The EU and the Global Economy

Think tanks and major news outlets have rallied about the question, and reaching a conclusion became urgent after the US election. Why is Europe falling so far behind the US? Output grows faster across the pond, the technologies of the future are developed in Silicon Valley, and Europe remains dependent on the US for security.

Although there has been discussion about the extent of the disparity, its underlying reasons seem clearer: Since the euro crisis, investment in Europe has lagged. Even though European banks were well-capitalized, with interest rates near zero up until the pandemic, investors seemed reluctant to invest in risky, high-yield opportunities in Europe, and when they did, they often chose the United States instead.

A few months ago, the man widely known for saving the euro, Mario Draghi, released a compelling report identifying the main reason behind the EU’s slowdown: institutional fragmentation. In his view, high-yield innovations face an easier way forward in the US, where they can quickly scale up. In Europe, in contrast, they face twenty-seven different legal and corporate compliance systems, all of which deter investors from even attempting it. The continent has the human capital and the savings to pursue these investments, but when it comes to scaling up, the EU’s fragmentation further threatens already high-risk endeavours. Overall, Draghi argues for institutional changes coupled with a classic Keynesian approach: a significant increase in spending. Underlying this proposal is the idea that the EU’s current equilibrium includes a big market failure – one that will not resolve itself.

Enrico Letta shares a similar view but proposes a smaller, more politically feasible path forward: The integration of three key sectors – financial, energy, and telecom. This would allow the huge number of small national companies to consolidate into larger EU companies, which could more easily invest on a continental scale.

Whether any of these proposals will ultimately come to fruition remains an open question. The debate over further integration in Brussels is endless, and traces back to the very origins of the EU. Margaret Thatcher famously declared “No, no, no” in the Commons when Brussels proposed that the UK join the euro, a stance that eventually led to her dismissal as party leader. But this position is far from isolated. Ultimately, integration requires incumbents to relinquish powers they may never be able to reclaim, and that is always a difficult ask.

There is, however, a recent development that may change this state of things. The election of Donald Trump and the security risk posed by Putin’s Russia have created consensus among EU officials on the need for further integration. This stance has been backed by Brussels’ recent permission for the use of EU funds in defence. But will this lead to integration in other areas? Will it convince investors? These questions remain unanswered.