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CIAO DATE: 3/99
Missing the Target? European Competitiveness Policies Revisited *
School of Management
Royal Holloway University of London
Please do not cite without the author’s prior permission.
Abstract
This paper explores the nature of European competitiveness and evaluates European policies intended to provide business with the ideal conditions for global competitiveness. We discuss the main elements of Europe’s competitiveness policies and identify the key issues which continue to restrict and undermine European competitiveness. Particular attention is devoted to the underdeveloped nature of the European venture capital industry and the largely misdirected efforts of the EU in enterprise promotion. We argue that Europe’s competitiveness is undermined, not so much by internal tariff barriers or a lack of innovation, as it has been in the past; but by a mistrust of venture capital-based enterprises and a resultant lack of venture equity for enterprising small companies and start-ups. Whilst the European Internal Market is incomplete and fraught with irregularities, and many European companies have yet to fully match their global rivals in product innovation, these problems have been recognised and are gradually being remedied. The real target now should be venture capital development and diffusion. This will not be an easy task, since it involves removing the embedded fear of risk which abides across Europe. Continental European governments and the European Commission can learn much in this respect from the Anglo-American model of capitalism and the competitiveness policies of successive British governments. Government can play a role through reviewing insolvency laws and simplifying company formation and product approval for instance. Pension funds and other large institutional investors can play their part by directing a larger share of their investment towards venture capital. Transnational corporations can be involved through sharing knowledge with smaller firms and providing nonguaranteed, long term loans to start-ups. A combined state-firm undertaking is required if a genuine cultural change is to be achieved and European competitiveness is to be invigorated.
1. Introduction
When measured in terms of trade surplus or investment flows, Europe 1 is a highly competitive region of the world economy. If we change the variables and assess competitiveness more as an indicator of increasing prosperity and societal well-being, we get a very different picture: growth levels are static, if not declining, in most states and unemployment levels are high in many countries. This paper strives to balance these two distinct interpretations of Europe’s relative socio-economic status. We critically examine the excesses of and blind-spots in European competitiveness policies, while at the same time refusing to accept the established belief that Europe is broadly ‘uncompetitive’.
The emphasis of public intervention in the European market has shifted from vertical actions promoting or protecting specific companies or business sectors, towards horizontal measures which encourage trans-sectoral functional development. National governments and the European Union (EU) are now preoccupied with developing the most ‘business friendly’ competitive infrastructure, rather than supporting corporate or sectoral champions in market competition. Global liberalisation, together with national regulatory reform, have been the primary causal factors in the emergence of this more complex and sector neutral explication of European competitiveness policies. The overall intention is to ease and encourage international competitiveness, particularly amongst small and medium sized enterprises (SMEs). This is an arduous task in view of the often contradictory approaches to capitalism and the role of the state which exist across Europe. Economic necessity is gradually bringing about a convergence of these contrasting European approaches. In the words of Alexis Jacquemin, senior economic advisor to the European Commission, ‘European attitudes about the market have changed and it is fair to say that there exists today a broad agreement that competition exercises a positive influence on social welfare’ (1995, p.2). The Jacquemin quote illustrates that the emerging model of European capitalism is closer to the German than to the British system, with an emphasis on both market competition and social obligations. This coincides with the Albert (1993) notion of ‘Rhine capitalism’, which he argued is built on a sounder foundation of social acceptability. This notion of ‘capitalism with a social conscience’ is the defining ideology behind contemporary European competitiveness policies. Even in Britain, with the arrival of Blair’s Labour government, competitiveness policies have been increasingly shaped by this social capitalism approach. It is, however, asinine to reject the established Anglo-American capitalist model so readily. In particular, continental European countries could benefit from the Anglo-American emphasis on public share ownership and the importance of private venture capital to enterprise and growth.
This paper assesses the main instrument of European competitiveness policies, enterprise promotion initiatives, and comments on its relative merits and demerits in terms of encouraging and facilitating competition in western Europe. We also flag up the key issues which continue to restrict and undermine European competitiveness. Particular attention is devoted to the underdeveloped nature of the European venture capital industry. The paper’s main theme is to delineate the problems of European business which are inadequately addressed by European policy-makers. We argue that government in Europe, particularly at an EU level, should concentrate its efforts on more facilitative measures for competitive promotion. These would include ensuring ease of establishment for firms across the EU, simplifying the commercial laws and regulatory conditions governing SMEs, and encouraging the natural growth of private venture capital funds. Inordinate policy emphasis still rests on technology policy/R&D initiatives, transport and infrastructure development, and other large, capital intensive policy sectors. These have been supplemented more recently by the provision of public venture capital funds and the development of full scale enterprise policies. This glut of new and old instruments have collectively missed the target of European competitiveness promotion.
2. Notions of Competitiveness
Measuring Competitiveness
Any evaluation of national competitiveness must begin with a consideration of two fundamental questions: ‘how and in what dimensions do we measure the competitiveness of a national economy, and what standards do we use in determining adequacy?’ (Scott and Lodge 1985, p.6). As we will see further on, measuring a country’s competitiveness is relatively straightforward but measuring the underlying input factors, or causes of competitiveness, is a separate and distinctly more complex matter. An important point to remember at this juncture is that any measures which are used can at best be relative and can never be absolute. Furthermore, the best performing economies are generally viewed as those with high productivity levels and growth rates, low unemployment and rising export volume. However, these economies are not necessarily the most suitable international competitive benchmarks: their success may, for instance, be due in part to unique factors such as historical underdevelopment. Similarly, it is important not to base a nation’s competitiveness on the relative performance of what Scott and Lodge (1985) term, ‘underachievers’. Long-standing national comparisons can become redundant if the benchmark country experiences economic decline and competitive malaise. Hence, it is advisable to establish competitive indices based on established patterns and norms, shielded (as much as possible) from economic cycles and competitive anomalies, which risk distorting any competitiveness measures.
The US President’s Commission on Industrial Competitiveness (1985) outlined four key indicators of competitiveness: labour productivity, real wage growth, real returns on capital employed, and the position in world trade (Thompson 1989, p.46). A decade later the EU’s first Competitiveness Advisory Group similarly advanced several indicators of competitiveness including growth, productivity and employment (CEC 1996, p.1). On all of these US and EU measures, bar its position in world trade (and investment), Europe fares poorly compared with the United States and Japan. 2 The result is a European gross domestic product (GDP) per capita nearly one-third below that of the US and one-sixth below that of Japan (CEC 1996, p.4). This is sufficient cause for concern to warrant attempts by policy-makers to develop an optimal model for European industrial competitiveness.
