Draghi unveils EU competitiveness plan

Mario Draghi, former President of the European Central Bank (ECB) and one-time prime minister of Italy, has recently published his report for the European Union (EU) into its future growth and economic success.

Once known as “Super Mario” when he saved the euro, he is very critical of the state of the EU economy, finding it has fallen badly behind the US this century. He draws attention to future declines in population and problems with gross domestic product (GDP). Mr Draghi said: “We share this cake which becomes smaller and smaller – with a smaller number of people”.

Since 2000, his study concluded that the US has grown real disposable income twice as fast as the EU. Even adjusting for purchasing power parity, US GDP per head is 34% higher than the EU. US GDP per head is double the EU. As if on cue, Germany has revealed weaker GDP and industrial data as the bloc seeks to close its borders to many migrants.

The three main causes of divergence

The first problem Mr Draghi has called the “innovation gap”.

The US has raced ahead in digital technology, whilst EU concentration on improving the technology of petrol and diesel cars is of diminishing use given ‘net-zero’ policies. The absence of new commercial technology in the fastest-growing areas and delays in adopting smart US technology in digital has set the EU back.

The second problem is expensive energy. EU electricity is two-to-three times more expensive than in the US and gas is four-to-five times the price. This places many EU businesses at a big competitive disadvantage and is leading to job losses and closures.

The third problem is the lack of security of crucial supplies and increasing dependence on imports. The need to withdraw all Russian gas in a hurry was a major disruption and increased costs at EU businesses. Europe lacks the commodities and components to exploit the electrical revolution in the way that China does.

The innovation gap

Mr Draghi points out that the top three research and development (R&D) spending companies in the EU are all auto companies. In the US, they are digital technology businesses. The EU auto industry, led by Germany, employs 15 million people. Many jobs are now at risk as many have been employed in researching, developing, producing and selling petrol and diesel vehicles.

Consequently, he proposes an increase in EU R&D spending, boosted by public-sector leadership. His own figures show that, in 2022, the EU government R&D spent 0.74% of GDP, already higher than the 0.65% seen in the US. It was the US’s much higher levels of private sector spending in growth sectors that made the difference.

Even within pharmaceuticals, where the EU has some important companies, he noted a shift in the relative position from the EU to the US with more spending and research across the Atlantic.

Mr Draghi discusses ways the EU could broaden its own access to investment monies through its planned capital markets reform. He explains how the EU needs to hold on to more successful companies, which often turn early to expanding in the US and then to raising money there.

The cost of ‘net-zero’ policy

Mr Draghi is a keen advocate of the EU and in favour of its policy thrust to decarbonise the economy. When European Commission President Ursula von der Leyen announced a Green Deal programme of subsidies and investments as the keystone of EU growth, she called it their “man on the moon moment”. Today Mr Draghi is concerned the satellite is underpowered to get there.

Despite welcoming the aims, he is very critical of the EU’s Green-Deal-driven strategy for its impact on the productivity, costs and competitiveness of much of EU industry. He states:

“The EU’s decarbonisation goals are also more ambitious than its competitors’, creating additional short-term costs for European industry. The EU has put in place binding legislation to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels. The US, by contrast, has set a non-binding target of a 50-52% reduction below (higher) 2005 levels by 2030, while China only aims for its carbon emissions to peak by the end of the decade. These differences create massive near-term investment needs for EU companies that their competitors do not face. For the four largest EIIs energy-intensive industries (chemicals, basic metals, non-metallic minerals and paper), decarbonisation is projected to cost €500bn overall over the next 15 years, while for the “hardest-to-abate” parts of the transport sector (maritime and aviation) investment needs stand at around €100bn each year from 2031 to 2050. The EU is also the only major region worldwide to have introduced a significant CO2 price. “

He also identifies the EU’s cruel dilemma over trying to accelerate its progress to net zero. To speed transition through the acquisition of more battery cars, the obvious way to get people to buy more is to allow very competitive lower-priced Chinese imports. The way to speed decarbonisation of electricity generation is to import more Chinese solar and wind turbine capacity. This would then mean the green jobs the EU is keen to generate will be more jobs in China rather than in the EU.

