Can the European Union get it together on capital markets? This is what’s at stake

“The money is in America.”

Every year, tens of thousands of new startups appear in Europe. They do a lot of different things, like offering cyber insurance or capturing and neutralizing carbon dioxide. But both aspiring and accomplished startup founders in the region often share one thing in common: they move to the US.

When a commenter on a recent Reddit thread about this trend bluntly noted that most of the money available to fund startups is in America, others suggested why – for one thing, the market there “isn’t fractured” into multiple countries and regulatory regimes.

It’s not clear if Mario Draghi spends time on Reddit. But the former European Central Bank president issued a jarring report last month that hit on the same theme; nearly a third of Europe’s startups founded between 2008 and 2021 and valued at over $1 billion have moved abroad, mostly to the US, he wrote. Integrating Europe’s capital markets will therefore be “crucial,” as the region scrambles to soup up its economy to confront new realities.

Integrating EU markets isn’t exactly a new idea, but it’s getting a second wind.

If the bloc can forge its long-anticipated capital markets union, the benefits could go far beyond startups to impact all kinds of enterprises, and anyone trying to accumulate wealth that hasn’t been passed down within a family for generations (in a part of the world where inheriting your affluence can still often seem like the norm).

Pooling financial resources by making it easier for a Czech teacher to invest in a French maker of electric car charging stations, or a Belgian insurer to buy an Italian recycling company’s debt, could unlock that kind of sequestered money and make it “productive,” as economists say. It could be used to pollinate more companies and infrastructure through the purchase of stocks and stakes, and as it moves across borders to create bigger firms and markets, it just might form a kind of financial Voltron better equipped for a fragmenting world.

Proponents say that as a capital markets union helps the EU turn more of its ingenuity into world-beating businesses, it could aid its existential battles with rival markets and a changing climate.

“Europe can gain a lot,” said Steffen Kern, chief economist and head of risk analysis at the European Securities and Markets Authority. But it will require developing “not only our markets but also the wider market environment,” he added. That means fostering sustainable financing options and pan-European infrastructure.

Plans for a capital markets union started to take concrete shape in 2015. Some countries are eager to kick things into a higher gear now.

France proposed earlier this year to start small, with a handful of countries forming a capital markets union on a “voluntary” basis. Last week, Spain’s economy minister followed up on that idea by suggesting a “competitiveness laboratory,” where at least three member states could design a pilot project for broader integration.

Other countries have been far less enthusiastic. There are fears that homegrown financial industries could be hindered, and smaller markets could fall further behind.

But Kern said security doesn’t have to be sacrificed: “Promoting competitiveness and financial stability is not a contradiction, but a mutually reinforcing process.” If the right protective policies are put in place, sustainable market development should follow.

Still, Europe is a place where economic nationalism often prevails. Not least where banking and finance are concerned. When a large Italian bank (with origins dating back to 1473) recently moved to acquire a large German bank (founded in 1870), hopes for the sector’s biggest pan-European merger in decades were swiftly contrasted with dismayed politicians who prefer home-grown “champions.”

Holdups for a capital markets union could be as trifling as settling on where it will locate. Would Greek retirees be happy to have their investments overseen from Berlin? Could German markets be content to answer to officials in Paris?

There’s a precedent for starting small. The EU originated with the Treaty of Rome in 1957, commercially binding its original six signatories at least in part to prevent them from following two devastating wars on the continent during that century with a third. The hazards are more external now, but still daunting.

A failure to form a capital markets union could be a way in which a lack of “union” in the European Union denies it a place as a third centre of gravity in the global economy alongside an increasingly inward-looking US and an expanding China.

Advocates of juicing the EU’s capital markets argue that banks remain way too prominent there. Banks might have money to lend, but they also just want tangible collateral and to be paid back with interest. They’re not built (nor should they be) to accept high risk for the sake of entrepreneurial spirit; someone depositing a paycheck into one end might not be thrilled with it being funneled to a bleeding-edge AI startup at the other.

Equity-based investors (I give you money for your AI startup, you give me an ownership stake) are a different story. Venture capital firms aim for just one or two of the startups that a fund invests in to generate big returns. But Europe’s pools of venture capital tend to be relatively shallow, and constrained by national borders.

Even if that AI startup does hook up with a European venture investor able to nourish it to healthy maturity, where can it hit the big time by offering shares to the public? Once again, relatively shallow pools of capital, this time in terms of what’s available through European stock exchanges, make the US a more attractive option.

The result: American companies tend to be bigger, and wield more market power (55% of the American workforce was employed at a large company as of a a few years ago, compared with 36% in the EU). Large Chinese companies, particularly carmakers, present their own set of challenges.

The US is in some ways mirroring the Chinese model now, by developing industrial policy heavy on government incentives for homegrown products and innovation. The net effect is that the two biggest economies in the world are doing their own pooling of internal resources, to carve their own paths.

For Europe, this challenge comes on top of an ageing domestic population and worsening impacts of climate change.

Nearly a decade after the capital markets union started to take form, current European Central Bank President Christine Lagarde warned that the combination of “deglobalization, demographics and decarbonization” means the effort must take on new urgency.

Europe is, after all, the place where momentous inventions like the first gas-powered car originated. It’s logical to look for ways to help it regain its footing, as companies from China and the US surge ahead with blunt force and bold new concepts.

It’s not just the technology of the future that’s at stake. Basic infrastructure like railways, any outsider’s idea of a staple of European life, could be revived. Earlier this month, a former Italian prime minister said that without a capital markets union, the region can probably forget the idea of a pan-European high-speed rail network.

But significant change would require stepping out of the region’s comfort zone. “As capital markets grow, so do financial risks,” Kern said, “and the macroprudential framework must be fit to address them.”

Boom and bust are facts of market-based life, and efforts to make money more productive can have the opposite effect, at least in the short term. The enviable venture capital industry in the US has been bloated with excessive funding lately; one Silicon Valley firm recently decided to simply return the money to its backers, rather than scour for appealing late-stage startups in need of investment.

And, self-preservation is a powerful instinct. Some people might be fine with a Europe that’s not breaking down traditional barriers to compete globally, if those barriers have helped maintain their own sense of security and high standard of living.

The question is how long that high standard can last.

For more context, here are links to further reading from the World Economic Forum's Strategic Intelligence platform:

On the Strategic Intelligence platform, you can find feeds of expert analysis related to the European Union, Capital Markets, and hundreds of additional topics. You’ll need to register to view.