The first Competitiveness Advisory Group appointed by the European Commission argued that competitiveness implies elements of productivity, efficiency and profitability and is a powerful means of achieving rising standards of living and increasing social welfare (CEC 1996, p.1). The critical determinants of competitiveness are, according to Tyson (1988), productivity improvements, and technological innovation. Similarly, Scott and Lodge argue that since World War Two, the shift of industrial activity towards science-based enterprises such as electronics or chemicals means that national competitiveness is increasingly dependent on technology, capital investment, and labour skills (1985, p.5). Unlike previous determinants of national competitive advantage, these factors are not naturally dependent on any particular region or nation state. These resources are internationally mobile and can be attracted and shaped by any state which has a suitable enterprise culture, liberal trade and investment laws, a strong scientific and technical infrastructure, and a good educational system. As Scott and Lodge argue, ‘competitiveness is more and more a matter of strategies [and structures], and less and less a product of natural endowments’ (1985, p.5).
These ideas lend credence to another approach - one which defines national competitiveness more in terms of structural resources and conditions than the measurable output and affect. The Swiss-based World Economic Forum (WEF) publishes an annual index of competitiveness, based on a very different set of criteria. The WEF argues that nations compete mainly in the sense that they choose alternative national economic institutions and strategies to promote more rapid growth and increases in living standards. 3 This concurs with Scott and Lodge’s argument that measuring indices such as a nation’s trade balance is, on its own, insufficient: one must also identify the critical forces that influence various industries and countries in areas such as research, innovation, investment, production, and so forth (1985, p.4). The WEF’s competitiveness criteria are compiled from a 49 country study and based on both hard statistics and subjective data which mostly comprises surveys of business people. Unlike rival indices, such as that produced by the International Institute for Management Development (IMD), the WEF excludes variables such as GDP growth, export growth, or inflows of foreign direct investment (FDI). They argue that these factors are the consequences and not the causes of a country’s competitiveness. The Forum argues instead that competitive countries are those which have the highest capacity for medium-term economic growth, taking into account their starting level of income. The WEF’s competitive index is built upon a set of measures (Figure 1), the most important ones being first, the openness of an economy to trade and investment; second, the role of government (e.g. public spending as a percentage of GDP); third, the efficiency of the financial sector; and fourth, the nature of the labour market (its flexibility as well as levels of education and skills). Quality of management, infrastructure and technology, and the effectiveness of legal and political institutions comprise the other factors. 4
Figure 1. WEF Measures of Competitiveness
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Government Finance Infrastructure Technology Management Labour Institutions |
EU countries fare well on infrastructure, technology, and management but generally lag behind the US and Japan, due mainly to their high taxes and inflexible labour markets. Nevertheless, viewed in these terms, individual EU Member States such as the UK, the Netherlands, Luxembourg, and Ireland perform extremely well relative to the rest of the world. These countries were ranked fourth, seventh, tenth, and eleventh respectively on the WEF’s 1998 league table of competitive countries. 5 All four countries improved on their 1997 rankings and all (bar Luxembourg) were also better placed than in the 1996 report. 6 Those EU countries which score best on the WEF’s annual global competitiveness rankings tend to be the most open to FDI, possess the most flexible labour markets, and have the lowest rates of corporate tax. Finland, Denmark, and Austria also make the 1998 global top twenty, as they did in the three previous years. 7 In contrast, France, Germany, Belgium, Portugal, Spain, and Sweden all consistently fall outside of the WEF’s top twenty, and both Italy and Greece do not even make the top forty of the world’s most competitive countries. 8
There is evidence to suggest that the criteria listed in the WEF index are considered important by governments when assessing their relative competitiveness. The benchmarking studies carried out by many governments during the 1990s were largely premised on such factors. For instance, the Dutch government tested their country’s competitiveness by looking at eight general variables. These included monetary and fiscal stability, infrastructure development, education standards, technology levels, labour market flexibility, capital market vibrancy, and tax rates. 9 The Dutch accepted that precise measures could never be obtained for most of these variables. However, the approximate findings generated served to provide the government with an indication of The Netherland’s competitiveness relative to other nations. This outcome was deemed satisfactory.
Although we may criticise the value judgements implicit in some WEF measurements and the unquantifiable nature of many, this conceptualisation serves to cast doubt on the argument that Europe as a whole has a competitive problem. 10 Positive national economic role models exist in Europe and a wide range of European companies are globally competitive. The ongoing debate on Europe’s lagging competitiveness may thus be construed as a largely political construct designed to legitimise the introduction of unpopular policy measures in many EU Member States.
3. The New Policy Agenda: Regaining Prosperity by Promoting Competitiveness
The 1990s did indeed witness the introduction of unpopular policies across the European Union. Many leaders argued that these were necessary if their nations were to be globally competitive. Sheltered markets with generous social welfare benefits were increasingly untenable as Europe liberalised, economies globalised and competition intensified. The monetary union convergence criteria placed even greater pressure on European governments to reduce public expenditure and tackle national debt. Governments such as Alain Juppe’s in France and Romano Prodi’s in Italy sought to restructure their economies and reduce public deficits. The resultant civil unrest and union-led strikes bore testament to the public’s resistance to change. Both Juppe and Prodi’s governments were subsequently defeated in national elections. However, even their leftwing successors, the socialist Jospin in France and the ex-communist D’Alema in Italy, recognised the need for social and economic restructuring and greater fiscal rectitude. Economic change is therefore proceeding, often cloaked in the rhetoric of declining national competitiveness. This has consequently led to the development of highly publicised competitiveness policies to promote exports and assist SMEs, and increased competition for inward investment between EU Member States. Many states did a complete volte-face on previous policies and positions, sometimes abandoning ideology and associated political baggage in a desperate effort to reduce employment and raise per capita GDP. In conceptual terms, these changes signified a move from interventionist, government-managed industrial policy towards a more discreet, government-as-partner competitiveness policy approach. This shift may best be conceptualised through examining competitiveness policy in action. We will now briefly explore the development of competitiveness policies in Britain and comment on their wider European applicability.
