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Mario Draghi: The Coimbra Call

Ladies and gentlemen,

I wish to thank you and I feel especially honoured by this invitation to reflect together on the challenges for Europe coming from this period of profound change in trade and international relations. 

These changes have been in the making for several years and the situation was deteriorating even before the recent tariff upheaval. So far, internal political fragmentation and sluggish growth have hindered an effective European response. 

But recent events are a break point. The vast use of unilateral actions to settle trade grievances, and the definitive disenfranchisement of the WTO, have undermined the multilateral order in a way that is hardly reversible.

For a large economy, the EU is highly open to trade. 

Almost one-fifth of our total value added comes from exports, double the figure in the US. More than 30 million jobs are supported by exports, or around 15% of employment. And we also run a large current account surplus of around 3% each year, implying that – in net terms – we absorb demand from the rest of the world.

This openness vastly increases the exposure of our growth and employment to the policy actions of our trading partners and to policy cycles originating outside Europe. And our main exposure is to the US.

We are exposed directly, as the US is our largest export market, with over 20% of our goods exports heading over the Atlantic.

And we are exposed indirectly, as the US is the main source of demand for our trading partners. This means that if US demand falters, our partners’ imports from Europe will also falter. Analysis by the ECB shows that, in the case of a shock to US GDP, these indirect effects on the euro area actually outweigh the direct effects. 

The recent actions of the US administration are therefore certain to affect the European economy. And even if trade tensions deescalate, uncertainty is likely to linger and act as headwind for investment across the EU manufacturing sector.

Now, we should ask why we ended being in the hands of US consumers to drive our growth. And we should ask how we can grow and generate wealth by ourselves.

Realistically, we cannot diversify away from the US in the short run. We can and should seek to unlock new trade routes and grow new markets. But any hopes that opening to the world will substitute for the US are likely to be disappointed.

The US accounts for almost two-thirds of the global trade deficit in goods. The next two largest economies – China and Japan – also run persistent current account surpluses. So, we will have to strike a deal with US that keeps our access open.

But in the longer run, it is gamble to believe that we will return to normal in our trade with the US after such a major unilateral breakdown in this relationship – or that new markets will grow fast enough to fill the gap the US leaves behind. 

If Europe truly wants to be less reliant on US growth, it will have to produce it itself.

The first action that we need to take is to change the macroeconomic policy framework that we designed after the great financial crisis and sovereign debt crisis. 

Up until this point, the EU had had a broadly balanced current account position and adequate domestic demand. But faced with the aftermath of these crises – a slow recovery and high public debt – governments sought to reorient the economy towards world markets and import demand from abroad.

The framework had three main elements.

The first was contractionary fiscal policy. From 2009 to 2019, the collective cyclically-adjusted fiscal stance in the euro area averaged 0.3%, compared -3.9% in the US. The main casualty of this consolidation was public investment, which dropped by almost a percentage point as a share of GDP and did not recover its pre-crisis level until the pandemic. 

The second element was a focus on external competitiveness over domestic productivity.  

Since 2000, annual labour productivity yearly growth in the EU has been just one half of what has been in the US, causing a cumulative productivity gap of 27 percentage points over the whole period. But instead of trying to reverse the trend in productivity, we adapted our labour policies around it. 

Especially after the crises, we made a deliberate effort to suppress wage growth to increase external competitiveness. Our real wages failed to keep pace even with our slow productivity, while US real wages rose 9 percentage points more than wages in the euro area in this time.

This wage suppression held down consumption and reinforced the hit to domestic demand from contractionary fiscal policy. Before 2008, domestic demand in the euro area grew at around the same pace as in the US. Since then, domestic demand in the US has grown more than twice as fast.

The third element was essentially giving up on developing the internal market as a source of growth.

Rules were not enforced, with infringement proceedings falling by 75% after 2011. And there was little progress in lowering internal barriers in services. Remarkably, external barriers in services fell faster than internal ones, redirecting demand outside of the EU. 

In this setting, rates of return for investors were depressed and capital was pushed outside of the EU in search of opportunities. From 2015-22, large European public companies had a rate of return on invested capital around 4 percentage points lower than their US peers. 

Recent reports tasked by the President of the European Commission and by the European Council provide a roadmap for a new policy framework. Among other pieces of policy advice, they propose higher investments and the dismantling of barriers that hamper the functioning of the internal market. 

