Note that this one’s more rambly than I wish, but I have a lot of thoughts and am not good at editing.  Suggestions for how to cut this down are appreciated if you want to leave a comment or an email. 

You might as well be lighting your money on fire…

When talking about the American vs European economies, the discussion always turns towards Tech.  “Europe missed the Tech boom” is a true, but surface level description of Europe’s stagnation in high tech industries.  Cloud computing, social media, AI, all the buzzwords of the last 20 years have been American, and some wonder why Europe doesn’t have trillion-dollar companies like Apple and Microsoft.  I’ve already pushed back on the “cultural” explanations for this, but I want to look deeper at some of the proposed solutions for helping Europe’s economy catch up. 

If you ask why Europe has a smaller Tech industry, there’s a few common answers given.  One is that Europe is fragmented linguistically, most people don’t speak each other’s language, while America has 300 million people all speaking one language.  But I’ve never been convinced by the argument that tech companies stop at the border.   

You can maybe make the argument that social media spreads fastest among people who speak the same language, but I’ve never seen this argument be well-quantified.  Facebook is used by half the earth’s population, they don’t all speak English, so why did it spread so easily even after maxing out in the English-speaking world?  And TikTok has been a viral hit among westerners, even though it started in China.  The language argument is often presented as obvious but without any evidence to support it, and I don’t think it’s reasonable until I see some evidence. 

Furthermore, social media is just a tiny piece of the Tech industry.  Apple, Microsoft, Spotify, Samsung, these aren’t social media companies.  So what explains why half of them are American, and the non-American ones aren’t even in the top 10? 

Another argument is that Europe is fragmented economically.  Still, I don’t really buy this.  It’s true that Europe is not wholly unified, different countries have different regulations.  But the EU is a common market of goods and services, overwhelmingly products sold in one country can likewise be sold in another.  If there was a European version of Apple or Samsung, their smartphones would almost certainly be buyable in any EU country.  Indeed, the market fragmentation never stopped Nokia from its 1-time dominance of cell phones, so why did this fragmentation prevent the emergence of a European smartphone company, if it never stopped the top European cell phone company? 

The final common answer is the one I want to discuss today: European investment is low because there is no unified capital market.  German investors invest in German companies, French investors in French companies, and this drastically limits how much capital is available for startups.  While Europe is trying to have 27 different capital markets, American capital is clustered in just 1 (Silicon Valley) or 2 (if you count Boston, New York, or one of the other “also rans”). 

I buy this argument more, but I want to start with some clarity on what it *really means* for a capital market to be “unified.” 

We’d say a market is unified when investors from one area are equally capable of investing in any other area.  Why might investors not invest across the border?  Tax and regulation mostly.   

Taxes don’t have to be *higher* to deter investment, *different* is more than enough.  Think of capital gains tax when an investor sells something they’ve invested in.  Some places allow a lower tax when you hold the investment longer (long-term capital gains), while others don’t make a distinction.  This may lead to a lower tax burden overall, but more tax-season headache in proving how long each investment was held, and proving it was held in the correct jurisdiction which allows this long-term capital gains distinction.  Sometimes it’s better to just invest everything in one place and hire less accountants. 

Different regulations would also be self-explanatory, there’s more bureaucratic overhead in understanding and applying different regulations for each different investment.  But here we come to the difficult part, and why I think Draghi’s drive for unification will face stiff headwinds.  Regulations have a moral component for lack of a better word.  When discussing regulations online, it’s not uncommon to see “regulations are written in blood” as an emotive argument put forth against deregulation.  Any attempt to pair back anything in the way of “red tape” faces a mountain of pushback from voters, and unifying the regulations will require *some* deregulation.   

*Some* country’s regulations will have to be cut, even if they’re simply replaced with those of another countries.  Even if regulations are “harmonized” by trying to bring them closer together, that still means some things get cut and some things get added.  And this will necessarily inflame the passions of the voters and commentators who say that “regulations are written in blood.”  Because while regulation of the capital markets might not have to do with healthcare and worker’s rights directly, they do have much to do with bankruptcy and ownership, which can be even more emotive. 

