TOMORROW ’ SE U RO P E :Uncertainty and unprecedented opportunity

2 Introduction

4 Economic growth

7 Innovation comeback

9 Brexit: A European perspective

11 Conclusion

2Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

Europe is at a crossroads. It faces many challenges, from globalisation and geopolitics, to the impact of new technologies and trade agreements. But change also brings exciting prospects for the brave and adaptable. Above all, innovation, entrepreneurship and investment will be the foundations of future prosperity.

And businesses – as the main creators of jobs and growth – have a pivotal role in determining what ‘Tomorrow’s Europe’ will become. Without doubt, uncertainty, but also unprecedented opportunity, lies ahead.

At a recent Barclays ‘Tomorrow’s Europe’ panel discussion in Berlin, experts engaged in a lively debate on what the European landscape may look like for businesses over the next decade. This viewpoint paper examines some of the thought leadership highlights from that event.

Introduction

Europe is at a crossroads. It faces many challenges, from globalisation and geopolitics, to the impact of new technologies and trade agreements.

Europe at a crossroads

Inspiring conversation at the ‘Tomorrow’s Europe’ event in Berlin

3Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

Tomorrow’s Europe panel experts

William HobbsHead of investment strategy, Barclays

William Hobbs joined Barclays in October 2005, working in the Equity Research team, covering the global consumer sector. He then moved into the investment strategy team running global equity strategy for the EMEA division. He is now head of investment strategy. William is a fellow of the Securities Institute and has close to 20 years of experience in the financial sector. He is a frequent contributor of economic and capital markets’ insight to Bloomberg, CNBC and others.

Özlem Bedre-Defolie Associate professor of economics, ESMT

Ozlem Bedre-Defolie is an associate professor of economics (with tenure) at ESMT Berlin and an affiliated associate professor at University of Bergen. She received her PHD in Economics from Toulouse School of Economics, France. Her research interests are mainly theoretical and applied microeconomics, and industrial organisation. More specifically, she studies economics of platforms, multiproduct firms, vertical relationships with focus on antitrust and regulation questions.

Ferdinand FichtnerHead of department, DIW Berlin

Dr Ferdinand Fichtner is head of the forecasting and economic policy department at DIW Berlin. He holds a PHD from the University of Cologne and wrote his dissertation thesis about the effects of monetary integration on economic welfare. He is one of the leading German experts on macroeconomic policy, with frequent appearances on national and international media and close connections with policy makers.

Josef JanningHead of European Council on Foreign Relations, Berlin office

Josef Janning joined the European Council on Foreign Relations in April 2014 as Senior Policy Fellow in the Berlin Office. Josef has published widely on European Affairs, International Relations, EU foreign and security policy, German foreign and European policy as well as global affairs. On these issues he also is a frequent commentator with German and international media.

These panel experts bring together a vast range of European experience with a global perspective. From investment and capital markets, to geopolitics, digital and macroeconomics, they are all leading commentators in their fields.

Introduction

4Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

Economic growth

The slowdown of the eurozone will affect all member states. Germany and France, the two largest economies of the eurozone, are expected to lose some steam this year and next.

Italy is expected to be hit the hardest, followed by the United Kingdom, as the economy’s complicated exit from the EU continues to take its toll on near term economic activity.

Eurozone growth forecast (%)

GDP change from previous year (%)

Europe’s major economies are expected to grow at a respectable pace over the next two years – but at a slightly slower rate than we’ve seen recently.

Losing steam, but optimistic outlook...

2017

2018

2019

Source: European Commission

2.1

2.0

2.4

Source: European Commission

1.7

1.5

2.2

2.4

2.2

3.1

France

UK

Italy

Spain

EU

Germany

-0.5

-0.4

-0.5

-0.4

-0.3

-0.7

2017 actual Forecasts

5Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

What is the short-term economic outlook for the EU area?

Ferdinand Fichtner:“We have growth forecast at between 1.5 and 2%. European Union monetary policy is expected to tighten, so we expect a slight deceleration overall. On the other hand, many countries – like Spain – which are still emerging from the crisis, are catching up.

Therefore, overall the predictions are solid. The risks, however, are also high. We have Donald Trump’s policies – trade restrictions, tariffs etc. – and Brexit. These are risks for the euro area and the EU as a whole, in terms of trade and investment demand and growth, but there are also a number of global and internal risks.

We still have problems regarding the institutions of the monetary union, and this has implications for growth in the euro area too. Risks are high but the baseline perspectives for the euro area and the EU are solid.”

Growth and geopoliticsEscalating trade disputes in 2018 between the United States and Europe have rattled investors, added to market volatility, and led businesses to re-think strategy.

To what extent are geopolitical factors hampering Europe’s economic growth?

Josef Janning:“The rise of geopolitics means an instrumentalisation of institutions, multinational regimes, economics and trade in general for political purposes.

As politics weaponises its economic assets, the more risks there are for the economy – particularly as the economy does not primarily run on what is best for businesses and investors, but on what adds to the power demands of the respective leadership.