3.1 National Competitiveness Policies: The Case of the United Kingdom
The development of competitiveness policy in the United Kingdom (UK) is worthy of closer inspection, given the UK’s position as the foremost European proponent of economic liberalisation and global competitiveness. Lawton (1999) illustrates how the evolving nature of EU industrial competitiveness policy would also suggest that the British approach is increasingly accepted across Europe as the most effective way of encouraging competition, stimulating enterprise and innovation, and reducing unemployment.
Former British President of the Board of Trade, Michael Heseltine, argued that the role of government is to create the conditions which enable firms to improve competitiveness (1994, p.9). He outlined nine ways in which government can contribute to corporate, and consequently national, competitiveness (Figure 2).
Figure 2. UK Competitiveness Policies: The Heseltine Model
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The creation of a stable macroeconomic environment is intended to allow business to plan ahead with confidence. A consistent and prudent monetary policy is therefore essential, with low inflation levels and sensible, steady interest rates. 11 The other instruments of British competitiveness policy under the Conservative government combine to place an emphasis on market liberalisation, minimal tax burdens and social costs, and government as competitive facilitator.
The general objectives changed only slightly with the arrival of a Labour government in 1997. The pragmatic approach of the Blair administration ensured little substantive change from the competitiveness policies of the previous government. In fact, many of the policy objectives listed in figure 2 were reiterated in the government’s 1998 White Paper on Competitiveness. As Prime Minister Blair stated in the White Paper:
The Government must promote competition, stimulating enterprise, flexibility and innovation by opening markets. But we must also invest in British capabilities when companies cannot alone: in education, in science and in the creation of a culture of enterprise. 12
The emphasis has therefore changed: a more active role is envisaged for government in the promotion of competitiveness. This is best encapsulated in what the 1998 Competitiveness White Paper describes as the three forces for growth and innovation in the British economy (Figure 3).
Figure 3. The Three Forces for National Growth and Innovation in the UK
| Forces for Competitiveness | Related Government Initiatives |
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| Capabilities | Financial investment in science and engineering base; promote commercialisation of university research; assist diffusion of information and communication technologies to SMEs; create new Enterprise Fund to support financing of start-ups; easing commercial regulation. |
| Collaboration | Support the Confederation of British Industry’s (CBI’s) campaign to encourage companies to adopt best practices; promote clustering in biotechnology and other industries; refocus regional aid to create higher value-added jobs. |
| Competition | Strengthen Office of Fair Trading; consider reform of merger policy; increase pressure for Europe-wide economic reform; press for increased international trade liberalisation. |
A telling sentence in Blair’s foreword to the Competitiveness White Paper is when he concedes that old-fashioned state intervention did not and cannot work but neither does naive reliance on markets. This indicates a more proactive approach to competitiveness enhancement by the Blair government than by its predecessors. It is also indicative of Blair’s preference for a partnership between business and government to advance corporate success and national prosperity. This is distinct from the ‘government solely as deregulator and macroeconomic stabiliser’ approach adopted by previous conservative administrations. Confirming some of the objectives outlined in Figure 3, sources in the UK’s Department of Trade and Enterprise 13 reveal that the British government place particular emphasis on increasing public spending on science and research, improving links between universities and business, and amending commercial law in a way which is beneficial to business. An example of the latter initiative is a review of insolvency law in an attempt to simplify corporate bankruptcy procedures and reduce the social stigma attached to business failure. Such an initiative would be an important step towards developing the kind of buoyant and rebounding entrepreneurial spirit which exists in the United States.
The overall approach of the existing British government is one which is more acceptable than its predecessors to other, predominantly social democratic, European governments. Weighed down with high unemployment levels and low growth rates, most European governments (particularly France, Germany and Italy) accept the need to liberalise their markets and engage more vigorously in the global economy. This need for policy change is compounded by both the Internal Market Programme’s deregulation process and the international trade liberalisation agenda of the World Trade Organisation. However, these administrations strive to maintain their fundamental social welfare commitments and remain ideologically committed to a leading role for government in the economy. Blair’s so-called ‘third way’ appears to offer them the chance to adjust to economic realities whilst at the same time preserving their core values and ideals.
4. The Evolution of EU Competitiveness Policies
European-level competitiveness policies have emerged from a number of Commission documents in the early 1990s, most notably the 1993 White Paper, Growth, Competitiveness and Employment and the 1994 Communication, An Industrial Competitiveness Policy for the European Union. In general, these documents affirmed the EU’s commitment to pursue a more liberal policy agenda, with an emphasis on deregulation and structural reform. At an EU level, research and development (R&D) initiatives, liberal competition rules, infrastructure development programmes, and education and training schemes all ultimately endeavour to encourage or facilitate corporate competitiveness. A further important but less developed policy instrument is enterprise promotion schemes, particularly efforts to encourage the growth of venture capital. We will examine this instrument in some detail in the next section.
European industrial policy now has the same objectives as competitiveness policy and utilises much the same instruments. The key enduring difference is in the approach pursued and emphasis adopted: competitiveness policies have a promotional approach with an emphasis on intangible, ‘upstream’ aspects of public investment in the economy. That is to say, rather than undertaking direct resource transfers (as with traditional industrial policy instruments such as R&D initiatives or public procurement), competitiveness policies encourage technological innovation and knowledge diffusion, provide corporate tax incentives, facilitate venture capital schemes for start-ups, and promote the internationalisation of SMEs. Competitiveness policies also emphasise actions that increase organisational productivity and cost efficiency. This is another differentiating feature from traditional industrial policies, which were more concerned with maintaining existing levels of output and protecting jobs.
4.1 The Enterprise Promotion Instrument
Enterprise promotion has emerged as the flagship instrument of EU competitiveness policy. It remains one of the least developed policy tools, yet in many ways it is the essence of any competitiveness policy in the era of global competition and economic liberalisation. Particular attention will be given here to the development of the European venture capital industry and the role which enterprise promotion policy has, or has not, played in the emergence of this vital sector.
