EU economic challenges
and Draghi’s misguided remedies

In September, Mario Draghi, formerly the Italian prime minister, head of the European Central Bank (ECB) and a prominent member of the pan-European establishment, together with his team issued a much-anticipated report on the economic state of the European Union. It highlighted the EU’s gloomy prospects without a change of course and presented a set of recommendations purporting to offer the bloc of 27 countries a brighter future. There has been a substantive debate across the continent about this influential report. The prevailing consensus is that its description of the current malaise is quite accurate and its cry of “Houston, we have a problem” seems justified when looking at all indicators of the EU’s economic trajectory.

It should serve as a warning to observers, however, that a simple description of the situation based on largely unchallenged data elicits such ovations and praise for honesty and openness. This alone reflects a significant decline in European discourse over the last 10 years at least, during which sophisticated European groupthink and the not-so-subtle pressures of political correctness have swept relevant topics and facts under the rug. We have sunk so low that today we are grateful even for a dispassionate look at the speedometer and tachometer of the EU’s economy, which for years did not interest the elite that commissioned the report, appropriately titled “The Future of European Competitiveness.” The concept of competitiveness had been long ignored in Europe and has only recently returned to the thinking of the bloc’s executive in the context of the union’s anemic post-pandemic recovery.

But back to the main finding of the report: The EU lags behind the United States and China, its global competitors, in key indicators such as productivity, per capita economic growth, innovation and rate of creation, and development of internationally competitive enterprises. That is truer in high-tech than in slower-growing traditional sectors. All of this is accompanied by an aging population and a lack of fuel in the form of labor, capital and new ideas, all of which need to be continually bolstered for the EU’s jet engines to maintain forward momentum and loft. The lack thereof is why we are losing altitude.

The union in turbulent times

The trends of economic decline are long-term, according to Mr. Draghi, but they have accelerated in recent years. The EU is to the world, economically and geographically, what Switzerland, the Czech Republic or Austria are to Europe. The EU is a modest territory caught between rivals, lacking resources and heavily reliant on the global division of labor, trade and interconnectedness to sell its goods and services. This reliance was beneficial in good times, when trade barriers were low, peace prevailed and there was a global commitment to cooperation based on respect for fundamental rules.

In such a world, the EU enjoyed the best of times after 1989 and made the most of it, even during the process of its enlargement while drawing in many from behind the former Iron Curtain. But the EU has been so intoxicated by its successes and the enrichment given by these circumstances, that in its pride it has become the world’s chief purveyor of overregulation and paternalistic advice to others on how to live, especially how to save the planet from the destruction that the growth of wealth itself supposedly inevitably brings. This has become European dogma. At its core, the no-growth agenda of decarbonization gradually became the bloc’s preeminent, and eventually only, defining policy.

The costs of the European model have since risen dramatically, while the bloc’s actual and potential returns have fallen.

 

But paradoxically, even this agenda, one not conducive to economic growth, could be financed so long as there was growth, given the circumstances mentioned above. The world took it in stride and could safely ignore the EU.

But the circumstances have changed with rising Sino-American tensions and their intensified trade warfare, the Covid-19 pandemic and then Russia’s invasion of Ukraine. Suddenly the old certainties of globalization, outsourcing, off-shoring, uninterrupted trade, just-in-time logistics, historically low defense spending and cheap raw materials vanished. The costs of the European model have since risen dramatically, while the bloc’s actual and potential returns have fallen. Mr. Draghi describes this politely. In addition to this, specifically in the EU, is the conundrum of undocumented migration, which, most likely, cannot be effectively solved on a European level because the EU is not a state. It is incredible how little current pan-European policies reflect this remarkably rapid change in the world in the last five years.

The sponsor and bold ideas

Few countries have become truly wealthy without first industrializing (a few small tax havens and oil and gas fields being the exceptions to this rule). Yet it is precisely industry that in the EU has gone from being the most highly prized asset to a beast to be slain. In the automotive industry, one of the remaining places where the EU successfully competed on the global stage before deciding to wage its holy war against the internal combustion engine, this is clearly visible.

And this is where the real problem with Mr. Draghi’s report begins. As the saying goes, nothing can be fixed by those who do not understand what is broken. As a former successful investment banker and advisor, Mr. Draghi knows what his clients can and cannot bear. And so, when he was given the assignment, he agreed – in the publicly spoken words of European Commission (EC) President Ursula von der Leyen, his client – not to disrupt two taboos: The report’s recommendations would reflect the sacrosanct European social model and the EU’s path to decarbonization. The unspoken agreement, it seems from the text, is that the commission and its policies will not be subjected to any criticism.

