Old Europe's New Shine
As European Union leaders meet in London to wrangle over
European Union budgets and the Anglo-Saxon versus the French
model, global investors have already voted and have 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 people (the United Kingdom is 15 times
larger) was always viewed as a bit of a laggard. Into the 1960s,
citizens had to pay for secondary education, and as late as
1987, Irish gross domestic product was only 69% of the average
of the nations that eventually formed the EU. The unemployment
rate was 17%.
Suddenly, its economy took off. Average GDP growth rates in the
1990s were 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
event, but rather to a confluence of policies, timing and
action.
In the late 1980s, 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 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, especially among Irish women.
The resultant rise of Dublin as a booming city and a major
financial hub also led to a tourist boom with more than 6
million annual visitors. Instead of talented Irish workers
migrating to the U.S. 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 exports, from stronger
domestic capital markets and from migration. Good 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 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, it was up more than 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 week's EU
summit, the U.K., which has benefited greatly from its openness
to the world. London has grown in the last 20 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
U.K. 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 iShares MSCI United Kingdom Index
is up 12% over the last 12 months.
While the American discussion of the flat tax doesn't seem to go
any further than the local Starbucks, many of the countries of
Eastern Europe have already adopted one. The flat tax, combined
with Eastern Europe's low cost structure, access to new EU
markets, and a strong work ethic have led to a surge in growth.
Because Eastern European stock markets are thinly traded, why
not use the iShares MSCI Austria Index as a proxy? Austria
serves as a gateway to Eastern Europe and functions as its
financial, transportation and logistical hub. Austria has also
cut its corporate tax rate from 34% to 25%. The Austrian ETF is
up 40% over the last 12 months.
Germany's GDP growth has been anemic, but the iShares MSCI
Germany Index 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 indices are doing well. The iShares
MSCI EMU Index is up over 15%, and the iShares S&P Europe 350
Index is up almost 16% during the past year. By comparison, the
S&P 500 is up a little better than 6%.
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. Especially as U.S. markets
continue to churn without making any forward progress, a new
investment in "Old Europe" could be a wise move for your
portfolio.
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