How to Fix the EU Economy

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The European economy is currently struggling. While there are some signs of recovery, growth has been weak since the pandemic. Europe also appears vulnerable to Trump's escalating trade wars. However, many of these issues are either self-inflicted or fixable.

In this video, we will explore some ways the EU could address its economic challenges.

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Fix the Single Market

One of the most important steps the EU can take to improve its economic prospects is to remove internal trade barriers within the single market. The European single market was built on the principles of the Four Freedoms: the free movement of goods, services, people, and capital. The core idea was that a large, unified market would be more beneficial than multiple smaller, fragmented national economies.

A single market benefits consumers by increasing competition and providing more choices. It also helps businesses by making it easier to trade within Europe and access a larger consumer base. Harmonized regulations were supposed to reduce bureaucracy, making life easier for businesses and national governments alike. European policymakers once looked enviously at the United States, where a vast unified market has contributed to economic growth.

However, the single market has not lived up to its full potential. In some cases, progress has even reversed. Concerns over immigration have led many EU countries to impose restrictions on cross-border travel. These restrictions, originally intended as temporary emergency measures, have become effectively permanent in some cases.

Beyond these restrictions, national governments are reluctant to cede power to Brussels, leading to poor regulatory harmonization. This makes doing business in another EU country unnecessarily difficult. For example, it is harder than it should be to sell French wine in Lithuania. It is even more challenging for professionals in the service sector, such as a German lawyer trying to practice in Slovenia.

A 2020 IMF study found that Europe's internal trade barriers are equivalent to a 45% tariff for manufacturing and a 110% tariff for services. These barriers are significantly higher than those between U.S. states, which explains why trade between EU countries is less than half the level of trade between U.S. states.

Ironically, these barriers are one reason why the EU trades so much with the rest of the world. When trading with neighboring countries is difficult, businesses seek opportunities elsewhere. EU-level free trade agreements have made international trade easier, contributing to the rise in the Eurozone's trade-to-GDP ratio from 31% in 1999 to 55% today. This figure is far higher than in the U.S., where trade accounts for just 25% of GDP.

Implement a Capital Markets Union

Another key improvement would be the creation of a capital markets union. While this might sound technical, the concept is simple and crucial. The goal is to establish a more integrated and open financial market across the EU, allowing companies in one EU country to easily raise funds from investors in other EU countries.

Currently, raising large amounts of capital in the EU is difficult because businesses are largely confined to their national financial markets. This limitation makes it harder for startups to secure funding and for established companies to expand.

One consequence is that Europe lacks major tech giants comparable to those in the U.S. This funding shortfall has contributed to lower productivity growth in Europe's tech sector compared to its U.S. counterpart. While productivity growth in most sectors has been similar between the EU and the U.S., American tech firms have significantly outpaced their European rivals in recent decades.

Regulatory challenges have further hindered Europe’s tech sector. For example, the General Data Protection Regulation (GDPR) is estimated to have reduced profits for small European tech firms by up to 12%, according to a 2022 analysis. To be clear, tech regulation is not inherently bad, and the U.S.'s laissez-faire approach has its drawbacks. However, some regulations have put European tech companies at a competitive disadvantage.

Boost Domestic Demand

The third major issue Europe needs to address is weak domestic demand. GDP is often calculated as the sum of four factors: investment, government spending, net exports, and domestic demand, which refers to consumer spending.

Domestic demand in the EU has been sluggish since the 2008 financial crisis, a problem that worsened after the pandemic. Eurozone consumption remains below pre-pandemic trends by some measures. As a result, the EU has become increasingly dependent on exports. Since 2008, the EU has consistently run trade surpluses, meaning it exports more than it imports.

This reliance on exports is not necessarily a bad thing. As long as there is demand for European goods abroad, it does not matter whether domestic or international consumers are buying them. However, it does make the EU more vulnerable to global economic slowdowns or disruptions in international trade.

For example, Trump has significant leverage over the EU because the European economy depends on American consumers. If the U.S. imposes tariffs, European manufacturers may struggle to sell their products. Similarly, declining consumer confidence in China, driven by the recent housing market downturn, has hurt European exports since many surplus goods were previously sold to China.

Looking ahead, potential disruptions in global trade due to Trump's policies could harm Europe. However, some of this impact could be mitigated if the EU finds ways to stimulate domestic demand.

The challenge is that stimulating demand usually requires government intervention, such as direct financial support for households. Unfortunately, apart from Germany, most European governments lack the fiscal flexibility for large stimulus programs. This raises questions about how they can effectively boost consumer spending.