In such circumstances, however, Mr. Draghi’s analytical journey must necessarily conclude with the breathtaking declaration that if the EU were ever forced to choose from its priorities – the social model and decarbonization along with prosperity, security and equality − the bloc would lose its raison d’etre. Really? If so, then Mr. Draghi has inadvertently and perhaps unjustly buried it.

It is the economist who should know that, in the face of budget constraints, it is necessary to prioritize, choose the more important goals and put the less important ones after them. What does every person, every company and every politician do in their lifetime? If the priorities increase and the money decreases, either all get less, or some have to give way.

Facts & figures

The Draghi Report’s three action areas

The EU is, as Mr. Draghi describes it, at a crossroads where the pie is not getting bigger and may, in fact, shrink. Existing priorities of decarbonization and European socialism are joined by a need for more defense and energy spending, an increasingly costly search for international trade and the painful costs of aging.

Since all of these aspirations are clearly not fundable even in affluent Europe, and yet cannot be prioritized (according to the brief), this then points Mr. Draghi logically in one direction: Large new loans must be created to finance the competitiveness reform. And since the private sector, according to the report, will not be willing or able to borrow and invest enough, and as some countries can no longer borrow much even at the nation-state level (like his own notoriously over-indebted Italy), then the solution must be pan-European debt.

Such was the famous 350 billion-euro post-pandemic loan under the NextGenerationEU program, one of former Chancellor Angela Merkel’s last big mistakes during her reign when she broke Germany’s long-standing principle of not allowing joint borrowing and states openly guaranteeing for one another. It is already becoming a headache, as repayments are due to start in 2028. When this happens, the resources available to the European budget will be reduced by a sixth, solely to pay the interest and principal.

Unfortunate conclusions

What can be done then? It is politically unviable to increase the contributions of member states – when the pie is shrinking, everyone wants to contribute less rather than more. This is especially true for net-contributor countries, which give more to the budget than they receive. It is also political suicide to reduce the income of everyone from farmers to poorer countries. And so, Mr. Draghi is straight away proposing to roll up this old loan and add another huge package on top of it.

This is akin to thinking that together we can buy new ovens and flour and believe we will miraculously bake a bigger cake. And that the wise central brain of humankind, which has made flour and ovens more expensive for years, will decide who is the winner of the best-baker contest. It is as if the old rule does not apply: The state cannot find winners, but losers can always find the state.

The Draghi report’s cardinal and irremediable flaw is that it fails even to mention that it is necessary to prioritize areas that the public sector needs to fund. He does not acknowledge that the European goals of decarbonization, addressing defense and aging, while noble, are probably no longer financeable. This is, again, a taboo. We will borrow and spend our future consumption today, just to maintain our current, unsustainable way of life a little longer. All in the foolish belief that if our ride has not worked well so far, speeding up will fix everything.

The state cannot find winners, but losers can always find the state.

 

It is tragicomical that, on the one hand, the report criticizes the rampant bureaucratization within the EU and the high cost of compliance with all the administrative rules on the business side, but on the other is paving the way for new, additional bureaucracy across the union. So, is Mr. Draghi proposing to abolish the General Data Protection Regulation? Repeal the Corporate Sustainability Reporting Directive? Stop the madness with the so-called Supply Chain Directive that makes every big company responsible for the ethics, fairness and sustainability of global business and trading partners no matter how far away territorially or culturally they happen to be? Limit regulation in cryptoassets, digital or financial markets? Or anything at all?

No, that would be too bold. It would be even more daring to propose removing the legislative initiative from the commission without an explicit request from member states, abolishing the developmental defect of European integration in the form of the European Parliament, or just fundamentally rethinking the whole costly concept of decarbonization.

Yet, it is not very bold to propose, in the interests of the EC and some of the elites of the big countries, further steps towards greater federalization of the EU, the removal of powers from the member states or the concentration of decision-making and simplification of the legislative process for proposals made by the Brussels executive itself. In the EU capital, such proposals are welcomed, although it is not at all clear why they should result in higher growth and better economic policy.

Realistically, such moves can exacerbate mistakes. Moreover, even the general notion that the EU can or should ever be like the U.S. − institutionally or in terms of the functioning of capital and other markets − is such an absurdity that it requires specific comment. Especially since the pursuit of this absurdity is Mr. Draghi’s suggestion.

What is Europe

For all the foolish euro-federalists, whether in Europe or the U.S., it bears repeating: The EU is effectively a “community of tribes.” These tribes, with historically different roots, elect their “tribal chiefs” in national elections and expect them, not the EC or the entirely artificial European Parliament, to solve their problems. That is why turnout in national elections is dramatically higher than in European elections. The latter are secondary.

