Europe’s Economic Predicament: How to Stop the Decline?
Introduction
As the global economy shifts, Europe finds itself grappling with stagnation. Slow growth, a widening gap with the United States, and declining geoeconomic influence are among its most significant challenges. Eurostat (2024) reports that the EU’s economy grew by an uninspiring 0.3% in the third quarter of 2024. This compares to the United States’ 2.8% growth in the same period (Bureau of Economic Analysis, 2024). On the surface, tightening monetary policy due to rising prices in the wake of Russia’s invasion of Ukraine is the obvious cause behind the economic stagnation. However, I argue that there are deeper systemic weaknesses plaguing Europe’s economy causing it to lose ground to its competitors. Structural inefficiencies and economic rigidities including high taxes, a lack of cohesion in the EU single market and adaptability to the current international political-economic climate, marginal private investment, and significantly low innovation dampen the continent’s business atmosphere. From an investor’s perspective, there aren’t many exciting opportunities in the region compared to others worldwide. This contrasts starkly with the United States, which outperforms Europe with greater adaptability and promising innovation. Given these developments, it is difficult for it to keep up with its competitors, particularly China, which is expanding its market share of high-tech exports at Europe’s expense.
Further, the EU’s geoeconomic influence has nosedived in recent years due to increasing conditionality associated with European credit, finance, or business, limiting its engagement with the global south The cost of doing business with Europe is too high for emerging markets, pivoting them towards China. Hence, Europe must shed its excessively restrictive environmental and social conditionalities to make it a more relevant business partner for today’s upcoming economies. The following article analyzes Europe’s current economic challenges and contextualizes its growth in global terms. Further, it examines its falling international economic competitiveness. Broadly, Europe’s economic policies need to be reconsidered and its single market needs to be deepened to encourage investment and boost its competitiveness. This begs the question: what’s really behind Europe’s uninspiring growth?
Innovation Deficit and Investment Shortfall
There are multiple deficiencies in Europe’s economy, the most prominent being a lack of innovation and investment. Mario Draghi, Italy’s former Prime Minister and a former President of the European Central Bank, identifies similar shortcomings in his recent report. In what’s being referred to as the ‘Draghi Report’ in the finance world, he notes that the EU’s single market is significantly fragmented in reality (Draghi, 2024). This is most evident when comparing European economic indicators to the US. Washington has consistently outpaced Brussels on GDP per capita and productivity. For instance, the IMF (2024) estimated American GDP per capita to be $86.6 thousand compared to the EU’s $46.6 thousand. This is mainly because of the lower costs of tech-related innovation and investment, a catalyst of growth in today’s era. Draghi notes that of the world’s fifty leading technology companies, only four are European. Further, the EU’s multi-layered regulatory environment is increasingly unattractive to businesses, making it difficult to secure investment for growth. Small and medium firms are most impacted by this shortcoming as they have fewer sources of financing in their infancy. By comparison, American and Gulf-based venture capital provides growing European companies with promising opportunities, incentivizing them to relocate out of the EU. For instance, the average venture capital fund size in the United States is $282 million as opposed to $128 million in the EU (Kumar, 2018). This shift is most pronounced in the case of tech startups as recent American regulations, such as the CHIPS Act, incentivizing investments in semiconductor and AI companies have enabled them to attract a larger pool of capital in the US. Thus, the EU must create an innovation-friendly ecosystem and homogenize investment regulation to improve the free flow of capital and retain growing companies.
Energy Dependency and Exacerbating Inflationary Pressures
Russia’s invasion of Ukraine and the skyrocketing energy costs have hit Europe hard. Rising energy costs significantly contributed to the EU’s high inflation, leaving the ECB with no choice but to tighten monetary policy, further dampening growth. This highlights Europe’s systemic energy vulnerabilities, springing from its decades-long reliance on Russian gas. For instance, Russian gas imports made up to 40% of Italy’s energy supply until 2022, and Austria has had to increase its Russian gas imports from 80% to 98% over the past 2 years (van Rij, 2024). Given these figures, it is no surprise that energy prices shot up due to supply shocks and the EU’s plans to suspend Russian gas imports in the wake of Moscow’s invasion of Ukraine. Hence, the EU’s current challenges act as a catalyst to diversify its energy imports, particularly from the United States and Qatar, to mitigate its reliance on Russian LNG (Saba, 2023). Europe has compromised its energy security to a great degree and paid the price for the same with high interest rates choking its growth. While the ECB continues with its planned rate cuts, Europe would be wise to diversify its energy imports. It is currently putting too much emphasis on renewable and decarbonized energy creation which will only pay dividends in the long-term. Therefore, to regain its energy security, the EU must prioritize fossil fuel imports from alternative sources in the near term to propel its growth. This can enable Europe to increase its long-term investments in renewable energy in order to meet its climate goals.
