The euro is ready for its close-up. With the United States’ economy swerving itself toward a recession and new European leadership pressing for more investment, the 20-country currency area could become more of a global economic engine. But the European Union has to do more than stand by and watch Washington fall apart. Member states will need to invest.
Tariff fights mean transatlantic tensions will only keep growing, as a new trade war gets underway. Furthermore, whipsawing US support for Ukraine has called into question longstanding security alliances. While a complete breakdown of NATO partnerships still seems unlikely, the Trump II administration’s isolationist bent has rightfully raised new questions about what Europe needs to do for itself. Portugal’s dilemma over how to replace its aging fighter planes shows the EU’s squeeze: EU member states instinctively want to pull back from dependence on US resources, but they also will need to think twice before ditching world-leading F-35 aircraft with lesser or unproven alternatives. Europe has little choice other than to step up.
Money and policy determination both are needed for the EU to rise to the occasion. The top priorities should be defense, better energy grids, and stronger economic growth, not necessarily in that order. Without a thriving economy, after all, everything else becomes harder. The euro is unlikely to supplant the dollar as the world’s biggest reserve currency, because of the way the dollar attracts investors in good times and acts as a safe haven in bad. Yet the single market and the common currency, working together, give Europe a springboard toward future success. Getting there will require rethinking the EU’s approach to budgets and debt, to put the focus on spending, implementation and resilience rather than pure financing capacity.
Better Building Blocks
The good news is, the euro is in far better shape than it was a decade ago, when it was crawling out from under existential threats that pushed five countries to need rescue. When Greece, Ireland, and Portugal ran into bond-market borrowing problems, investors fled, and banking crises in Spain and Cyprus compounded the eurozone’s struggles. However, the experience forced European leaders to work together and led to a series of very welcome reforms. Thanks to the banking union, the 2014 shift to European Central Bank oversight of the region’s biggest financial institutions, eurozone banks are generally well capitalized and better protected against economic turmoil. The EU also has had time to overcome its historic reluctance to joint debt.
From 2010 to 2015, the raging sovereign debt crisis repeatedly forced national leaders to cross previously sacrosanct red lines. Over time, eurozone members realized that half measures to borrow jointly were less efficient and more costly than simply ramping up the EU budget. In the beginning, however, countries were determined to do only the minimum possible to link their fiscal fortunes. This resulted in a five-year cycle oriented around borrowing capacity, as finance ministers assembled an increasingly powerful range of rescue instruments at the European Stability Mechanism and its sister initiatives. Importantly, these tools were aimed at shoring up capacity but actively limiting how much it could be used: Successive instruments came with ever more careful requirements for conditionality, and the ESM’s precautionary credit lines and direct bank recapitalization programs were not deployed.
This worked for the challenges at hand, and in fact the euro area’s biggest crisis-fighting program was also its cheapest: The ECB pledged to do “whatever it takes” to save the currency and floated unlimited purchases under its Outright Monetary Transactions framework, and it never had to follow through. This meant the strings attached could be strong. Conversations about “moral hazard” prompted the ECB to link its promises to ESM and International Monetary Fund oversight, and many policymakers hoped the programs would never need to be used. Instead, the very existence of these programs was intended to create confidence in financial markets that the euro area was worth lending to, a gambit that by and large succeeded.
Half-learned Lessons
The 2020 COVID-19 pandemic capitalized on the EU’s hard-won new comfort with bond investors, and countries opened their wallets to support citizens during the early months of shutdowns and uncertainty. The EU also took a more open-minded approach to further financial support, creating the SURE unemployment backstop and the €750-billion Next Generation EU (NGEU) program and encouraging member states to seek extensive loans and grants. These measures supplanted the ESM, which was not tapped even though that lender also offered funding on attractive terms.
As a result, Brussels for the first time began to borrow collectively at scale, and financial market conversations about European joint debt now focus on the prospect that there could be too little of it rather than the risks of jointly stepping up. This is not to say that individual member states like France and Italy can ignore their national balance sheets, as investors still require countries to show that their spending plans are long-term sustainable. But when it comes to the EU as a whole, investors have welcomed the increased borrowing and the rise of a “safe asset” that can anchor a broad range of capital market activity.
