How fiscal choices and trade strategy shape Europe’s productivity
Friday, 28 November 2025
Europe’s productivity performance is often explained by technology, skills or firms’ behaviour. But there is another piece of the puzzle: the macroeconomic environment created by fiscal and trade policy. In a recent Future is Blue podcast episode, we spoke with Luca Fornaro (CREI, Barcelona School of Economics) and Miguel Ángel González-Simón (Funcas) about how budget choices, public investment and Europe’s role in global trade shape productivity.
The key message: productivity depends not only on technology or firm effort, but also on public choices about investment, taxation, and Europe’s global economic role.
[Access here the full episode].How fiscal policy influences productivity
Fornaro explained that fiscal policy affects productivity through three main channels: public investment, taxation, and aggregate demand.
- Public investment may facilitate private activity: Governments provide essential infrastructure and services—such as property rights enforcement, education, and research—that enable firms to operate and innovate. Public R&D, in particular, creates knowledge for firms, supporting private investment and growth.
- The tax system matters: higher corporate tax reduces expected profits and can discourage investment in long-term productivity assets like R&D.
- Aggregate demand plays a key role too: Firms adopt new technologies and expand when they anticipate demand. Fiscal policy can help through public procurement and other mechanisms.
He also warned that fiscal tightening—spending cuts or higher taxes—can have enduring costs. Firms may cut back on investment and innovation. “For R&D to have an impact on firms’ productivity takes a lag of at least three to four years,” Fornaro added, emphasizing that fiscal changes now may only deliver results in the future.
This logic forms the basis for his concept of “fiscal stagnation traps.” In highly indebted countries, the need for budget surpluses tends to increase distortionary taxes and reduce public investment. The result is weaker innovation and slower growth, making debt reduction even more difficult. Italy’s experience since the 1990s, Fornaro argued, shows this self-reinforcing cycle. With public debt now elevated across much of Europe, several countries could face similar risks.
Europe’s fiscal framework and budget constraints
González-Simón expanded the focus to Europe’s institutional context. He argued that the EU’s fiscal setup heightens the risks Fornaro highlighted.
A central concern is the absence of a common fiscal capacity. Without a central body able to support member states facing shocks, markets may doubt weaker governments’ ability to respond. This lack of a collective response risks undermining the credibility of national public finances.
The energy crisis of 2022 highlighted these asymmetries. Germany could introduce large fiscal packages, while countries like Italy had less space to manoeuvre. The Next Generation EU package helped, but its temporary and fragmented nature leaves issues unresolved.
González-Simón stressed that “without addressing institutional credibility, pro-growth fiscal policies will not deliver the productivity gains Europe needs.”
On Spain, he highlighted how operating without an approved national budget since 2023 hampers the government’s ability to respond to today’s challenges—such as productivity and housing—because resources remain stuck in outdated budget priorities. This inertia could signal institutional weakness, further undermining credibility and dissuading investment.
Trade policy and technological competition
Turning to trade, Fornaro discussed how tariffs—and broader trade policies—shape the global geography of innovation.
High-tech firms tend to cluster to benefit from knowledge spillovers and access to specialized inputs. Attracting such clusters brings significant economic and strategic benefits. In this context, tariffs are increasingly used as a tool of technological rivalry: limiting access to a country’s markets or skilled labor can prompt firms to relocate R&D activities, shifting the geography of innovation.
However, restricting key inputs—such as researchers, venture capital, or advanced equipment—can backfire, damaging the imposing country’s own ecosystem. Fornaro argued that Europe must identify strategic sectors (such as green tech, defense, AI, and pharmaceuticals) and focus on retaining and strengthening them, combining protection with targeted incentives and robust public research programs.
Europe must stay open to international talent and knowledge. “It’s very important for Europe to create an environment attractive to foreign researchers and high-tech workers,” Fornaro said, suggesting this is crucial for future prosperity.
Strategic autonomy: between protection and openness
González-Simón addressed Europe’s debate over strategic autonomy versus openness, especially regarding China. The EU runs large trade deficits in critical inputs such as semiconductors.
He cautioned that striving for full self-sufficiency—the “autarky” route—would be prohibitively expensive, time-consuming, and ultimately less effective than more nuanced alternatives. Instead, he advocated “selective diversification”—deepening partnerships with chosen, reliable countries, guided by both economic and geopolitical factors. For example, agreements like those with Mercosur can help Europe reduce dependency on single suppliers while creating new opportunities for European firms.
From vicious to virtuous circles
Fornaro concluded that the European Commission should prioritize innovation: increase spending on basic R&D, remove barriers within the Single Market, and better coordinate monetary and fiscal policy to ensure strong demand for investment. If productivity picks up, stronger growth will help lower debt ratios and open space for yet more pro-growth policies—creating a virtuous cycle.
Yet, Fornaro and González-Simón both emphasized that gains from higher productivity must be shared fairly, within and between EU members. The effectiveness of both fiscal and trade strategies rests not just on their scale but on their composition and implementation. Europe’s ability to move from stagnation to renewed dynamism ultimately hinges on credible institutions, resilient-yet-open trade, and a sustained commitment to innovation.
[Access here the full episode].Carlos Carnicero Urabayen