What's Next for Europe?

The effects of currency woes, energy issues and social media on the European Union

The timing of the November 2010 inaugural meeting of the Bad Ragaz Group could not have been more propitious. As signs of economic recovery clashed with the realities of the Irish bailout and renewed concerns about additional financial contagion in the eurozone, the meeting's theme—"What's Next for Europe?"—was already on the minds of the senior business executives, economists, policymakers and thought leaders who gathered at Switzerland's Bad Ragaz resort for two days of discussions.

Forty European executives—current and next-generation leaders representing multiple industries and sectors from 12 countries—gathered at the Swiss alpine resort of Bad Ragaz in November 2010 to ponder Europe's future challenges and opportunities. Discussions by these members of the Bad Ragaz Group (BRG) centered on the risks and opportunities associated with integration and globalization during these challenging geopolitical and economic times.¹ Specifically, members discussed the outlook for the European economy, the impact of social media, Europe's uncertain energy prospects, and the future of the euro. This paper summarizes the discussions.

Outlook for the European Economy

The BRG assembled in the wake of an ominous forecast from the Organisation of Economic Co-operation and Development (OECD). According to OECD estimates, Europe will account for a mere 11 percent of global GDP by 2020 (based on purchasing power parity), a drop of 18 percent from 2008. By contrast, China will control 28 percent of global GDP and the United States 14 percent by 2030. Recent data from Eurostat and the Bureau of Economic Affairs back up this outlook, as the groups found that average annual growth in labor productivity in Europe had declined both in absolute terms and relative to the United States since 2000. Growth in Europe's labor productivity, which was 2.4 percent annually between 1973 and 1995, declined to 1.5 percent per year from 1995 to 2006. In the United States, the levels rose from 1.2 percent to 2.3 percent during the same time periods.

Europe's aging population and low birth rates pose profound implications for the future. With the exception of Japan, the oldest countries in the world are all in the EU—including Italy, Germany, Greece, Sweden, Portugal, Spain, France, the United Kingdom and Finland. EU unemployment is also high and climbing (10.1 percent throughout the EU, and 9.6 percent in the euro-zone), and a decline in stimulus spending could slow the recovery. For example, the United Kingdom, plans to slash 500,000 public service jobs over the next four years.

Nevertheless, some good news exists in Europe. Europe's per-capita income remains comparatively high, and the continent still ranks among the world's most competitive economic regions according to the World Economic Forum, with Switzerland, Sweden, Germany, Finland, the Netherlands and Denmark holding six of the top 10 positions.

The operative question now: How can Europe remain competitive as global economic production and consumption move to the developing world? Some recovery has taken place since the Great Recession, but new short-term systemic shocks could resurface while longer-term structural issues remain. Are we, as one thought leader argued, facing a "dawn in the east, dust in the west" proposition?

Figure 1: Participants' views on the European economy

Conference attendees were generally upbeat about Europe's long-term prognosis; they said that it is stronger and economically more resilient than widely believed, with deep reserves of talent and economic resources backed by years of peace and prosperity (see figure 1). Most agreed that the euro will survive despite integration fatigue, poor economic governance and a lack of competitiveness in the periphery. This view is backed by staunch political will across the continent and structural reforms that have been pushed through in the past two years in Spain, Portugal, Ireland and even France. Germany's economy is another main area of strength, based on its industrial excellence and capacity to exploit the boom in emerging economies. (In fact, one participant suggested emerging economies could be Europe's salvation.) Germany's strength is welcomed even while it highlights the EU's internal imbalances, which now pose a real risk of further financial crises in what looks to be a two-speed Europe.

One urgent priority, many participants said, was banking reform, an issue still outstanding as the financial crisis ends. Europe could face a double crisis—troubled banks coupled with mounting sovereign debt obligations, especially in the periphery—that would require improved economic and functional governance for survival. Still, Europe has a strong history of reinvention, evident in Germany's emergence from Europe's "sick man" to economic powerhouse, and the United Kingdom's recovery under Margaret Thatcher.

Ongoing European political integration is another pressing issue. Most participants expect it to continue, since there is little alternative and the case for expanding the political union is now much stronger than before. Yet political leadership remains weak. Traditionally, the EU has been a product of the political elite, but business and financial leaders may need to step in as Europe tries to finance its welfare-state system as the population ages. The continent will have to redefine its social contract by reforming labor markets, tax systems, education and security. The latest Anglo-French common defense accords are a hopeful sign in this regard.

