Commentary: Europe Is Playing With Fire

An upsurge in protectionist rhetoric sends just the wrong message to investors

When news came in mid-March that Switzerland's Novartis (NVS ) might counter Paris-based Sanofi-Synthélabo's unwelcome bid for French drugmaker Aventis (AVE ), the official reaction from Paris was swift: Aventis ought to remain French. Prime Minister Jean-Pierre Raffarin even invoked national security. Aventis vaccines, he said, could be used in the event of a bioterrorist attack. Can't trust those Swiss.

France's response is an unfortunate reminder that liberalization is still a tough sell in Europe. It wasn't quite a return to the bad old days, when governments stepped into the market to help national champions such as Italy's Olivetti or France's Groupe Bull. Thanks to competition rules imposed by the European Union, national governments now lack the legal power either to pump aid into faltering companies or to block most foreign takeovers. Indeed, by late March, Raffarin was willing to listen to arguments from Aventis' boss, Igor Landau, as to why a Novartis takeover wouldn't hurt France.

But just about everywhere you look in Europe, the protectionist rhetoric is rising. Keeping national control over key companies and industries is seen as a way to make sure jobs don't evaporate. In Italy, the government is examining ideas to salvage national carrier Alitalia, one of Europe's worst-performing airlines. Ceding to union opposition to planned job cuts, the government replaced Alitalia's chief executive in February. Germany's industrial leaders and politicians have circled the wagons around Frankfurt's Deutsche Bank (DB ). They warn of dire consequences should the once-mighty financial group fall into foreign hands. And Paris is preparing $5.2 billion in aid to prop up engineering giant Alstom -- in part to keep the group's rail technology out of the hands of German rival Siemens (SI ). "The message increasingly is: 'We believe in market forces, but only up to a point,"' says Katinka Barysch, chief economist at the Centre for European Reform, a London think tank.

That's exactly the wrong message for slow-growth, high-unemployment Europe to be broadcasting right now. Even though there is little real bite in the populist panderings of European politicians in defense of national groups, the entire investment climate is affected. "There is more rhetoric and posturing than actual interference," says Eric Chaney, chief European economist at Morgan Stanley (MWD ) in London. "But financial markets do take this seriously, and their view is that European governments are interfering in business."

The real danger will come if this rhetoric is transformed into policy. Many worry that proposals now being floated by France, Germany, and -- surprisingly -- Britain could hobble the European Commission's ability to pry open markets. All three countries favor an EC vice-president who would be responsible for economic and industrial policy. French President Jacques Chirac, German Chancellor Gerhard Schröder, and British Prime Minister Tony Blair, in a document issued in mid-February, said they expect the EC "to take more account of the necessary industrial development of Europe." Many suspect that to be a coded call for the EC to relax pressure on national champions such as Germany's Volkswagen and France's Electricité de France.

If so, it's bad news. Europe has overcapacity in everything from autos and airlines to banks and stores. If more takeovers aren't allowed, the overcapacity will hobble the economy's ability to generate growth and jobs. Mergers within borders might be encouraged, but it's the cross-border deals that create powerhouses with global reach.

A confrontation is already brewing. On Mar. 30, the EC gave Germany two months to change a 44-year-old statute protecting VW from a hostile takeover. The regulation, said the commission, is a violation of EU law because it "constitutes a restriction on cross-border direct investment." But with the Schröder government and the center-right opposition united to protect VW, it could be an uphill battle for Brussels. Many European politicians will be hoping for Berlin to prevail. That would not be good for Europe's economic health.

By John Rossant

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