Politico: Europe's economy is going down along with its former prosperity
The foundation of European prosperity is about to collapse, the economy has gone into a tailspin, and the continent is not participating at all in the race for new technologies, writes Politico. Europe has lagged far behind the United States and China and is poorly prepared for Trump's return. Therefore, nothing good awaits her.
Matthew Karnichnig
Stagnation, weakening competitiveness, Donald Trump — The Old World is facing an “existential challenge.”
Europe's time is running out.
In a matter of weeks, Donald Trump will return to the White House, the continent's economy has gone into a tailspin, and the foundation on which the region's prosperity stands has not just cracked, but is about to collapse.
In recent decades, Europe's economy has proved surprisingly resilient against the backdrop of the bloc's eastward expansion and high demand for its goods in Asia and the United States. However, China's protracted boom is fading, and trade tensions with Washington are muddying the waters of the Atlantic, and the carefree days are clearly over.
Economic difficulties across the continent are escalating, and this unpleasant headwind threatens to escalate into a real squall next year, when Europe risks being caught in the hot hand of Trump, who has broken loose. In addition to extensive duties on everything from Bordeaux to Brioni (his favorite manufacturer of Italian suits), the future leader of the free world will surely impose new demands on NATO countries: fork out for your own defense, otherwise you will lose American protection.
As European capitals are already struggling with growing deficits due to reduced tax revenues, they face even greater financial difficulties, fraught with further political and social upheavals.
Recessions and trade wars come and go, but the bitter truth of the current moment lies in the fact that the EU has turned into an innovation desert, and this does not bode well for its prosperity.
Despite a rich history of stunning inventions and daring scientific breakthroughs, Europe, which once gave the world everything from cars to telephones, radio, television and pharmaceuticals, has turned into an outsider.
Europe was once associated with cutting-edge automotive technology, but today there is not a single European brand among the 15 best-selling electric vehicles. As former Italian Prime Minister and central bank governor Mario Draghi noted in a recent report on Europe's weakening competitiveness, only four of the world's 50 largest technology companies are European.
If Europe continues on its current trajectory, it will face an “Italian” future: decaying beauty and the unenviable fate of a debt-ridden open-air museum for American and Chinese tourists.
“We are going through a period of rapid technological change, driven in particular by digital innovation, but unlike in the past, Europe has moved away from the forefront of progress,” Christine Lagarde, president of the European Central Bank (ECB), said in November.
In a speech at the medieval Bernardine College in Paris, Lagarde warned that Europe's vaunted social model would be under threat if it did not change course as quickly as possible.
“Otherwise, we won't be able to create wealth to meet the growing demands for spending on security, climate change, and environmental protection,” she said.
Draghi, who presented his report to the European Commission in September, was even more blunt: “This is an existential challenge.”
Dilapidated infrastructure
Alas, restoring Europe's economic infrastructure is easier said than done.
Never before has Europe been so sensitive to the vagaries of American trade policy as it is now — with Donald Trump in the White House and a Republican majority in both houses of Congress.
If Trump follows through on his threat and imposes duties on imports from the continent of up to 20%, he will deal a deafening blow to European industry. With more than 500 billion euros of annual exports from the EU, America is by far the most important market for European goods.
However, for some unknown reason, Europe was poorly prepared for Trump's return. European Commission President Ursula von der Leyen's first reaction to his re-election was to suggest that Europe buy more liquefied natural gas (LNG) from the United States. Trump may be pleased with this, but it's not exactly a strategy.
“Europe's leaders did not bother to learn from the last Trump presidency, and now it will come back to us like a boomerang,” says Clemens Fuest, president of the Munich—based Institute for Economic Research.
Fuest warns that Trump will not necessarily be bad news for the EU. For example, if he implements his plans and returns large-scale tax breaks for the rich and introduces new duties, inflation in the United States may jump, spurring interest rates. This will strengthen the dollar, which in turn will benefit European exporters as they convert their American earnings back into euros.
Trump may also agree to extensive trade negotiations with Europe and waive new duties as such.
However, the forebodings of the European industry about the new president are not the most joyful, largely because its leaders have a good memory.
In 2018, Trump imposed duties on European steel and aluminum, which remain in force to this day. US President Joe Biden agreed to suspend them until March 2025, paving the way for another confrontation between the Old World and Trump in the first weeks of the new administration. European central bankers are already warning that a new wave of tariffs could not only reignite inflation, but also fundamentally undermine global trade itself.
