Caught between stagnation, declining competitiveness, and Donald Trump, Europe faces an „existential challenge” and is running out of time. We are on the brink of an economic apocalypse and must understand how we got here and what we can still do now.
Recessions and trade wars come and go, but what makes this situation so dangerous for the continent’s prosperity has to do with the most important of all uncomfortable truths: the EU has become a desert of innovation, as outlined in an analysis published by Politico.
Although Europe has a rich history of spectacular inventions, including scientific discoveries that have given the world everything from cars to telephones, radios, televisions, and pharmaceutical products, it has turned into a system of using others' innovations.
Once synonymous with cutting-edge automotive technology, today's Europe doesn't even have a presence in the top 15 best-selling electric vehicles.
Admittedly, warnings have not been lacking. Only four of the top 50 technology companies in the world are European, noted former Italian Prime Minister and central banker Mario Draghi in his recent report on Europe's declining competitiveness.
"We are living in a period of rapid technological change, driven especially by advances in digital innovation, and unlike in the past, Europe is no longer at the forefront of progress," stated Christine Lagarde, President of the European Central Bank (ECB), in November.
She warned that Europe's acclaimed social model could be in jeopardy if it does not change course quickly. "Otherwise, we will not be able to generate the wealth we will need to meet our growing spending needs to ensure security, combat climate change, and protect the environment," she said.
Draghi, who presented his report to the European Commission in September, was more direct: "This is an existential challenge," he emphasized.
Trump is just a symptom of deeper problems
With Donald Trump in the White House and his Republicans controlling both chambers of Congress, Europe has never been more exposed to the whims of American trade policy.
If Trump follows through on his threat to impose tariffs of up to 20% on imports from the continent, the European industry would take a hard hit. With over 500 billion euros in annual exports to the US from the EU, America is by far the most important destination for European goods.
Yet, Europe seems to have done too little to prepare for Trump's return. The first response of the President of the European Commission, Ursula von der Leyen, to her re-election was to suggest that Europe should buy more liquefied natural gas (LNG) from the US. This might please Trump for a while, but it's not a strategy.
In European industry, there is a bad feeling about the future American president, largely because executives have a good memory.
In 2018, Trump imposed tariffs on European steel and aluminum. Joe Biden agreed to suspend them until March 2025. European central banks are already warning that a new round of tariffs could reignite inflation and fundamentally undermine global trade.
But Trump is just one problem, the most recent one. In fact, he is just a symptom of deeper problems.
The extent to which Europe has lost ground to the United States in terms of economic competitiveness since the beginning of the century is astonishing. The difference in GDP per capita, for example, has doubled with some values at 30%, mainly due to lower productivity growth in the EU.
Put simply, Europeans are not working enough. On average, a German employee, for example, works over 20% fewer hours than their American counterparts.
Another cause of Europe's declining productivity is the corporate sector's failure to innovate. US technology companies, for instance, spend twice as much as European technology firms on research and development, according to the International Monetary Fund (IMF).
While US companies have seen a 40% increase in productivity since 2005, productivity in the European tech sector has stagnated.
The gap is evident even on stock exchanges: while US stock valuations have tripled since 2005, Europe's have only increased by 60%.
To say that Europe is behind would be an understatement - in fact, it's not even in the race, the publication emphasizes.
Europe has never reached its goal of spending 3% of the EU's GDP on research and development, the main driver of economic innovation. In fact, spending on such research by European companies and the public sector remains stuck at around 2%, roughly where it was in 2000.
European universities would be ideal places to kickstart innovation and research, but even here the continent is lagging behind.
In the global university rankings, compiled by Times Higher Education, only one EU institution made it into the top 30, the Technical University of Munich - at number 30.
And now comes the most painful problem.
The dirty little secret
Here comes Germany into play. The dirty secret of European research and development spending is that half of it comes from Germany. And most of these investments flow into one sector: the automotive one.
While this might seem obvious given the size of the sector (the annual revenue of the German automotive industry is nearly 500 billion euros), it doesn't yield the best returns on investments. This is because innovations in the automotive industry, such as improving fuel efficiency of an engine, are limited.
In other words, auto companies are effectively reinventing the wheel, instead of offering entirely new products like an iPhone or Instagram, which would create an entirely new market.
Europe has remained consistent. In 2003, the largest corporate investors in research and development in the EU were Mercedes, VW, and Siemens, the German engineering giant. In 2022, they were Mercedes, VW, and Bosch.
Overall, while it's not good to put all your eggs in one basket, it worked for Europe until it didn't. Although Europe accounts for over 40% of global research and development spending in the automotive sector, the praised German automakers missed the bet on electric vehicles.