You may benefit in the short term – Trump’s tariffs may give a short-term boost to certain sectors of the industry, but the overall effect, I think, will be negative. It will disrupt trade and the incentives of productivity growth, in search of rent-seeking or of taking advantage of those niches that politics are creating.”

The role of strong institutionsNew theories of economic growth are shedding light on the understanding of differences in prosperity across countries. Many now claim the strength of economic institutions is pivotal.

What role do EU institutions play in recent theories of economic growth?

Will Hobbs:“It has long been accepted that economic growth and rising living standards are a relatively new phenomenon. Prior to the 18th century, the world economy flatlined; from generation to generation, living standards barely budged.

Then from around 1750, output per head suddenly took off and has kept on rising ever since, growing at around 1.5% per year. What changed in the middle of the 18th century? Previous answers have centred on a change in the nature of innovation. Ideas like the spinning jenny and the steam engine finally freed us from our physical and geographical constraints.

However, a new study of the entire millennium suggests a broader explanation. Using higher frequency measures, it was found that while growth up until the mid 18th century did indeed flatline on average, there were significant swings within it.

The reason that average growth was far lower during this period was not so much an absence of growth, but because expanding periods were almost exactly offset by contracting periods.

Essentially, the revolution in living standards after 1750 may owe more than previously thought to the increasingly robust and elaborate institutional context. While recessions occurred c.50% of the time prior to 1700, they have occurred 30% of the time since 1700 and only 17% of the time since 1900.”

History of recessions (%)

1200-1700

Post 1700

Post 1900

Source: Barclays

30

17

50

Economic growth

6Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

Europe’s digital economyDigital economies are central to European growth, as it grows seven times faster than the rest of the economy. In its regulatory role, the EU is working hard to keep pace with digitisation

What are the challenges facing the growth of the digital economy?

Özlem Bedre-Defolie:“The digitisation of the economy has brought online platforms which facilitate transactions between user groups by reducing search and transaction costs.

For instance, eBay and Amazon marketplaces enable sellers and buyers to find each at a much lower cost than in bricks and mortar stores. They bring a lot of value to consumers, small businesses and entrepreneurs, but they also raise a lot of challenges for business and policy-makers.

How these business models work is a big question, and how they compare to traditional ones. In order to be a viable business, they need to attract different groups and there are network effects between these groups.

These network effects lead to strong market power of few players, which raises anti-trust concerns.”

Economic growth

Digital advances mean Europe is connected like never before

7Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

Fiscal futureIt is often proposed that the European Union should adopt a form of fiscal union. On the one hand, it’s argued that fiscal union might give the eurozone strength and stability by mutualising credit risk.

On the other, that governments need flexibility to deal with their own problems. When it comes to what’s best for innovation, however, the jury is still out.

Innovation comeback

Innovation is an important step towards unlocking Europe’s success across sectors and industries. The pivotal question now is: how can all EU countries unlock their potential and stay ahead?

Europe’s moment

Traditional payment models are being disrupted by new technology€50bn of revenue lost per year, due to EU cross-border VAT fraud

Source: European commission

8Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

How can Europe be innovative in fostering its digital economy, while staying competitive?

Özlem Bedre-Defolie:“I believe that fiscal union is a very important thing to achieve for the future of the European Union. The EU made an important step in the e-commerce space, with the very latest reform of VAT for e-commerce that was signed in December 2017.

This creates opportunities for those who want to sell their products online from one country to another EU country, cross-border – you have to sign up to the tax system of the country where you are selling the product, everything is managed and centralised... And you can do all in your own language.

This is a huge innovation for the EU and will constitute the next step for fiscal union, serving to improve the single market; essentially, driving cross-border trade and making it easier for sellers to trade across borders.

Another point is that the EU was losing 5 million euros a year from uncollected taxes in European e-commerce. We need to recover these losses, make it much more transparent, and make it much easier to access other countries’ customers.”

Engines for growthWhile Europe’s economy may be picking up, there is much talk of its engine for future growth: research and innovation.

The EU is implementing policies and programmes that support the development of innovation to increase investment in research and development, and to better convert research into improved goods, services, or processes for the market.

Number of Unicorns, December 2017

What will propel future European innovations

Ferdinand Fichtner:“Given all the developments we’ve seen over the years, Europe and the euro area have a great growth opportunity on their hands. What Trump is doing is massively hostile for innovation, and so many companies and academics operating or working in the US are thinking of coming back to Germany or Europe. The same goes for the UK, with many considering pursuing an academic career in continental Europe because funding is coming from the EU.

These are all issues that could be good for the development of the European Union. It has to be attractive for researchers and scientists to stay in Europe, and if you achieve this, it could have huge consequent benefits for the innovativeness of the region.”

Evolution of business R&D intensity, 2000-2016

Institutions and innovationJust as academics are drawing correlations between economic prosperity and strong institutions, there’s increasing dialogue surrounding innovation and the institutional context in which it’s being developed and nurtured.

With every change comes opportunity; how can businesses exploit these opportunities?

Will Hobbs:“One of the things that the UK has struggled with a lot – and this is something that Germany is quite famous for – is that institutions support the dissemination of innovation. The Bank of England has highlighted this, but too often in the UK it is just the frontier companies that are enjoying the fruits of innovation; the tail of underperforming countries is much larger than you find in Germany or indeed France.

