Europe’s biggest economic wounds are self-inflicted

European flags at the EU Commission headquarters in Brussels. The bloc's recent experiences show how quickly hard-won unity can fade when commitments are not maintained. AFP

When European Central Bank president Christine Lagarde warns that Europe’s “old growth model” has aged and its reliance on exports is now a “vulnerability”, it is worth listening. Central bank heads rarely use such choice language.

In an eye-opening speech in Frankfurt last month, Ms Lagarde said the bloc’s export engine had stalled and its industrial base – above all in Germany, though she did not mention it by name – is losing steam.

She urged policymakers to boost the domestic economy, arguing that its “latent strengths” have helped to cushion recent shocks – a fair observation, given the worst fears about Russia cutting off energy exports to Europe in 2022 did not materialise.

US Fed has been too slow lowering interest rates, says former treasury secretary

Read More

European Central Bank president Christine Lagarde delivers her keynote speech at Euro Finance Week, a week-long conference in Frankfurt, Germany. Reuters

Europe’s economy has grown a little faster than expected this year but that modest rebound masks deeper structural problems. The single market remains fragmented, holding back the bloc’s productivity, growth and living standards.

The bloc's economic divisions are not just a localised problem; they are pushing capital, companies and innovation abroad, with knock-on effects for the global economy.

It is tempting to blame these struggles on the conflict in Ukraine, or trade tensions with the US and China. In reality, Europe’s enduring weakness is largely self-inflicted – the result of policy choices that have allowed the single market to fragment from within.

Five trends show how this is happening. First, non-tariff barriers to trade between member states have increased. The ECB, Mrs Lagarde’s own institution, estimates that internal obstacles are now equivalent to tariffs of 100 per cent in services and 65 per cent on goods.

While those estimates can be debated on technical grounds, the underlying point stands: too many rules still protect domestic providers in Europe’s vast service sector from internal competition, often justified on safety grounds.

Second, EU governments still buy almost everything at home. Research shows member states source little across borders. In theory, the single market guarantees that companies can bid for public contracts across borders. In reality, there’s strong home bias: less than 5 per cent of contracts go to firms based in another EU country.

Europe still has deep pools of savings, skilled labour and strong institutions ... what it lacks is the financial plumbing to connect them

As governments across Europe plan a surge in defence spending in response to Russia’s war in Ukraine and doubts over US support under President Donald Trump, limiting procurement to national suppliers rather than sourcing EU-wide will drive up costs and dilute the impact of that investment.

Third, even after decades of integration, Europeans still tend to buy locally. Distinct national tastes keep consumer markets more fragmented than the single market implies. Preferences for grocery products differ far more across countries than within them – orders of magnitude more than in the US. That’s one reason trade within Europe still trails commerce between US states.

Fourth, enforcement of single-market rules slumped by 80 per cent during the first three years of European Commission president Ursula von der Leyen’s first term, according to a report by the Financial Times. When countries stop following single market rules, they start setting standards and creating other hidden barriers that favour local firms.

That makes it harder to do business across borders and leaves Europe less competitive with the US and China. Without firmer oversight from Brussels, the single market will keep fragmenting.

Fifth, since the financial crisis of 2008-09, Brussels has repeatedly relaxed its state-aid rules, allowing governments to support struggling companies through grants, tax breaks and subsidised loans. These tools were first used to stabilise the banking sector in 2008, then revived more broadly during the Covid-19 pandemic and the 2022 energy shock. They have proved difficult to unwind: in 2025, the EU went further still, easing the rules again to promote investment in green technology and bolster European industry.

The result is that wealthier countries such as Germany and the Netherlands have spent far more supporting their industries than others can afford, tilting competition inside the single market. For a French firm competing in Greece, it hardly matters whether its subsidised rival is German or Chinese; the competitive disadvantage is the same.

Collectively, these five developments have left Europe more fragmented; a weakening of the single market that makes the continent less competitive on the global stage. The signs are clear for all to see.

America’s productivity has grown more than twice as fast as Europe’s over the past two decades, sparking fears in Brussels of a “competitiveness crisis”. The problem goes beyond output per hour.

Innovation is also lagging and for many of Europe’s faster-growing companies, expansion and financing happen abroad rather than at home – underscoring how hard it is for firms to scale within the single market.

Together, these trends mean Europe’s fragmentation is no longer an internal problem. The solution, though, is obvious. Europe still has deep pools of savings, skilled labour and strong institutions, the kind of “latent strengths” Mrs Lagarde referred to. What it lacks is the financial plumbing to connect them.

As my IMD colleague Arturo Bris has argued, money still struggles to move across EU borders because financial rules, taxes and oversight differ from country to country. This fragmentation makes it costlier to invest and leaves trillions of euros sitting idle in national markets.

A truly single capital market would change that, allowing funds to flow where they are most productive, giving firms cheaper access to finance and helping Europe narrow its productivity gap with the US.

That would help mend Europe’s fragmentation and answer Mrs Lagarde’s call to build resilience from within. The single market once made the continent strong; it’s time to renew it, without turning inward behind a “Fortress Europe” of protectionist policies.

The lesson matters for the Gulf as well: as the region pursues deeper integration, Europe’s experience shows how quickly hard-won unity can fade when commitments are not maintained.