Commissioner Gentiloni humbly asks for more ━ The European Conservative

On 15 November, the European Commission published its views on the EU’s economy for the next few years. It can be summed up in two words: fearful desires.

Presenting the outlook, Economic Commissioner Paolo Gentiloni looks like Oliver Twist from the Charles Dickens classic. Where the young boy humbly asks for some more food, Commissioner Gentiloni devoutly hopes for a little more economic growth.

His timid attitude is appropriate: The whole argument for economic growth in the Commission’s outlook rests on a little bit less inflation and a little drop in interest rates.

Frankly, if I were to present this report to the people of Europe, I would also be humbled. The expected adjustments in inflation and interest rates are modest, implying small increases in GDP growth. Normally, the economy would also have other sources of growth, including high demand for labor, which raises money wages as employers compete for workers. However, with unemployment remaining in the 6-6.5% range (for the euro area; 6% for the EU as a whole), there is little chance that Europe’s workforce can benefit from excess labor demand.

This clearly means that the only growth generator in the European economy, the real wage, is dependent on a return to price stability and a continuation of the ECB’s interest rate reduction policy. Given that these two things happen – which is likely – the Commission forecasts that euro area GDP will grow by 0.8% this year, 1.3% next year and 1.6% in 2026. The figures for the EU as a whole are slightly higher: 0.9%, 1.5% and 1.8%.

These are modest numbers to say the least. The Commission’s report suggests that they show that Europe is emerging from a prolonged period of economic stagnation, but when the best real growth rate you can hope for in the next two years is 1.8%, your economy has not really left stagnation. It takes more than 2% real annual growth, sustained over an extended period, to break the shackles of stagnation.

It is understandable that Commissioner Gentiloni has a humble approach to presenting the report. In doing so, he conveys more information to the public than what is stated in the economic statistics in his report. He signals with more than his words that Europe really has little to boast about or hope for in terms of economic future.

He’s right: in the report’s own numbers, there are no improvements in the economy for 2025 and 2026 that couldn’t be washed away by even a moderate shift for the worse in some key variable.

With all this in mind, however, it is worth noting that the predicted modest improvements in the European economy over the next two years will indeed happen. The Commission report’s projected fall in inflation from 2.6% to 2.0% for the EU as a whole will at least maintain real wages; more significant increases in household consumption would come from an increase in consumer confidence.

In short, Commission Gentiloni can be confident that the modest GDP growth forecasts will very likely come true.

But at this point the inevitable question arises: What needs to happen for the European economy to improve at faster rates than predicted by the Commission? In short: How far into the future can the EU’s economy survive without being sucked back into the stagnant quagmire it so desperately needs to leave behind?

In what is likely an attempt to draw blood from a stone, the Commission’s outlook expresses hope for an investment boom in the wake of lower interest rates. If this were to happen, it would actually help the EU economy into a phase of stronger GDP growth. The problem is that there isn’t much to hope for here; generally speaking, for every €100 that companies spend on capital formation, around €90 is motivated by increased demand for their products.

The influence of interest rates on investment is residual at best.

In the situation in which the EU finds itself today, a joint effort to deregulate the economy will most likely have a stronger effect on corporate investment than a given drop in interest rates would have. This deregulatory effort must be centered around the vast array of “environmental regulations” that trap businesses across the European continent. If it could also be extended to include labor laws, it would do wonders to improve the overall business climate and thus strengthen the incentives for investment.

As a benchmark estimate, the rules account for around €50 out of every €100 that a company pays in tax. Some regulations are of course more expensive than others, but in general there is great potential for improvement in Europe’s business climate, if only the relevant authorities would take this potential seriously.

An even stronger potential source of economic growth lies in the reduction of the size of the state. Across the EU, public spending consumes 40-50% of GDP, with taxes not far behind. At these levels, public sector spending significantly intrudes on the forces that generate economic growth; for every ten percentage points that this consumption ratio rises above 40% of GDP, real GDP growth falls by at least one percentage point over time.

In other words,

• If the government spends 40-50% of GDP, real GDP growth falls from e.g. 2% to 1% per year;
• If the government spends 50-60% of GDP, real GDP growth falls from e.g. 1% to 0% per year.

Other factors also affect GDP growth, including but not limited to regulations. As it is yet another form of government intrusion into the economy, it is fair to say that the government is the biggest culprit in preventing the European economy from growing and creating more prosperity.