- This year the EU has commissioned two reports by former Italian prime ministers, Enrico Letta and Mario Draghi, to set out policies to raise Europe’s anaemic growth rate. The long shadow of the financial and euro crises, Covid-19 and the energy price shock after Russia’s invasion of Ukraine have all contributed to the continent’s disappointing economic performance. But so too have several long-standing problems with the EU’s economic structures. Letta has called for ‘more single market’ – deeper internal EU economic integration – as a way to raise competition and productivity. Draghi is likely to do the same when his report comes out in July.
- In this paper – which is the first to comprehensively assess the winning and losing subnational regions from trade within the EU – we identify four key facts that policy-makers should consider when pursuing more single market integration:
1. Integration of goods markets has slowed. Since 2012, intra-EU trade in goods has grown no faster than global goods trade, in contrast to previous decades: the 2004 enlargement, for example, saw rapid growth in manufacturing capacity in Central and Eastern Europe, raising trade within the single market.
2. Goods trade is a ‘convergence engine’. As we show using a ‘gravity model’ (of the type that correctly predicted large Brexit costs), between 2008 and 2018 poorer and less populous regions of the EU became, on average, increasingly important sites for export-oriented manufacturers to locate factories. That is because they are constantly on the hunt for cheaper land and labour. But it is unlikely that there will be further big integration wins in goods trade as production costs in newer Central and Eastern member-states converge with the EU average – at least until Ukraine and other candidate states accede, probably in the 2030s.
3. Services trade, on the other hand, has been growing much more rapidly within the single market than globally. And it has been catching up with goods trade within the EU – by value, it has grown from a third of goods exports in 2012 to a half in 2022. While the single market for services is by no means ‘complete’, the movement of skilled service workers and capital, and the provision of cross-border services, is far easier within the EU than outside it. And there is much more that the EU could do to reduce barriers to trade in services – which would raise growth.
4. Services trade tends to be ‘centripetal’, however – with exporters clustering together, often in large and rich cities. We show that, if anything, this process has strengthened: a region’s success at exporting services is increasingly associated with the hallmarks of a ‘knowledge economy’ – high numbers of graduates, workers in tech, science, finance and other specialist fields, and effective and non-corrupt governance. Further single market integration in services will tend to reward already rich and successful places, with the potential to drive further political wedges between liberal cities and their more conservative hinterlands.
- If it wants to raise growth, the EU should move forward with its stalled capital and banking union projects; create European markets in telecoms, energy and online services; and try again to remove national regulations, such as professional qualifications, insurance mandates and language requirements that discriminate against services providers from other member-states. But it should also reform its regional spending, known as ‘cohesion policy’, to tackle the divergences that services trade promotes.
- With Central and Eastern Europe rapidly converging with Western European living standards, more regional funds should be directed towards city-regions with high growth potential, complementing existing allocations based on relative poverty. Many post-industrial cities have struggled, as productive services firms have chosen richer cities. To spread the economic benefits of agglomeration, we propose that the EU should identify ‘growth city regions’ in each member-state. These are non-capital cities that have the potential to become bigger centres for tradeable services – be they tech, engineering, finance, design or education. Money should be spent on:
1. Improving transport links within these cities and with surrounding towns. This will improve matches between workers’ skills and employers, by creating larger labour markets within commutable distances.
2. Raising the density of cities – much as better metropolitan transport expands labour markets, so does concentrating more workers and employers together in space. EU funds could be used to provide other infrastructure that facilitates that density, such as water, energy and telecoms.
3. Improving energy efficiency and electrification. Cities are more energy efficient than more sprawling patterns of settlement, but net zero will entail a large rise in electricity demand, with heating, transport and industry all needing to be electrified. Lower energy costs will make cities more productive.
- The EU should also locate any new agencies, and Horizon-funded research and development institutions in these growth city-regions and encourage national governments to do the same. These can help form the clusters of expertise that private companies can draw on and encourage them to move operations there. Choosing Paris for the European Banking Authority and Amsterdam for the European Medicines Agency, instead of second-tier knowledge hubs, this was a missed opportunity.
