The first estimate of GDP growth for the third quarter will be released at the end of the month in the Eurozone, but don’t hold your breath. It will most certainly be weak and disappointing, as it has been over the past two years. Since the end of the fiscally driven post-pandemic boost, growth has been anemic in Europe, and the GDP is barely up since Q3 2022. A number of specific headwinds have affected the Eurozone, such as energy supply disruptions, weak Chinese demand for industrial and manufactured European goods, tight monetary policy and reduced fiscal support. But Europe mostly suffers from structural flaws that have hampered its ability to grow over more than two decades now. In this context, Mario Draghi’s report on “The future of European competitiveness”, released in September, is a milestone for economic policies on the Continent. It unambiguously summarizes the reasons behind the growth slowdown since the start of the century, and it brings forward what needs to be done to save Europe from “a slow agony”. Europe needs to grow faster, not only in the short run after the recent deterioration in economic indicators, but over the longer run as well in order to preserve its place in the new world economic order that is taking shape.

Mario Draghi’s report was released at a time when the Eurozone is experiencing another episode of economic weakness. After a near recession in 2023, economic growth had resumed in early 2024 with a pickup in household consumption and exports. Unfortunately, this encouraging dynamic has rapidly lost momentum and the +0.2% growth in GDP recorded during the second quarter was only due to exports and government spendings, while private consumption stalled, and business investment declined.

The slowing dynamic appears to have extended throughout the summer and doesn’t bode well for GDP growth in the second part of the year: most economic indicators have disappointed expectations and deteriorated recently, pointing to subdued growth at best for the Eurozone as a whole. The PMI Composite index has fallen back below the limit between expansion and contraction of the activity in September and has remained in “contraction territory” in October. Germany is experiencing a particularly tough situation. The German industry is suffering from contracting activity since 2023, dragging the entire economy downward. The labor market has been deteriorating over the past two years as well, with the unemployment rate up from a record low of 5% in 2022 to its current 6%. Consumer confidence is depressed, and consumption stagnant, with no sign of imminent improvement in sight.

Confidence is depressed in all sectors of the German economy, at recession levels

Europe has been hit by a succession of adverse developments since 2022: sanctions against Russia following Ukraine’s invasion, the ensuing cut from Russian gas supply, weaker Chinese demand for manufactured goods, a surge in inflation and the subsequent sharp rise in interest rates have been headwinds for all European economies. But they have affected Germany most, due to the structure of its economy, even if other Eurozone economies have suffered from the same circumstantial pressures.

Opposite to the early 2010’s, economic sentiment is depressed in “core” European economies while quite positive in southern countries

 In contrast, Southern European economies have been less impacted by those factors and have benefited from resilient demand for services, and tourism in particular. Economic sentiment and growth in those economies have been on a positive trend in 2024, while Northern economies were losing steam. A stark reversal from the situation prevailing a decade ago when “peripheral” economies were plunged into severe recessions while “core” economies were driving growth in Europe...

In September, former ECB President and Italian Prime Minister Mario Draghi presented a comprehensive report, “The future of European competitiveness”, that sets a milestone for Europe’s economic policies. Starting with an uncompromising analysis of the European Union's economic situation, Mario Draghi then proposes a set of recommendations and policies that need to be implemented in order to foster sustainable growth in Europe and prevent “a slow agony” for the world’s second largest economy.

Europe needs to reignite stalling productivity growth

Mr Draghi’s statement is so clear it can simply be quoted: “Europe’s need for growth is rising. The EU is entering the first period in its recent history in which growth will not be supported by rising populations. By 2040, the workforce is projected to shrink by close to 2 million workers each year. We will have to lean more on productivity to drive growth. If the EU were to maintain its average productivity growth rate since 2015, it would only be enough to keep GDP constant until 2050 – at a time when the EU is facing a series of new investment needs that will have to be financed through higher growth. To digitalise and decarbonise the economy and increase our defense capacity, the investment share in Europe will have to rise by around 5 percentage points of GDP to levels last seen in the 1960s and 70s. This is unprecedented”.

5% of the European Union’s GDP represents more than EUR 800bn of new investment per year, indeed a considerable amount that will require combined contributions from both the private and public sectors. At a time when public debt has exceeded 100% of GDP in most large European economies (Germany being the noticeable exception), the idea of a sharp increase in public debt to finance those investments may sound paradoxical. However, the report points to the fact that, if those investments effectively increase productivity and growth going forward, they will ultimately contribute to improve the situation of public finances by creating more fiscal space for governments.

The timing of the release of the report on the future of European competitiveness can be seen from two angles. In a sense, it comes at a timely moment when the aftermaths of the Covid pandemic are now mostly dissipated, when deteriorating growth clearly calls for some reaction, and before the rise of higher challenges for the European economy as the global trade order is being redefined. Draghi’s clear call for urgent and bold action sets a path forward for improving the currently bleak outlook of the European economy.

 Unfortunately, this report can also be seen as coming at the worse possible moment given the current economic and political context in Europe. In essence, the strategy and recommendations of Mario Draghi require European countries to cooperate and take collective decisions that will improve common growth prospects over the medium-term. Just the opposite of short-sighted decisions designed to address immediate public opinion’s concerns, as is currently the Zeitgeist in Europe. In that respect, two reactions from Germany’s finance minister have highlighted the difficulty of the task ahead: less than three hours after the release of the Draghi report, Christian Lindner clearly rejected the idea of shared borrowing at the European level: “Germany will not agree to this”. A few weeks later, Christian Lindner was said to have warned his Italian counterpart against a takeover of Commerzbank by Unicredit. Those can hardly be seen as signs of enthusiasm from Europe’s largest economy at the idea of more economic integration and cooperation.

The United States have had their Bidenomics, that has spurred investment in infrastructures and new factories while supporting consumption with extended social benefits and tax cuts for households. China just announced a massive stimulus package that is so far focused on supply-side policies, to facilitate access to credit and halt the fall of the real estate market, but could soon be complemented by measures targeted at households and designed to revive consumption. Europe is the one large economic area lagging behind in terms of fiscal support, and this may be part of the explanation for the disappointing economic performances of the past two years.

Individually, the main European economies have no wiggle room to provide fiscal stimulus in the short term. After a concerning deterioration of public deficits in the past few years, France has no choice but to draw up an “austerity” budget for next year, that will have to be adopted via a special procedure given the lack of majority in Parliament for the government. Far from being a stimulus, fiscal policy will be a headwind for growth in France in 2025. Italy is in a similar situation, after the European Council opened an excessive deficit procedure for the third largest economy of the European Union, along with France, Belgium and a handful of East European economies.

As for Germany, it would have ample room for maneuver on the fiscal front given the low level of its debt-to-GDP ratio (just above 60%). But Europe’s largest economy is constrained by its self-imposed constitutional rule prohibiting budget deficits. This debt brake rule was well intended when introduced in 2009 and played its role of preventing fiscal inconsequence in the ensuing decade.