The legal and institutional basis of EU enterprise policy emerged in the 1980s, as a direct response to the competitive problems of many European SMEs. Three statistical reasons may be advanced to justify the emerging policy emphasis on SMEs. 14 First, their sheer number: there are some 15.8 million SMEs in the EU, which is 99.8 per cent of the total number of enterprises in existence. Second, the number of people employed by SMEs is enormous: SMEs account for 66.52 per cent of the total EU private sector workforce, compared with 33.48 per cent employed by large or transnational enterprises. Third, concurrently, their share of turnover is huge, comprising just under two-thirds of the EU total. In addition, SMEs are the main source of job creation across the EU, as proven by Eurostat surveys conducted between 1988 and 1996. To take the example of Germany, Europe’s economic powerhouse, the Mittelstand (small to medium-sized, family run companies) form the core of the country’s commercial might. The two million, largely industrial, Mittelstand provide 80 per cent of all German jobs and have been more profitable as a group than the country’s large multinational enterprises 15 . If, in the context of a liberal global economic environment, European competitiveness is to improve, enterprise culture therefore needs to be encouraged.
Article 130 of the Treaty on European Union (the so-called Maastricht Treaty) provided a new and more specific legal base for enterprise policy, making a specific commitment to:
encouraging an environment favourable to initiative and to the development of undertakings throughout the Community, particularly small and medium-sized undertakings.
This is indicative of the EU’s realisation, in the early 1990s, that a clearer focus needed to be given to the encouragement of Europe’s enterprise culture. Prior efforts at enhancing competitiveness were largely misdirected, being concerned with assisting large national champions to structurally adjust to changing market conditions and competitive forces. Although attempts were made from the early 1980s to encourage and assist SME growth, minimal resources were directed to these efforts until a decade later. A more important issue is that few of the structural and legal impediments to the development of European start-up enterprises were tackled until the post-Maastricht era. The removal of such regulatory obstacles to enterprise is the most tangible direct contribution which government and the EU can make to the promotion of European competitiveness. As the European Roundtable of Industrialists (ERT) argue:
The cancer of over-regulation is one of Europe’s major competitive handicaps and a direct factor behind excessive unemployment – and the small companies are its principal victims (ERT 1998, p. 96).
This view is supported by other influential organisations such as the European employer’s association, UNICE, and the Competitiveness Advisory Group. They argue that there are plausible and direct linkages between over-regulation, uncompetitiveness, and unemployment. A restrictive and expensive regulatory burden in Europe has a disproportionate effect on SMEs. Studies 16 have proven that administrative cost weighs heavily on small business: smaller companies face a cost burden of 3,500 ECU per employee per annum, compared with 600 ECU for larger companies. Such costs can arise, for instance, from inflexible social legislation and the process of attaining technical approval for opening a new facility. These overly burdensome regulatory regimes result in extra costs which can be especially consequential for smaller companies. This in turn can serve to dampen Europe’s enterprise culture (halting an SME’s expansion plans for instance) and can thus translate into lower economic growth levels and less job creation.
4.2 Improving the Business Environment for Smaller Companies
The 1992 articulation of European enterprise policy was followed in 1993 by the decision to institute a multi-annual programme of EU measures to intensify the priority areas and to ensure the continuity and consolidation of policy for enterprise, in particular SMEs. This Decision 17 allocated a budget of ECU 112.2 million to enterprise policy for the 1993-96 period. An integrated programme in favour of SMEs and the craft sector was adopted by the Commission in 1994 with the objective of assembling the various initiatives into a global framework, with a view to ensuring their coherence and to giving them a higher profile. A Decision 18 followed in 1996 to provide the legal and budgetary basis for the Union’s specific SME policy actions and to clearly delineate the integrated priority actions for SMEs (see Figure 4). This was accompanied by an agreed budget of ECU 180 million for the 1997-2000 period.
Figure 4. EU Priority Actions for SMEs
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| Source: 1996 Integrated Programme for SMEs, see COM(96) 329 final of 10.7.1996. |
In addition, a variety of other EU policies contained SME-targeted initiatives. These included R&TD policies (the fourth and fifth Framework Programmes), the Information Society initiative (IS action plan), training programmes (through the European Social Fund for instance), local development initiatives and public procurement schemes, and regional infrastructure programmes.
4.3 Sources of EU Funding for Small Business
As early as 1989, the European Commission, in association with the European Venture Capital Association, had begun funding initiatives for small business in Europe. The European Seed Capital Scheme was launched, with the explicit aim of stimulating the creation of start-up capital funds and making capital available to small or untested companies which may encounter difficulties in raising funds from the market. New technology firms with a relatively long development phase were particular beneficiaries of this scheme which, by early 1996, had raised ECU 52 million in capital. This scheme was complemented in 1997 with the launch of another EU fund, I-TEC, also aimed at encouraging investment in innovative business.
Amongst the initiatives to improve the financial environment, a round table of bankers and small businesses has been set up to improve small business access to finance. A recommendation on payment terms for commercial transactions 19 aims to combat delays in payment and a Directive has been produced on cross-border payments. Several other Directives and initiatives have been adopted, intended to create a more favourable business environment for SMES/start-ups. These include the simplification of conditions of access to insurance markets, subsidised loans for job-creating SMEs, and the creation of the European Investment Fund (EIF) 20 , aimed at granting loan guarantees for projects relating to trans-European networks and for small business.
Financial support for Europe’s start-ups and SMEs can be found in a range of other EU policies. The European Investment Bank (EIB) is a non-profit-making institution providing flexible medium- and long-term loans for capital investment projects which meet the EU’s policy objectives. SMEs constitute one of the priority categories for EIB funding. Approximately 10 per cent of the total resources of the European Regional Development Fund (ERDF) are devoted specifically to the internationalisation of small businesses and to promoting improvements in their competitiveness. The European Social Fund (ESF) also provides support to entrepreneurial activity, with a view to the development of new SMEs and resultant job creation. EU-sponsored R&TD programmes provide further opportunities for SMEs to obtain capital to assist their growth and development. Small businesses benefit from a variety of other smaller funds. These include sector-specific sources such as the Agricultural Funds or RETEX for the development of enterprise in the textile sector, and location-specific funds such as REGIS for peripheral regions and URBAN for metropolitan areas.