These measures are self-reinforcing.

Higher investments can generate a strong internal demand impulse, offsetting any headwinds coming from weaker US demand. Lower internal barriers will increase the elasticity of supply, helping temper inflationary pressures emanating from higher investment – especially if world trade becomes more fragmented. 

In parallel, a well-functioning single market will raise productivity growth, lifting rates of return and pulling in more private investment. And that will in turn lead to higher wages and consumption, both to compensate higher productivity and because a strong domestic market means less focus on external competitiveness. 

But to finance higher investments, Europe is mostly relying on national budgets. 

The EU has recently reformed its fiscal rules to enable higher investments, as well as activating the “escape clause” to facilitate higher defence spending. But so far only 5 of the 17 euro area countries – representing around 50% of GDP – have opted for an extended adjustment period under the new rules. And several countries have indicated that they will not use the escape clause owing to lack of fiscal space. 

This underscores that, when debt is already high, making categories of public expenditure exempt from fiscal rules can only go so far. 

In this context, issuing common EU debt to fund common spending is a key component of the policy roadmap. It can ensure that aggregate spending does not fall short. And it can ensure – especially for defence – that more spending will take place in Europe and that it will contribute to operational effectiveness and to higher economic growth than otherwise.

Moreover, issuing common debt would provide the “missing link” in Europe’s fragmented capital markets, which is the absence of a common safe asset. This would help make capital markets deeper and more liquid, creating a virtuous circle between higher rates of return and greater financing opportunities.

Altogether, this roadmap would both increase our growth and show that we are able to produce wealth for our citizens at home. 

Does our past performance suggest we are credible in carrying it out?

It is often said that “Europe only moves forward in crisis”. But in truth our crisis began almost twenty years ago. 

It was at this time that the geopolitical construct that was created after World War Two, and which peaked with the fall of the Soviet Union, began crumbling. And it was at this time that our position in global innovation and technology started to fall behind. But for much of this time we ignored all signs. 

Consider energy. Our gas imports from Russia kept growing even after its invasion of Crimea, and well after Putin’s hostility to the West and the EU had been widely stated.

We paid a high price when the gas was cut off, losing more than a year of economic growth, and we are now attempting to accelerate the transition to renewables to strengthen our energy independence. But this requires a fundamental transformation of our energy system which we have not been able to deliver. 

We are hampered by the inherent intermittency of renewables, by our inadequate grids and by long bureaucratic delays for new installations. We see frequent surges in energy prices when renewables are not generating and expensive backup power sources need to be used. High energy prices and the shortcomings of the network are, first and foremost, a threat to the survival of our industry, a major obstacle to our competitiveness and an unbearable burden for our households, and, if not addressed, the major threat to our decarbonisation strategy.

Three courses of action are necessary. First, we need to carry out a large investment plan at the European level to build the grids and interconnectors necessary to make a renewables-based network adequate to the energy transformation we aspire to. Second, we need to reform how our energy market operates, working to loosen the link between the prices of gas and renewables. It is disheartening to see how Europe has become hostage to entrenched vested interests. The European Commission, which has already created a taskforce on transparency, may also want to launch an independent inquiry into the overall functioning of EU energy markets. And because in Europe sun and wind cannot guarantee security of supply under any scenario, we need to be ready to use all possible clean energy sources and to be neutral towards new energy solutions. 

Consider technology. As the cloud computing and AI revolutions have gained steam, Europe has been left out. But we have continued to create an environment that hinders radical innovation. 

The fragmentation of our single market has hampered tech startups from reaching the scale necessary to succeed in this sector. Our competition policies have been unable to adapt to the nature of the technological transformation that was taking place before our eyes. Among other changes, innovation should have played a greater role in competition decisions. 

And we have allowed regulation to grow as digital services have expanded. This was motivated by a well-founded concern for consumer protection, but it did not consider the effect on small European tech firms that – unlike their large US competitors – lacked the capacity to comply. Now, we face a regulatory framework that is excessive in some key areas and, worse still, fragmented. There are over 270 regulators active in digital networks across all Member States.

It is said that AI is a “transformational” technology, like electricity was 140 years ago. But AI is actually based on an orchestration of at least four other technologies: cloud, and its capacity to store large quantities of data; supercomputing, and its ability to rapidly carry out huge numbers of operations per unit of time; cyber security, which protects data in highly sensitive sectors, like science, defence, health and finance; and data networks and transmission, such as 5G and 6G, fibre optic and satellites. 

