Empowering transformation in Europe

Europe is facing major economic and security challenges. The European Commission (EC) has started translating the Draghi report’s recommendations into effective proposals.

On the economic front, insufficient investment and weakening productivity, coupled with an ageing population, are weighing on potential growth in Europe in general and in the Eurozone in particular. On the security front, the White House's announcement that the US will abandon its military umbrella over Europe will force EU Member States to step up their defence efforts significantly.

The decision recently ratified by the German parliament to massively increase infrastructure and defence spending represents a historic shift that will revive German growth, which Europe should benefit from in the coming decade.
EU leaders are preparing to take significant measures on both fronts. The EC is in the process of translating some of the Draghi report’s recommendations – published in 2024 – into action. Its proposals will be examined by the European Parliament this year, starting on 1 April with the vote on the ‘stop the clock’ proposal (postponing the implementation of key EU sustainable development legislation until 2027-28) of the "Omnibus Package“¹.

In the medium term, our scenario for Europe assumes that the EU will gradually catch up in terms of investment, innovation and competitiveness.

For the Eurozone, we incorporate part of the EU Commission’s Competitiveness Compass and its implications on growth by assuming a boost to productivity in two ways:

		The boost from artificial intelligence (AI), which has a major impact on labour productivity
		The boost from reforms improving competitiveness (i.e., governance, public procurement, ease of doing business) is conservatively estimated to contribute about 1% to growth over 10 years, in line with research on the impacts of structural reforms.

In a nutshell, the broad guidelines for action are:


• Reducing regulation and administrative burdens to encourage innovation and improve productivity;

• Relaxing regulations on sustainable finance to support Small and Medium-sized Enterprises (SMEs);

• Reducing external energy dependency and developing renewable energies to enhance competitiveness, particularly for countries with a strong industrial base;

• Closer integration of capital markets to effectively channel Europe's abundant savings;

• Broadening and strengthening existing commercial partnerships to reduce dependency of supply chains.
   

2025 is a pivotal year as the EC unveils concrete action plans:

1. The Competitiveness Compass (presented on 29 January 2025) outlined flagship measures aimed to reverse industrial decline and step up efforts to compete with the US and China in areas like AI, while reducing energy costs and cutting red tape. Its three main pillars are innovation (promoting AI and robotics), decarbonisation (facilitating affordable energy access and reducing CO2 emissions), and security and defence (increasing resilience).

2. The Clean Industrial Deal (CID, presented on 26 February 2025) details actions to help energy-intensive industries decarbonise and stimulate clean technology production, aiming to lower energy bills. The goal is to stimulate investment by fostering innovation and competitiveness, making decarbonisation a growth driver for industry. The EU must accelerate clean energy deployment by speeding up electrification, creating an internal energy market, and reducing the share of imported fossil fuels in the energy mix. To finance this transition, the CID will mobilise more than EUR 100bn, is proposing to adopt a new framework for state aid aimed at deploying renewable energies (in order to speed up their approval). The CID is also proposing to increase the amount of financial guarantees to support investments, which according to the EC should make it possible to mobilise up to EUR 50bn.

3. Finally, the EC’s White Paper on Defence, along with the “ReArm Europe/Readiness 2030 plan (both presented on 19 March) proposes measures to strengthen the defence sector. The recommended strategy is the most important undertaking since the Cold War. Among the conditions for achieving this are the establishment of pan-European supply chains and the promotion of innovative Research & Development, in order to increase the economic impact of defence spending over time. To this end, the strategy will offer member states financial levers to stimulate investment, with the potential mobilisation of nearly EUR 800 bn over the next four years. The flagship measures are centred on three main axes: first, enabling member states to increase their defence spending without triggering an excessive deficit procedure, allowing each member state to mobilise up to 1.5% of GDP per year in additional defence spending. Second, granting up to EUR 150 bn in loans to member states for defence-related investments via a new instrument called 'SAFE.' Lastly, accelerating the establishment of the ‘Investment and Savings Union’ (the new name for the Capital Markets Union).

Are European equities becoming structurally more appealing?

After a prolonged period of underperformance, European equities have started to reverse this trend.

Historically, European equities outperformed in the 90s due to strong economic growth from market integration, technological advancements and regulatory changes, but they have lagged over the past decade.

With more attractive valuations (although to a lesser extent after the recent rally), and anticipated gains from industrial policies and higher productivity that could trigger relevant changes at sector/ country levels, we project European equities will outperform the world index over the next decade.

Despite the recent outperformance, we believe that the structurally improved appeal for Europe should continue, supported by the recently approved extraordinary fiscal push in Germany and a potential ceasefire and reconstruction in Ukraine.