Slow Economic Adaptability and Policy Fragmentation
Apart from energy, another European industry yearning for policy focus is defense. While defense budgets have seen a rise since Russia invaded Ukraine, the EU’s defense outlook remains bleak. Decades of underinvestment and free-riding on American support have put Europe in a difficult position. Donald Trump’s election victory exacerbates uncertainties for the EU and NATO, as it is clear that supporting Israel and countering China will be the incoming administration’s primary focus. From tackling missile shortages to closing structural gaps in their military infrastructure, European states need to prioritize military spending over the long term, moving beyond their tactical response to current Russian aggression. Defense bonds, currently a prominent topic in EU military and economic discourse, offer a potential solution. These debt securities are issued by governments to fund military activities or procurements in times of crisis. They would enable Europe to tap a large pool of investments and reduce free-riding by incentivizing governments to use their defense debts productively. However, they have faced opposition, particularly from Germany, as they would weigh on government debt (Ojewska, 2024). This is a testament to one of the EU’s major weaknesses, and probably its Achilles Heel: its inability to achieve institutional consensus due to varying economic priorities and threat perceptions among member states. Defense bonds may prove to be a viable policy if each member state could offer national guarantees proportional to their GDP or defense spending. This would distribute risk and provide additional financial backing for the bonds, making them more attractive to investors.
The American Debt Advantage: It Helps When Your Currency Runs the World
If European nations are cautious about their debt burdens, how has the United States managed to sustain its astronomical deficits? The US Federal Government currently has a staggering $36 trillion in debt, bringing its debt-to-GDP ratio to 124% (Fiscal Data, 2024). Government spending in the aftermath of the COVID-19 pandemic significantly contributed to the rising debt burden, with fiscal stimulus, such as the CARES Act of 2020, adding $2.3 trillion to American debt alone (Wharton School, 2020). The United States can afford such high levels of debt by borrowing money from a variety of sources, primarily bonds and treasury bills. They are available to be bought by investors in financial markets and are more attractive than debts of other countries. The dollar’s status as the world’s reserve currency, its easy convertibility, and robust investor confidence underpinned by the American economy’s strong credit rating make these instruments a safe bet for stakeholders. Europe lacks this ability to essentially finance its debt, tying its governments in frustrating fiscal straitjackets. Eurozone economies hence need to strengthen demand for the Euro of FX markets. This can be achieved by creating euro-dominated instruments, such as the defense bonds mentioned earlier, boosting the currency’s international use.
Geoeconomic Implications: Europe’s Global Influence in Decline
Europe has ceded its position as a central power in international relations, first to the United States after World War II and more recently to a formidable challenge from China. At the heart of Europe’s declining influence has been its inability to adapt to the shifting power dynamics in global politics. Emerging market economies in the global south are increasingly turning to China as their primary economic partner, shrinking the EU’s share of potential foreign markets.
There are two primary reasons for this decline. First, other countries, particularly China, have significantly outpaced European economies in R&D. Supported by state backing and large market capitalizations, Chinese companies have gained economies of scale over EU firms. For instance, in the electric vehicle sector, Chinese companies hold a 30-40% cost advantage over Europe and have innovated new technologies including solid-state and cobalt-free batteries, pulling further ahead of EU manufacturers (Bailey, 2024). The situation became so dire that the EU imposed tariffs of up to 45.3% on Chinese electric vehicle imports, which were flooding European markets and cutting indigenous manufacturers’ market share by 20%(Blenkinsop, 2024). Europe therefore must boost R&D efforts to protect its indigenous firms from being wiped out by cheaper and ever-improving Chinese competition.
The second reason is more structural, deeply rooted in European thought and its approach to engaging with the global south’s emerging markets. While it has a wide-ranging network of multi-sectoral partnerships with these countries, Europe is still perceived as self-serving and neocolonial. While countries like China make offers that emerging markets in Africa and Asia cannot refuse, the EU is making offers that they often reject. This highlights a clear disconnect between the priorities of the global south and the EU. Keeping a better track of what it competitors are doing can help Europe shape its presence in developing regions. For instance, learning from Beijing’s strategy, the EU must note that emerging markets want access to cheap and ready finance for growth. Yet, it remains fixated on imposing its vision of democracy, climate-friendly policies, and human rights on potential partners. Essentially, while emerging markets aim to secure business opportunities, they receive lectures on environmental, social, and corporate governance standards from European states. Therefore, to remain relevant in the contemporary world order, the EU must realign its approach with the needs of its potential partners, or risk losing further influence to an unrelenting China.
Conclusion
To encapsulate its current predicament in French President Emmanuel Macron’s words “Europe is over-regulating and under-investing” (Bloomberg, 2024). By continuing with its clearly obsolete engagement model, the EU risks pushing itself out of the global market in the near future. To reverse this economic stagnation and geoeconomic decline, Europe must undertake a reassessment of its economic and foreign policy. Prioritizing private sector investment and reducing taxation are key steps toward fostering a more dynamic and competitive business environment. Further, energy diversification and short-term reliance on alternative fossil fuel imports can provide the necessary stability to recover from current vulnerabilities. Finally, Europe must shed restrictive conditionalities and reframe its engagement with the Global South to build mutually beneficial economic partnerships. These measures can pave the way for a revitalized Europe and enable its repositioning as a global economic leader.
Ishan Jasuja is a Fellow at the Sixteenth Council.
