Why Politicians Are Harmless

The United States and the EU may have growing differences on everything from Mideast policy to the environment, but the past two weeks have proved that their markets, at least, remain as interdependent as ever. With fears of further terror strikes and more corporate-accounting debacles in the air, markets on both sides of the Atlantic have been hovering around five-year lows. The situation wasn't helped by the demise in early July of yet another corporate titan, Vivendi CEO Jean-Marie Messier, who had infamously enraged his countrymen by proclaiming the French cultural exception "dead." His ouster was supported by a coalition of disgruntled shareholders and board members, and may have been hastened by disapproval from French President Jacques Chirac, who declared such views on French culture to be a "deep mental aberration that nothing can justify."

So maybe the post-September 11, post-Enron buzz was right: from now on, national politics will indeed begin to exert more influence over markets. But take a closer look at Vivendi. Most analysts agree that the company's troubles have had more to do with fears about its high debt and the possibility of dubious accounting than any concern with Messier's cultural affinities. And in Europe as a whole, it's fair to say that national politics are becoming less and less linked to sustained market movements. National elections may still produce market blips. But these reactions are usually short-lived. Increasingly, only regional and global politics are strong enough to move European markets.

Consider the events that have had the most sustained effect on European markets over the past several years. These include German reunification, Britain's 1992 decision to step back from euro membership and 1995 fears that France would not go through with the budget cuts and other reforms leading up to the new currency. All these alarms threatened European integration and globalization--and those same two great trends are making it harder for individual governments to control the business environment. In a borderless Europe with a single currency, national leaders no longer have the power to control monetary policy or capital flows. Even tax policy is slowly slipping out of their hands: the EU already has an agreed minimum VAT rate of 15 percent, and the EC is trying to harmonize taxes on corporate income, energy and digital products.

Where national governments do still hold the power to tax, the effect on corporations will be dampened by their mobility. Over the past two decades, it has become easier and easier for companies in areas like manufacturing, technology and financial services to relocate business across borders. Germany's refusal to cut taxes has resulted in a constant outflow of capital over the past two years, slowly but surely eroding the country's tax base. At the same time, German banks these days are less likely to respond to political pressure to help bail out ailing companies, even very-high-profile ones like the Kirch media group, as witnessed by the rising number of corporate insolvencies in Germany.

Aside from all this, global investors simply don't see all that much difference between European politicians. Unless someone like Jean-Marie Le Pen were elected, markets would be unlikely to react dramatically. "Politics in Europe has been moving towards the center for some time now," says Richard Reid, chief European-equities economist for Citigroup. "I'd never expect to see a significant change of policy in, for example, Germany, no matter who was elected." This is in sharp contrast to developing countries like Brazil and Turkey, where less global integration, more state control and precarious financial situations make singular national events much more likely to influence markets. Investors aren't worried that Europe's center-right and center-left politicians will end up in market-moving brawls. With export earnings representing about 30 percent of GDP in Eurozone countries (as opposed to 15 percent or less in a country like Turkey or Brazil), European markets rise and fall more on U.S. consumer sentiment and the latest news about global telecoms than the words of any particular politician.

Admittedly, tighter government regulation of financial services after 9-11, and post-scandal reforms of accounting standards in both the United States and Europe, may eventually have some effect on global stock performance. But again, these changes will likely be coordinated on a regional, or even global, basis. Pre-Enron and WorldCom, policymakers within the EC were already pushing for more fully integrated financial markets in order to compete with the United States. And mutual accounting reforms would likely stabilize markets by giving investors numbers they can trust and making it easier for them to track exactly what multinationals are doing across borders. In this sense, governments in Europe and elsewhere can exert a powerful effect on the corporate world. They'll just have to do it together.