Yet the pandemic rescue money has not all reached its destination. According to the European Commission, only a fraction of the money has gone out the door: Disbursements so far are about €197 billion in grants, or just over half what has been committed, and €109 billion in loans, roughly a third of what’s on the table. Since the program can no longer borrow new funds after 2026, much of this money may never reach its target.
The lesson here should be that joint borrowing can work and that joint spending needs some improvement. Financial market confidence is great for selling bonds but does not put shovels in the ground.
Fighting the New War, Financing the Last One
When countries are facing practical needs, they need effective action as well as functional bank accounts. Yet so far, much of the debate around how to ramp up defense spending has focused around how to raise the funds, and not what to do with them. It’s heartening that Europe is at least theoretically willing to coordinate finances. This time around, however, loan programs are not the missing link. Europe has plenty of tools for raising funds from the marketplace, either by selling bonds or through public-private investment initiatives. What it doesn’t yet have are enough concrete plans for more cross-border energy infrastructure, joint defense procurement at scale, and more integrated capital markets. While each of these goals enjoys high level support, turning lofty consensus into workable actions is still a big challenge.
When it comes to defense spending, creating a new joint lending facility might make it easier for some countries to shave down borrowing costs compared to the interest rates they could get on their own, but the savings might not be big enough to justify the political and administrative work necessary to get things up and running—nor would it guarantee that even a perfectly designed program had many takers. The EU’s Re-Arm EU program, renamed “Readiness 2030” after Italian and Spanish objections, with its proposed €150 billion financing tool and an €800 billion total envelope, cannot just reassure markets with capacity. The EU’s task now is to figure out who will field the troops and what equipment to give them. Since armies and arsenals are national, it makes sense to center these budgetary efforts around national coffers while using the EU’s collective size to negotiate bigger orders with better pricing from available suppliers.
On energy, the EU has boldly and correctly reaffirmed its climate goals, aiming for a commitment to reduce carbon emissions by 90 percent by 2040. The proposed Clean Industrial Deal also pledges to boost productivity across the economy, not just in low-emissions sectors, by emphasizing electrification, clean-tech innovation, and strategic use of resources like steel and aluminum that remain energy intensive for now. The plan calls for making use of regulation, taxation, state aid, and simplification in a collective bid to bring energy costs down and get growth up.
Finally on capital markets, the time is more than ripe to move ahead with capital markets union, the 10-year-old plan to unlock better financing options for Europe’s small and medium sized companies and to offer investors and pension planners more access to wealth creation. While member states have long been reluctant to cede local control over financial industries that they perceive among national champions, the current urgency to compete with US cash may prompt them to move ahead with better retail savings standards and more joint supervision. This type of coordination and standard-setting, combined with a better-enforced common rulebook, can give investors better reasons to invest in Europe instead of reflexively chasing returns in New York or Silicon Valley.
No Contradiction about Europe’s Needs
State aid is at the heart of many of the EU’s plans to move ahead, both to manage spillovers from US turmoil and to shepherd the types of investment Europe needs to move ahead. There is a welcome recognition that a greater focus on public goods, beyond protecting Europe’s traditional strengths of education, health care, and basic research, will be necessary to prepare the EU for the challenges ahead.
Building support for these efforts will be stronger if countries feel like their EU neighbors are working toward the same goals, not trying to outspend each other or make the single market more economically lopsided. The European Commission has proposed a competitiveness coordination tool that would allow it and the member states to work out medium-term plans for industrial support. This kind of governance could allow member states more leeway to hand out subsidies while also preserving EU-wide guidance, and it might work even better if combined with centrally funded program as well.
As always with Brussels-style planning, the tug of war between proper oversight and timely spending would be an ever-present specter. Likewise, Brussels has a long history of putting out detailed and largely ignored country-specific recommendations. But perhaps more money could flow if member states had confidence that national and EU officials had sufficient voice and common goals.
As Bruegel’s Heather Grabbe and Jeromin Zettelmeyer wrote, there is no contradiction between what Europe needs to do to address its structural problems and what it needs to do to respond to the Trump administration. The EU needs to boost productivity, save for its future wellbeing, and ensure its energy and military security. Better ways of spending money—not just raising it—will help the EU meet its climate goals while also pushing the economy forward. That, in turn, will build confidence in Europe and keep the euro in the global role it was designed to serve.
Rebecca Christie is IPQ’s Brussels columnist and senior fellow at Bruegel, the European think tank specializing in economics.