The quality of political leadership in Europe raised concerns among participants. One wondered how everyone could be so bullish when Europe lacked the leadership to guide it through all the challenges. Another pointed to a widening perception gap among citizens, which he feared could lead to heightened nationalism. "The elites may be optimistic," he maintained, "but the people are not." Various BRG members considered the possibility that a new EU political core, with as many as four countries using the euro while fusing their economic, budget and defense policies, could spur others to join.

Some agreement was reached over the point that most Europeans persist in holding an antiquated attitude that nation-states are the only solution. This asymmetry—between transnational economics and national politics—has created competition when cooperation needs to be the operating model. "Taboos need to be broken," one participant observed, "specifically by moving forward with the politically difficult structural transitions now underway in some European countries." Retirement age is one clear priority, as is improving the capacity of European countries to mobilize risk capital, which too often migrates to the United States and elsewhere.

One participant worried that the current crisis had overshadowed important strategic considerations for the future of Europe. He lamented the lack of investment in critical areas, such as education, R&D and even security and defense. If these problems are ignored, he argued, the fundamental model could come into jeopardy. Another participant pointed to the reactive nature of many of Europe's leadership. "What will be the next wake-up call for the EU—another crisis?," he asked. "Instead of piling one system on top of another, Europe needs to streamline the entire process."

These myriad considerations led one participant to conclude with a call for optimism. "We cannot afford to be pessimistic. If the EU collapsed, then the world would be in shambles, too. We now need a very significant political step. We need more Europe, more integration."

The Impact of Social Media

Social media is changing the face of Europe—the planet's most connected region, with four of the top five and eight of the top 10 "wired" countries in the world.² As a result, Europe is a main player in this rapidly unfolding global revolution.

Worldwide, social media is now the Internet's number-one activity, with the major sites (including Facebook and Twitter) now boasting a combined total of almost 900 million users. Messaging via social platforms overtook classic email last year as the most common form of online communication. In the United States, an estimated one out of every seven married couples met through social media. The revolution is even transcending age groups, with users age 55 and older representing Facebook's fastest-growing group.

When asked if they were members of any of the major social media sites, a little more than half of BRG participants (52 percent) said yes, while 48 percent said no. As one member noted, "The ongoing transformation of social and economic systems is a new normal in which old attitudes and practices simply no longer apply."

The enormity of the social media revolution—the unprecedented transformation in connectedness—raises as many questions as it answers. How far will the changes go? How will privacy and other complex policy challenges affect the changes? How do we address the massive overflow of information that comes from new levels of social networking?

The impact on the corporate world is already a given; businesses are adapting to increased price transparency and endless customer reviews. One-quarter of search results for the world's 20 largest brands are derived from user-generated content, which means more control for buyers and less for sellers. While 14 percent of consumers say they trust advertisements, a staggering 78 percent say they trust peer-to-peer recommendations of products. It's little wonder, then, that companies are moving quickly into the social media space.³ (Coca-Cola, for example, has more than 21 million followers on Facebook.) Young professionals claim that they now routinely use social media to hire, find personnel information and interact with peers and customers. The challenge for businesses is to develop a lasting connection between online use and consumption, to have information customized to individual consumer profiles, and to manage the risks amid the extraordinary opportunities. While social media makes it more difficult for brands to control their messages, it empowers individuals to express themselves—a potentially powerful tool for companies.

How will social media evolve in the coming years? Some BRG participants believe the use of online payments will soar; that Google has a banking license in the Netherlands shows how social media could evolve. The transnational challenge of addressing issues of privacy, defamation, fraud and the protection of minors will also become more pressing. Attendees debated whether these issues could be regulated at the national level or whether social media—through self-regulation—would have to expand their own "constitutions," regulations and rules.

The overriding challenge is keeping up with the more rapid flows of data, information and knowledge delivered through online channels. There is a fundamental mismatch between the endless amount of cyberspace and data, on one hand, and the limited amount of human capacity, on the other. This suggests that the focus needs to shift to the behavioral use of information, rather than trying to improve technology.

Europe's Uncertain Energy Prospects

As Europe plans for a world beyond "peak oil," the trajectory of its energy future remains in question. Global reliance on fossil fuels continues as the balance of global production and consumption fundamentally changes. Will Europe be a bystander to change or a leader in efficiency and clean energy? What will be the consequences of Europe's planned energy policies?