4.4 The Single Market and Enterprise Promotion
The overarching EU enterprise policy initiative is of course the Internal Market Programme. This has served to remove many of the barriers to cross-national trade and investment in Europe, as well as providing a stimulus to overall demand and business development. The development of the Internal Market has brought new challenges also to SMEs, serving to sharpen competition, increase costs and administrative burdens, and heighten the necessity to pursue constant cost reduction techniques (Grant Thornton 1998). Moreover, a study by the Association Française Pour Normalisation (AFNOR) showed that the principles of the Single Market and standardisation are generally very poorly understood. This is due to difficulties gaining access to information and because of the low participation rate of SMEs in the work on European, or even national, standards. Small businesses have difficulties formalising their quality procedures and often make over-complex interpretations of standards and set up cumbersome and expensive systems. In this context, the Internal Market (and the single currency) will precipitate restructuring and short term difficulties for many SMEs whilst the positive effects will materialise in the medium to long term. For many SMEs, particularly start-up enterprises, with limited resources and often significant loan repayments, this time lag factor may prove detrimental. Although support schemes and policies are in place across Europe, little can really be done to ensure that start-ups and other SMEs successfully bridge the gap between Single Market-inspired short-term pain and long-term gain.
Despite the assorted European enterprise policy initiatives in existence, SMEs have accrued little tangible benefit to date. As the EU-sponsored Competitiveness Advisory Group (CAG) concedes, for the most part, those programmes which have been developed by both the EU and its Member States to assist SMEs have been inadequately focused and integrated. This is particularly true for initiatives intended to remove obstacles to international trade and investment for SMEs (Jacquemin and Pench 1997, p.193). Attempts are underway by the Commission to address these criticisms but it remains to be seen how successful these will prove.
5. Venture Capital: The Competitive Catalyst
In the previous section we explored the nature and development of European enterprise policy and identified the assorted means by which SMEs can obtain finance from EU sources. A wide range of public funding options exist but as the EU’s own Competitiveness Advisory Group has acknowledged, these frequently fail to hit the target of enterprise stimulation. As with so many well-intended EU policies, a significant sum of money is being spent but the results are inconclusive. Within EU enterprise policy, the emphasis has been on providing or facilitating venture capital access to start-ups and small business. This is credible given that venture capital is a vital catalyst for economic growth and job creation. However, venture capital is about risk-taking: it is the willingness to risk investing money in an unproven or untried enterprise. Furthermore, compared to traditional borrowed capital, venture capital is unsecured finance: there is no collateral, so the financier takes a stake in the company instead. When viewed in this way, economic logic and historical precedent would suggest that venture capital is a derivative of the market rather than a product of public policy. Europe’s national champion policies of the 1960s and 1970s would indicate that government rarely picks corporate winners. It is even less likely to do so with fast changing, high risk enterprises, many of which end in bankruptcy. In addition, as the experiences of state-owned enterprises across Europe will attest to, political factors can often distort economic common sense when government is involved in the strategy-making process.
This section has three objectives, all of which contribute to the argument that the public promotion and facilitation of the European venture capital industry is essential to European enterprise and competitiveness but the actual provision of venture capital finance is the domain of the private sector. We begin by briefly discussing the nature and development of the European venture capital industry. We illustrate the emergent competitive dynamics of the sector and its ability to grow, unaided by public policy initiatives. The second objective is to consider national government venture capital schemes, particularly the case of Germany. The evidence suggests that these schemes have proven successful in short-term enterprise promotion but may not be viable in the long term. The third objective is to examine the emerging private sources of venture capital in Europe (namely pension funds and transnational corporations) and the extent to which they are likely to replace most public sources of venture capital in the medium to long term.
5.1 The Development of Venture Capital in Europe
Private equity provides equity capital to enterprises not quoted on a stock market. Private equity can be used to develop new products and processes, to expand working capital, to make acquisitions, or to strengthen a company’s balance sheet. 21 It can also resolve ownership and management issues, e.g. a succession in family-owned companies, or the buyout or buyin of a business by experienced managers may be achieved using private equity. According to the European Venture Capital Association (EVCA), venture capital is, strictly speaking, a subset of private equity and refers to equity investment made for the launch, early development, or expansion of a business. Variations exist among countries as to what precisely is meant by venture capital and private equity. In Europe, these terms are generally used interchangeably and venture capital thus includes management buyouts and buyins. This is in contrast to the US, where such actions are not classified as venture capital. The British Venture Capital Association (BVCA) define venture capital as providing:
long-term, committed, risk-sharing equity capital, to help unquoted companies grow and compete...It seeks to increase a company’s value to its owners (BVCA 1998).
A further important distinguishing feature of venture capital, compared with bank loans for instance, is that whilst banks have a legal right to interest on a loan and its repayment, irrespective of the borrower’s success or failure, the venture capital investor’s returns are dependent on the growth and profitability of the business.
Although synonymous with high technology sectors (often the riskiest investments), venture capitalists specialise in a wide array of fast growing industries. The development of a national (or European) venture capital industry is dependent on a combination of variables. These include the size of the technology sector, a culture of entrepreneurship, the existence of financial markets for new companies, and public policy incentives (Auer et al. 1993, p.299). Public policy incentives are generally fiscal in nature but can also be regulatory reliefs such as those discussed earlier in this paper.
