Reforms or decline: What Mario Draghi’s report means for Europe
Wednesday, 18 september 2024
In a new episode of the Future is Blue podcast series we covered the implications of the Mario Draghi report, a landmark document that calls for urgent and bold reforms to address Europe’s economic decline. Joined by Sander Tordoir, Chief Economist at the Centre for European Reform, and Raymond Torres, Director of Funcas Europe, we examine Draghi's proposals and the challenges they pose to EU leaders.
You can access the podcast episode here.
The tone of urgency
The report, according to Tordoir is “lucid” and “uncompromising.” Draghi did not mince words, referring to Europe’s agonizing economy if decisive policies are not enacted. “The productivity gap with the US is stark,” Tordoir points out. “It is now 70% explained by lower productivity growth in Europe. If we don't act, Europe’s GDP will stagnate, leaving the economy the same size in 2050 as it is today.”
Draghi’s message is a necessary wake-up call. According to Torres, "the report rightly identifies a sustainability risk for Europe’s socio-economic model, which hinges on the economy’s ability to grow. If productivity and innovation continue to lag, it will be increasingly difficult to fund the welfare state." Draghi’s diagnosis of the problem is accurate, but the solutions require overcoming significant hurdles.
Innovation gap and investment needs
A central theme of the report is the growing innovation gap between the EU and the US, particularly in sectors like artificial intelligence (AI) and other emerging technologies. European companies, particularly in the tech sector, may prefer to relocate to the US to access better financing and fewer regulatory hurdles. About 30% of Europe’s most innovative firms move to the US once they get big enough because Europe lacks the demand and market scale that these companies need to thrive.
Draghi’s report suggests that Europe’s underperformance in innovation also stems from fragmented capital markets and an overly complex regulatory environment, which stifles growth. However, Tordoir points out that Draghi’s call for €800 billion in annual investment is already part of the EU’s climate and defence commitments. "Draghi is holding up a mirror to Europe’s leaders… The €800 billion isn't a new figure. It's tied to existing targets. The real question is how Europe will fund these investments."
There is a broader underinvestment problem in Europe. According to Torres, “it’s not just about innovation; Europe is exporting its savings in order to strengthen the capital base abroad instead of investing domestically. We're seeing €150 billion in foreign direct investment outflows in just the first half of this year alone. Europe needs to reverse this trend and invest more at home if it wants to remain competitive.”
Balancing decarbonization and competitiveness
Decarbonization is another key focus of Draghi’s report. It comes with significant challenges. European energy prices are higher than those in the US or China, which puts Europe at a competitive disadvantage. The report calls for reforms to the EU’s energy market, but this is easier said than done.
Tordoir emphasizes that Draghi's approach to industrial policy is crucial. “Draghi is saying that while we need to meet climate goals (for example for solar panels) we can’t just import everything from China. Europe needs to develop its own green technologies, whether it's in hydrogen, batteries, or electric vehicles. It’s about maintaining competitiveness while ensuring that our industries aren't wiped out by cheaper, subsidized imports from China.”
Torres adds a broader perspective: "We have sectors like wind energy and parts of the renewable energy market where Europe still has a critical mass. But we risk losing industries like semiconductors, where we’re already far behind. Draghi’s proposals aim to protect those strategic industries while acknowledging that not every sector can be saved, when it lacks critical mass."
Foreign economic policy: reducing dependencies
Draghi’s call for a cohesive EU foreign economic policy is another highlight of the report. He advocates for reducing Europe’s dependence on foreign suppliers of critical materials and technologies. However, the question remains whether the EU can act as a unified force in this area, given its diverse national interests.
“Europe’s fragmented approach to issues like 5G and energy dependence is a huge vulnerability,” notes Tordoir. Individual EU countries, often under economic pressure, have been swayed to make decisions that weaken the collective bargaining power of the EU. “We’ve seen Spain, for instance, recently shift its stance on electric vehicle tariffs after China offered a €1 billion investment. This kind of division leaves Europe exposed.”
Raymond Torres agrees that while a unified policy would be ideal, achieving it will be challenging. “Each country is grappling with its own set of issues. The problem is, in the absence of consensus on critical European-wide issues, fragmentation forces will become stronger. The next few months, with a new European Commission, will be crucial in determining whether we can agree on common policies or fragment further.”
The path forward
Looking ahead, there is a narrow window of opportunity for Europe to take action. With the upcoming appointment of a new European Commission, there is hope for renewed focus on the Draghi report’s proposals. But as Tordoir warns, “the real movement on this report, if any, will likely come next year” when the political situation in countries like Germany and France may be more stable. But the risk is that, like past grand strategies, this report will be discussed and then forgotten.
Torres suggests adding some kind of institutional framework to the report to maintain momentum. “Perhaps the EU could create a Council of Economic Advisers to ensure that reports like these don’t just gather dust. We need follow-up to see how the ideas can make their way through policy-making.”
Conclusion
The Draghi report presents Europe with an existential choice: take bold steps now or risk economic stagnation and social decline. As Tordoir and Torres point out, the challenges are immense, but so are the opportunities. Europe must act soon, or risk losing its competitive edge in an increasingly competitive world.
Access the podcast episode here.
Carlos Carnicero Urabayen