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- The EU Is In Trouble
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Let’s dive in…
I'm guessing 99% of Americans were too busy talking about Trump's love for cats and dogs to notice anything going on in Europe the week before last. But there was something significant. Mario Draghi (former Italian Prime Minister and President of the European Central Bank) released a report on European Union competitiveness that has made headlines across the continent.
That sounds boring, but it's important. In my view, the EU is committing slow suicide. Between its over-regulation, hostility to tech, lack of population growth, cultural aversion to the market, and misguided energy policy, I don't see a bright future.
This chart sums it up. In 2002, EU countries on average had about 17% less in Gross Domestic Product than the US. That gap has grown to 30%. Europe is getting poorer relative to the other major economic and power players: the US and China.
Why Europe is Getting Poorer
Draghi's report identifies many issues, but three dominate:
1. No integrated capital market: While the Euro is each country's currency, it isn't backed by an integrated budgetary and debt market. When the US wants to spend money, it issues Treasury bonds to pay for it. The EU has no integrated way to issue such debt. Each country does it on their own.
2. Lack of reliable and affordable energy: The EU does not have reliable and affordable access to energy. Before the Ukraine War, Russia pretty much filled the gap. That allowed countries like Germany to indulge in decarbonization fantasies and begin shutting down nuclear power plants. Now energy costs are 2-3x what companies and people pay in the US.
3. Regulatory issues: Europe hates tech, and try firing someone in France. Europe has actually expressed pride in leading the world in regulation. That's like leading the world in strangling kittens. The EU has particularly specialized in regulations like GDPR and the AI Act focused on tech. It's hard to imagine leading the world in growth going forward without a robust tech sector. And it's hard to imagine having a robust tech sector when your government spends most of its time trying to figure out how to make your job harder.
To ameliorate these issues, Draghi proposes two key projects. First, a massive investment campaign totaling 4-5% of EU GDP or about $800 billion to invest in innovative technologies. He sees the EU financing that investment by issuing joint EU bonds (i.e., integrating their debt market a bit more).
Second, he wants the EU to focus on collective purchases for key inputs like energy to take advantage of its market size. He also calls for more coordination on lifting regulatory barriers.
Draghi should be commended for the bluntness with which he outlines the EU's issues, but ultimately I think the project is doomed. In my opinion, the EU will continue to get poorer into the foreseeable future.
Why Draghi's Solutions Won't Work
Let me be clear up front: if adopted, Draghi's solutions would help quite a bit. No dispute there. The problem is they won't be adopted, and even if they were, they wouldn't be enough to really change the game. The EU has three main issues:
1. Nationalism: The main reason his proposals won't happen is because of nationalism. In the end, these are separate countries and cultures. Germans want to fund their own innovation for their own reasons and don't particularly care to increase their debt burden to fund Italy's. Inevitably, any funding that would be raised would be chopped up and sent to each country to focus on their own pet projects.
2. Demographics: The other reason these recommendations can't bridge the gap are some of the realities facing Europe. It is an aging society, and they seem to be focused more on padding retirement than investing in innovative tech.
3. Culture: There are notable exceptions, but Europe's shared culture doesn't seem to value entrepreneurship and some of the inequality that comes with it. In fact, Draghi specifically calls this out. He writes:
"As outlined above, the US has pulled ahead of the EU owing to its stronger position in breakthrough technologies, yet it displays higher rates of inequality. A European approach must ensure that productivity growth and social inclusion go hand-in-hand."
Good luck with that. As he himself points out later in that same paragraph, growth and technological change come with lots of disruption and tend to increase inequality. I don't see how you get one without the other. There's a trade-off to be made between growth and inequality, and it seems clear the EU wants less growth to ensure less inequality. I'd like to keep eating fries all day and not get fatter too, but such is life.
Another aspect of European culture is the close ties between governments and large corporations. We have this in the US with banks and a few others, but it tends to be more isolated and the support more episodic. I can see corporate lobbies in Germany, France, Italy, and in other countries making sure any largesse goes to their industries and not to new sectors with little political support. Germany is going to sign up for 800 billion euros in debt and Volkswagen is grabbing a large chunk? Unlikely.