Europe has lost ground in AI and all four other technologies – and we must work in all these areas if we are to catch up. It would not be realistic to think that we could fill this gap any time soon but what we could and should do is to focus on specific sectors that are key for growth, welfare and security of our citizens.

For example, we should create a European strategic cloud that gives us data sovereignty in critical domains, such as defence and security. We must invest more to build up our common supercomputing infrastructure, the Euro-HPC network. And we must develop a European cyber security capability, as we are losing competitiveness in 5G and are weak in satellite communications. Today, there is a material risk that we end up having to depend on US and Chinese technology in the most sensitive component, which is the safe transmission of data.

All this will require a major industrial strategy in Europe.   And it is only through pooling our resources and capabilities that we can reach the scale that these technologies require. 

Then consider defence. Rising threats on our Eastern border have been evident for at least a decade. Russia makes no secret that it views us as an enemy to be weakened via hybrid warfare. Ten years ago it invaded Crimea, and three years ago it proceeded to invade Ukraine. 

But as this threat has mounted, we have done little to strengthen our common defence. Today, Europe has 1.4 million military personnel, making it one of the largest forces in the world. But it is divided into 27 armies, with no common chain of command, technological fragmentation and a lack of common strategies – all of which make us irrelevant from military standpoint. 

As the US security umbrella is pulled back, we are waking up to our own weakness. But we should be surprised only by the speed of this change. The strategy of Russia was announced years ago. 

We might now be too late to influence short-term events. Even though we have provided around half of the military aid to Ukraine, we will probably be bystanders in a peace negotiation that concerns our future and our values.

But we are not too late to change the outlook 5-10 years from now, if we take the right steps today to develop our defence industrial capacity and strategic capabilities. 

We need to reduce the fragmentation of our defence industry and encourage consolidation into a few large players. We need to create a European defence plan based on interoperability across all the military assets we produce – land, sea, air and space. We need to create a safe European cyberspace through greater coordination and investment in common digital technologies. And to say that all this is utopia and impossible to achieve is tantamount to accepting our military irrelevance. 

And, for the space sector, we need to drastically reform the interplay between EU and national agencies, and we need much greater involvement of the private sector. For example, in the US 50% of space investment is financed privately, whereas in Europe the public sector finances 80%. That in turn leads to major inefficiencies, such as the principle of geographic return that fragments the European space sector and, as it has been hindering progress for decades, should be abandoned

Still, we should not forget that our founding fathers have bequeathed to us a Europe we should be proud of. While we assess the weaknesses of Europe’s present, we should look unceasingly for hope in its future.

When in the past the EU has made a material jump towards greater integration, three factors have typically been present.

First, a crisis that proves beyond doubt that the previous system has become unsustainable. Second, a large political shock that upends the institutional order. And third, an already-existing action plan that all parties can sign up to.

Take the example of the creation of the euro. This idea had been on the table since the 1960s but was always seen as beyond the realm of current possibilities. Then in short space of time the three factors came together.

The 1980s saw a series of exchange rate crises that injected unacceptable volatility into the economy and made people willing to consider the single currency as an alternative. Then German reunification happened, which required a new settlement to bind Germany more tightly into Europe. And the Delors Report, which had been published in 1989, provided the action plan to capitalise on this political moment. 

Today, for the first time in perhaps 30 years, all three factors are present again.

Since 2020, we have lost our growth model, our energy model and our defence model. Europeans feel the sense of crisis acutely. Growth, energy and defence are the fundamental areas in which governments must provide for their citizens, yet in each one we have found ourselves hostage to fortune and exposed to the unpredictable decisions of others.

As a result, perceptions among industry, workers, politicians and markets have changed from complacency to alarm. The material risks we face to our growth, our social values and our identity, hang over all our decisions. 

We are seeing major institutional ruptures. The political shock from the US is massive. And this has been matched by a complete change of course in countries like Germany, and by a new determination in the Commission to tackle barriers and bureaucracy.

And we have the beginning of an action plan, which is provided by the recent reports. Their policy advice has become, if possible, even more urgent today.

We will invest again in Europe, massively and responsibly. We will take on the vested interests that presently block our path to a future based on innovation rather than privilege. And we will protect and preserve our freedom.