The State of the European Union speech must address the return of economic policy trade-offs

On 13 September, European Commission president Ursula von der Leyen will deliver her last State of the Union (SOTEU) speech – last, that is, unless she receives a new mandate next year. As well as recapping on her term in office, she should outline what the next Commission president should do. In terms of economic policy, she should use the SOTEU to acknowledge the obsolescence of the European Union ‘business model’.

In particular, the legacy of the COVID-19 pandemic on value chains, the economic implications of Russia’s war of aggression, stubborn inflation and rapidly deteriorating economic activity have brought back policy trade-offs. This is a change from the pandemic, when the EU’s economic response was unprecedented (first and foremost with the NextGenerationEU (NGEU) recovery programme), but rested on an absence of substantive trade-offs.

The next Commission and European Parliament will face four immediate challenges: the risk of entrenched stagflation, the looming prospects of financial (and real) fragmentation, the breakdown of the consensus on the green transition and the increasing pressure on competitiveness. However, the economic malaise of the EU runs deeper. Its export-oriented, energy-dependent, demography-stagnant features make its business model ultimately unsustainable. The need to quickly overcome dependence on Russian gas has accelerated an inescapable trend: in a world of very large players, it is economically risky and politically unwise to essentially rely on foreign demand for sustaining growth. The same reasoning applies to raw materials and supply chains: longer value chains and a greater reliance on third countries ensure economic efficiency in ‘normal’ times but come at a price in terms of security.

Striking the right balance between preserving openness and guaranteeing essential supplies will be vital for the future economic wellbeing of Europe and for its role in global governance. Furthermore, the war in Ukraine shows the increasing importance of EU defence and of managing migrations flows at EU level.

The EU must react to these challenges with a unifying, coherent strategy, and this should be the thread running through the SOTEU. Increasing the supply of European public goods (EPGs) in economic and non-economic areas should be the way forward: the EU should focus on EU projects financed by EU resources to tackle EU challenges.

By reducing tensions between EU budget net payers and recipients, EPGs would be politically less contentious than other forms of central fiscal capacity. Identifying and financing EPGs, giving the EU a stronger role in delivering on common projects, would be a better approach for the new Commission than proposing a new stabilisation tool or launching an NGEU 2.0.

Genuine EPGs remain under-supplied in the ‘triple’ digital, green and social transition, the provision of essential raw materials, security and defence, and health. Notable examples could be cross-border digital infrastructure and energy projects, the common purchase of critical raw materials or a EU platform for skills acquisition and exchanges.

A pragmatic way forward to ensure the delivery and financing of EPGs would be to rely on existing EU programmes, but revamping them and refocussing on cross-country projects. For instance, EU Important Projects of Common European Interest (IPCEI) have great potential if national and EU resources could be combined to achieve a critical mass. The Commission has already proposed a Strategic Technologies for Europe Platform to get more from EU funds. This is a good first step but should in the medium run be transformed into a European Sovereignty Fund, as initially envisaged by von der Leyen.

The credibility of such spending programmes must rely on reliable revenues. A proposal on new EU corporate taxation (BEFIT), due the day before the SOTEU, provides an opportunity to adopt genuine EU own resources. The political resistance will be huge, as shown by the negative reactions of some EU finance ministers in July to current (modest) proposals by the Commission on new resources for the EU budget. However, political leaders should understand that the alternative would be the EU acting only reactively, repeatedly taking extraordinary measures under exceptional circumstances.    

As von der Leyen pointed out in the SOTEU speeches of the last two years, the response to the pandemic rightly emphasised common responsibility. Markets appreciated the strong political cohesion in support of an ambitious policy strategy. Investors are again looking for leadership. The SOTEU should frame the basic choices ahead if the EU business model is to be revamped.