4. The Euro: The Euro itself is a drag on growth. When European states had separate currencies, weaker economies like Italy could devalue their Lira against the German Deutsche Mark during times of stress. That made Italian goods cheaper and increased exports. Or Italy could spend more in key sectors to boost production when Germany refused.
With all these countries locked into the Euro and budget constraints essentially controlled by a Germany bent on exporting goods and consuming none, everyone is running a suboptimal economic policy. In some ways, the Euro is a German death cult slowly strangling the Continent. Nothing in Draghi's report will really change that reality.
Why Do Anything?
Some could argue that these measures aren’t necessary. Europe is great. People have a good quality of life, work less, and enjoy themselves more. They don’t what Anglo Saxon values creeping in.
Even just a few years ago, most American progressives would agree. They would constantly point to one or another aspect of the European welfare state and say, “We’re the only developed Western country that doesn’t have that.”
They say it less now because the ostrich move isn’t going to work for much longer. The system is breaking under the weight of less productivity, less growth, and higher costs. Eventually Europe is going to run out of money to support its massive number of retirees. Then they’ll have to degrade the quality and quantity of services and many think this process has already begun.
And because the population is so old I don’t think you’ll see a real revolution that could spur change. Most likely the long, slow suicide just keeps going and quality of life gets worse.
What Should be Done
I think the EU would be much better off going to less centralization rather than more. True if they could come together as one unified state and throw off the shackles of German economic and energy policy, then staying together in the Euro makes sense. I rate that possibility at about zero.
Instead, they should dissolve the Euro and let every country conduct the investment and borrowing policy it wants. The EU can remain a free trade area and coordination point on policy, but it can't run Europe-wide industrial and economic strategy. It isn't a country.
Henry Kissinger famously said, "I will believe in Europe when there is a phone number I can call to talk to it." There's still no number. There's a President and Commission, etc., but they are just order takers. You need to call Berlin, Paris, Rome, and 10 other countries to get anything done. You call Brussels to be polite.
A devolution will allow more experimentation and force some amount of competition. It would also allow some economies to throw off the German yoke with its export-driven, low-investment model. A country with slightly better demographics might be able to loosen the regulatory straight jacket (ie dump the AI Act), invest in leading edge tech, and maybe come out ahead.
Why It's Important to the US
We should pay close attention to this in the US because we are flirting with some of the same issues. There are strong voices on both sides of the political spectrum calling for a more European-style approach here in the US. I believe we are too fractious and anti-elite to go down a similar path to Europe, but the threat is there.
American elites, with the exception of parts of Silicon Valley, think in similar ways to the Europeans. But the US has a much stronger rural, fly-over state, anti-elite faction. Paris and London are more firmly in control of their countries than Washington, DC or New York are of the US. Thank God for that.
We also talk about Europe as a partner. I question this view. It was certainly true in the Cold War, and I love vacationing in Lucca as much as the next guy. But when it comes time to face off against the Chinese, I think Georgia Meloni (the Italian Prime Minister) is going to be cutting deals with Xi Jinping in the back room, and most likely that won't matter. I question how strong that partnership is going to be or how valuable Europe would be in it.
If I'm a US diplomat, I'm much more concerned about the views in New Delhi, Hanoi, Canberra, and Tokyo than I am about the ones in Paris, but there are ways in which we can team up to counter Chinese trade policy at least.
In the end though, there are still 450 million people who live there, a collection of key companies (particularly in pharmaceuticals), and many well-educated and productive people who will contribute to a better future for humanity. As the US, we will continue to overemphasize Europe because of our cultural connections and inertia and because it's a nice place to visit, but I don't hold out much hope of anything more than a continued slow decay. Sorry for the dark ending here. I'll do something more uplifting for next week.
Keep Learning,
Alan
P.P.S.
1 It’s true that on a Purchasing Power Parity comparison the decline is less but PPP has a lot of issues and raw GDP numbers are more accurate in my view.
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