A prominent European leader correctly identifies that EU states are lagging behind their global competitors. The reason? Low growth induced by piles of red tape imposed since the financial crisis.
Sounds familiar, right? Except it’s not Liz Truss saying this, but Mario Draghi, former European Central Bank chief and ex-Prime Minister of Italy. Career technocrat Draghi was tasked by Ursula von der Leyen to find out the reasons behind the EU’s sluggish economic performance. His report is out, and it is a dire assessment of what went wrong with the EU’s economy over the last decade.
While both may have identified correctly the problem of European competitiveness (or the lack thereof), it is the response to it that matters the most. The UK failed to rise to the challenge under the leadership of Truss, and there are only mildly encouraging signs that this may change under Starmer. But will the EU’s approach be any different?
Draghi confirmed what European free marketeers have been saying for a while: despite the successful foundations of the Single Market, Europe has been lagging behind the US and China because of overregulation and over taxation, which has been getting worse since the financial crisis. EU legislation doubled since the implementation of the Lisbon Treaty in 2010 and increased seven fold since the Maastricht Treaty. The brunt of this regulatory burden is felt by SMEs, with more than half citing them as the core business challenge they face.
So now that we have established that free marketeers and (some) politicians are on the same side when it comes to the analysis of the problem and the ultimate goals (namely increasing Europe’s competitiveness and boosting economic growth), it is worth looking at the solutions proposed.
Draghi acknowledges that red tape must be reduced in the tech sector. The sector has propelled productivity growth in the US, but could not develop at the same pace in Europe as a result of countless tech regulations, like GDPR, the Digital Markets Act, the Digital Services Act and the AI Act. If European startups manage to navigate the maze of EU tech regulations, they are still likely to leave the bloc in order to scale their activities due to a lack of funding opportunities on the old continent.
Draghi’s recommendations to fix the lack of investments in Europe is only tinkering on the edges. Although his recommendations to better coordinate research and innovation between EU members or rethinking the stringent capital requirements under Solvency II are commendable, they don’t solve the crucial difference between the US and Europe. ‘The level of pension assets in the EU was only 32% of GDP while in the US total assets amounted to 142% of GDP’ – a staggering difference correctly identified by Draghi.
Essentially, European countries’ pay-as-you-go pension systems are not only a problem because they’re turning into Ponzi schemes due to the demographic crisis, but also because they lack an important vehicle of business financing: major pension funds. While Draghi is asking EU member states to better coordinate their fractured state aid mechanism and potentially secure more funding for the EU, he does not spell out an obvious solution: to reform pension systems and ensure that they are based on capitalisation, rather than redistribution. If the current estimated shortfall in European pension contributions relative to the total cost – which is estimated at 5.6% of the EU’s GDP, or €823 billion – would be closed thanks to moving to a system based on capitalisation, then Draghi would be able to close the investment funding gap between the EU and the US without having to resort to more common borrowing by the EU, as he suggested.
Like most politicians, Draghi is unable to resist the temptation of having his cake and eating it. While he elaborates in detail how the US is outperforming the EU in almost all key economic metrics, he explicitly rejects the idea of dropping any of the costly aspects of the welfare state. Keeping the generous welfare systems in Europe with its declining demographics and investing similar amounts in industrial policy as the US is not possible, even if leaders desire it with all their hearts. We would be better off to acknowledge existing trade-offs and ensure that Europe does not try to outcompete the US or China with state subsidies they cannot afford.
As Truss painfully learned, a correct diagnosis is only the first step of the puzzle. A misguided and ill-timed treatment of the sickness can only make things worse. But it must be emphasised that Draghi’s report is a step in the right direction. EU policymakers are finally waking up to the reality that without economic growth, Europe will be condemned to a slow, agonising decline. An Italian economist would understand that threat more than anyone else.
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