“If the U.S. government fulfills this promise, we are facing a serious turning point for international trade,” Joachim Nagel, president of the German Bundesbank, said recently.
Ongoing challenges
Alas, Trump is just a symptom of much deeper problems.
Although the EU is fixated on Trump and what he can do next, he is not the main problem for the European economy. Ultimately, all he has achieved with his constant bravado and threats of tariffs is to lift the veil and expose the fragility of the European economic model.
If Europe had a stronger economic foundation and was more competitive than the United States, Trump would have virtually no leverage.
Europe's lag in terms of economic competitiveness has been staggering since the turn of the century. For example, the gap in GDP per capita has doubled in some indicators to 30%, mainly due to low labor productivity growth in the EU.
Simply put, the Europeans are simply underworking. For example, the average German employee works at least 20% fewer hours than his American counterpart.
Another reason for the decline in labor productivity in Europe is the inability or unwillingness of the corporate sector to innovate.
According to the International Monetary Fund (IMF), American technology companies spend twice as much on research and development as European ones. And here's the result: American companies have experienced a forty percent jump in productivity since 2005, while European companies, on the contrary, are stagnating.
This gap has also affected the stock market: the valuation of the US stock market has more than tripled since 2005, while the European one has increased by only 60%.
“Europe is lagging behind in new technologies that will drive future growth,” Lagarde said in a speech in Paris.
That's an understatement. Europe is not just lagging behind — it is not participating in this race at all.
At the EU summit in Lisbon in 2000, the leaders decided to make the European economy “the most competitive in the world.” A key pillar of the so-called Lisbon Strategy was a “decisive leap in investment in higher education, research and innovation.”
A quarter of a century has passed, and Europe has not only failed to achieve its goal, but has also lagged significantly behind both the United States and China.
Europe has yet to achieve its goal of spending 3% of the bloc's GDP on research and development (R&D), the main engine of economic innovation. Moreover, research spending by European companies and the public sector has stagnated at about 2%, about the same as it was in 2000.
It would seem that European universities in Europe are asking for the role of a platform for innovation and research, but even here the continent does not stand up to any comparisons.
The Times Higher Education magazine's ranking of the world's 30 leading universities includes only one EU institution. This is the Technical University of Munich, and it took a modest 30th place.
Europe's investment in R&D is not just too small — a significant portion of it goes “to the wrong areas,” said Fuest from the Munich Institute for Economic Research.
A dirty little secret
That's where Germany comes up in the conversation. The dirty secret of European R&D spending is that half of it is in Germany. And most of these investments come from a single sector: the automotive industry.
Although this may seem obvious based on the size of the industry (the annual revenue of the German automotive industry is almost half a trillion euros), this is not the place where you can get the most out of your invested dollars (or euros). The fact is that the automotive industry is improving gradually (take at least such an indicator as the fuel efficiency of the engine).
In other words, companies are literally reinventing the wheel, not fundamentally new products like the iPhone or Instagram that create a new market.
In this sense, Europe is very consistent. In 2003, the largest corporate investors in R&D in the block were Mercedes, Volkswagen and the German engineering giant Siemens. In 2022, Mercedes, VW and the German auto parts manufacturer Bosch became them again.
In general, the European idea of putting all the eggs in one basket worked well... until suddenly she stopped. Although Europe accounts for more than 40% of global R&D spending in the automotive industry, the vaunted German automakers have somehow mysteriously managed to skip the opportunity to engage in electric vehicles.
This failure is at the root of Germany's economic malaise, as evidenced by Volkswagen's recent announcement of the first-ever closure of German factories. The German auto industry, which employs about 800,000 people domestically alone, has served as the lifeblood of its economy for decades, making an incomparable contribution to the country's growth.
Now, the dominance of the German automotive industry is under threat, as others, in particular Tesla and many Chinese manufacturers, have occupied this niche due to their unwillingness to invest in electric vehicles. While these companies were investing heavily in battery technology and obtaining valuable patents, the Germans were perfecting the diesel engine. It turned out so-so.
The crisis in the German automotive world is just the tip of the iceberg. The country is desperately struggling with many other complex issues that undermine its economic potential. The most painful thing is the double blow of the rapid aging of society and the shortage of highly qualified personnel.
