02 02 2025

The EU is not having an easy time lately

EU is worried about its future and asked former European Central Bank director Mario Draghi to report on the challenges and the way forward. The report was presented in September 2024. EU is worried about its future and asked former European Central Bank director Mario Draghi to report on the challenges and the way forward. The report was presented in September 2024. https://commission.europa.eu/topics/eu-competitiveness/draghi-report_en

Things don’t look particularly good for the EU lately. Economic stagnation, reports pointing to falling competitivity in key sectors, negative economic impact of the sanctions, increasing financial burden from the Ukraine war, caught up in the middle of the US-China confrontation, and so on. There are ways out of this, but political and institutional factors question the ability of EU to succeed.

EU is pressured from all sides. First an unfriendly US under Biden, forcing EU to substitute cheap Russian gas with expensive and dirty ‘Freedom Gas from the US and to join it in a sanctions war against China, from which the EU has little to gain. And now an even more unfriendly US under Trump threatening with tariffs and forcing the EU and the EU countries to use more of their scarce financial resources to shoulder the cost of the Ukraine war and rearming. At the same time, EU is losing its competitive edge to China in a series of key sectors, not the least electric cars, but also in EU green transition” priority sectors such as solar panels, inverters, wind turbines, heat pumps, and so on. Politically, EU has discredited itself in much of the Global South because of its unconditional support for the Israeli genocide and apartheid politics in Gaza and the West Bank. And now it is staring into the abyss of a humiliating political and military defeat in Ukraine.

On the positive side, inflation looks now to be roughly under control at less than 3%, and the unemployment at around 6% is at its lowest level in decades. However, it is still very high by international standards, and youth unemployment is embarrassingly high (16%) and rising. The public debt at 80-90% of GDP is somewhat lower than in the US, but as the EU, unlike the US, cannot simply print money, this leaves little room for increasing public spending to stimulate economic growth and lower unemployment.

To all this comes that the EU, according to a flurry of reports, most famously the 2024 ‘Draghi Report, has serious problems with its international competitivity, suggesting the need for breathtaking investments to overcome this.

If we take the point of departure in the Draghi Report’, it claims that the EU economic model since 1990 was based on three foundations: a growing international trade, cheap Russian energy and the US taking the responsibility for EU security. Now these three foundations are floundering.

Firstly, the international trade is threatened by the new geopolitical tensions and what the IMF calls ‘geoeconomic fragmentation.

Trade wars and sanctions have set forth a process of splitting up the world market in segments. It is being called ‘Geoeconomic fragmentation’ . The consequences are profound, for the worse or for the better. Image from https://cepr.org/publications/dp19352

Secondly, the report stresses the high cost of energy as one of the main reasons for EU’s present economic pains (electricity costs are up to 3 times higher than in the US and gas prices up to 5 times higher). The main culprit is the shift from cheap Russian piped gas to expensive LNG from the US and Qatar. EU has itself to blame too, as it has invented a very particular EU energy market system where the most expensive electricity sets the price for the whole market, and that happens to be gas-fired power plants 55% of the time.

Thirdly, now the EU countries are supposed on the top of it all to invest heavily in rearming.

The “Draghi Report” states, as do also other similar reports from for example the World Economic Forum, that EU has to accelerate innovation and find new growth engines. At the same time, it has to bring down energy prices while continuing to decarbonize. And it has to rearm. To manage these transformations, the report proposes a new industrial strategy for Europe, where promising sectors are supported, with particular emphasis on sectors related to thegreeningof the economy.

Much hope is pinned on a reduction in energy prices in the long term as a result of the heavy investments in renewable energy. But it will take time. To reduce the energy prices in the short to medium term, the report proposes to abandon EU’s infatuation with spot market prices for energy and instead go for longer price agreements with suppliers (funny enough, exactly what Russia was proposing in 2021 for its sale of natural gas to the EU, a proposal that EU spurned). Furthermore, EU should decouple electricity prices from the expensive LNG so that consumers can benefit from the cheaper nuclear and renewable energy. A no-brainer if you use common sense, but a radical U-turn for the EU.

EU has shifted from piped Russian natural gas to US fracking gas converted to LNG, sent by ship to Europe and converted back again to natural gas. Fracking has not been allowed in EU countries because of environmental concerns. The image by Joshua Doubek, wikimedia commons, shows a Haliburton fracking operation. No wonder the guy looks happy.

Other countries are implementing policies along the lines proposed by the Draghi report. Most obviously China, which for decades has had a strong industrial policy that includes the ‘green economy’ sectors, but also the US, India, Russia, Turkey and several middle income countries. However, the EU is facing some particular challenges due to its special history, institutions and political and ideological orientation.

