The European Reboot That Isn’t Coming

Super Mario is back! No, not the video game hero—we are referring to former ECB President and technocratic Italian Prime Minister Mario Draghi. Yes, the man who allegedly saved the euro with his 2012 promise to do “whatever it takes” to prevent the single currency from splintering has returned, this time not with any official power—but a Brussels-hatched, 400-page recipe for improving eurozone competitiveness relative to America and China.

Draghi’s new plan amounts to a sweeping overhaul of not only how Europe operates but the very zeitgeist its regulatory bodies operate with. For investors, there is little of note here—except what the report and reaction to it says about sentiment towards the EU economy.

The recommendation amounts to a combination of long-term forecasts and prisoner-of-the-moment extrapolation of recent problems. Among the long-term forecasts, it cites Europe’s aging society as an alleged demographic headwind and argues the EU’s structural antipathy to big companies and Tech as responsible for widening the gap between it and America. On the extrapolations, he wags a finger at a lack of energy sources (extrapolating recent high prices forward) and reliance on imported goods tied to national security. There is merit to some of these thoughts, but it also isn’t hard to see them as widely known features existing for most of the last two decades and the latter two as very rooted in (again, widely known) recent experience.

From our read of coverage, his recommendations seem like a mish mosh of sensible red-tape cutting and far-flung arguments for grand schemes like collective debt issuance to fund €800 billion in additional annual Brussels-directed spending. Regardless, this lengthy tome seems to us like little more than the world’s longest fairy tale. The main concepts in this aren’t happening any time soon—nowhere near soon enough to sway stocks.

Collective Spending and Debt Isn’t Likely on This Scale

To begin with the obvious hang up: Collective debt issuance. Since its inception in the late 1990s, many economists and pundits have considered the eurozone an “incomplete” project. The 20 nations share a central bank and a currency—a monetary union. However, beyond a relatively minimalistic typical EU budget, fiscal policy is controlled chiefly by national governments. Germany taxes Germans and issues German bunds, with spending directed by Berlin, under the auspices of the country’s debt brake and other local policies designed to restrict deficit spending. France taxes French people, issues OATs in Paris and spends under, well, less restrictive parameters, etc., etc., and so forth.

The trouble comes when you try to design a fiscal policy for Europe. Tax revenue in Germany can’t legally fund spending in Slovakia or Greece or Spain or wherever. This is unlike the US, where federal taxes derived from income earned in Vermont could fund projects in Arizona. The fifty US states are a fiscal transfer union. 

There has been talk of creating such a union in Europe since the 1990s. It bubbled up again and again during the mid-2010s, as the eurozone debt crisis (and Super Mario!) stole headlines. The idea was even posited in the aftermath as a lasting “fix.”

But it didn’t happen.

In 2020, the pandemic did give birth to shared EU debt, and the bloc subsequently issued a small amount of collective debt to aid Ukraine. But in total you are talking around €800 billion. And the legislation was temporary.

It took a world crisis to get that. But Draghi’s plan calls for that much issuance and spending annually aimed at augmenting an economic statistic (competitiveness, productivity) academics themselves debate how to measure, much less conjure up top-down methods to boost. Spending on collective defense is also controversial even now. Ministers broached the idea of five-year EU “Defense Bonds” in June. It went nowhere. Draghi’s planned spending seems like a stretch.

National governments in the richer Northern nations—Germany, the Netherlands, etc—have little desire to share debt with the rest on an ongoing basis. While printers were still whirring out copies of Draghi’s work, German Finance Minister Christian Lindner said as much, flatly noting that “Germany will not agree to this.”^[i] Though other members of Germany’s broad, fragile coalition government seem more on board, Lindner’s Dutch counterpart, Eelco Heinen, echoed his comment, noting that, “more money is not always the solution,” a position shared by other members of the Dutch government. With many EU governments gridlocked by shaky coalition governments, such a sweeping shift seems like a challenge to pass.

Further to Heinen’s point, there is also no proof EU competitiveness, to the extent it is an issue, would be fixed by centralized spending. Governments often do little more than pick winners and losers when allocating capital. They misdirect spending. They foster investment in uneconomical areas. And EU spending and debt issuance risks crowding out both the private sector and national government funding plans. This isn’t a panacea.

On Red Tape

Draghi further proposes an almost complete reversal in the EU’s approach to mergers and antitrust. The Continent is dotted with small and mid-size firms struggling to compete at scale with those overseas, and Draghi’s report notes that regulators need to take a lighter touch toward proposed mergers. This would likely be beneficial, both to Europe’s economy and capital markets. But the EU is famously aggressive at blocking mergers, particularly when it comes to national “champions” or other cherished firms. (This isn’t to say the US and others aren’t guilty—see every major US politician’s reaction to Nippon’s bid for US Steel.)

Draghi also wrote of trying to ease innovators’ path to capital, facilitating local investment in tech and AI. He points out less than a handful of the world’s biggest Tech firms are in Europe. Fair point. But here, too, the regulatory approach would likely need to change. After all, Brussels regulators have largely looked at big Tech as a foreign source of funds they can hit with periodic lawsuits and occasionally win—with two big examples in the news this week.

He also called the need for uniform decisions by national governments on key policy matters (like the aforementioned collective debt issuance) a negative. He argues for a majority vote, supermajority—or even select members of the bloc just going on their own—should be sufficient to enact laws. We struggle to see Germany acceding to that idea.

Too Long Term to Matter

But the basis for all these recommendations is the gap that has opened between Europe and, for example, the US, on productivity. It cites demographic shifts to note that vast increases in output per person will be needed to keep GDP steady by … 2050.

Perhaps he is correct. Perhaps not. But for stocks, something targeting stabilization in a metric 25 years distant isn’t relevant. His report is a fun academic exercise. Maybe it is a symbolic document that spurs the EU to reform, better integrate financial markets, issue collective debt and cut red tape. Maybe none of that happens. Maybe some of the low-hanging fruit does. But it likely isn’t coming soon enough to affect corporate profits in the next 3 – 30 months. Some of the officials commenting on it noted it is a decision for the next Multiannual Financial Framework (EU budget).^[ii] That won’t be until 2027.

About the only thing we draw from Draghi’s work is this: It—and the headline reaction to it—has hyped competitiveness as a threat to the eurozone, risking stagnation or a plan to fix a “broken” Europe … or face a “slow agony.”^[iii] This … for a wealthy economy that is growing. For a continent with some of the world’s most desirable private companies. Have the value-tilted markets there been in favor of late? No, they haven’t. But in markets, no leadership is permanent. All the reaction to Draghi’s big report seems to illustrate sentiment that is way too entrenched in negativity.