Fragmented Finances: Why Europe’s Capital Markets Union Remains Elusive

Raghav Motwani

In 2024, the European Union (EU) finds itself working in crisis management. As the war sparked by the Russian invasion of Ukraine looks set to continue into its third year, the economic strains on the EU have also intensified. Amidst this Mario Draghi, the former president of the European Central Bank (ECB), wrote a scathing report on The Future of European Competitiveness in September 2024. His report has brought the issue of European economic stagnation, and Europe’s economic future back to the front and centre of EU politics

Why are there calls for a Capital Markets Union?

Between 2009 and 2023 nominal GDP grew by over 70% in the USA, while in the EU it has grown by 22%[1]. During the same period, US household wealth increased by 151%, compared to only 55% in the EU[2]. This massive underperformance highlights fifteen years of stagnation, as Europe struggles to keep up with the growth of the USA. There are plenty of possible explanations for this: EU fragmentation, Brexit and its fallout, or aging demographics. However, key beyond all these issues has been a lack of investment. Amongst other reasons, the lack of a functional pension fund system in the EU limits private investment and is limited by difficulties in cross-border investing. For example, total pension assets in the EU amount to 32% of GDP, while in the UK this is 100% and the US it is 142% respectively.

This is highlighted by Figure 1, which shows the EU lags significantly behind the US in relative private and public sector investment. This has led to weaker business innovation. While American companies have continued to grow and establish themselves globally as household names, their European counterparts have failed to do so.   

Figure 1

In his report, Draghi argues for an unprecedented level of investment in Europe, €750-800 billion of additional capital investment. For context, the Marshall Plan, which helped rebuild Europe after World War II, accounted for around 1-2% of GDP. In contrast, Draghi's proposed investment would amount to 4.4-4.7% of GDP. Central to Draghi's vision is the establishment of a Capital Markets Union (CMU) between EU member states. This initiative would aim to integrate financial markets across member states through centralisation. A CMU would aim to reduce barriers to cross-border investments, lower the cost of capital, and increase access to financing for innovative European firms.  With Europe facing growing geopolitical risks, such as prolonged global conflicts and further US isolationism, the urgency for economic integrations is mounting. A CMU would help Europe strengthen its financial autonomy and enhance the global competitiveness of EU firms.

What is Stopping a Capital Markets Union?

While a Capital Markets Union offers clear economic benefits, the EU must overcome several hurdles that stand in the way of this. Firstly, the diversity and fragmentation within the EU itself. Each of the 27 member states has its own set of legal frameworks, regulations and financial systems. This complicates cross-border investments, importantly within a CMU the relationship of a firm and its creditors in the case of a bankruptcy. For a functional CMU, member states would have to align on such key regulations, which the majority are not willing to do. The proposal of losing control over financial markets will be seen as attacks on sovereignty, regardless of potential economic benefits.

The differing level of economic development across member states also poses an obstacle to a CMU. Central and Eastern European national representatives recently criticised Draghi’s ‘old Europe’ mindset, seeing his proposals as disproportionately beneficial to the larger economies of Germany and France. Southern European countries such as Italy and Greece are still recovering from the Eurozone debt crisis, and their politicians are wary of a system that could consolidate power in the hands of wealthier northern states. Trust between member states has been frayed by previous economic issues, and creating a CMU requires a level of cooperation that, for now, remains elusive.

Political dynamics further complicate the process. The prominence of populist leaders such as Victor Orban and the rise of nationalist groups, like the German Alternative for Deutschland (AfD) presents increased opposition to further EU integration. These movements prioritise national sovereignty, and rally against ceding more power to Brussels. The sentiments that Brussels already wields too much influence on domestic affairs has been highlighted and further exacerbated by Brexit.

The Long Road Ahead

The prospect of a CMU materialising in the short-term seems distant, as opposition within the EU seems too significant to overcome. Even as economic challenges persist, the current political climate does not favour the bold moves necessary for such integration. Looking further ahead, the future is less certain. Global power dynamics could force European leaders to reconsider deeper financial cooperation. However, as things stand, Europe’s political landscape, with rising nationalist sentiment and fragmented leadership, makes a CMU improbable. Unless Europe can reconcile its internal divisions, Draghi’s vision will remain a distant goal.

[1] https://data.worldbank.org/indicator/NY.GDP.PCAP.CD?locations=EU-US

[2] https://commission.europa.eu/document/download/ec1409c1-d4b4-4882-8bdd-3519f86bbb92_en?filename=The%20future%20of%20European%20competitiveness_%20In-depth%20analysis%20and%20recommendations_0.pdf