In mid-September former ECB President Mario Draghi published a 400-page report recommending changes necessary to boost the EU’s competitiveness. Although couched in broadly positive language, the document did little to conceal his bleak assessment of the present economic condition of the bloc. Over the life of the EU, Europe has become “less equal, less prosperous and less secure”. There are only three possible future directions for Europe; ‘exit, [continued1] paralysis, or integration’2:
“Exit has been tried and has not delivered what its proponents hoped for. Paralysis is becoming untenable as we slide towards greater anxiety and insecurity. So, integration is our only hope left.”
The Report purports to set out an overall new strategy for Europe, recommending new policies for Europe in key areas, of which there are five main ones. Firstly, innovation; noting that Europe has fallen way behind the US and China3:
“there is no EU company with a market capitalisation over EUR 100 billion that has been set up from scratch in the last fifty years. All six US companies with valuations above EUR 1 trillion have been created in that period of time”;
Mr Draghi attributed this innovation lag to haphazard spending on research and development by individual member states and called for centralization of both funding for, and supervision of innovation efforts. Secondly, Europe needs a plan for “decarbonisation and competitiveness”, building on Europe’s ambitious climate targets; such decarbonisation should help Europe lead the world in lowering energy prices and improving competitiveness.
Thirdly, Europe needs to increase security and reduce dependencies. Echoing former President Trump, Mr Draghi recommends spending 2% of Europe’s GDP on security and defence, but centrally administered. China is mentioned multiple times with a warning that Europe should reduce its dependencies on others and treat China now as a competitor rather than a partner.
Fourthly, Europe lacks an industrial strategy; again it lags the US and China in this regard, and as technology is advancing rapidly throughout the world Europe needs a new industrial strategy which makes provision for technological advancement and artificial intelligence.
Fifthly, and of utmost importance, is how to finance the recommended reforms. The Report calls for a “massive volume” of new, centrally administered investment. A figure of an additional euros 800 billion per annum is mentioned, to be financed by more common debt. But this is just the public component; historically, notes Mr Draghi, large EU projects have been financed 80:20 by the private and public sectors, and major steps are needed to complete Capital Markets Union and the Single Market in order to attract the concomitant component of private investment, so that private investment can be reoriented towards hi-tech sectors and the called for industrial strategy can evolve.
Our opinion is that potential problems with these recommendations include:
- The assumption that decarbonisation, with net zero by 2050 already hardwired into EU law, is an economic opportunity that will lead to both lower energy prices and economic growth, is contentious. If renewables bring about lower energy prices, there would by now be no need for taxpayer subsidies.
- Despite Mr Draghi’s attempts to argue that centralised spending on innovation will succeed where to date this has primarily occurred at member state level, his proposals for a new legislative designation of an “Innovative European Company” raise fears of governments trying to pick commercial winners.
- The call for greater integration, put differently, greater deferment of authority from member states to EU institutions, comes at a time when in practice member states are tending to do the opposite. For example, in defiance of EU rules, Italy and Germany have both recently hardened national borders in order to curb illegal immigration4.
- Completion of Capital Markets Union. We noted in January 20225 that none of the infrastructure necessary for Capital Markets union had been set up despite the declared post Brexit policy of having the EU compete for capital markets business with London. This was because Amsterdam, Paris and Germany in particular were reluctant to cede any turf to each other. Since 2022 little has changed.
Responses to the Draghi Paper – Scepticism
The UK’s Lord David Frost, who sat across the table from Michel Barnier during Brexit negotiations, was quick to point out the historical disconnect between the EU’s policy strategy statements and economic outcomes6.
- In 1993, as the Maastricht Treaty was coming into force cementing the establishment of the European Union as a quasi-federal state with its own currency an central bank, former President Delors presented the EU’s strategy for economic growth.
- In 2000 the Lisbon strategy would “make the EU the most competitive economy in the world.”
- 2010 witnessed the launch of Europe 2020; a strategy for “smart, sustainable and inclusive growth.”
- In 2020 the New Green Deal was announced as “a modern, comprehensive and resource efficient strategy.”
If Lord Frost speaks from the political right, the left was equally sceptical. Social Europe is a think tank heavily influenced by economics Nobel laureate Paul Krugman. They opined that Mr Draghi erred by placing “competitiveness” at the centre of the agenda because, citing Krugman, it is fallacious to think that countries can compete as companies do7.
An even stronger criticism of present strategy, laying the blame squarely on the flawed structure of the euro currency and the inability of the ECB to prevent member states borrowing via the settlements system, was published by Thorsten Polleit, writing for the Mises Institute8. Although published before the Draghi Report, Polleit’s comments about the settlements system – Target 2 – echo observations which Bob Lyddon has previously published9. Although the latest (July 202410) aggregate figure for usage of Target 2 financing by debtor countries – euros 1.6 trillion, is slightly down on the end 2021 figure of 1.8 trillion, Lyddon notes that the ECB publishes figures on a netted basis which conceal true exposures of around double the published figures. Compared with published general gross government debt figures for all member states of a combined euros 15 trillion, this hidden additional 1.6 trillion represents a further 9% of unrecorded debt (1.6/18.2). Do Europe’s leading policy makers understand the true level of member state exposure to both actual and contingent liabilities under the ECB, Eurosystem, bailout funds (eg European Stability Mechanism), and other common liability arrangements such as Invest EU and the Pandemic Funds? Do they care?
Conclusion – Do the Numbers Matter?
Perhaps the main difference between the policies of the ECB when led by President Draghi, and since 2019 when led by President Lagarde, is that Mr Draghi’s repeatedly called for member states to curb spending in order to comply with the 2012 Stability and Growth Pact rules limiting annual spending deficits to 3% of GDP and cumulative debt to 60% of GDP. Under Mme Lagarde the closest the rhetoric ever gets to this is talk of “excessive” deficits, never of total indebtedness. These 3% and 60% targets are clearly now unrealistic, a point tacitly acknowledged by Mr Draghi’s paper which called for centrally administered spending of 3% of GDP on innovation and 2% on security. Perhaps he might argue, surely unconvincingly, that if centrally administered, then somehow this 5% does not count towards member state totals. His Report makes scant reference to debt and overwhelmingly uses the term “investment”. This is not new; what is new is to entirely disregard present levels of debt exposures for the bloc which only ten years ago was in crisis as six member states accepted bailout programmes when unable to refinance their debts.
Just as in July we raised the question of whether the numbers matter, specifically regarding France11, so Mr Draghi’s important September paper buttresses the view that at policymaker level they do not.
1 Our word, clearly implied by the rest of the text
2 Speech to the European Parliament, 17/09/2024 at p9: fcbc7ada-213b-4679-83f7-69a4c2127a25_en (europa.eu)
3 Ibid at p 3
4 Germany brings in its plan to end free-for-all illegal migration that has seen a wave of Islamist attacks with crackdown on all its borders which has sparked fury among its EU neighbours | Daily Mail Online
5 IREF Newsletter January 2022: The Passing of Jacques Delors, Architect of the Euro. How will his Legacy Play Out?
6 The EU has run out of road – and only Starmer hasn’t noticed (telegraph.co.uk)
7 Draghi on ‘competitiveness’: new wine in an old bottle (socialeurope.eu)
8 The Euro Is a Frankenstein-Currency | Mises Institute
9 TARGET2 harbours risks even greater than the enormous ones acknowledged by the European Central Bank | Lyddon Consulting
10 TARGET balances | ECB Data Portal (europa.eu)
11 IREF Newsletter July: Financial Market Developments in light of the recent electoral events. Is any part of Europe facing a financial crisis?
Picture by Nicolas Hoizey
