean, cash-rich, and newly aggressive--just as counterparts in the U.S. face the mature end of the business cycle. At KSB, a pump and valve maker near Frankfurt, the black ink is starting to flow after new management cut out $122 million in overhead, pared the product line, and trimmed the workforce by 1,100 people, to 14,000. Now the $1.1 billion company is setting up a global manufacturing network. "We have to use this time of strong exports to make ourselves competitive for when the wind turns against us," says CEO Josef Gerstner.

Of course, the downside to the Europeans' competitive push is stubborn unemployment--especially in Germany, where 2.4 million jobs have vanished since 1991. Despite the export boom, Munich-based economic consulting group IFO estimates that German industrial companies will actually cut their workforces by 3% this year and a further 1% in 1998. Says Jon F. Chait, president of Manpower Europe: "I hear a dramatic sucking sound as companies do everything possible to move jobs out of the European Union."

TIMID REFORMS. But Chait notes the trend could be reversed if Europe relaxes its labor regulations. So far, Germany, with its average $26.50 hourly wages and benefits and 36-hour workweek, has only timidly begun to reform its laws. France seems to be swimming upstream, as the new Socialist government plans to cut the workweek and create 350,000 jobs in the public sector over the next five years. Yet Italy's new Treu Law, about to go into effect, gives a badly needed shot of flexibility by legalizing temporary hires and breaking the state monopoly on employment agencies.

Italians hope that the result will be similar to the sharp 3% drop in unemployment that ensued when Spain's center-right government passed similar laws last April. One sign that attitudes are changing is Manpower's growing network of temp agencies in Europe. The company has been growing at a 30%-a-year clip in France and plans to set up 250 offices throughout Italy over the next five years.

Until now, economic improvement in Europe has been mostly due to tough slogging by corporate managers, and growth has come at workers' expense. "Europe's recovery is still a fragile creature," cautions Francesco Caio, CEO of Italian white-goods giant Merloni Elettrodomestici. But if the numbers keep on looking good, politicians will have more wiggle room to push through reforms that will give the recovery real staying power--and Europeans something to cheer about.By John Rossant in Rome, with Gail Edmondson in Paris, Karen Lowry Miller in Frankfurt, William Echikson in Brussels, and bureau reportsReturn to top

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