Trump may not be the nightmare European economies fear

In the short-term this judgment looks a fair reflection of the respective paths for the US and European economies. But there is another interpretation - using a longer-term perspective - that is worth considering. An unconstrained Trump Presidency may be just what the European economy needs to shake it out of its post-Global Financial Crisis funk.

Let us unpack this unconventional argument, not least because you are unlikely to hear it uttered publicly from any European finance minister, prime minister, or president. But make no mistake it will be the centerpiece of private discussions amongst European economic powerbrokers as they consider the likely fallout of a renewed Trump Presidency.

The first thing to note is that US-European economic divergence is not a new thing. Gross Domestic Product (GDP), stock market valuations, and disposable incomes have all grown faster in the United States than in Europe for more than fifteen years. Any explanation for these trends is multi-faceted and includes different demographic trends, a starkly different regulatory response to the Financial Crisis, tighter fiscal policy constraints across Europe, and a very different approach to energy self-sufficiency. However a Trump Presidency with mercantilist economic priorities and a narrower interpretation of the US’s defence responsibilities to the European continent may be the catalyst for change that many in Europe have been seeking.

The economic issues facing Europe - both the twenty-seven countries within the European Union and the wider European area - have been subject to plenty of scrutiny even ahead of Donald Trump’s latest triumph. Reports by former Italian Prime Minister Enrico Letta, and former European Central Bank Governor, Mario Draghi, have both laid bare the incomplete features of economic union. However it is another former European leader, Jean Claude Junker, who infamously noted back in 2007 that “We all know what to do, but we don’t know how to get re-elected once we have done it”. It might just be that the brooding shadow of Mr Trump provides the political cover to do just that.

So which otherwise intractable European policy issues may see movement in response to events the other side of the Atlantic?

The first issue in the cross hairs is whether Europe’s largest but also its slowest growing economy, Germany, will alter its fiscal stance in response to a new Trump administration. Since 2009 Germany’s Schuldenbremse - or debt brake - has limited the German government’s ability to run deficits outside of a severe economic crisis. Whilst the German economics community have largely supported this approach and its conservative approach to public debt, the electrification of large parts of the global economy has encouraged Germany’s economic competitors to use public sector debt to seed the technological transition, and generate domestic industrial capacity. The economic risk of Germany getting left behind has already created a political fallout and fresh federal elections in February. A Trump administration that eyes Germany’s sixty-three billion Euro trade surplus could quickly ratchet up the pressure to abolish Germany’s Schwarze Null policy.

Second, there is the enormous question of European defence and the degree to which a Trump administration will stand behind Ukraine and the wider European region if European contributions to NATO remain just 1.3% of GDP, whilst the US commits 3%. There are much better qualified people than I to judge the fallout from such a threat, however there are positive economic ramifications should Europe respond to the threat by devoting more to national defence budgets. The first is the direct impulse such spending has on the economy through defence sector jobs and government contracts. However much less appreciated is the private sector spillover into technology leadership from greater Research and Development spending. Much of the high value technology capability being exploited by the US and Chinese technology sectors began its life as line items on a military research budget. That Europe so visibly lags in the race to create and scale innovative, globally-relevant technology companies is in part of a function of decades of underinvestment in its own defence. Almost seventy years ago the lack of US support for the major European powers during the Suez Crisis persuaded France of the need for domestic nuclear capability in both weaponry, and energy. An echo from history may not be the economic disaster that is widely assumed.

Tangential to this is the completion of a Capital Markets and Banking Union across Europe. Both the Draghi and Letta reports noted the competitive disadvantage this generates in providing scale-up capital for European technology companies. High European household saving - at more than 15% of total income so far this year compared to just 4% in the US. This increasingly flows in to subsidizing the cost of capital for US companies. The wisdom of this broad-brush approach to capital flows is being debated both sides of the English Channel. A Trump Presidency that makes a further play for capital to relocate to the US only serves to amplify this European problem, and the backbone for a solution.

For the UK - Europe’s second largest economy - the questions posed by a Trump Presidency are more strategic. Firstly, with a relatively small direct exposure to a global trade war the choice is whether to participate in any multilateral escalation to US tariffs or take advantage of trade flux by importing goods that the EU or China may look to price more keenly. Amidst fears of domestic UK inflation from recent tax increases and energy policies such external disinflation has significant attractions. Secondly, having largely followed the European regulatory model since the Brexit vote does the UK use a Trump-led divergence as a reason to perform a pivot in areas such as financial services regulation where Trump plans big repeals in areas such as banking capital requirements and US alignment with Basel III regulations, and in cryptoasset regulation. Thirdly, and perhaps most politically appealing for the UK is whether Trump’s approach to smaller government - exemplified by his rather gimmicky Department of Government Efficiency (DOGE) - provides a credible alternative economic path for a UK which under both the former Conservative government and the current Labour government is taking the tax take and scale of UK public spending to a 75-year high. Offering a genuine economic choice at the next election will be easier for Conservative or Reform leaders to make if the latest US experiment with smaller government throws off encouraging results.

Let us not kid ourselves, Donald Trump is not the US President that European leaders wanted. But he might just be the President they all need.

 

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