Traditionally, venture capital has been primarily an American phenomenon. It exists in large quantities in Asia but is largely composed of corporate investment by giant conglomerates or family-run businesses. In Europe, the lack of a vigorous venture capital culture has been perceived as a primary competitive weakness. A European Parliament research report argues that there is a real need for simpler access to venture capital in Europe and that this factor proves to be a great obstacle to SME innovation (1996, p.55). A survey by the British Venture Capital Association (BVCA) demonstrated that venture-backed companies create more jobs and provide a major boost to economic growth. Within the UK for instance, during the first half of the 1990s, the number of people employed in venture-backed companies increased by 15 per cent, against a national growth rate of less than 1 per cent. In total, more than one million people in the UK are estimated to be employed in companies funded through venture capital. Moreover, growth levels in venture-backed companies sales, exports, profits, and investment all tend to be significantly higher than the national average. 22
Until the mid-1990s, venture capital was scarce in Europe, particularly compared with the abundance of capital available to start-up companies in the US. However, in 1997, European venture capital firms raised $22 billion, more than double the figure for 1996. 23 Almost half of this total originated in Britain, the second largest venture capital centre in the world after the US. 24 Funding rose by more than 650 per cent in Germany and nearly 2,000 per cent in Sweden. European venture capital has traditionally favoured relatively mature firms but investment in start-ups increased by 60 per cent in 1997. This increase is indicative of the trend towards investing in businesses throughout Europe as national economies grow. An explanation for the sudden and rapid increase in investment in start-up ventures may be the fact that Europeans are increasingly eager to invest in equities. As surveys argue:
Europe’s myriad growth-company stockmarkets now provide a handy means for venture capitalists to cash out as their investments mature, so encouraging them to invest more in young firms. 25
The emergence of the Neuer Markt in Frankfurt was accompanied by the launching of small company markets in Britain, Ireland, France, Belgium, and the Netherlands. The Neuer Markt and its French, Dutch, Belgian, and Italian counterparts subsequently united to form the pan-European small stock market network, Euro. NM. By the end of 1998, 150 companies were quoted on the Euro. NM, with a total market capitalisation of $28.4 billion. Market performance consistently exceeded expectations, with the Euro. NM All-Share Index increasing in value by 262 per cent between early 1997 and late 1998. 26 The European Association of Securities Dealers Automated Quotation (EASDAQ) was created in 1996 as a stock market to meet the demand for capital of high-growth companies by providing a broad spread of investors with a highly regulated market. EASDAQ is modelled on America’s NASDAQ market. Many venture capitalists hope that EASDAQ will make it easier to bring start-ups to market and encourage wary institutional investors to put more cash into venture capital funds. 27
These various markets are by no means alike: Britain’s Alternative Investment Market (AIM) list such miniature oddities as pawnbrokers and tea merchants, whereas EASDAQ and the Neuer Markt specialise in high-tech biotech, software, and microelectronics companies. France’s Nouvelle Marche has alternated between approaches, choosing initially to list companies such as Proxidis, a hairdressing salon chain, but subsequently switching its focus to high technology companies. 28 Of these SME markets, the UK’s AIM has grown the fastest, in large part due to looser regulation on the part of both government and the London Stock Exchange, the AIM’s parent company. The Euro. NM and Easdaq, as the two main transnational markets, have emerged as direct competitors in many instances. This development is a further sign of the increasingly competitive and dynamic nature of the wider small business investment culture in Europe. It is also indicative of the market’s ability to generate equity culture and competition, regardless of public policy initiatives.
5.2 National Policies for Venture Capital Promotion
An OECD report 29 argues that the rationale for government venture capital schemes is to fill funding gaps that prevent small, innovative businesses from obtaining sufficient funds. Such start-ups are often viewed sceptically by traditional sources of finance, such as banks. Government funding schemes aim to raise the survival rate of these companies and consequently boost economic growth and employment figures. In 1998, the then German Minister for Education, Science and Research and Development, Jürgen Rüttgers, received the European Life Sciences entrepreneur award. This was an unusual choice but it serves to illustrate the leading role which government in Germany has taken in promoting enterprise. The award was given on the basis of the minister’s work on the BioRegio initiative, established in 1995 by the German federal government as a competitive funding scheme for biotechnology ventures. The initiative has resulted in the proliferation of small biotechnology companies throughout Germany. BioRegio is just part of a much broader package of federal and state assistance that is making Germany one of the most interesting and lucrative areas for start-up businesses in Europe 30 . The principal federal initiative is the BTU programme and parallel state programmes include Bayern Kapital in Bavaria. For every DM1 of venture capital investment, an embryonic technology company can attract a further DM1 in so-called ‘soft loans’ from the federal government and often another DM1 from the state government. Thus, an average venture capital package can be tripled in value as a result of governmental assistance. The government also guarantees half of the venture capitalist’s investment. The total amount of public money spent on venture capital investment in Germany doubled between 1996 and 1997 and is twice as much as spent in other large European economies such as Britain.
Criticism has been voiced at this government involvement in venture capital: private venture capitalists complain that too much public money is readily available in Europe and that they are forced to compete for business with government institutions. 31 Public finance schemes thus hamper the natural development of the European venture capital industry. A 1997 OECD report on government venture capital schemes further argues that such projects can displace private capital through unfair competition, introduce distortions in venture capital markets and lead to bad investments at high public cost. On the latter point, governments may attain short-term benefits for their economies but at significant cost to the exchequer. More often that not, government is likely to misdirect funds and lose its investment. Taken together, these criticisms suggest that the more advisable policy route would be one which focused on the facilitation of enterprise and venture capital access, rather than on the direct provision of venture equity.
Other European governments, most notably in France, are looking to the German model for guidance in their attempts to foster young high technology companies. It is seen by many politicians as an important policy weapon in their efforts to combat unemployment. Approaches differ however. The French government are keen to emulate the German approach involving direct equity investment by government. The British government on the other hand, as discussed earlier, place more emphasis on easing competition laws governing enterprise and investing in basic science and research. 32 Evidence from the previous sector indicates that the British approach is more appropriate, as private venture capital funds will grow due to market demand and the development of small company stock markets. The subsequent sections will provide further support for this position.
5.3 Sourcing Venture Capital from Pension Funds
Europe’s small company markets are fragile and the companies listed on them are mostly miniature. In spite of this, the new equity bourses passed their first real test in 1998, emerging relatively unscathed from the financial market upheavals of that summer. Commentators 33 generally agree that they are developing well and defining their own relative strengths and specialisations.
Much of Europe’s venture capital investment is used to finance changes in firm ownership (mainly management buy-outs), 34 hardly the stuff which comprises a dynamic enterprise system. The problem stems in large part from the sources of European venture capital: about one-third emanates from banks, content with safe investments. Unlike the US, private investors and pension fund investors account for a small portion of Europe’s total venture capital. Pension funds are an important source of capital for some country’s venture funds though, most notably in the UK. Almost one third of total venture capital funds raised in Britain emanate from pension funds. UK pension fund managers have historically invested a very small percentage of their assets (less than one per cent) in venture capital. This compares with average venture capital investment allocations of 5 per cent among US pension funds. This is a major potential future growth area for venture capital funds across Europe. Taking the US figure as an achievable goal, European venture capital funds could increase tenfold if pension fund managers were encouraged to invest more in this area. There is evidence to suggest that pension funds achieve a higher return on investment from venture capital funds than from other investment options. The British Venture Capital Association’s annual ‘Performance Measurement Survey’ has demonstrated that in aggregate, venture capital funds out perform all the aggregated assets held by UK pension funds, and on a three to five year basis, both the FTSE 100 and All Share Indices. This would suggest that venture capital funds are not as risky an investment for institutional investors as is commonly assumed. Thus, although Europe does not lack capital for start-ups, it is still a long way from having a well-developed venture capital culture.
