Two Ways To Profit From Europe’s Steady Shift To A Free Market

The European election result has been met with little interest in the United States; for one thing, the plethora of parties from 27 different countries makes it almost incomprehensible. Yet it continued a long-term, very important trend, which should be hugely interesting to international investors.

You see, the longstanding attitude toward Europe - that it is an anti-free-market continent that should be of little interest to investors - is wrong; for the last couple of decades, it has been becoming more free-market-oriented, coming closer to the U.S. economic system.

You can see this more clearly by examining the last four European elections - 1994, 1999, 2004 and:

• Group I: Socialist/Green - believing in strong state control over the economy, whether for political or environmental reasons.
• Group II: Center-right - often nationalist, but believing generally in a free-market economy, although generally with greater government involvement and more welfare payments than in the United States, and finally.
• Group III: Centrist/Other - either small center parties holding the balance of power in domestic parliaments or the inevitable residue of the unclassifiable.

Thus, the British Conservatives and German Christian Democrats fall in Group II, as would some smaller parties, like the British U.K. Independence Party and the Swedish Pirate party (which is a small libertarian anti-copyright outfit). The British Labor party, the French Socialists, various hard-left parties and the Greens fall into Group I. The British Liberal Democrats, the German Free Democrats and such economically un-definable parties as the British National Party fall into Group III. This gives anomalies - the German Free Democrats are highly free-market-oriented, for example - but most of them are fairly small and should cancel out.

Then since 1994, EU elections have shown the following trend:

• 1994: 12 countries. Socialist Group I parties 249 seats of 567, 44%, Group II 40%, Group III 16%.

• 1999: 15 countries. Socialist Group 1 parties 270 of 626, 43%, Group II 45%, Group III 12%.

• 2004: 25 countries. Socialist Group I parties 283 of 732, 39%, Group II 45%, Group III 16%.

• 2009: 27 countries. Socialist Group I parties 243 of 736, 33%, Group II 45%, Group III 22%.

You can see the trend. The Socialist/Green contingent has declined considerably from 44% of the total to 33%, while the Center-Right has increased moderately, from 40% to 45% (the Group III - liberals and miscellaneous - is a bit overstated for 2009, because many of the small parties haven’t yet sorted out which European grouping they will align with). Individual countries swing left and right, as in the United States, but there are enough countries in the EU for these swings to cancel out, leaving only a steady movement towards the Center-right.

One of the causes of this movement is the expansion of the EU - with the exception of the Scandinavian countries, which entered in 1995, most of the new countries are former members of the communist bloc, with an aversion to many aspects of government control. Nevertheless, it’s completely consistent across all four elections, not a temporary mood swing. What’s more, it’s substantial enough to make a big difference in EU policymaking, taking it strongly in the direction of free markets, if not necessarily in the direction of smaller government. A coalition majority sufficient to push through legislation would have been socialist-dominated in 1994; it would now be center-right-dominated.

Investors would do well to bear this trend in mind. Productivity growth has been generally slower in Western Europe than in the United States - but not much slower. In Eastern Europe, however, productivity growth has run at East Asian levels of 5% per annum or more, as the generally excellent education systems and heavy foreign investment of those countries has allowed them to catch up with the rich West. Overall, it’s likely that European productivity growth will speed up in years ahead, translating into faster growth in the overall economy, as EU policymakers remove additional trade barriers and pursue reforms that are modestly free-market in focus.

In the United States, meanwhile, the Barack Obama administration looks likely to substantially increase the government’s share of gross domestic product (GDP), taking the U.S. economic picture much closer to that of Europe. That may cause U.S. productivity growth to slow to European levels. Of course, as investors we would pay more for an increasing productivity growth trend than a declining one - which is why it is strange that most Price/Earnings (P/E) ratios in the EU are below the 13.6 average of the U.S. Standard & Poor’s 500 Index.

To celebrate the EU election result - or to position yourself for the region’s favorable prospects - you might look at the Vanguard European ETF (VGK: 41.43 +0.45 +1.10%), which tracks the Morgan Stanley Capital International Europe Index. With net assets of $1.54 billion and a Price/Earnings Ratio of 8.2, it’s a way to get into a huge market on a bargain basis.