EU: a steady erosion of growth potential.

The EU ranks second of the G20 economies in terms of overall GDP at market exchange rates, after the US. However, it is now just two-thirds the size of that economy. It was slightly larger in the early 1990s. The EU is only 8th of the G20 economies in terms of GDP per head at PPP.

A substantial decline in the population of working age (taken as the number of 15-64 years old) over the next 25 years is forecast by the UN. That will constrain GDP growth, as will weaker productivity growth in the EU than the US. That has been the trend for many years. It is possible that there will be a productivity resurgence but, looking ahead, that depends on the success the EU has in embracing new technology. That will require substantial new investment in decarbonisation and digitalisation on top of the increase required for greater defence spending.

The 3Ds of Draghi

We see the longer-run trend growth of GDP at around 1% p.a. Trends in the first half of 2025 and the IMF’s forecast for the full year are broadly in line with that potential.

One former concern – high inflation – has been successfully tackled. CPI headline inflation is at target and underlying inflation is trending lower, reaching  2.3% in July.

The EU has low CO2e emissions per head by international standards but is still not on track for net zero in 2050, on our estimate.

The level of government debt is high but the debt/GDP ratio rises only modestly, from 89% in 2025 to 93% in 2030 on the IMF's forecast. Even so, high debt levels remain a concern in France and Italy.

The overall EU current account surplus is expected to be maintained over the next five years. Coupled with a modest net external asset position, the fundamentals supporting the euro are strong.

There is clearly an attempt to promote the role of the euro as an alternative to the US dollar as a reserve currency but the obstacles to this are clearly recognised. Christine lagarde, ECB President, recently commented that  Europe’s economic prosperity is “geared towards a world that is gradually disappearing”. The “old growth model” had become outdated, as its dependence on exports had become a “vulnerability”.https://www.ft.com/content/3054af60-228d-4a7b-b28e-7b7470d16453?shareType=nongift

Lagarde pointed to a two-year-old ECB forecast that predicted that euro area exports would grow by about 8 per cent by mid-2025. “In reality, they have not grown at all,” she said. Without directly mentioning Germany, she said that “countries with large manufacturing sectors” had faced “a prolonged slump in industrial production”. In Germany, the bloc’s largest economy, manufacturing output fell to 2005 levels over the summer, with carmakers and the wider engineering sector falling into crisis.

Lagarde called on policymakers to double down on existing domestic strengths by removing internal barriers to trade, pointing to a forthcoming ECB analysis showing that current hurdles were equivalent to a 100 per cent tariff on services and a 65 per cent tariff on goods. Lagarde accused policymakers of squandering the past six years, during which “our internal market has stood still”, and warned of a slide into slow but steady decline. “Another six years of inaction — and lost growth — would not just be disappointing. It would be irresponsible,” she said. Europe’s economic weaknesses “do not trigger dramatic crises” but “erode growth quietly, as each new shock nudges us on to a slightly lower trajectory”, Lagarde said. Over time, she said, this added up to a “material” setback to growth and productivity.