Why Europe may pursue tighter integration in a fragmenting world

The idea of seamless movement of capital across Europe’s various economies and markets – a capital markets union, in shorthand – has been a long-held goal across the European Union. But it remains elusive.

It has been touted by proponents as a key step towards greater European integration and continent-wide growth, by opening up capital markets to investment from across the bloc. For opponents, however, a capital markets union represents a potential infringement of sovereignty, a threat to national competitiveness or attractiveness, and even a risk to European financial stability in the face of potential economic crises.

Now, more than 10 years after the idea was first launched, a capital markets union is firmly back on the agenda of European leaders. And this time the debate is being driven as much by necessity as it is by opportunity.

That’s because Europe finds itself in a very different reality compared with a decade ago, when then-European Commission President Jean-Claude Juncker announced plans for an open European market for investment.

This new reality is a feature of unfolding events as European leaders look at ways to increase military spending in response to pressure from the US, and was on full display at the World Economic Forum Annual Meeting in Davos last month.

Key topics of conversation at the annual meeting included the inevitable impacts of new technologies like artificial intelligence, and expectations for the new US administration. Unfortunately for the many European leaders in attendance, another distinct theme was pessimism about the future of Europe’s economy. Whether it was due to stagnant growth, persistent inflation, a manufacturing decline, or low productivity levels, the lack of optimism about the future of the EU was notable.

Perhaps chief among the concerns over Europe’s economy was its apparent inability to retain the young technology companies working on products likely to drive the future of the global economy.

In a recent opinion piece, European Commission President Ursula von der Leyen and President of the European Central Bank Christine Lagarde issued a stark warning. “Our competitiveness is at risk,” they wrote. “While a global revolution in artificial intelligence unfolds, the EU could find itself on the sidelines.”

They alluded to what’s become an all-too-familiar dynamic. A European entrepreneur starts a technology company that quickly gains traction, while benefitting from a deep local talent pool. But when it comes to scaling up, and even potentially offering shares to the public by listing on an exchange, the entrepreneur opts to do this in the US. The European startup becomes an American company, with all the economic benefits that brings to the US economy.

According to a report published last year by former European Central Bank President Mario Draghi, nearly a third of European startups founded between 2008 and 2021 and valued at more than $1 billion have moved abroad – most of them to the US.

Integrating Europe’s capital markets in a way that helps prevent this outflow will be “crucial,” Draghi wrote.

Another prominent topic at Davos was the worsening fragmentation of the global economy, amid weakening trade ties and geopolitical friction.

Lagarde and others argued that Europe must move in the opposite direction. “We need a banking union, we need a capital markets union. We need to keep the talent at home, we need to keep the savings at home,” Lagarde said during a Davos panel discussion.

The sentiment was not unique.

“Integration, having really large markets, removing the different regulations that exist from security to the health sector, bankruptcy laws, state aid rules — all of these need to be seamless in Europe,” said Nadia Calviño, president of the European Investment Bank, “so that investors from pension funds to international investors or even retail investors in Europe, are actually investing in the whole of the EU. And that gives scale. The key element in this would be the capital markets union.”

The issue in Europe is not that there isn’t enough money. In fact, European bank accounts are relatively overflowing.

Every year, European households save roughly €1.3 trillion. By the end of 2023, Eurostat estimates, these households were sitting on roughly €37 trillion in savings. This is capital that European leaders argue could be invested in the pan-European economy, if a capital markets union were to be realized.

According to EY, only 17% of EU household assets are currently invested in financial securities such as stocks or bonds – a stark contrast to the US, where the figure is 43%.

The issue of a capital markets union has moved from bloc-wide debate into the national politics of European countries. At Davos, German Leader of the Opposition Friedrich Merz outlined the prospects for its role in a recovery of both the German and European economies.

“Let us not speak about all these systems about how to save money from the banking sector,” said Merz. “Let’s talk about the open capital market and how to bring companies from Europe to the capital market.”

“We have to provide growing companies with capital market infrastructure,” he continued. “This is something which is in my view one of the key positions we have to achieve as fast as possible, to give our companies the best platform for going public not just in America, but in Europe.”

Momentum appears to be building for a capital markets union. But we’ve been here before.

The difference, however, is the state of Europe. There is a growing awareness across European Union member states that something must change for the world’s largest single market.

At Davos 2024, Lagarde said she believed that would be the year of the capital markets union.

She had to repeat herself at this year’s meeting. Many people across Europe, not least the region’s budding entrepreneurs, hope that she will not have to repeat herself yet again next year.