The Bank of England’s chief economist, Andy Haldane, argues persuasively that the UK needs to do more to provide a more helpful institutional context specifically to disseminate the fruits of innovation more widely.”

EU United States China

Source: The World Economic Forum

109

26

59

2

South Korea

Innovation comeback

Source: The World Economic Forum

South Korea Japan United States China EU

GD

P (%

)

2008 20162000

9Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

How can Europe maintain business competitiveness across the world in the future?

Ferdinand Fichtner:“If we ensure that the environment is good for academic research, by making universities attractive to promising scholars with a welcoming atmosphere, this is the best way to improve innovativeness in Europe and overcome the problems Europe is facing.

To make people productive, you need to make an environment that improves productivity.”

E-Commerce shift?With the United Kingdom accounting for the largest e-commerce market in Europe, the online retail landscape may provide a big opportunity for European businesses, post-Brexit.

Brexit: A European perspective

While the United Kingdom deliberates its exit strategy from the EU, European businesses are considering how the vacuum may create opportunities and shift the balance of entrepreneurial power in their favour.

A vacuum of opportunity?

25% 7.9%

The UK has the largest E-Commerce market in Europe

The UK has the largest E-GDP in the world

Source: The World Economic Forum

10Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

How will the balance of e-commerce change post Brexit?

Özlem Bedre-Defolie:“The UK represents the largest e-commerce market in Europe at 25%. 18% of the UK’s retail trade comes from e-commerce and the UK has the largest e-GDP in the world – an impressive 7.9%.

This indicates that after Brexit, we will see a big shake up of e-commerce. With the highest internet penetration rate in the world of 80.5%, Europe has the potential to be a leader in e-commerce, but it’s currently not.

This is largely driven by the variances by country: e-commerce is 15% of Germany’s retail trade, while in Spain it’s only 4.8%, 4.3% in Poland and only 3.4% in Italy. Europe needs to figure out the causes of these differences and how to solve these issues.

With the infrastructure in place, it is clear that the digital economy provides tremendous growth opportunities for Europe, which can be up to EUR 250 billion according to European Commission report on Digital Economy (2015).”

Increasing investment noiseWith a maelstrom of geopolitical factors at play in Europe and globally at present – Brexit being one of them – it’s a noisy time for investors. Despite this, Europe is looking much less disruptive than before.

What about Brexit from an investment perspective?

Will Hobbs:“From an investment perspective, the interesting thing we’ve seen since the UK EU referendum decision is that the world outside of the UK is enjoying an increasing noisy economic party, with investment picking up in Europe, Asia and the US.

The US seems to be indulging in a sulky cigarette outside for the moment. We suspect that long term, the pull of a reasonably attractive demographic profile, a competitive corporate sector, legal system and wider business environment will drag the UK economy back up to a reasonable trend.

However, in the short run, the economy’s ability to weather shocks is becoming more questionable.”

Doing business in EuropeWhile Brexit may shift the balance of power regarding entrepreneurship and innovation in favour of Europe, in Britain, the future of industry is uncertain. And the spectre of trade negotiations and diminished competitiveness is looming large on the UK horizon.

What scenario will Brexit leave behind?

Josef Janning:“Another phase of real challenge is still to come. When the UK leaves the EU, it’s looking likely that it will be cut-off from full access to the financial markets, and therefore face a sort of offshore scenario.

There will be massive incentives to go for de-regulation, particularly to attract business, and so we expect the government to go through the regulatory registry, cut red tape and take regulations away.

This could make it harder for British manufacturers, even in a free trade environment, to do business in Europe, so we may see a trajectory whereby the country moves both politically and economically even further away from Europe.”

Global investment levels are on the rise

The European balance of power is shifting

Brexit: A European perspective

11Tomorrow’s Europe: Uncertainty and unprecedented opportunity…

If prosperity and progress are to flourish in Europe, it needs a new story to tell; one that appeals to researchers, businesses, innovators and investors alike. Europe is at a crossroads; it now needs to take the path that leads to unprecedented business opportunity.

Are we going to see a weakening or strengthening of common policies in Europe and how will that affect competitiveness?

Josef Janning:“Europe doesn’t have a powerful narrative about what it is. Many believe it’s about overcoming the nation state, while in reality, the EU is an agency created to reject the nation state – to compensate for some of its functional deficits and its weaknesses.

What we need is a better, more honest and clear understanding about what this Europe is, so people understand that it’s ok to be proud to be Danish, as long as you understand that you can enjoy that luxury because there’s Brussels.

The nationalists are destroying what they’re claiming to preserve, so if we want to continue this diverse set of rather small nations with their languages and cultures and differences, we need to invest into our instruments of humanity.

And that’s difficult to communicate, but once you understand this, you probably have less reason to be fearful of the Brussels process.”

Conclusion

On the whole, experts agree that the European Union lacks a powerful narrative about what it is now – and more importantly, what it will be in the future.

Europe: A lack of narrative?