We have arrived at this tribal form in Europe through the centuries-long process of forming nations that have replaced the feudal system; there is no real alternative to it. In the U.S., there is one commander-in-chief and Americans understand this well because they feel like they are one tribe, even if perhaps divided sharply in opinion.

However, to change this in the EU would require a complete abandonment of intra-tribal democracy – it would be reckless social engineering. That in bad times, tribes turn primarily inwards and beggar-thy-neighbor politics run rampant is a feature, not a flaw, of the union. Intuition leads voters to demand answers and solutions primarily from their national leaders, whom they believe have the power to not only find solutions but to implement them. That this is often not the case is another matter.

Seen through this lens, the EU is very much a project mainly for good times, and every crisis shakes its foundations. That has been seen in the financial, fiscal, migration and pandemic crises. The only thing that keeps these shocks within acceptable limits has been a functioning economy generating enough resources to allow the crises to be “flooded with money” and thus extinguished. If the economy does not work, then the EU as it stands is finished, because the electorate in individual member states will no longer be willing and able to ignore the bloc, but will blame it and all its neighbors for its troubles. If the market and wealth creation do not work, politics of hate will. We know this all too well in Europe. It is certainly better to not revive these slumbering demons.

The misery of the messenger and the contractor

It is charming when Mr. Draghi quite rightly points out that the EU would benefit from a greater deepening of the single market, especially one for services, not just goods. Commendable! Of course, we all know that services are somehow always more politically sensitive, because, unlike containers full of goods, it is the voters who are playing a role here. Who should know that better than the former prime minister of Italy? The country that, for example, has been in a legal dispute with the EC for almost 20 years over the release of monstrously anticompetitive practices in the awarding of private concessions for the use of Italy’s public beaches, which some families have inherited generationally without facing any competition.

What has Mr. Draghi done in this matter? Little. As head of the ECB, what did he do to deepen the integration of the euro credit market, which is struggling, and where it is absolutely uncommon for a small businessman in Italy to take out a loan in France or Germany, even though they pay in one currency? Almost nothing. What was done for a less risk-averse banking sector, when risk aversion in banks is seen as a problem for developing riskier businesses in Europe? Well, he presided over the greatest tightening of banking regulation in modern history. And so on.

The author of this text has repeatedly experienced the reality of the single market for goods, where a given online shop of a European manufacturer delivers its wares only to the Iberian Peninsula and another only to German-speaking countries, with the only certainty for a customer elsewhere being a certain American giant, Amazon. This is the mental reality of Europe, which must be taken into account.

No one in the pro-Ukrainian European establishment has even dared to suggest that aid to Ukraine could also be on a market basis and that the EU could, for example, buy much cheaper Ukrainian grain. And even Mr. Draghi has not demonstrated such market courage.

To Mr. Draghi, then, let us say: Will you ask a plumber who has failed to deal in the slightest with a backed-up toilet in one flat to fix the sewage system in the whole estate? Not to mention when he confidently comes up with a price tag reminiscent of the cost of reconstructing the Taj Mahal, as Woody Allen would ironically add? Hardly.

The meager value of the report and its recommendations is demonstrated in the revolutionary proposal that a possible reassessment of car emission limits be conducted a year earlier, in 2025 as opposed to 2026, being proposed in September by a former climate radical, the German Minister for Economic Affairs and Climate Protection, Robert Habeck. Mr. Draghi’s report is silent on this.

The lesson for EU member states, then, is that it is unlikely there will be any practical guidance on the way forward in this opus. Countries will have to look out for themselves. Where? Well, precisely in their diversity and heterogeneity, and in healthy competition among themselves, in their ability to produce, as long as we do not artificially slow it to zero, in establishing new trade relations wherever possible, so that the essential benefits of the division of labor are preserved.

Tariff wars with the world will not save the EU, nor will pulling other countries from its neighborhood closer, which conversely erodes the single market. The bloc will not be saved by “friend-shoring” (that is, in pulling production from hostile countries to Europe as a place that will want and need to find many new trading friends); nor by the concept that industry and manufacturing of any kind are foul and must be curtailed. At the same time, the union seems to hope that the progressive monopolization of totalitarian decision-making in China will lead to an accumulation of economic and political mistakes there that the EU will not replicate.

The massive joint borrowing of public money, the unrealistic dreams of a single capital market in the EU or the utopia of competition with U.S. private firms through state subsidies and grant policies will not solve the problem. Yet, this is precisely what Mr. Draghi’s report recommends in abundance. It is therefore, unfortunately, just a set of mostly mistaken or unrealistic recommendations sent by the wrong messenger to the wrong address.

This report was originally published here: https://www.gisreportsonline.com/r/draghi-report-misguided/