Five Challenges for the European Union

Before the 2008 crisis

The first decade following the introduction of the EMU saw continuity in the process of Europeanisation embarked upon as from the formation of the Common Market, based on financial liberalization and market globalization. As argued in Celi et al., Europeanisation meant EU-wide application of a policy of deregulation of goods, labour and capital markets that affected the timing, shape and direction of the European integration process, halting the process of convergence between the core and the SP of the EU. The more developed core (centred on Germany) increased its productive and technological capacity; the SP, caught between product competition within the EU and cost competition from emerging economies in the international markets, saw a decline in its manufacturing capacity.

With the fall of the Soviet Union and the entry of the former Socialist countries of Central and Eastern Europe in the EU, the Eastern Periphery (EP) became a key gear of Germany's manufacturing matrix. A huge flow of direct investments, primarily in the automotive sector, transformed the economies of the Visegrad Pact (Poland, Hungry, Slovakia, and Check Republic) into an essential source of intermediate goods (medium and medium–high quality) for the German industry. A well-qualified, extremely cheap workforce, generous subsidies and tax breaks, as well as geographical proximity and historical links, are among the determining factors of the increasingly tight links between the core and its EP.

The impressive growth in manufacturing capacity in the East led to a restructuring in the hierarchical organization of the supply chains across Europe: the weaker suppliers in the South were displaced by their cheaper competitors in the East, while the highly specialised suppliers of components in the industrial regions of the South maintained, and even increased, their close links with the German producers.Footnote 3 The crowding-out of the less dynamic firms in the SP did not take the form of efficiency-enhancing market selection but rather a generalized reduction of production capacity, contributing to fuel a well-documented process of 'poor tertiarisation' of the SP. On the other hand, the EP's industrial miracle was created by foreign, mostly German, direct investment, with the automotive sector taking the lion's share. So far, we have seen no comparable development of other productive sectors, nor has the automotive sector created spill-over effects in the rest of the economy. On the contrary, the surge in the production of components for the automotive sector has partly displaced other productions, leading to an increasing 'mono-specialization' of these economies. Despite a growing shortage of skilled labour, wages have remained modest. Threats of production shifting further East, to Romania, Turkey, or to North Africa, are reflected in the adoption of a wage containment policy at home, driving young people with high educational qualifications to emigrate, and weakening the countries' skills base. With domestic demand subdued, the high growth rates recorded by these countries are entirely led by the growth in exports of local production by foreign multinationals (i.e., the so-called "integrated peripheral markets"). While their intensive specialisation in the automotive industry makes them totally dependent on the health of the German automotive industry, the foreign control of production decisions, innovation processes and markets makes it extremely difficult to undertake an independent, less unbalanced development path.

To conclude, the two peripheries - the Southern one, made up of the Mediterranean economies, and the Eastern one, with the prominent role of the Visegrad countries - suffer from different fragilities, which descend from their common, albeit diverse, economic and financial dependence on the core. However, the core itself is dependent for its growth on the pattern of specialisation within the EU: the Southern markets providing an outlet for its increasing surplus of manufactures, the Eastern countries supplying cheap inputs for its industries. This combination of structural divergence and economic interdependence lies behind the fragility of the Union as well as of the improbability of its disintegration given the high costs it would entail for core and peripheries alike.

The age of austerity

In the first period of the EMU (2000–2008), the core-SP structural divergence was partly hidden by massive financial flows to the periphery. The 2008 financial crisis, and the ensuing international liquidity crunch, prompted a "sudden stop" of capital flows and a collapse in demand and imports. At that point, the structural and institutional flaws of the EMU became evident: the reaction to the crisis aggravated the divergence. With the blame for the crisis put squarely on borrowers, austerity policies were advocated (or imposed) to ensure debtor countries' public and private solvency.

With austerity killing demand, growth and imports in the SP, Germany, which had built most of its huge trade surplus between 2003 and 2008 by exporting to the periphery, had to find new outlets for its goods. Special international conditions - namely, China's huge growth, which gobbled up German capital goods and high-quality durable consumer products (particularly cars), and the vigorous American recovery - supported Germany's ability to redirect its trade flows, expand its market shares outside the EMU, and make a speedy return to its pre-crisis production levels. The United Kingdom, the United States, but above all China, became the most important markets for German exports. The rapid recovery of the German economy pulled the EP along with it: the Visegrad countries recorded unparalleled growth in Europe.

