The report by former Italian Prime Minister Enrico Letta was discussed at the European Council of 17 and 18 April. It ‘independent High-Level Report on the future of the Single Market’ was drawn up at the request of the council to address the problem that the EU’s economic growth is lagging behind that of the United States. A report by Mario Draghi, another Italian former prime minister, prepared at the request of commission chairman Ursula von der Leyen, on “how to strengthen the EU’s competitiveness in a changed geopolitical context” is expected in June.
The gap between the US and the EU has tripled in the last 25 years. When the euro was introduced, the American economy was 11 percent larger. That difference has grown to 30 percent. The EU is falling further behind on a broad front.
The difference is even more stark when looking at nominal gross domestic product (GDP). While the eurozone remains at around 15 trillion dollars, the US is now at 27 trillion dollars (plus 80 percent), although part of this is due to the appreciation of the dollar.
Completion of the internal market
In his report, Letta calls for the completion of the internal market, more specifically for further integration of capital, telecom and energy markets and for the reduction of bureaucracy and regulatory burden. The most important recommendation is the formation of a capital markets union. The banking system in the EU appears to be insufficiently able to finance business investments and with a capital market, private (venture) capital becomes available. This is especially important for SMEs.
Letta’s recommendations landed on fertile ground. The European Council largely adopted them, except in the areas of financing and taxation. Various member states do not see any point in sending more money to ‘Brussels’ and member states such as Luxembourg and Ireland are reluctant to see their revenue model as a tax haven disappear.
But more financing is also not necessary. Completing the internal market does not have to cost money at all. In order for the internal market to function optimally, all obstacles to economic growth must first and foremost be removed. Budgetary space can even be freed up by not spending unnecessary money on climate policy. The industry does not need support. Rather, free it from restrictive regulations. Financing is possible via the capital market.
Tax harmonization is also not necessary. In the US the ‘states‘ lively with each other in tax matters without any problem. In short, finally act on the ambitions that the EU laid down in 2000 in the so-called Lisbon agenda.to become the most competitive and dynamic knowledge-based economy in the world’.
Not much has come of it so far. Instead of going to innovation, a relatively large amount of EU money goes to the old economy. Vested interests dominate in the allocation of public funds and nepotism and corruption lurk. We have already seen this with the cohesion funds and are currently seeing this with the spending of the corona recovery funds (in Italy and Greece).
The completion of the internal market also suffered damage because Member States favored their own businesses through all kinds of protective constructions and the European Commission hardly intervened to correct this behavior. As a result, markets remained fragmented and economies of scale failed to materialize, a prerequisite for the creation of successful international players. In contrast to the US, where firms did have the opportunity to grow because of the one large market.
American companies have more freedom
The comparison with the US makes sense. There, the business community is not saddled with restrictive regulations (80 percent of the legislation in the EU now comes from ‘Brussels’), expensive energy and an entrepreneurially unfriendly government policy. The basic rule in the US is that anything goes unless it is explicitly prohibited. In the EU it is the other way around: nothing is allowed unless it is permitted.
American business uses this freedom to ‘do business’, to make profit by taking risks. Investments are financed with the help of risk-bearing private (venture) capital. On a highly developed capital market, which does not exist in the EU. The European financial markets are fragmented and risk capital is hardly available. Certainly not for SMEs, which are dependent on a banking system that imposes strict requirements on financing, with also high costs.
The fact that Letta advocates an EU capital market is therefore a good recommendation. Where he goes wrong is by already taking a (partial) advance on Mario Draghi’s report. Much has already been leaked. Draghi’s main recommendation will be to create a large industrial fund to outpace the US and China. According to Draghi, there is no longer fair competition. Great powers such as the US and China are increasingly turning to protectionist policies.
Draghi’s ideas are a response to Joe Biden’s Inflation Reduction Act, which provides subsidies in the form of tax breaks to companies investing in the US. The exodus of EU industry to the US is of course not the intention.
Draghi wants to use Eurobonds to finance his plans. That is the wrong response. The US has no industrial policy. Stimulating investments through tax breaks is something different, namely a protectionist measure to bring back industry that had moved to low-wage countries. Going along with such protectionist policies is unwise. That leads to a ‘race to the bottom.
Both industrial policy and Eurobonds are a bad idea. Industrial policy has never worked – the government should not take the place of the entrepreneur – and Eurobonds mean in practice financing of the southern member states (including France) by the northern ones.
Don’t throw good money after bad
About Letta’s proposals and their discussion in the European Council, Prime Minister Mark Rutte said that ‘the Netherlands is prepared to give up sovereignty for a stronger internal market’. Many were shocked by this comment. Firstly, Rutte is outgoing and secondly, the majority of the Dutch population does not want more, but less EU.
However, Rutte’s offending comment about transferring sovereignty was specifically about the creation of a capital market union like in the US. This makes more private (venture) capital available to the business community. I think he’s right about that.
Letta recommends completing the internal market to catch up with the US. Fine, but also remove the obstacles that do not affect business in the US. And as a government, do not sit in the entrepreneur’s shoes. Industrial policy and Eurobonds are not necessary, that is throwing good money after bad. It is better to remove the current stifling regulations, business-unfriendly government policy and structurally high energy costs and to complete the internal market with a capital market. In other words: stop putting ourselves behind.
Johannes Verlood was affiliated with the Dutch Ministry of Foreign Affairs for almost four decades, based in Jakarta, Saint Petersburg and Paris, among others.
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