Trump is often jeered for his numerous corporate bankruptcies.  He in turn calls bankruptcy a smart business move when needed.  It’s true that an investor can expect 9 investments to go bust for every 1 that succeeds.  And it’s true that American bankruptcy laws are quite lenient.  And it’s also true that a smart investor be foolish to not take advantage of any edge the law can give them, lenient bankruptcy is one such edge. 

But bankruptcy stirs passions because someone’s left holding the bag.  If Europe is going to unify its capital markets, it’s going to inflame those passions.  When the banks went bankrupt in 2008, it stirred immense passion because of who had to pay and who was left holding the bag.  Changing these laws raises the specter of the financial crisis, and any recent bankruptcies will get put under a microscope to point out how things would be different in a unified EU capital market.   

To put some meat on these bones, let’s say a car company is going bankrupt in Bulgaria.  We’ll call it “Bulgarian Cars,” its owner and CEO is Mr Car, its workers belong to the “United Car Workers Union,” UCWU.  It has purchasing agreements for steel with “Steely Corp” and its sole creditor is “Big Banking,” who is unfortunately unaware that Mr Car is about to go bankrupt. 

Under the current Bulgarian system, Big Banking can (if they desire) simply take possession of all the “Bulgarian Cars” assets, and sell them in a fire sale to get back the money they are owed.  This means the factory, the showroom, and anything else could be closed down in an instant.  Big Banking gets back their money, Mr Car is broke, UCWU are out of their jobs, and Steely Corp lost its biggest customer. 

But how would this situation be effected by Draghi’s directive to unify EU capital markets?  How would the bankruptcy be altered?  Who would win, and who would lose? 

Draghi has already signaled that unified EU bankruptcy must allow for “debtor in possession,” meaning Mr Car can keep control of his company while working out a repayment plan with Big Banking.  This system allows Mr Car (or any investor) to try to rescue their company, even in bankruptcy. It’s part of what made Trump’s bankruptcies so painless. 

In France, a debtor is immediately granted relief from creditors upon filing restructuring plans.  In Germany, the debtor may *request relief*, but it isn’t automatic.  But if the capital markets are to be unified, Bulgaria must follow the direction of France and Germany and give Mr Car a reprieve from his creditors.

But should Mr Car even be *granted* relief?  He drove the company into the ground in the first place!  Why does he get to stay in charge, paying himself an obscene salary all the while?  Draghi’s unified capital markets would allow a lot more “Trump-like” bankruptcies ripe for this kind of outrage-bait, with a villainous CEO stiffing creditors, unions, and business partners while still bringing home fat checks. 

And what happens to UCWU?  They just finished negotiating a new contract with Bulgarian Cars. The contract included conditions and a long notice period before a new contract can be renegotiated.  But most EU countries allow the suspension of a union contract to help the company exit bankruptcy.  So Draghi’s unified capital market raises the possibility of workers losing out so that bankers and executives can keep the company going.  Workers’ pain for bosses’ gain. 

And through all this, what about Steely Corp, who just lost its biggest customer?  Bankruptcies are always politically fraught as they can cause a domino effect into other industries.  This is why some nations focus so much on business continuity, even if it comes at the expense of creditors and workers.  Steely Corp will want to lobby the government that UCWU and Big Banking can go to hell, they want to ensure that Bulgarian Cars returns to solvency no matter what.  Otherwise Steely Corp itself may go under, and the national news will blame the Government for letting not one, but *two* major employers go bankrupt.   

How much will Draghi’s unified capital market allow Governments to “save” companies this way?  Under certain restructuring scenarios, the Government will essentially be picking winners and losers in the market.  Demand Big Banking take a debt restructuring, demand UCWU accept a new contract, and you’re making banks and workers lose so that car and steel companies can win.  This doesn’t always fly with EU rules around fairness, and certainly won’t fly with some sections of the commentariat. 

This post was a lot less focused than usual, but it’s been in my mind for weeks.  “Unify the EU’s capital markets” sounds so obvious, why haven’t they done it?  They haven’t done it because it involves politically fraught trade-offs about ownership and hierarchy.  “Who wins and loses in a bankruptcy case” is just the top of the mountain.  Questions of equity investment, investor’s rights, corporate governance, union rights, these are also fraught questions that will have to be answered in a unified capital market.  Whatever answer is chosen will inevitably piss *someone* off, which is why countries are so slow to change these laws.  But until countries are willing to make big changes, the EU capital markets will never be unified.