With the abrupt change in the international scenario in 2016, Germany's (and the entire EMU's) mercantilist strategy was up against the ropes. The Brexit referendum, Trump's election, and the U-turn in Chinese economic policy inaugurated a phase of retreat in international trade. Trade with the UK began to suffer due to the increasing uncertainty in future trade relations. When the United States took action to reduce the external deficit, China and Germany, the countries with the largest trade surpluses vis-à-vis the United States, were caught in the crosshairs. Trade tensions between the US and China put further pressure on international trade. The export-led growth model that had so far supported Germany's leadership began to creak. The change in world trade took its toll on German (and EU) growth rates. From the second quarter of 2017, the slowdown in German exports hit industrial production and the GDP, widening the growth gap with China and the USA and dragging the whole EMU along with it (Fig. 1).

Fig. 1 GDP per capita (rate of change over the previous quarter, 2016–2019).

As the escalation of trade disputes affected relations between the United States and Germany (and by extension the EU), the negative effects on Europe's (export-led) growth intensified. In the last quarter of 2019, just a few months before the outbreak of Covid-19 in the EU, Germany's growth rate zeroed. Income growth estimates for the rest of Europe were consequently reduced.

Enters the Covid-19

The pandemic arrived in Europe from the south: Italy was the first country to suffer the contagion. Its abrupt, dramatic effects exposed the fragility of the periphery and the crippling effects of austerity policies. Since 2010, across the board cuts in social spending had hit the entire range, from health to education, from social assistance to social investment. Figures 2, 3 and 4 show the evolution of the share of public expenditure on education and health (divided between general expenditure and hospitals) relative to GDP in the EMU, Germany and the SP between 2008 and 2018. Many hospitals had been closed, the number of beds reduced, medical and nursing staff cut back. It is not surprising that the death toll was higher where intensive care facilities were scarcer. On the eve of the Covid crisis, public health accounted for 6.5 percent of the social product in Italy and Spain, and almost 10% in Germany, where per capita healthcare spending did not suffer cuts due to austerity (though it was not completely spared self-imposed restrictions). The Covid-19 exposed another aspect of the 'divisive' Union: different capacities to respond to the pandemic crisis.

Fig. 2 Public spending on education. EMU, Germany and SP's countries.

Fig. 3 Public spending on health (general). EMU, Germany and SP's countries.

Fig. 4 Public spending on health (hospitals). EMU, Germany and selection of SP's countries.

Economic ideology shares with austerity the responsibility for the scant endowment of medical equipment and health staff. Efficiency, understood as cost reduction, has been taken as the guiding principle. The obsession with competitiveness and reliance solely on the export-led growth model accounts for the almost exclusive emphasis on "tradable" sectors, to the detriment of "non-tradable" sectors (housing, health, education, welfare services in general), considered of lesser importance for international competition. This means that, in the era of austerity, these items have been the first to be sacrificed, in debtor and creditor countries alike. Chazan reports that for years, politicians and health economists in Germany have complained that the country has too many hospitals, with the Bertelsmann Foundation recommending halving the number of hospital, from 1400 to fewer than 600. Only such a radical consolidation - the Bertelsmann study argued - would "improve patient care and mitigate the shortage of doctors and nursing staff". The pandemic succeeded in transforming this "oversupply" into an asset.

The same logic of pursuing the lowest cost guided the international location of production, which displaced domestic production and weakened production capacity in the SP. From a regional (European) point of view, this process resulted in a reorganisation of production and trade relations between core, EP and SP. On a global scale, core and peripheries entered into very long and complex GVCs that proved extremely vulnerable in the face of the interruptions prompted by the pandemic. Personal protective equipment, respirators, medicines: the emergency has made it clear what it means to lose the capacity to produce domestically, both in quantity and quality, what is urgently needed, bringing the problem of self-sufficiency back to the attention of economists and policymakers.