Draghi offers the EU a future of the Good, the Very Bad and the Dead Ugly

Note: This comment originally appeared on September 12 in our weekly newsletter Signal Berlaymont

Brussels this week at last saw the long-awaited presentation of Mario Draghi’s advisory report on EU competitiveness. Draghi is a former Italian prime minister and former president of the European Central Bank. One might think given Italy’s poor economic performance in the last two decades, he may not be the best person to ask. He also played an important role in committing the ECB to propping up deeply indebted Eurozone governments through loose monetary policies. As a result, those governments lacked any incentive to implement politically painful competitiveness reforms, so they could generate economic growth and tax revenue. The ECB’s money-printing machine takes care of that.

In spite of all that, the EU Commission president Ursula von der Leyen chose to solicit Draghi’s advice anyway. Before discussing the good, let’s first discuss the ugly and the bad.

The ugly

Predictably, at the core of Draghi’s advice is suggesting more EU jointly-issued debt and EU taxes. This is to finance €800 billion extra EU spending a year, labelled as “investment”. The fact current EU spending has a poor track record, and is regularly criticised by the EU’s own auditing body, clearly was not relevant.

Thankfully, according to one EU diplomat, “proposing joint EU borrowing in the current political climate across the EU is an absolute non-starter.” Germany’s finance minister Christian Lindner immediately shot down the idea, saying: “Joint EU borrowing will not solve the structural problems.” He also noted pooling different countries’ risks and liability “creates democratic and fiscal problems. Germany won’t agree to this.”

But that doesn’t mean more jointly-issued debt won’t be forthcoming. We already have the EU’s €800 billion Covid Recovery Fund, officially named the “Recovery and Resilience Facility” (RRF). This is not financed by contributions from EU member states. Instead, it is financed by the European Commission issuing common debt—despite legal doubts whether the EU was authorised to go into debt.

At some point, the EU will need to repay these “Eurobonds”. Then the Commission will turn to member states, giving them three options: transfer money to the Commission so it can repay the debt, allow the Commission to tax citizens directly, or let the Commission issue new debt to refinance the old. The most likely outcome is the last one, as many member states are in dire financial straits, and unwilling to give up their taxation power. This bad habit, of not paying down debt but filing fresh debts on top of it, is these countries’ standard procedure for dealing with debt anyway.

Over time, EU governments may prefer financing the regular EU budget this way too. Why have an embarrassing fight between net payers and contributors every seven years, when there is a murkier method on hand for financing EU spending? Yes, with jointly issued debt, it is also possible to identify net payers and receivers, but it is much more difficult to calculate.

In sum, Draghi’s wishes are likely to come true—not thanks to his report, but due to the temptations of running up excessive public debt.

The bad

Draghi also wants to further erode the EU’s ban on unfair state aid, at least for what he identifies as “strategic sectors”. This wouldn’t differ much from what the Commission is already doing anyway: letting bigger EU member states splash huge amounts of their taxpayers’ money to their favourite sectors of their economy, ignoring complaints by smaller members. At some point, the smaller countries may start wondering what the whole point is of the EU.

Another prominent suggestion by Draghi is to use EU resources for defence spending. The fact the EU treaties restrict the EU from wading into defence spending is a hurdle here, however. Then there is the precedent of the “European Peace Facility”, amongst others. This is a European fund to support Ukraine’s defence needs, financed through contributions from EU members. In practise, it is part and parcel of the EU’s machinery.

Germany is wary of Draghi’s suggestion for defence Eurobonds, but his other defence recommendations may succeed. One of these is implementing the “European preference principle”, a vague concept which is likely to come down to favouring European companies in public tenders—a French idea. Another is creating an EU “Defence Industry Authority”, which can make procurements centrally on EU countries’ behalf. Member state governments are not above favouring domestic companies, or transferring more power to the EU in the hope that this will make taxpayers from other EU countries pay the bill. So expect this to happen.

The good

Not everything in the report is either ugly or bad. Apart from having a good sense of humour, Draghi actually did include some decent suggestions in his report to improve EU competitiveness. For a start, the document explicitly recognises “high energy costs in Europe are an obstacle to growth”, thereby criticising the EU’s own climate dogma. He says:

“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.”

Draghi’s report does not go much further into this, but it at least showcases a positive attitude towards nuclear power. This might sound like common sense, but in the EU policy bubble—where Germany’s current anti-nuclear government holds a great deal of sway—it is not seen as an obvious truth.

Also Draghi makes some good points about EU regulation. His report mentions that “regulatory barriers to scaling up are particularly onerous in the tech sector, especially for young companies.” It adds: “While the ambitions of the EU’s GDPR and AI act are commendable, their complexity and risk of overlaps and inconsistencies can undermine developments in the field of AI by EU industry actors.” The AI act has been mocked as a comical endeavour by a continent with hardly any AI innovation deciding to roll out an attempt at regulating it. It supposes the “Brussels effect” will then export its regulations to the rest of the world. But then, the EU was always very proud of its GDPR regulation.

At his press conference, Draghi was even harsher. He stated: “The General Data Protection Regulation (GDPR) is estimated to have reduced the profits for small tech companies by more than 15 per cent,” adding that “with this legislation, we are killing our companies.” He also pointed out ever more stringent EU tech regulation in the end benefits US big tech giants, saying: “Only larger companies—which are often non-EU based—have the financial capacity and incentive to bear the costs of complying.”

Then, instead of launching a European Operation “¡Afuera!”, modelled on Argentinian President Javier Milei‘s war on red tape, Draghi suggests tinkering in the margins: like simplifying regulation and making sure there are no contradictions between the new AI act and GDPR.

Conclusion

The EU’s challenges are massive. As Draghi’s report recalls, around 70 per cent of the EU’s per capita GDP gap with the US is explained by lower productivity in the EU. Draghi’s response, however, amounts to calling for more of the same.

Over the years, industrial policy has failed badly in France, where it was very popular. For example, France’s “Plan Calcul”, between 1966 and 1975, hoped to create a French indigenous technological and information industry. Instead, what happened was the US conglomerate Honeywell bought up most of the would-be “national champions”. Who could think this failed kind of approach would then work at the EU level?

This is especially perplexing when the report correctly identifies the causes of the EU’s dire economic state: confusing, badly drafted regulation which is suspicious of innovation; coupled with expensive energy, a result of a costly climate policy. In both cases, the EU sits at the heart of the problem.

Just scrapping all of the EU’s climate and environmental regulation that has been passed during the last five years, along with the EU’s AI Act and GDPR, would be a very fine start. Unfortunately, this is not what Draghi suggests.