As Europe is discovering, the past is rarely past. Weaknesses exposed by the forgotten 2011 European debt crisis remain unresolved. Five areas of unaddressed concern remain.
First, European growth is lacklustre. Between 2010 and 2023, European GDP grew cumulatively by 21 percent, compared to America's 34 percent. Current forecasts project medium-term annual real growth at around 1-1.5 percent. Causes include low investment in infrastructure, new technologies, research and development, and poor productivity improvements. Weak consumption and high saving rates reflect low consumer confidence.
Europe's economic model is increasingly unworkable. Post-war success was based on rebuilding shattered economies, the generous Marshall Plan, low labour costs and a strong technical and manufacturing base. The common market, reinforced by the single currency since 1999, facilitated trade amongst members. The expansion of the European Union (EU) and the reunification of Germany created new pools of cheap labour and new markets. Most recently, the emergence of China provided demand for automobiles, machinery, and industrial technologies, which underpin growth.
The position is now different. Dependence on exports to compensate for anaemic domestic consumption creates problems. Intra-European trade relies on recycling German savings and trade surpluses to net importing Mediterranean and Eastern European nations to finance purchases of Germany's exports. The substantial internal financial imbalances were exacerbated by the European Central Bank (ECB) bailouts of crisis-afflicted Greece, Cyprus, Italy, Portugal, Spain and Ireland in 2012. Germany is now owed over €1 trillion mainly by Italy, France, Spain, Portugal and Greece.
Excessive reliance on China, the EU's third-largest export market and now the largest source of imports, is evident. Europe now runs trade deficits with China, reflecting the latter's rapid move up the value chain. China is now a potent competitor with significantly lower costs in semiconductors, white goods, consumer electronics, and automotive. The looming trade conflict over electric vehicles evidences this shift.
As nations emphasise sovereignty, such as the US MAGA movement, global trade friction is unhelpful to European exporters.
Europe's competitiveness is affected by an ageing population (the working-age population is expected to decline 15 percent by 2070) and increasing resistance to immigration to boost the workforce. The replacement of cheap Russian gas imports with expensive US and Gulf LNG has increased costs by 30-40 percent, creating new dependencies.
Non-wage items, such as social, unemployment, and medical insurances, add up to 40 percent to labour costs. Europe's unfunded overgenerous welfare state, including relatively early retirement and generous pensions, is unsustainable. Overzealous, complex, overlapping regulations are a drag on efficiency. Brussels' intervention adheres to the principle of all extraneous bureaucracies—self-perpetuation and mission creep.
Second, debt. EU's government gross debt is nearly 88 percent of GDP. The highest debt levels are Greece (164 percent), Italy (137 percent), France (112 percent), Belgium (108 percent), Spain (105 percent), and Portugal (101 percent). Due to its legislated debt brake, which limits borrowing but may be loosened, Germany's debt to GDP is a more modest 62 percent. However, like some other member states, it has substantial unfunded pension liabilities. The EU's own separate debt is expected to reach €900 billion by the end of 2026 to fund coronavirus recovery programmes and support for Ukraine. This limits the ability of state investment in infrastructure renewal or boost domestic demand directly.
The debt levels are problematic, especially if the market loses confidence and interest costs rise. France's debt costs recently exceeded those of Greece! There is no plan to restore public finances. The bond market periodically forces weaker states to implement austerity measures, which have perverse side effects, such as skimping on measures to counter extreme weather, with disastrous results.
Third, the Euro's structural flaws continue. The inability to devalue or set individual monetary policy limits the flexibility of members with different requirements. At the same time, there is no common fiscal policy because of Germany's reluctance to de facto financial underwrite EU common debt. A currency without a country and states without a sovereign currency severely restrict policy options.
Fourth, security concerns. In the post-World War 2 period, the EU benefitted from modest defence spending, using the US umbrella enshrined in NATO to guarantee its security. After 1989 and the collapse of the Soviet Union, it also gained from a significant peace dividend, diverting funds from defence to more productive sectors, which is now being unwound.
As foreshadowed by President Trump, the US will likely force European countries to increase defence spending substantially and bear the bulk of the cost of support for Ukraine. The peace dividend is reversing with the onset of a second cold war. Unless the conflict is resolved, the EU's determination to continue supporting Ukraine in combat and reconstruction will strain its finances and industrial capacity. An additional constraint will be the need to support large numbers of refugees from Ukraine (estimated at over six million). Continued instability in the Middle East and Africa will result in a steady flow of displaced people into Europe, further pressuring resources.
Finally, political dysfunction, as Germany and France demonstrate, means that Europe is incapable of enacting the policies and reforms needed to manage these pressures. The electorate in member states has fragmented into far right, far left and centrist groupings, often of roughly equal size. Voters, many of whom share a pathological dislike of governments and elite politicians and bureaucrats, have shifted support from traditional parties to more extreme populist movements. Central concerns include sovereignty, immigration and border security, and disagreements on social issues around diversity and inclusion. Economic disagreements revolve around living costs, housing, sounder public finances, and expansion or preservation of existing welfare benefits. Even where these parties are unlikely to rule, they now set the political agenda.
Lack of governing majorities means unwieldy and unstable coalitions with contradictory political positions. Victor tyranny and lack of the loser's consent lead to continuous trench warfare, preventing action.
At a transnational level, the EU, where decisions require unanimity or consensus, is paralysed by two divides: North-South (a fiscally conservative Northern Europe against a spendthrift Latin approach) and East-West (a liberal West matched by a socially conservative East).
Problems will move from the periphery (smaller states) to the EU core (Germany, France, Italy). While Europe's size and wealth make immediate collapse unlikely, the trajectory is one of steady decline punctuated by successive crises, which may prove impervious to the ECB's 'whatever it takes' mantra.
Former banker and author of The Age of Stagnation
Satyajit Das
(Views are personal)