Simon Nixon / Feb 2024
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The prospect of a second Trump presidency has sent European political leaders into a tailspin - and with good reason. Countries that have prospered for decades under a US security umbrella are having to face up the reality that American support for Ukraine is waning before a single general election ballot has been cast and that America’s commitment to Nato can no longer be assured. As I argued here last month, this is a potentially existential crisis for the continent that will require European governments to increase their support for Ukraine, boost defence spending and shoulder more responsibility for their own security, including via deeper military integration.
Foreign policy, however, begins at home. There’s no security without a strong and resilient economy. This is something that Europeans can no longer taken for granted. The continent’s economic performance has been lacklustre for many years. In 2013, the European Union’s economy was 91 per cent of the size of the US economy in dollar terms, today it is 65 per cent; GDP per capita is 27 per cent that of the US. That gap is growing, as European growth trails the US and China. Meanwhile Europe is falling behind in the technologies of the future: America dominates digital and AI and China dominates green technology. That is hardly a basis for strategic autonomy.
The Italian Jobs
The problem is that the EU single market is not working as well as it should. A recent report by the McKinsey Global Institute lays bare the scale of the challenge. It noted that Europe’s internal market is larger than China’s and almost as big as the U.S.’s. But when it compared companies with more than $1 billion in revenue, U.S. firms between 2015 and 2022 spent 80% more on research and development, delivered 30 per cent faster revenue growth and 30% higher return on capital, and were valued by the market 2.5 times higher. No wonder EU leaders have commissioned two former Italian prime ministers to identify what has gone wrong and what to do about it: Enrico Letta will report on how to reform the single market in March; while Mario Draghi is investigating how to restore Europe’s competitiveness.
One explanation that can be immediately ruled out: that the EU is a protectionist, anti-free market cartel. As one might expect of a project championed by Margaret Thatcher, the single market was established on impeccable neo-liberal principles. The Commission was armed with formidable powers, which it has never been afraid to deploy, to preserve a level playing field by strictly policing state aid and to ensure markets remain competitive through robust merger controls. What’s more, the EU is outward-looking on trade: it is 30 per cent and 70 per cent more open than America and China respectively, according to International Monetary Fund data.
In fact, part of the EU’s problem may be an excess of free market zeal. In an interesting column from the Wall Street Journal, Greg Ip notes that one downside of the EU’s laudable determination to maintain open, competitive markets and thereby keep prices low for consumers is that this may have made it harder for European firms to achieve sufficient scale and profitability to compete with their US rivals in terms of investment and innovation. The problem arises because of a tendency to assess competition on the basis of 27 connected national markets, rather than as one single market, as one might logically expect. A case in point is telecoms:
For example, to preserve competition, European regulators have resisted mergers that leave just a handful of mobile phone carriers per market. As a result Europe now has 43 groups running 102 mobile operators serving a population of 474 million, while the U.S. has three major networks serving a population of 335 million, according to telecommunications consultant John Strand. China and India are even more concentrated.
European mobile customers as a result pay only about a third of what Americans do. But that’s why European carriers invest only half as much per customer and their networks are commensurately worse, Strand said: “Getting a 5G signal in Germany is like finding a Biden supporter at a Trump rally.” Putting European networks on a par with the U.S. would cost about $300 billion, he estimated.
Of course, the EU also suffers from an excess of regulatory zeal. While the single market may have swept away 27 different national regulatory regimes, and therefore be considered an exercise in deregulation for companies trading cross-border, many of the harmonised rules that have emerged from Brussels to replace them have been too prescriptive and come with onerous reporting requirements. A particular bugbear of business is the “precautionary principle”, whereby the EU regulates where it believes there may be a risk of harm, rather than evidence of harm.
Precautionary Principle
This is hardly a new issue. I noted in this piece for the WSJ in 2015 how the EU’s chemical testing regime, which could take up to 13 years to licence a new compound, and the prohibition against gene-editing, which may soon be partially lifted, have driven significant investment and innovation offshore. Now the fear is that the EU has made the same mistake with AI with a new Digital Services Act which places onerous reporting requirements on tech firms and places restrictions on AI development for applications that have not even been invented yet.
At the same time, in too many areas, the single market has never gone deep enough, particular in services. Despite a push in 2016 to create a European professional card, which would allow qualifications to be recognised across the bloc, this has so far only been extended to six professions. The need for the EU to develop a capital markets union to enable growing firms to access alternative sources of equity and debt finance from outside the banking system has been obvious since at least the eurozone debt crisis, but the progress has stalled. The European Round Table for Industry reckons that the single market is only 75 per cent complete, while the remaining trade frictions have the effect of reducing EU GDP by five to 10 per cent.
Meanwhile the political consensus that underpins the single market risks fraying amid an explosion in state aid after the rules were suspended during the pandemic. As much as €760 billion of state aid has been authorised over the last few years, similar to the grants and subsidies made available under President Joe Biden’s Inflation Reduction Act. Of this, Germany was responsible for nearly half, France for 22 per cent and Italy for eight per cent. That inevitably stokes tensions between member states, as it undermines the level playing field, particularly for smaller countries. The suspension of rules is supposed to have ended this year. But with America and China lavishing subsidies on domestic production, this genie is not going back in its bottle.
Old Ideas Please
Draghi and Letta will be under no illusions as to what needs to be done. As multiple past reports have concluded, the priority must be to complete the single market. But that requires deeper integration, which brings difficult trade-offs. Completing the single market in services means confronting powerful lobby groups opposed to the mutual recognition of qualifications. Plans to create a capital markets union have previously foundered on the reluctance of governments to yield sovereignty over areas such as bankruptcy law. A European industrial strategy requires EU-wide state aid, which in turn requires a bigger EU budget or more common borrowing. A single market approach to competition could lead to fewer players and higher prices.
Persuading EU leaders to back deeper integration may look an even harder task now. The European Parliament elections in June seem certain to lead to significant gains for eurosceptic right-wing nationalists. Yet the history of the EU is one of dramatic leaps forward in the heat of a crisis. The creation of a eurozone bailout fund had seemed politically impossible up until the moment it was created in the midst of the eurozone crisis. Common European debt issuance had seemed like a fantasy until the Next Generation EU fund was launched in the midst of the pandemic.
There is no such thing as a new idea in Brussels, only old ideas whose time has come. Everyone who cares about Europe’s security, which should include those outside the EU such as Britain, must hope that the the time to fix the single market is now. The alternative is a Europe that becomes progressively weaker and more fragmented.
More of the author’s writings can be found at his 'Wealth of Nations' susbstack.