5.4 Sourcing Venture Capital from Big Business
A second emerging source of private venture capital in Europe is big business. Anxious to ensure their ‘corporate good citizen’ credentials, many large enterprises have developed schemes to help promote start-up companies. Their rationale is often driven by considerations such as job losses resulting from restructuring programmes. For example, British Steel invests an average of £2 million per annum in small companies. This loan fund is dedicated to the regeneration of areas in which they have closed facilities. The company mainly offers (unsecured) small-scale packages of equity and loan finance. 35 This action helps many entrepreneurs to attract further capital from more traditional sources such as banks.
Similarly, Shell established a small business unit in 1985 with the stated intention of helping to create jobs. It provides start-ups with seed capital, to a maximum of $125,000. Expertise on a range of practical issues is also provided on an ongoing basis. Many of the start-up companies which receive funding are founded by former Shell employees. This fact would indicate that Shell’s good works in venture capital provision may be an effective means of minimising the social fall-out resulting from staff reductions. The same may be true for Renault, which offers training and advice (but no finance) to employees who wish to set up small businesses in France.
Several other large European companies are actively involved in assisting start-ups and SME development. Saint-Gobain (France), ABB (Sweden), Unilever (UK/Netherlands), PetroFina (Belgium), Total (France), and Iberdrola (Spain) all participate in such philanthropic activities. These schemes, sometimes operated in partnership with government, offer a wide range of support mechanisms to smaller companies. 36 These include the facilitation or provision of:
Thus, the evidence shows that the provision of finance is not the only way in which big business helps to stimulate and grow smaller European enterprises. However, it is a vital one: as the European Round Table of Industrialists argue, in addition to providing capital directly, these small-scale loans ‘often act as a signal of confidence and enable funds to be attracted from other sources’ (1996, p.52).
As alluded to earlier, there are often underlying self-serving principles for such apparent altruism. In addition to the job substitution function, some large companies assist in the development of SMEs which may subsequently serve as suppliers or distributors for their products or services. These smaller firms may also generate new technologies which the larger ‘sponsor’ may subsequently obtain, by means of acquisition perhaps. Nevertheless, jobs are ultimately created and wealth is generated and for these reasons alone we may ignore the more cynical interpretation of large companies true motives.
6. Promoting European Venture Capital: The Policy Challenge
As we illustrated in the preceding section, pension funds and big business are the two most promising emergent sources of venture capital in Europe. Logic suggests that private funds generated will continue to grow as the benefits accrued from long-shot, long-term investments bear fruit. A role does remain for governmental agencies. Whilst the actual money for start-up enterprise or SME expansion activities may be derived from private sources, the structural and legal conditions for venture capital development are still determined by government. Moreover, the public sector can be instrumental in encouraging individuals and organisations to invest in high risk enterprise. The European Venture Capital Association (EVCA) argues that, in order to maximise European growth, innovation and employment, six main policy challenges must be addressed by European policy makers (Figure 5).
Figure 5. European Policy Challenges for Venture Capital Promotion
| 1. Create an entrepreneurial environment |
| 2. Encourage tax-efficient share incentives |
| 3. Develop long-term capital sources |
| 4. Facilitate fund formation |
| 5. Give public support only when partnered with private equity |
| 6. Encourage competitive stock markets for smaller and growth companies |
The European Round Table of Industrialists (ERT) concurs with most these public policy tasks. They argue that government can encourage competitive stock markets for SMEs through assuring the further development of EASDAQ; complete the Single Market so as to simplify cross-border activities for SMEs; and facilitate a more entrepreneurial environment through ensuring that EU regulations are not overly burdensome for smaller firms. For the latter objective, emphasis is placed on the need to streamline procedures for company formation, construction permits, plant inspections, environmental audits, and product approval (ERT 1998, p.98). The simplifying of regulations is the most important role for government in stimulating enterprise and promoting competitiveness. The ERT cautions against the EVCA’s fifth policy challenge. They argue that, regardless of the existence of matching private equity, public funds should not be used to favour companies of a particular size or sector. Rather, the market should choose the winners. Several of the other policy objectives defined by the EVCA are already being tackled – without the need for proactive public policy. For example, competitive small company stock markets have evolved naturally through market competition. In particular, competition between EASDAQ and Euro. NM has intensified. Fund formation has also begun, primarily in the UK, with large institutional investors playing an increasing role. Long term capital sources are increasingly available from private sources such as large transnational corporations. The implications are that an entrepreneurial environment does not need to be artificially created but is instead emerging naturally through market demand. The venture capital sector is surviving and growing, largely unaided by national government and the EU and ignored throughout much of Europe by institutional investors. However, its potential has yet to be fully realised and, relative to the US and Japan, European venture capital is still minor league. As such, European competitiveness is structurally challenged.
7. Conclusions
We began this paper by casting doubt on the widely held belief that Europe is broadly uncompetitive. Established competitiveness indices rank seven of the EU’s fifteen members in the top twenty most competitive countries in the world. Moreover, there are a large number of world class European firms, competing in everything from precision instruments and pharmaceuticals to banking and insurance. Problems exist but these are more often the result of specific national policies and structural obstacles than of some overarching and ill-defined European competitiveness debility. The debate on Europe’s competitive malaise may therefore be seen as a largely political construct designed by governments to facilitate the implementation of often unpopular policy measures aimed at tackling national competitiveness hindrances. These policy measures collectively constitute ‘competitiveness policy’ and have emerged in place of traditional industrial policy approaches. In examining the nature and affect of British competitiveness policy, we argue that the UK provides a politically acceptable and economically viable model for other European states to emulate.
EU competitiveness policy has evolved along similar lines to national policies, with particular emphasis on enterprise promotion. A broad array of deregulation initiatives, financial incentives, and other schemes exist to encourage Europe’s entrepreneurs. The problem is that the EU does not ‘miss the target’ for competitive promotion per se ; instead, its approach has been misfocused and poorly integrated.