Many Germans hoped that the massive influx of refugees that Germany has sheltered in recent years would ease this pressure. The problem is that only a few of the refugees have enough education and skills to take up high-class engineering and other technical jobs opened in German companies.
Given the pace of cuts in German industry, the labor shortage may soon resolve itself — albeit not for the better. In the last few weeks alone, companies such as VW, Ford, and steel giant ThyssenKrupp have announced tens of thousands of layoffs, to name just a few.
Faced with high energy costs, expensive labor, and burdensome legislation, many large German companies are going all-in and moving to other regions. According to a recent survey by the German Chamber of Commerce and Industry, almost 40% of German manufacturing companies have thought about this.
Veronica Grimm, a member of the German Council of Economic Experts (an independent group of leading economists advising the German government), argues that the only way for the country to stop this recession is to implement large—scale structural reforms to encourage investment.
“The situation is very grim,” Grimm said last month after the publication of the annual report on the state of the German economy.
“Stuck in the 19th century”
The failures of the EU's largest economy inevitably affect the entire bloc. This is especially true in Central and Eastern Europe, which German car and equipment manufacturers have essentially turned into an assembly plant over the past decades.
Whichever car you buy — Mercedes, BMW or Volkswagen — components like the engine or suspension will be made in Hungary, Slovakia or Poland.
The secret to the insurmountable crisis of the German car industry is that the continent no longer has anything to rely on.
And here the contrast with the United States is also striking.
In 2003, the largest R&D investors in the United States were Ford, Pfizer, and General Motors. Two decades later, Amazon, Alphabet (Google), and Meta* (Facebook*) top the list.
Given the superiority of Silicon Valley technologies in general and these players in particular, it is difficult to imagine that European technologies would ever compete in the same league, let alone on equal terms.
One of the reasons is money. Companies in the United States are usually funded by risky capital. But its volume in Europe is only a small part of the American one. In the last decade alone, American venture capital firms have raised $800 billion more than their European competitors, according to the IMF.
Instead of investing money in the future, Europeans prefer to keep it in cash in a bank, where inflation is gradually eating up about 14 trillion euros of their savings.
“Modest amounts of venture capital in Europe deprive innovative companies of investments and make it difficult to stimulate economic growth and living standards,” the IMF analysts concluded.
But if cars and information technology don't work, the EU will always be able to rely on 19th-century technologies that have always served it flawlessly, such as cars and trains, won't it?
Alas, this is where the Chinese come into play.
The share of manufacturing sectors where Chinese companies compete directly with representatives of the eurozone has grown from almost a quarter in 2002 to two-fifths today, according to a recent ECB analysis.
To make matters worse, the Chinese are trading very harshly, and this has significantly reduced the EU's share of global trade.
The politics of the Ostrich
Europe is facing stagnant growth, weak competitiveness, and tensions with Washington (and these are just some of the most pressing problems), and it would seem that the time is ripe for heated public discussions about large-scale reforms.
It's not like that. Draghi's report was discussed by the leading European media for about a day, after which it was safely forgotten. The IMF and the ECB are also constantly sounding the alarm, but they ignore the Europeans.
It's probably because the Europeans haven't been really hurt yet — at least not yet.
Although the EU's share of global GDP is steadily declining, it leads all world tables in terms of the generosity of social security systems.
However, as the region's economic prospects darken, Europeans will be bitterly disappointed. Countries like France, with budget deficits of 6% this year and 7% next year (more than double the euro zone's allowable limit), will find it difficult to maintain a welfare state.
Currently, Paris spends over 30% of GDP on social spending, and this is one of the highest rates in the world. A number of other EU countries are almost not far behind.
If Europe's economic fate does not change soon, painful decisions are ahead — as Greece did in 2010 — as borrowing costs are steadily rising.
This will surely lead to a radicalization of politics, as happened with Greece during its debt crisis, as populists on the right and left will not miss the opportunity to attack the elite.
This radicalization is already underway in a number of countries and has taken the most alarming turn in France. The success of the political marginals is all the more alarming when you consider that the worst economic suffering seems to be yet to come.
The catch is that by the time the Europeans wake up to a new reality, they may not be able to change anything.
* A product of the Meta company, which is banned in Russia as extremist.