This failure lies at the heart of Germany's economic problems, as evidenced by VW's announcement that it will close some German factories, for the first time in its history. Germany's automotive sector, which employs around 800,000 domestically, has been the lifeblood of its economy for decades, contributing more than any other sector to the country's growth.
The dominance of the German automotive sector is at risk, as its reluctance to invest in electric vehicles has led others - especially Tesla and a host of Chinese manufacturers - to exploit this gap. While these companies have heavily invested in battery technology and secured valuable patents, the Germans have been working on trying to perfect the diesel engine. And it didn't turn out well at all.
Europe only has outdated German cars
The crisis in the German auto world is just the tip of the iceberg. The country is struggling to cope with a multitude of other complicated challenges that are weakening its economic potential. The strongest blows it has taken include a rapidly aging society and a lack of highly skilled workers.
Many hoped that the large influx of refugees Germany experienced in recent years would alleviate this pressure. The problem is that few of the refugees have the training and skills required to fill top engineering positions and other technical roles that German companies are seeking to fill.
In just the past few weeks, VW, Ford, and steel producer ThyssenKrupp, to name just a few, have announced tens of thousands of layoffs.
Faced with some of the highest energy costs in the world, expensive labor, and burdensome regulations, many large German companies simply raise the stakes and move to other regions. Almost 40% of German industrial companies are considering such a move, according to a recent survey by DIHK, a business lobby group.
However, what makes the crisis in the German auto industry so problematic for the entire continent is that Europe has nothing else to fall back on.
And in this regard, the contrast with the US is strong and all to the detriment of the Old Continent, the publication points out.
In 2003, the largest corporations with the highest contributions to research and development in the USA were Ford, Pfizer, and General Motors. Two decades later, these are Amazon, Alphabet (Google), and Meta (Facebook).
Considering how much these giants and other players from Silicon Valley dominate the world of technology, it's hard to see how European technology could ever evolve in the same league, let alone catch up.
One reason is money. Startups in the USA are generally funded by venture capital. But venture capital funds in Europe represent only a slice of what it means in the USA. In the last decade alone, US venture capital firms have raised $800 billion more than their European counterparts, according to the IMF.
Instead of investing their money in the future, Europeans prefer to leave it in cash in the bank, where savings totaling about 14 trillion euros are slowly eroded by inflation.
Paris and Berlin: Two governments running out of money
And now we can ask ourselves: if they can't handle cars and IT, could the EU rely on 19th-century technologies in which it has always excelled, such as cars and trains, right?
Unfortunately, here come the Chinese. According to a recent analysis by the ECB, the number of sectors in which Chinese firms directly compete with those in the euro area, many of them car manufacturers, has increased from about a quarter in 2002 to two-fifths at present. Worse, the Chinese are extremely aggressive on prices, which has contributed to a significant decline in the EU's share of global trade.
Ignored Alarms and Troubles Ahead
Draghi's report was covered by the main media institutions on the continent for about a day and then quickly forgotten. Similarly, the continuous sound of IMF and ECB alarms has been ignored.
That's because Europeans probably don't feel any pain - not yet. Although the EU has a continuously declining share of the global GDP, it leads all charts in terms of the generosity of social welfare systems.
As the economic outlook of the region worsens, however, Europeans are approaching a harsh awakening to reality. Countries like France, facing a budget deficit of 6% this year and 7% in 2025 - more than double the allowed limit in the euro area - will have difficulties in maintaining a generous welfare state. Paris currently spends over 30% of GDP on social expenditures, among the highest in the world. Many other EU countries are not far behind.
If Europe's economic wealth does not reverse soon, those countries will face some tough decisions - just as Greece did in 2010 - as their borrowing costs rise.
The likely outcome is a politicization, as Greece experienced during the debt crisis, as populists, whether far-right or left-wing, take advantage of the opportunity to attack the institution of democracy. Unfortunately, Romania is also part of this:
This radicalization is already unfolding in several countries and is most worrying in France. The success of extremists is even more worrying considering that the worst of economic pains is likely yet to come.
This scenario outlined by Politico sounds familiar, right? Yes, because we find it in Romania as well:
- Economist: We Will Enter an Economic Withdrawal. When we get our salary, we spend it on the first night in a fancy club, then we eat pretzels and borrow to pay the rent
- Romania's Rating Downgrade Pushes us into the Arms of the IMF. I'm afraid the road to junk is getting shorter
- Nearly 3% Drop on the Stock Exchange after the Announcement of PSD's Withdrawal from Government
The problem is that until Europeans wake up to their new reality, it may be too late to do much, concludes the publication.
T.D.