Whilst the European policy paradigm has shifted towards a more promotional position, the underlying problems of European competitiveness (manifest in high unemployment and low growth and productivity rates) cannot be addressed through a ‘policy fix’ alone. Instead, both government policy and market forces are required to tackle remaining structural hindrances in the European business environment. The role of government is certainly crucial in the removal of restrictive regulations and practices, together with the development of commercial law which is more flexible in cases of business failure. However, in establishing venture capital funds, the European Commission, together with national governments such as Germany are, in effect, providing subsidies to small companies. Lessons from the past should prove that this approach leads to abuse of resources and the development of a dependency culture, with many companies growing accustomed to regular public cash infusions. There is little evidence to suggest that it ever translates into an improvement in competitiveness. We have shown in this paper that the European venture capital industry has the ability to develop of its own accord, relatively unaided by public policy initiatives. This private sector development can emerge from the involvement of first, big institutional investors, particularly a less risk averse pension fund sector; and second, large transnational corporations endeavouring to assure their image as socially responsible organisations. Whilst its potential remains underdeveloped, the role of government should be to facilitate its growth and not to compete with the private sector through developing its own equity provision schemes. As has been the case so often in the recent past, Europe’s policy-makers cannot resist the opportunity to dabble in the operations and financing of the market economy. This interventionist tendency, clouded by social democratic ideals, is the enduring weakness of European competitiveness policies.
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Endnotes
*: Prepared for presentation at the annual meeting of the International Studies Association, Washington, D.C., February 16–20, 1999. Back.
Note 1: For simplicity purposes, the terms ‘Europe’ and ‘European Union’ will be used interchangeably in this paper. ‘European competitiveness’ refers only to the competitiveness of that area and those countries which constitute the European Union. Back.
Note 2: The European Commission has, for example, acknowledged that Europe continues to lag significantly behind the US and Japan in terms of both labour productivity and the proportion of the working age population that is employed (CEC 1996, p.4). Back.
Note 3: This argument is taken from a WEF press release on the 1996 Global Competitiveness Report, located at www.weforum.org Back.
Note 4: These measures of a country’s competitiveness are found in the World Economic Forum’s 1998 Global Competitiveness Report and also in a press release on the report, dated 4 June 1998. Back.
Note 5: Data on national competitiveness rankings is taken from the World Economic Forum’s 1998 Global Competitiveness Report and available from the WEF’s internet site. Back.
Note 6: The 1997 World Economic Forum Global Competitiveness Report ranked the UK, the Netherlands, Luxembourg and Ireland, seventh, twelfth, eleventh, and sixteenth respectively; and the 1996 report put these countries in respective fifteenth, seventeenth, fifth, and twenty-sixth positions. Back.
Note 7: Austria did drop down to twenty-seventh position in 1997 but re-entered the top twenty the following year. Back.
Note 8: These findings are based on WEF Global Competitiveness Reports, 1995-8. Back.
Note 9: These variables in the Dutch government’s benchmarking survey are taken from the European Round Table of Industrialists 1996 report on benchmarking, p.11. Back.
Note 10: This argument is sustained by author’s such as Strange 1998, p. 102-3. Back.
Note 11: The European Roundtable of Industrialists support this argument that ‘at the highest level, it is [government’s] job to create a macroeconomic environment that...includes stable economic conditions, stable currency...’ (1998, p.96). Back.
Note 12: Cited in UK Department of Trade and Industry (1998), Our Competitive Future: building the knowledge driven economy, White Paper on Competitiveness. Back.
Note 13: Discussions between this author and Department of Trade and Industry officials, January 1999. Back.
Note 14: Data is derived from the Eurostat SME Project database, 1997. Back.
Note 15: This discussion of Germany’s Mittelstand is taken largely from a Time magazine article entitled ‘Germany’s Mittelstand finds new ways to thrive’, September 28, 1998, p.32. Back.
Note 16: Competitiveness Advisory Group findings cited in the 1996 ERT report, A stimulus to job creation, p.14. Back.
Note 17: Council Decision 93/379/EEC of 14 June 1993, published in OJ L 161 of 2.7.1993, p.68. Back.
Note 18: COM(96) 98 final of 20.03.1996. Back.
Note 19: Commission recommendation to the Member States on payment periods in commercial transactions, OJ C 144, 10.6.1995 and OJ L 127, 1.6.1995. Back.
Note 20: The European Investment Fund emerged from the 1992 Edinburgh Council meeting. Back.
Note 21: This interpretation of private equity/venture capital and its uses is derived in large part from official documentation of the European Venture Capital Association. Back.
Note 22: Data derived from the British Venture Capital Association survey, The Economic Impact of Venture Capital in the UK, 1996 and 1998 (undertaken with PricewaterhouseCoopers). Back.
Note 23: These figures are taken from an article in The Economist magazine entitled ‘Europe’s great experiment’, 13 June 1998. Back.
Note 24: Britain’s venture capital industry is longer established and more developed than its EU partners.
For further detail, see Gordon C. Murray’s article ‘Evolution and Change: an analysis of the first decade of the UK venture capital industry’, in Journal of Business Finance & Accounting, 22(8), December 1995. Back.
Note 26: Data derived from Euro. NM press release, 20 th November 1998. Back.
Note 27: The Economist, ‘Venture capitalists: a really big adventure’, 25 January 1997, p.20. Back.
Note 28: This argument is taken from an Economist magazine article on small company stockmarkets, 15 March 1997. Back.
Note 29: Organisation for Economic Cooperation and Development (1997), Government venture capital for technology-based firms (Paris: OECD). Back.
Note 30: Katherine Campbell, ‘No negative noises yet’, Financial Times, November 27, 1998. Back.
Note 31: This argument was advanced by a number of venture capital company executives in interviews with this author, December 1998/January 1999. Back.
Note 32: This approach is clear in the British Government’s 1998 White Paper on Competitiveness and from discussions with officials at the British Department of Trade and Industry. Back.
Note 33: This positive assessment is sustained for instance in a 1998 report published by 3i Venturelab, an entrepreneurship study centre established by the European private equity group, 3i, and the business school INSEAD. Back.
Note 34: The Economist, ‘Venture capitalists: a really big adventure’, 25 January 1997, p.20. Back.
Note 35: Data on big business as a source of venture capital is derived from the European Round Table of Industrialists 1996 report, A stimulus to job creation, pp.42-51. Back.
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