Mr Draghi has limited solutions available to tackle these problems. As a result, he does not query the EU’s decision to place high tariffs on Chinese electric cars to make them less attractive and to slow their entry into the market. He is a keen advocate of the carbon border adjustment mechanism, a tariff on imported goods that benefit from cheaper fossil-fuel energy in their production. These moves might give EU industry some respite, but mean higher prices for consumers, lower living standards and lower rates of adoption of the new products.

His calculation of very large financing needs to make the investments in renewable power and electrical equipment to replace fossil-fuel transport and heating systems leads him to recommend higher levels of EU public spending to pump prime more private-sector investment. This would entail more EU borrowing, which Germany is seeking to prevent.

Security and dependency

Mr Draghi wishes to see the EU build up both its capacity to make things at home and to strengthen its collective defence. He points to the EU’s need to import many of its computer chips, crucial raw materials and green product components. He implies an envious glance over to the US, with the onshoring subsidies and regulations boosting American industrial capabilities, made so much easier by low energy costs.

He regrets the way EU armies and navies rely primarily on imported defence goods from the US. He tells us the EU countries produce 12 different tanks, where the US makes one. He looks forward to greater standardisation of weapons and more EU manufacture.

There is an allusion to the way the EU has relied on the US defence umbrella for many years, enjoying considerably lower defence spending as a result. With a European war in Ukraine, a perceived Russian threat and US equivocation about how much of the EU’s defence they should supply, it will be necessary for EU countries to expand their forces to provide more credible independent defence. This too requires substantial increased spending including capital spending on weapons systems and equipment.

The conclusion is a four-point strategy to start to reverse the widening gap between the EU and US. He wants to see a more integrated and regulated single market. He wants related EU industrial, competitiveness and trade policies that reinforce the market. He wants a colossal increase in state and private-sector investment, and he wants new governance with faster and simpler process to change laws and policies at EU level.

Mr Draghi sees a need for an extra 5% of GDP to be invested every year, or €800bn. He sees the stretch in trying to meet increased budget demands for a growth policy when this must be combined with running an expensive EU welfare policy to maintain the social model – but he recommends doing both.

The feasibility of the plan

The EU has been here before with big plans to raise productivity and competitiveness whilst doing more together using the central powers of the union, rather than at member-state level. His wish to see larger EU spending on investment and growth immediately faces the difficulties of some states not wishing to sanction a further major increase in EU debt. German finance minister Christian Lindner recently restated the government’s opposition.

Following his work to squeeze the Italian deficit down, Mr Draghi knows all about the need for prudent finances. His wish to see more EU law can be met, but care is needed lest more law means more rules and costs on EU businesses that US and Chinese business do not face.

Mr Draghi does not offer a solution to the conflicts in the EU’s ‘net-zero’ policies. He is right to show how the short-term outcome is considerably more expensive energy than competitors and much bigger investment programmes to change the way things are manufactured and how power is produced. Higher tariffs will give EU industry a breather, but do not make it more competitive. No tariffs mean more closures of domestic businesses as imports of cars, batteries, solar panels are cheaper than production costs in the EU. The ‘net-zero’ policy has become the delay to the ‘man-on-the-moon’ moment.

Cost a problem for Mr Draghi’s plan

The EU is currently at risk of recession, with German industry hard hit. Its export markets in China are not buoyant, its car product range is not sufficiently geared to the world of battery cars and autos are still a large proportion of industrial activity. The EU needs to find ways to catch up with digital technology to achieve anything like the Draghi leap forward in investment.

EU markets would need to become more liquid and more enterprising more quickly to deliver so much money, which is unlikely. This is another EU report that is good on analysis but may stay little used owing to disagreements about how much to borrow. Meanwhile, political parties remain more preoccupied with the movement of people than with economic growth.

You can read Mario Draghi’s full report here.