EU was not born as a neoliberal project, but it turned into that during the 1980ties. The main emphasis has since been on the creation of an internal market with regulation at EU level only. Subsidies, preferential loans, tax credits and so on for priority sectors or companies are explicitly forbidden, both at national and EU level. State-owned enterprises were privatised and particularly in the energy sector the drive was for the creation of an EU electricity market, based on pure market principles. The EU bureaucracy has been trained and disciplined in this sense.

After decades of market based globalisation, now most developed countries are increasingly returning to national industrial policies where they try to create and stimulate the growth of priority sectors and companies. There are many reasons for this, among these that the technology tends to create international monopolies with high barriers for newcomers, and also the realisation of the risks related to globalised supply chains, as demonstrated by the Covid epidemics and the steadily more aggressive Western sanctions policy.

One of the bigger EU projects was support to the Swedish Company Northvolt to secure European production of lithium batteries for electric vehicles. It went into bankruptcy in November 2024, and has sought Chapter 11 bankruptcy protection in the US (?!). Industrial policy is not always smooth sailing. Photo by Northvolt.

The many reports on EU’s competitivity challenges state that EU has a unique capacity to overcome these, citing the high level of economic development, leadership in several crucial industries, world-class universities and the necessary institutions in place.

I tend to be a bit more pessimistic.

Firstly, many of the policy proposals need to be carried out at Union level, and most of the reports recommend strengthening EU’s power to take decisions on behalf of the member countries using simple majority, thus moving towards a federalised EU. This will be met with resistance from several EU countries and from political forces which are favouring a union of (strong) independent National States, not a federation. So this part will not be easy sailing. The EU should perhaps consider some other way of doing things, where responsibility is delegated out to the member states, but I guess this is contrary to EU bureaucracy thinking.

Secondly, the EU regulations and institutions are not designed to implement a strong industrial policy, neither is the bureaucracy ideologically prepared for this. EU has the whole time been about ensuring competition, harmonising regulations, regulating monopolies, avoiding subsidies, and so on. There is a big jump from regulation to a proactive industrial policy. The fact that the EU has produced a flurry of strategy and policy papers filled with buzzwords (‘green deal’, ‘net-zero’, ‘industrial renaissance’, ‘made in Europe’, and so on) doesn’t change that.

The European Processor Initiative is an interesting project to design and build a new family of European low-power processors. It is led by a consortium of European companies and universities. However, if succesful, it is not clear how or if mass production will be carried out. Another major initiative in this field has been to attract the American company Intel to build a semiconductor factory in Germany, a project that would not lead to any European independence in this field – and which in any case is paralysed by Intel's deep financial problems. Image: https://www.european-processor-initiative.eu/news/

Thirdly, there is the question of funding as huge funds are necessary for a new industrial policy. The Draghi report, as well as other reports, recommend relying mainly on private sector funding. EU has a limited budget, and up to now member countries have resisted special EU taxes to fund a larger budget. Some member countries, among these Germany, are dead against giving EU the right to take out loans backed collectively by all countries. A new concept has been invented called ‘crowding in private capital’ which should mobilise funds from pension funds, investment funds, hedge funds and so on to take on the investments in innovation, greening, defence and the like. But this is not going to happen unless the EU guarantees the return on these private investments, called ‘de-risking’. This is not without risks. These guarantees would be off the books, as was the case with the bad loans causing the 2008-2009 international financial crisis. What does the EU have to back the guarantees in a worst case scenario?

Fourthly, and perhaps most importantly, all this requires political independence, particularly from the US. Since the second world war, most European countries, and later on the EU, have gradually been reduced to US vassal states. They are usually courteously being called “allies”, but we all know what we are talking about. If not, President Donald Trump is making this submission absolutely clear, and impossible to hide. The reaction from the EU countries to the threats from Trump has been muted, like beaten dogs crawling on their belly. Dignity is a word that has no longer any meaning in the EU. There are some voices within the EU calling for this submission to end and the EU to defend its independence. But if forced to choose between loyalty to the EU or the US, there are many EU countries, particularly the Baltic and Eastern European countries, that will choose the US. That could break the EU.

From being the masters of the world a little more than one hundred years back, the waning European grand powers are commanding less and less respect around the world. Not funny. And there is no easy ways out of this humiliation.

Poor EU.

 

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I found on the Internet the illustration below of how fracking of oil and gas is carried out. It is easy to see why there are environmental concerns about this method.

Graphic of the fracking process by Emilia Wilkinson, https://commons.wikimedia.org/wiki/File:Diagram_of_Hydraulic_Fracking.jpg

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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