What steps may be taken to rescue the Eurozone?

Back in the summer of 2012, the then President of the ECB, Mario Draghi pledged to do “whatever it takes” to ‘save’ the euro from imploding under the weight of the debt crisis that had engulfed the region. He succeeded. Now he’s back twelve years later, not as ECB head, but to plead with EU leaders for another ‘whatever it takes’ commitment to pull the region out of a hole. The problem is that he’s not likely to be successful this time.

Draghi has just released a report that details the euro zone’s competitive failings, particularly compared to the US, and suggests ways to catch up. The failings are numerous. They include a failure to innovate and fund new technologies which leaves Europe focussed too much on mature technologies. The corollary of this is that productivity is poor; lagging some distance behind the US.

In the past, weak productivity might have been less problematic because the rising population still allowed incremental economic growth. But now population growth is going in reverse, and stronger productivity is the only way to grow and lift living standards. Why has the EU fallen into this predicament? Draghi lists a number of factors such as higher energy prices than the US. He also mentions more unstable geopolitics that leaves the region particularly exposed to suppliers that might turn against the EU, as we saw in the case of Russia’s invasion of Ukraine and subsequent collapse in energy supply to the EU.

So far, many EU leaders could agree wholeheartedly with Draghi’s conclusions. But when it comes to the solutions, there is one that is already causing a stir and will likely scupper the EU’s ability to close the growth and productivity gap with the US. It relates to the development of a capital markets that is so important when it comes to commercialising new innovation. Draghi highlights how issues like the lack of a single securities regulator, the absence of uniformity in processes such as clearing and settlement, and differing tax and insolvency regimes across countries hinder financing.

In particular, there’s too much focus on bank loans and not enough on other types of financing new industries. Once again, many EU policymakers would probably agree with this, even if Draghi has lost a few by now. But it is the next recommendation that’s likely to prove the dealbreaker for many more EU politicians. For Draghi argues that the achievement of capital market realistically requires the issuance of a common safe asset. It’s an old bugbear for many euro zone countries, especially Germany.

In fact, it has not just been around as long as EMU has been in place; it was even a subject of fierce debate when EU Commission officials and EU leaders were putting together the blueprint for a common currency all those years before the euro was introduced in 1999. And while there has been some progress in issuing common euro zone debt to fund specific initiatives, resistance to common debt today seems as strong as it was in 1999. In fact, it may even be stronger given the debt crisis that we saw in the likes of Greece back in 2010-12 when Drahi had to ‘save the euro’.

In short, a single (euro) safe asset seems very unlikely and, if that’s the case, euro zone countries, like Germany, may stay stuck in the less productive ‘mature’ industries, leaving the US to race ahead. Indeed, the US’s pace could get even faster if former President Trump wins the election in November. Is this outlook destined to keep the value of the euro down against the dollar? Not necessarily. After all, the euro zone has been in this predicament for a long time and, on occasions the euro has been very strong against the dollar.

In addition, the US’s race ahead means sucking in huge amounts of foreign savings, because the US cannot generate all the domestic savings it needs to fund this investment push, and there’s always a danger that these savings depart – as we may have seen recently in the case of Japan.