Excerpted from the book, INVESTING IN THE NEW EUROPE  © 2001 by Eric Uhlfelder.  Published by arrangement with Bloomberg Press.

France: A quiet revolution

In the offices of Gemplus SCA in Provence, the world's largest manufacturer of smart cards has made English its spoken language. The company is waging battle against the French unions, planning new production facilities in countries where labor is cheap, and working out details for an initial public offering in the states.

In France's rural heartland, Pechiney SA, Europe's leading producer of primary aluminum, adopted a major restructuring program shortly after the firm was privatized in 1995. Employee incentives are enhancing productivity while the combination of early retirement packages and increasing use of temporary workers is making the firm more competitive and profitable.

Compagnie d'Assurances Mutuelles contre l'Incendie, an insurance firm founded in 1817 in northern France, adopted a moniker in the 1980s that could be pronounced similarly in nearly every Western European language. In linguistically minded France, nothing is closer to anathema. A decade later, after buying controlling stakes in Equitable Life, Donaldson Lufkin & Jenrette, and Alliance Capital Management, and with $789 billion in assets under management as of the end of 1999, Paris- based AXA has become the world's second largest asset manager, right behind Fidelity.

A Definitive Shift:

Despite the political rhetoric and the election of a new Socialist government in 1997 as the country was preparing to meet the stiff fiscal requirements of monetary union, France is in the midst of an economic revolution. Change may be slow, and the French may argue that they aren’t trading in their socialist affections for capitalism.

But continued privatization of major state operations and the desire to increasingly promote free enterprise to ensure that these new public offerings succeed in the global marketplace speak most clearly about where France is heading. BusinessWeek illustrated the point in a lead story that identified "a small but growing army of citizens wanting to shrink the state's role (where government outlays are 54 percent of GDP, the highest of all G-7 nations), reverse a pervasive hostility toward entrepreneurs, and erase the handout mentality that is ingrained in French society." And for this to be happening in a country with the second largest economy in Europe that’s experienced only a single year of recession since the end of the Second World War bodes well for investors.

Strong Performance:

French stocks have been among the best-performing European shares over the second half of the 1990s, having appreciated 24.07 percent a year in dollar terms between 1995 and 1999 . In 1998, the year leading up to EMU, French shares soared nearly 40 percent. In 1999, they tacked on another 28 percent – nearly 50 percent in euro terms.

Two dominant factors fueled the growth in French equities. The first was broad European and global strength throughout much of the 1990s that made France the third largest recipient of foreign direct investment in the world and the largest within the eurozone. The second force was expanding domestic consumer confidence spurred on by real wage growth, optimism about monetary union, and the country’s solid economic performance, illustrated by the following statistics:

Weaknesses:

However, there are two sour spots: debt and jobs.

While having barely satisfied the terms of monetary union, France’s high debt-to-GDP ratio has in fact been trending the wrong way as the government seeks to cushion some of the hardship brought on by the demands of Maastricht. Corporate subsidies, dubious job programs, extensive unemployment, and social security benefits have pushed the ratio up from 48.5 percent in 1994 to 59 percent by the end of 1999, while other eurozone nations’ debt positions have been improving.

Given the increase in public outlays, this leaves Marie Owens Thomsen, economist at Merrill Lynch in Paris, to question the degree of fundamental change that has been achieved. She believes that current positive trends are more the result of “greater economic activity, not reform of old and stale ways, leaving France critically exposed to the business cycle next time it turns.”

Looking at France's troubled employment picture suggests that Thomsen may have a point. The government's most significant jobs policy – shortening the workweek from 39 to 35 hours – is supposed to force businesses to increase the number of employees. However, because the law prohibits any corresponding reduction in wages (although it does give employers greater scheduling flexibility), the result may fuel inflation, make businesses less efficient, and encourage management to consider overtime schemes or temporary labor rather than the addition of new 35- hour-a-week workers.

The Jospin government has resorted to the shorter work week strategy because, paradoxically, steady economic growth has failed to substantially cut into the country’s high jobless rate. While having finally broke below 10.0 percent in 2000, unemployment had been fluctuating between 10.6 and 12.5 percent during the latter half of the 1990s. This suggests that increasing corporate profitability has been based more on enhanced efficiencies rather than domestic expansion. And it may suggest corporate hesitancy to take on the liability of permanent workers.

Certainly the case can be made that the country’s changing business culture is departing from the traditional focus on job creation and market share, focusing instead on shareholder value. And clearly, the increasing role of foreign institutional investors in French equity markets (who now own more than 40 percent of CAC40 shares) has been a driving force behind this change.

Shareholder Value:

After reviewing the operations of the country’s largest firms making up the SBF120 index, BNP Paribas, France's largest investment bank, made the following discoveries:

The result: annual earnings per share growth increased from an average of 2.9 percent in the early 1990s to 16 percent in 1998. While BNP Paribas observed that “French companies still contain a significant untapped reservoir of shareholder value, especially when compared to other European countries (Switzerland, the Netherlands, Sweden, the United Kingdom, Germany and Spain), the impact of these trends has helped boost stock prices, bringing better visibility of strategy and higher valuations.”

The link between government and business that for so long had kept management focus on jobs is also being severed with the phasing out of a practice known as Noyeau Dur. Management and board members of France's largest privatized firms often came from the bureaucratic ranks of government, lacking expertise in their assigned businesses. Further, officials would often hold voting positions at several different firms at once, establishing a significant cross-shareholder network among the country's largest companies. The goal was to sustain government involvement in corporate decision making and to prevent hostile takeovers, particularly by foreign concerns. However, this layer of bureaucracy that stretched across much of the country’s privatized landscape has retarded corporate restructuring, and in certain instances, has led to some big losses including those at UAP (now AXA), Elf Aquitaine (now Total-Fina-Elf), and Crèdit Lyonnaise during the mid-1990s. The BNP Paribas study found that between 1996 and 1998, “virtually all mergers and acquisitions in France involved almost no mass layoffs,” while at the same time, underperforming assets were rarely sold off.

But all that is beginning to change as the concept of corporate governance enters into the Gallic vocabulary. Diminishing state regulation is enhancing French companies’ ability to operate more efficiently and profitably. And in the more competitive climate of common currency, even the socialists are realizing that proceeding in this direction holds the best hope for the French economy and the welfare of her citizens.

Eric Uhlfelder is the author of "Investing in the New Europe," recently published by Bloomberg Press, and is European Editor at Investing Across Borders. For more information, please go to InvestingInEurope.com.

May not be modified, copied, reproduced, republished, downloaded, uploaded, posted, transmitted or distributed in any manner.