Draghi Report and European Crisis

Europe is increasingly caught between East and West. Eastern regimes compete politically, socially, and economically with the United States, and Europe looks like a clay pot among iron pots. We can debate at length the general merits and demerits of different systems, but the economic data provides an objective assessment of the growing gap that separates us from the giants. Mario Draghi did an excellent analytical job in his report on present and future competitiveness, fact-checking (the kind that Meta doesn’t want to do anymore for a week now), which is critical to making decisions and changing the course of history. In short, the report argues that Europe is still succeeding but has become sick without realizing it, setting ambitious and perhaps now unattainable environmental goals, neglecting research applied to business, and suffering from an ambiguity between the centrality of nation-states and the importance of supranational institutions. Let’s explore why.

Europe at the dawn of the third millennium: a single market for 440 million consumers and 23 million companies producing about 17% of global GDP. Income inequality is ten percentage points lower than in the USA and China. Life expectancy is great, and we are ahead in the application of basic democratic rules with an excellent education system. One would expect the results to follow such a flattering picture, especially given the growing importance of human capital for production. Instead, Mario Draghi reminds us of reality, at least if we compare ourselves to the USA: the GDP gap between Europe and the USA has doubled in twenty years, rising from 15% in 2002 to 30% in 2023. Even if the report overlooks it, such a rosy picture has not prevented the significant political problems and growing consensus in favor of right-wing extremism that did so much damage less than a century ago.

The reason for the income gap: 70% of the gap is due to differences in labor productivity. Although not mentioned in the report, it should be noted that an empirical law of macroeconomics attributed to economist Arthur Okun states that a 2% increase in output is equivalent to a 1% increase in productivity. Thus, the relationship between production and productivity is a long-term element that we do not detect today, but it does not mean that the picture is not worrying, because over the last twenty years, the microeconomic cause of the different productivity trends has a first and last name: artificial intelligence. Europe has been late in developing this technology and, most importantly, has failed to create companies and business models that can support innovation. Two facts are quite clear: in the last fifty years, the period in which all six American companies now worth over a trillion were founded, there has not been a single European company with a market capitalization of over 100 billion euros. In 2021, European companies spent half as much on R&D as US companies.

Bridging the gap: not an easy task. The report highlights elements of system improvement that would clearly be important to implement, such as enabling university researchers to engage in entrepreneurial activities in a simpler, more stimulating and less bureaucratic way, improving the European copyright protection structure and allowing companies to develop within a simplified institutional and legislative framework protected from over-regulation. These are very useful suggestions, but they seem like mere palliatives given the scale of the problem. The report quantifies the financial requirements needed to improve the situation: an annual investment increase of €750 to €800 billion, corresponding to 4.4% – 4.7% of Europe’s GDP in 2023, is needed to achieve the targets (thus, investment should increase from the current 22-27% of GDP, in contrast to the trend observed in recent years). By comparison, Marshall Plan investments between 1948 and 1951 were equivalent to 1-2% of European GDP.

Environmental goals and the energy transition: Europe has moved to the forefront of the world in terms of environmental sustainability. The goals mentioned in the report speak for themselves: the EU has passed binding legislation to reduce greenhouse gas emissions by at least 55% by 2030 from 1990 levels; the United States has set a non-binding target to reduce carbon emissions by 50-52% from 2005 levels by 2030, while China plans to peak carbon emissions only by the end of the decade. As the report notes, “these differences create huge short-term investment needs for EU companies that their competitors do not have to meet.” In addition to the general problem for the European economy, there are also corresponding problems at sectoral level, in particular for the so-called high-emitting sectors (including chemical, metallurgic, paper-making, and others), which suffer from critical problems with the availability of volumes and the costs of bank financing and insurance contracts, without being able to benefit from public support measures that could make the transition less efficient. An even more serious problem in light of the above goals is the lack of industrial policy at the European level, which has led to the loss of the European advantage in renewable energy that has instead gone to China. There is therefore a risk that the pursuit of environmental goals will increase dependence on Chinese imports and thus create a new source of geopolitical risk, repeating what has happened with energy (from Russia) and security (from the USA).

The role of finance: where to find the resources to fund the expanded Marshall Plan? European private investors are known to avoid risks: all Europeans would like their kids to work at Google and would like to have a Google research center close to home, but few are willing to put their money into funding new tech companies. That leaves institutional investors, which, however, have the disadvantage of being located in different places (e.g. many in Holland and few in Italy) and lacking skills in technology investment that are insufficient for careful and diversified investing. Finally, according to the Report, European banks generally lack adequate products and skills for venture capital financing and do not generate adequate profitability, both because of the absence of Banking Union and the excessive fragmentation of national financial markets that are not fully Europeanized. The report notes that overall growth in banks’ lending capacity could be helped by more pragmatic regulation that would allow them to make greater use of securitization techniques.

Conclusions: Mario Draghi explained to Europeans that the road ahead is difficult, perhaps more difficult than we thought, and that he is credited with pointing out the structural reforms useful to allow our companies to be competitive in global markets. Let’s not forget that the comparison to the United States puts us in the position of choosing the best economy class of all time. Learning from Americans is useful and does not require abandoning our cultural and social specifics. The fundamental ambiguity that distinguishes us, a market economy tightly regulated by increasingly European institutions, is increasingly confronted with the reality of nation states. What is really striking is the lack of debate, at least in Italy, about the implications of the report. Do the government and the opposition share the results of the analysis and its conclusions for economic policy? An open and transparent discussion of the most important issues would allow Italians and other Europeans to better understand the positions of different political movements, as well as be able to guide future votes. Unacceptable is the current situation in which the Report that technically and orderly discusses fundamental elements of our economic and social life is essentially ignored in the public debate.