EU energy consumption has increased steadily for several decades (tied closely to GDP growth) and has been met with increasing dependence on energy imports. Currently, the EU goes outside the continent for 80 percent of its oil, 60 percent of its natural gas, 40 percent of its coal, and 97 percent of its uranium. Overall, about 10 percent of the EU's energy comes from Russia; the fastest-growing import sources are Norway, Algeria and Qatar.

Oil and coal consumption is expected to flatten or decline as the search for cleaner, more renewable energy continues. Natural gas is one increasingly prevalent alternative, as it is affordable, flexible and relatively clean. Including unconventional natural gas such as shale, the EU currently has 250 years of supply based on current production rates, with widespread sources on the world market. However, Europe may not get full access to these supplies, as its geological formations and the structure of property rights for extraction and environmental constraints are less attractive in Europe than in the United States.

Reducing the need for imported energy will be a key issue, and renewable energy will be vital. Fortunately, "power to the people" is coming closer to reality in this realm. As prices for photovoltaic (PV) solar power and small windmills fall, more building and home owners can now generate their own power and even sell surplus power back to the grid via smart meters, which will lead to new business models.4 Other imminent technologies are vertical-drive windmills, nano-driven battery and storage technology, and high-efficiency transmission lines. Therefore, Europe's target of generating one-fifth of its energy from renewable energy by 2020 is feasible.

Perhaps the biggest, and most unavoidable, problem for Europe's sustainable energy future is that it does not receive as much sun as Africa, Asia or the southwestern United States, so solar power likely cannot dominate in Europe. The internal market also is inefficient, for example with diesel fuel prices varying from €0.98 (US$1.33) per liter in Bulgaria to €1.44 (US$1.96) per liter in the United Kingdom. But on the whole, the EU is far more energy efficient than the United States or Asia, and continuing to improve that performance should be a major strategic focus for the EU.

Figure 2: Assessing Europe's energy future

The varied opinions of BRG participants highlighted Europe's uncertain energy prospects (see figure 2). One BRG thought leader warned against placing too much trust in the most commonly available (and cited) data, such as the International Energy Agency's World Economic Outlook, when it comes to making long-term plans. These sources, he said, may underestimate the demand for unconventional gas in emerging markets such as China, and it may not sufficiently take into account likely improvements in nuclear technology and safety, or advances in hybrid and electric vehicle production.

Another participant argued that smart energy needs more subsidies and greater Europe-wide cooperation. Above all, the IT, telecom and energy industries must work together to take advantage of smart grids.5 Participants noted the need for large investmens—for example, Poland will have to invest €50 billion (US$68 billion) by 2040 to replace aging power plants—coupled with pronounced market and political uncertainty make this a particular challenge. As Europe decentralizes its energy production, it will have to refocus on generating energy rather than distributing it.

The cost effectiveness of the de-carbonization process will be at the center of policy choices, and some leaders questioned the push toward cutting Europe's carbon emissions. Because CO₂ emissions in Europe account for only 10 percent of global pollution, reducing emissions by 20 or even 40 percent would not make an appreciable difference. Instead, they argued, Europe should do more at the international level to ensure that other countries join its CO₂ reduction goal.

Whether the move to renewable energy may have been too rapid—and too costly—the key now is for Europe to act as one entity. If gas and nuclear are the way to go, as some participants suggested, Europe will need bolder leadership and a more pragmatic approach than it has now.

The Future of the Euro

Debate about the future of the euro permeated most of the discussions. Two senior members of A.T. Kearney's Global Business Policy Council kicked off the final session of the meeting with a mock debate on the future of the euro.

The optimistic side offered five compelling reasons why the euro would survive. First was the view that the euro was too important politically for leaders to allow for its "deconstruction." After all, it is still the cornerstone of Europe's core political project. Second, the remarkably high direct costs of unwinding the currency (and restoring national currencies) and the massive secondary impacts would make dissolution economically unlikely. Third, the impact on countries outside of Europe would be too massive to ignore. Fourth is the fact that despite recent turmoil, the euro has been a strong and stable currency during its existence. And finally, the various debt and banking crises within the euro have led to significant austerity measures.