- City-regions should have a bigger role in choosing which projects are EU-funded. In many member-states national or state governments are in charge, and too much funding is disbursed without input from cities, which are increasingly the key unit of economic geography.
- This strategy would be politically challenging, as it would entail funds being distributed less by rules – a region’s GDP relative to the EU average; and more by judgement – which regions have the most capacity for growth? But, by integrating European services markets and investing in cities that have the potential to take advantage, the EU would raise growth and spread activity beyond successful metropolises. The EU should, however, continue to provide funds to poorer regions that are struggling to converge with European living standards.
1. INTRODUCTION
As its new legislators assemble following June’s European Parliament election, the EU is faced with major economic challenges. The European economy expanded at 2 to 3 per cent annually throughout the 1990s and early 2000s, but growth has never fully recovered from the 2008 financial crisis. While Europe continues to rank highly on broader measures of well-being, its growth has fallen well behind that of the US. Boosting growth is vital for Europe to deal with high levels of public debt, demands for higher spending on defence in the wake of Russia’s war on Ukraine, investment needed to curb emissions, and a rapidly ageing population.
Europe faces other looming threats. The US and China are subsidising industries and protecting domestic markets. The EU economy is highly exposed to this turn towards economic nationalism by major trading partners: the share of extra-EU foreign trade to GDP stood at over 40 per cent in 2021, vastly more than that of the US and China.1 China is also ramping up production of goods like electric vehicles and machinery, leading to an export glut that threatens Europe’s cutting-edge manufacturing sector. Europe also lags in technology creation and diffusion, just as artificial intelligence might unlock new productivity gains.
The search for higher economic growth, and the risk of global fragmentation, has rekindled European ambitions to deepen economic integration within Europe. Built to deliver unfettered movement of goods, services, capital, and labour across member-states, the EU’s single market has fostered trade, generated investment and stimulated growth. But there has been little progress on completing the single market for services – the largest sector of the economy, and the least integrated – in the last 20 years. Capital also remains ring-fenced along national lines despite the EU’s capital markets and banking union projects. Reducing such barriers to trade and investment would boost competition and dynamism by allowing more productive firms in any EU country to capture market share from less productive ones –and become more competitive in global markets. The EU tasked former Italian prime ministers Mario Draghi and Enrico Letta to make proposals in this direction and guide economic policy in the years ahead.2 Letta published his report in April, whilst Draghi is expected to do so in July 2024.
A more integrated single market, however, puts the spotlight on a longstanding challenge that has received less attention: regional disparities. The single market has been instrumental in raising standards of living for many regions and for the EU as a whole. At the same time, it has contributed to widening the economic gap between the EU’s metropolitan cities and successful industrial centres on the one hand, and post-industrial cities and more peripheral regions on the other.3 Intra-EU services exports are growing rapidly, despite regulatory barriers, but tradeable services firms tend to congregate in already prosperous cities. The EU is also edging towards another round of enlargement, with the accession in the medium to long term of Ukraine, Moldova and countries in the Western Balkans. Manufacturers may once again cut costs by shifting supply chains to poorer member-states, just as they did after the 2004 expansion to Central and Eastern Europe. This could trigger jitters about losses of manufacturing capacity elsewhere in Europe, especially now that Chinese import competition is also intensifying.
This dynamic, where internal market integration and the incorporation of new member-states raises growth but creates regional winners and losers, requires reforms to the EU’s regional policies. The EU should target resources on the places that may be able to take more advantage of trade within the single market. That has the potential to raise growth, but it must be handled carefully: the EU must also provide resources to regions that show less promise but need better infrastructure, technology and skills.
Using a dataset on goods and services trade within the single market between 2008 and 2018, this paper identifies how and where trade activities are concentrated, assesses shifts in regional trade patterns over time, and determines which regions have managed to leverage the single market to their advantage and which have been left behind – and why. As the EU contemplates expanding the single market in services and capital, the EU should consider a reformed cohesion policy that provides resources to city-regions that need help to take advantage of lower barriers in the services sector.
About the author:
John Springford is an associate fellow
Sander Tordoir is chief economist at the CER
Lucas Resende Carvalho is project manager, Europe’s Future Programme, Bertelsmann Stiftung