The EconomistFebruary 22nd 2020 Business 632
1rising accounting phenomenon. These al-
low buyers to ignore inconvenient ex-
penses more or less at will, for example by
assuming merging firms will successfully
cut costs once combined. Loan documents
are drawn up using the fiddled profit fig-
ures as a baseline.
Often the losers are firms with too much
debt. If a recession is triggered by rising in-
terest rates they get hit just before the
downturn begins and again once it is in full
swing, as sales slide and they struggle to
meet interest costs or refinance loans.
Since 2007 overall corporate debt has risen.
In Europe non-financial corporate debt
now stands at nearly 110% of gdp, com-
pared with under 90% in 2007. In America
businesses are now borrowing more than
households for the first time since 1991.
Much of the money has gone to compa-
nies with far less ability to repay their cur-
rent debts, let alone when a downturn
strikes. In the rich world one in eight estab-
lished companies makes too little profit to
pay the interest on their loans, let alone the
principal. That is up from one in 14 in 2007,
according to the Bank for International Set-
tlements. A recession half as bad as the
2007-09 slump would result in $19trn of
corporate debt—nearly 40% of the total—
being owed by such straitened companies,
according to the imf. Janet Yellen, a former
chair of the Federal Reserve, has warned
that “if we have a downturn in the econ-
omy, there are a lot of firms that will go
bankrupt, I think, because of this debt. It
would probably worsen a downturn.”
Optimists argue that the structure of
debt has become more flexible. Banks are
in better shape thanks to new (albeit large-
ly untested) regulations enacted since
2008, and so should be able to keep lending
if the economy sours. Businesses have
been able to secure loans with fewer
strings attached, for example if they look
like they may struggle to repay the money.
In America, businesses now borrow in-
creasingly from lenders outside the bank-
ing system, such as the private offices of
rich families, or pension funds. These,
some say, can knock heads together quick-
ly and help firms recover. It is best to take
such statements with a pinch of salt. A
mini-panic in late 2018 saw the price of
many private-debt instruments plunge,
suggesting the system is fragile.Winners and losers
Who will be the winners? Every recession
has them. Warren Buffett picked up assets
on the cheap in 2007-09, while JPMorgan
Chase cemented its place as America’s
leading bank as the industry retrenched.
Firms that thrive in downturns tend to
have the clarity of purpose and financial
muscle to keep investing and growing as
others pull back, says Martin Reeves of the
bcgHenderson Institute. It is a test of man-agement and culture but also requires
strong balance-sheets: 15% of firms in the
s&p500 have more cash than debt, includ-
ing Apple and Monster Beverage. Investors
with money are watching and waiting. The
private-equity industry has some $2trn of
cash. Mr Buffett sits on $128bn.
A recession will come, eventually.
When it does it will batter companies that
have been sustained only by low interest
rates. The churn as those businesses are
sold, restructured or dissolved will extract
an economic and human toll. Recrimina-
tions will fly, then abate. In time, the more
productive firms that survived will think of
ways to invest money profitably. That will
lead to new jobs, then economic growth,
then exuberance—and the cycle will start
all over again. 7Period of adjustment^4Sources: AlphaSense;
Zion Research Group*With market capitalisation over $5bn
†Earnings before interest, tax,
depreciation and amortisationUnited States, number of companies* with
“adjusted EBITDA†” mentioned in regulatory filings0501001502002502008 09 10 11 12 13 14 15 16 17 18M
ark zuckerberg might not have
liked everything he heard, but Face-
book’s boss got the timing right for a recent
visit to Brussels. He was among the first
outsiders to hear about the European Un-
ion’s ambitious plans to keep the technol-
ogy industry in check, outlined in a series
of documents made public a few days later,
on February 19th. His visit is an admission
that political paralysis in Washington, dc,
has handed the euthe opportunity to be-
come the world’s most important source of
tech regulation.
Europe is both gnome and giant in the
tech world. The continent has lots of cut-
ting-edge technology but hardly any signif-
icant digital platforms. It accounts for less
than 4% of the market capitalisation of the
world’s 70 largest platforms (Americaboasts 73% and China 18%). At the same
time, the euis a huge market, with a popu-
lation of more than 500m, which no tech ti-
tan can ignore. It contributes about a quar-
ter of the revenues of Facebook and Google.
This combination has given rise to what
Anu Bradford of Columbia Law School
calls, in a new book of the same name, the
“Brussels effect”. Digital services are, in her
words, often “indivisible”. It would be too
expensive for big tech firms to offer sub-
stantially different services outside the eu.
As a result, most have adopted the General
Data Protection Regulation, Europe’s strict
privacy law, as a global standard. Govern-
ments, too, have taken more than a page
from the eu’s data-protection book. About
120 countries have now passed privacy
laws, most of which resemble the gdpr and
its predecessors.
The European Commission wants to re-
peat the trick in other areas. The main doc-
ument presented this week, a white paper
on artificial intelligence, is a grab bag of
measures to foster the use ofaiin Europe
and to limit its perceived dangers. The
commission also released a “strategy” to
promote the use of data, the most impor-
tant input for aiapplications. The idea is to
create a “single European data space” in
which digital information flows freely and
securely. To make that happen, the com-
mission wants, among other things, to
eliminate legal barriers that keep firms
from sharing data, as well as investment in
cloud services that facilitate sharing.
Both papers are part of the eu’s overall
“digital strategy”, which was also present-
ed. Later this year the commission will put
forward a draft of a “Digital Services Act”.
Dominant tech firms should expect stricter
rules not only about how they police the
content that users generate, but the extent
to which they can discriminate against ri-
vals that use their services. All this is
rounded up by a review of competition
policy. Details are scarce, but proposed leg-
islation in Germany indicates the direction
of travel: data will become far more impor-
tant for determining whether a company is
dominant and whether it has abused its
market power.
There are signs that the Brussels effect
will work its magic again. Facebook is not
the only tech giant to accept Europe as the
world’s main source of tech regulation for
some time to come. Sundar Pichai, the boss
of Alphabet, Google’s parent, recently paid
a visit to the Belgian capital. He called for
“sensible regulation” of ai. Brad Smith, Mi-
crosoft’s president, is a regular guest.
America’s tech titans also increasingly use
the euto influence the debate at home. It
saves some lobbying there, if they can help
shape widely adopted regulations that em-
anate from Europe.
But the Brussels effect may be less effec-
tive than in the past. The ground on whichBERLIN AND SAN FRANCISCO
The European Union wants to set the
rules in the tech worldTech regulationThe Brussels effect,
continued