Deeper integration needed for Europe to compete in fragmented world

Global crises present opportunity for enlargement and reform

Geopolitics is shaping the global economic agenda, and to compete in an increasingly fragmented world, Europe needs to come together. This was the key takeaway from the macro discussions of the DZ BANK International Capital Markets Conference in Berlin, hosted in collaboration with KfW and OMFIF. The event convened a global audience of policy-makers, politicians, business leaders and financial market practitioners to discuss macro, markets and digital and sustainable transformations.

Developments in the US pose risks for Europe

Following the International Monetary Fund’s spring meetings in Washington, the economic and political outlook in the US was a key topic of discussion at the Berlin conference. The outcome of the presidential election in the US holds significant implications for Europe, with uncertainties surrounding Nato, Russia and China policies under either Donald Trump or Joe Biden administrations. A Trump presidency would be ‘very unpredictable’, noted one panellist, as Trump’s comments have raised questions about his commitment to Nato. Many have expressed concern about Trump’s ‘pro-Russian tendencies’. One speaker noted, ‘Trump would be a much bigger challenge for Europe than the Biden team would be.’

‘The possibility of a second Trump term increases the pressure on us… People are a long way from realising the size of the economic challenges in front of us,’ reflected Florian Toncar, parliamentary state secretary at Germany’s ministry of finance. ‘We [Europe] must look to other priorities, including paying more for defence.’

Presenting another challenge, the last mile of reining inflation into target range has proved more difficult to complete in the US than in Europe. As supply-side pressures ease in Europe, goods inflation is coming down quickly (although services inflation is somewhat stickier). Meanwhile in the US, strong demand is keeping prices elevated. This, coupled with strong economic growth, has delayed rate cuts by the Federal Reserve.

As one panellist mentioned, ‘Six months ago, markets were pricing in five to six rate cuts by the Fed in 2024. Now it is down to two to three.’ If the European Central Bank cuts before the Federal Reserve System – the most likely outcome according to the speakers – it could depress the euro against the dollar.

Finally, concerns were raised over US fiscal policy and debt sustainability, along with questions surrounding Europe’s economic strategy and response to US policies. Commenting on the US Inflation Reduction Act, Toncar noted that Europe spends a similar amount on the green transition via the NextGenerationEU, emphasising the need for European policy-makers to act and move forward with plans for reinvigorating the economy.

‘I think we should stop complaining about the American strategy… We probably should rather focus on quality [public expenditures] and setting the conditions that can keep the European economy competitive.’ He noted that the €800bn NGEU fund is of a similar order of magnitude to the IRA and that funds are still in the process of implementation.

Opportunities to enhance competitiveness – given political will

Speakers noted that Europe boasts several comparative advantages, including its strategic location between US and Asian markets, its manufacturing power and the diversity of its member states. The openness of European economies was also identified as a strength.

However, structural issues such as fragmentation, demographic challenges and a lack of coherent industrial policy are eroding the competitiveness of Europe compared to the US and China, which have more interventionist and protectionist economic policies in comparison.

‘EU enlargement in some shape or form is indispensable,’ explained one panellist, pointing specifically at the Western Balkans, Ukraine and Georgia as potential new EU member states. ‘Competition is about scale. You have Factory US and Factory China – we need Factory Europe to compete.’ They emphasised Europe’s historical comparative advantage in manufacturing, but noted the scale needed to produce at a good price.

In terms of reforms, Toncar reiterated the challenges and priorities for European competitiveness. This would require addressing bottlenecks in finance and human capital, incentivising full-time work and higher participation rates, reducing red tape and mobilising private investment. ‘Capital Markets Union must be one of the top three priorities of the next European Commission,’ he warned, stating that at present, European capital markets do not currently match the financing needs in Europe and more work needs to be done to mobilise private capital.

While common challenges across European countries necessitate a more unified approach to policy-making and economic reform – such as demographic changes and productivity growth – there are divergent economic developments within Europe, particularly between southern and northern economies. Panellists mentioned that these discrepancies raise questions about the ECB’s reaction function and the need for coordinated policy responses.

Some speakers were fearful that a coherent policy response will remain elusive. With far-right parties expected to make gains in the upcoming European Parliamentary elections, it seems less likely that the European electorate will be willing to grant more power to Brussels.

But perhaps global shocks are the wake-up call Europe needs. Some panellists were optimistic that the challenging environment can spur the political will needed to introduce much needed reforms. ‘In area of defence and industrial policy, those are two big areas where we can make significant progress in 10 years,’ one speaker stated.

Historically, the most meaningful EU reforms have come about during times of crisis. In a volatile, unpredictable and fragmented world, European policy-makers should closely examine how they can improve their countries’ performance and competitiveness – and drive on further with European integration.

Taylor Pearce is Senior Economist, Economic and Monetary Policy Institute, OMFIF.

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