ROI-EU gets a lousy ‘Draghi report’ card. But it might not matter: Klement

By Joachim Klement

LONDON, Oct 21 (Reuters) - It has been more than a year since Mario Draghi presented his eponymous report urging the European Union to invest heavily to improve productivity and economic resilience. The follow-through by the EU has been roundly criticised. But the region may not need to worry about that.

When the former president of the European Central Bank presented his report on EU competitiveness in 2024, he urged the bloc to pursue much-needed reforms to improve productivity.

The European Commission on September 16 held a high-level conference to review its progress. And while the Commission did its best to claim credit for 33 flagship and 14 legislative initiatives, it was widely panned for moving too slowly, not least by Draghi himself.

He has a point. The EU is continuing to fall behind.

Whether you look at the 15 years since the end of the financial crisis, or the last five years since the COVID-19 pandemic began, productivity growth in Europe has lagged that of the United States. Euro zone labour productivity growth since 2020 has been a paltry 0.7% per year, less than half the U.S.'s 1.5% annual rate.

Productivity growth isn’t everything, of course, but in a world of demographic headwinds – something the EU certainly faces - investment and productivity are pretty much the only levers governments can pull to increase GDP growth and generate the tax revenues needed to keep deficits under control.

In the OECD’s latest long-term growth projections, it forecasts that GDP growth in Europe will accelerate from the poor levels of the last five years, but only to 1.3% per year in real terms, well behind the U.S.’ 2.1% annual projected growth.

REARMAMENT BOOST

However, things may not be as dire as they seem.

For one, Europe’s new "Readiness 2030" rearmament programme will provide 150 billion euros in loans under the SAFE (Security Action for Europe) initiative that are not reflected in the OECD’s long-term projections.

And if EU member states increase their defence spending in line with the new NATO goals, the total may reach 800 billion euros in the next ten years, resulting in additional defence investment of 4.5% of EU GDP over ten years.

This has the potential to boost European growth significantly. Research by BBVA shows that defence spending in Europe has a much higher fiscal multiplier than in the U.S.

While studies usually put the fiscal multiplier for U.S. defence spending in the range of 0.5 to 1.0, they find that fiscal multipliers for defence expenditures in Europe are consistently above 1.0. The BBVA analysis found that for every 1% of GDP in defence spending in Europe, trend GDP in the region increases by 1.6% after two years, after which the impact of the spending dissipates.

This means that 150 billion euros in defence loans have the potential to boost EU GDP growth by 1.6% over two years if deployed at once. However, the spending is instead expected to be spread out over ten years, meaning the region could see a persistent GDP bump over the next decade. And this would, of course, be magnified if the region reaches the full 800 billion euro target.

EUROPE’S GROWTH POWERHOUSE

One country that already has committed to a large upsurge in defence spending is Germany. Europe’s largest economy plans to increase its defence budget to 3.5% of GDP by 2030, rather than by 2035 as NATO requires.

Germany will also start to roll out its 500 billion euro infrastructure investment programme next year.

The German government, unlike those in several other EU member states, has been able to agree on a budget and implement the necessary processes to get the money flowing. And starting in 2026, Germany intends to spend 58 billion euros per year on infrastructure, up from 38 billion euros in 2025.

Most of these investments will be in transport infrastructure, with another large chunk in energy transition and digital infrastructure.

These investments are likely to give German productivity and GDP growth a powerful boost. A new study indicated that German government investments in infrastructure have a fiscal multiplier above 2.0, with levels approaching 2.5 in Germany and the euro zone after three years.

If that proves accurate, then Germany’s infrastructure spending could lift German GDP by an eye-popping 29% over ten years. That would, in turn, boost EU GDP by 7% over the coming decade.

To be sure, Germany’s infrastructure spending may not be that successful, since it will replace some investments that would have been made anyway.

But even if it is just half as effective as these studies predict, Germany’s GDP could still rise by an additional 1.4% per year for the coming decade, giving a 0.3% annual boost to the EU’s GDP growth. Add that to the expected 0.6% annual increase in EU GDP growth from Readiness 2030, and Europe’s economic growth in the next five to ten years could match or even surpass that of the U.S.

Draghi could scarcely have hoped for a better outcome.

(The views expressed here are those of Joachim Klement, an investment strategist at Panmure Liberum, the UK's largest independent investment bank).

Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global financial commentary. ROI delivers thought-provoking, data-driven analysis of everything from swap rates to soybeans. Markets are moving faster than ever. ROI, can help you keep up. Follow ROI on LinkedIn, and X.