The counterpoint argued that the euro was born flawed and remains so today. It has no way to correct imbalances between trade-deficit and trade-surplus countries, no method for transfer payments, and a mechanism for controlling national deficits that has been repeatedly broken by France and Germany. There are, in this pessimistic point-of-view, three potential scenarios:

• Perform "Band-Aid" crisis management that patches over big wounds by imposing austerity measures, amid continued high unemployment and a social crisis
• Develop a broader monetary and fiscal union, similar to the United States, with fiscal transfers, automatic re-stabilization and possibly even a full European federal state
• Launch a two-tier euro, with a short "holiday" from the euro imposed on affected countries

Whatever the outcome, both sides agreed that a breakup of the euro would be catastrophic for world financial markets and especially for Europe, leading to massive bank failures and a gaping need for new currency controls. Germany would lose many of its export markets as the new mark would rise in value to punitive levels, while Greece, Portugal and Spain would see the cost of their existing euro debts skyrocket as they would have to be paid in new weaker currencies. Ultimately, the domino effect could be another "Lehman Brothers moment" for the global financial system.

Following the debate, participants broke into four groups, each representing a hypothetical European company, to discuss the potential for failure of the euro, their strategies to address the potential instability of a failing euro, and their public policy recommendations. The following provides a synopsis of each hypothetical company:

German equipment company. This German mid-sized heavy equipment company has revenues of about €10 billion (US$14 billion) and manufacturing facilities in Germany and five other EU countries. Eighty percent of its operations comes from exports, of which 70 percent remain within the EU. Participants in this group determined that the decline of the euro would increase costs for raw materials, R&D and engineering, diminish the company's competitiveness, and cause balance-sheet challenges such as drops in debt-to-equity ratios and affect its ability to mobilize capital.

To respond, group members decided the company should take a short-term focus by hedging, creating alliances (outsourcing some services to lower-cost countries), and wherever possible reallocating sourcing for raw materials. As for public policy recommendations, the government should invest in education, ensure a stable integration process of new member countries, and engage in more responsible fiscal policies. Furthermore, they proposed a joint effort of business and government leaders to educate people about the benefits of a stable and free-trade Europe.

French automaker. This hypothetical company is a large, France-based car and truck maker with revenues exceeding €60 billion (US$82 billion). Its production is concentrated in the EU, and sales within account for half of operations, with the remainder going primarily to emerging markets. Euro instability would translate into three major challenges for this firm: rising energy prices, gaining access to capital, and the need to rethink its medium- and long-term manufacturing footprint. Group members recommended that the company engage in new joint ventures (perhaps with China) and that its board of directors use scenario analyses to assess the potential impact of various outcomes of the crisis.

The group's policy recommendations included recapitalizing the banking system ("there's no other option," the group determined) and engage unions to address macroeconomic and financial challenges. They also said it was critical to establish a dialogue with the public on the different options—and price tags—associated with restructuring.

French consumer goods manufacturer. This France-based, multinational consumer goods company with revenues exceeding €50 billion (US$68 billion) is focused on high-income consumers. Sixty percent of its exports go to China and the United States, with its strongest recent growth in China and other emerging markets.

Members of this group emphasized the immediate impact of currency volatility on revenue—especially the bottom line—and proposed urgent steps to increase capital. Beyond this, they suggested hedging by sourcing from markets with weaker currencies, and repositioning the company's marketing with more local and customized offerings. In the longer term, they proposed diversifying the supply chain, first in procurement and then in production lines. Their public policy recommendations included more transparent policies from government officials, actions to promote stability, and more responsible monetary and social positions.

Swiss consumer goods manufacturer. This hypothetical Switzerland-based consumer products company has equivalent revenue of €15 billion (US$20 billion) and Swiss and EU production footprints. Ninety percent of its production is exported, half to the EU, and it is experiencing strong growth in China, India and other emerging markets. Group members believed that euro volatility would have little impact on a Swiss company so they decided the company should put a premium on flexibility in pricing strategies. In addition, they would move pre-production to other European sites and establish congruent financing structures where production is located.

In policy making, the firm should advocate for the Swiss government to maintain access to the EU free-trade zone, pursue free-trade agreements with other countries, reduce taxes and welfare-state spending.

Continuing the Dialogue

As the final session wrapped up, most participants agreed that the dialogue between the private and public sectors in Europe needed to be strengthened to meet the array of changes. As one BRG participant said, "There should be more dialogue between business, entrepreneurs and politicians to educate the public about the cost of being irrational."

¹ The Bad Ragaz Group is supported by A.T. Kearney's European practices and its Global Business Policy Council. Discussions are governed by Chatham House rules so no participant is quoted by name.
² Wired refers to access to broadband Internet.
³ For more information, see "Socially Awkward Media" in Executive Agenda, Vol. XIII, No. 2, 2010, at www.atkearney.com.

Copyright 2011, A.T. Kearney, Inc. All rights reserved.