17 September 2024

CER: Draghi's plan to rescue the European economy: Will EU leaders do whatever it takes?

by Tordoir , Berg , Cornago , Meyers , Scazzieri: Draghi’s report on the ailing European economy contains hard truths for EU leaders, who have long failed to confront Europe’s declining growth rate head-on.

• The report’s diagnosis is hard to argue with: Europe’s innovative capacity is declining, compared with other major advanced economies, as is its business dynamism. Intensifying state-led Chinese competition, geopolitical tensions and continued reliance on imported energy mean that policy procrastination could lead to permanent stagnation, or worse.
• Some of Draghi’s proposed fixes are new, even ground-breaking. Others have been in the EU debate for a long time. The report’s vital contribution is that it brings them together into a coherent growth agenda and that it tries to recognise the trade-offs involved in delivering it. In five areas, Draghi’s proposals will spark especially fierce debates about the direction of EU economic policy.
• First, Draghi rightly identifies Europe’s competitiveness challenge as being about improving productivity, including by closing an annual private and public investment gap of around €800 billion. He implicitly rejects boosting exports through wage repression and overly tight budgets, a strategy which served Europe poorly during the eurozone debt crisis and would backfire even more in a protectionist era.
• But Germany and many frugal member-states are still wedded to the export-led model of growth. And the EU policy framework is poorly equipped to run an economy ‘hot’ with internal demand: fiscal rules remain quite strict and the EU’s pandemic recovery fund will run out in 2026.
• Second, Draghi shifts away from a yes-or-no debate on industrial policy to a nuanced when-and-how discussion considering the characteristics of each industry, its prospects and its strategic value. He distinguishes between sectors where the EU has lost its comparative advantage entirely, those that are employment-rich, those that are critical for security, and infant industries: they all require a different mix of trade and industrial policies ranging from accepting imports to bringing in foreign technology to setting up trade protections.
• In practice, the EU will find it challenging to be hard-nosed in responding to demands by EU firms for aid and protection, to avoid wasting taxpayer money and to avoid helping incumbents over younger and more innovative firms. Draghi also advocates a tougher EU line on Chinese mercantilism and closer alignment with the US, which will prove controversial. Critics will fret that the EU taking a more hawkish line on China could be the final nail in the coffin of the frail rules-based trade system, on which the EU itself remains deeply reliant, and it could undermine developing countries. 
• Third, Draghi suggests that competition authorities take more account of innovation and common continental interests like security. These are sound ideas in principle and Draghi’s approach is hardly an unconditional endorsement of ‘European champions’. However, his reform proposals still carry risks which are not fully acknowledged and are not always consistent with each other.
• Fourth, the report calls for more joint decision-making in key economic policy areas. More majority voting and common regulatory frameworks to escape the patchwork of national ones would strengthen the EU’s economic capacity to act. But member-state reluctance to cede sovereignty will make this politically difficult, leaving the EU vulnerable to ill-coordinated policies and pressure from external powers on individual member-states.
• Fifth, the EU will need money to achieve some of these objectives. Draghi suggests scaling up the EU budget and redirecting spending to strategic priorities. But fundamental reform of the EU budget has repeatedly proved impossible, while national budgets in many member-states are stretched. Draghi’s suggestion for some common debt may be unavoidable but it is controversial, even if it is only used for productivity-increasing investments in EU public goods such as breakthrough innovations, defence and cross-border energy infrastructure.
• Immediate outcries from some German politicians stumbling over Draghi’s reference to common debt do not bode well, even though Germany, as the EU’s stagnant industrial powerhouse, would be a major beneficiary from an EU growth agenda.
• Draghi’s sectoral proposals for innovation, energy and defence should be more uncontroversial. He suggests more funding for research and rolling back excessive regulation and cross-border barriers in the single market, all of which hamper the efforts of innovative European firms to scale up. Like Enrico Letta in his single market report, Draghi stresses that unlocking more high-risk investment through deeper and more liquid capital markets is critical.
• As ways of lowering energy prices, the report advocates improved collective gas procurement, stronger regulation of gas trading practices and accelerating technology-neutral energy decarbonisation. Draghi also rightly advocates for more funding, industry consolidation and enhanced EU co-ordination to counteract the EU’s fragmented defence sector.
• Implementing these plans will still be difficult: member-states have so far been reluctant to give additional powers to Brussels in these areas, for example over defence policies and procurement.
• Draghi poses the right challenge to EU policy-makers in an age of increased geopolitical competition and burgeoning investment needs. But will EU member-states rise to meet it? Or succumb to the narcissism of their differences and face a ‘slow agony’ of fading growth, economic heft and global influence?...

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