Europe’s increasingly volatile industrial doom loop

France’s civil Maginot Line has just been crossed. The government has essentially fallen.

Massive budget deficits, way over European Union limits, forced the Macron government to propose spending cuts to get their deficit below 5 percent of GDP from more than 6 percent. That was, however, enough to unify the hard right and left in opposition. The center is nowhere to be found.

France, Europe’s second-largest economy, is now adrift in a sea of uncertainty. Both equity and credit markets are suffering and the bottom is not in sight.

Northeast of France, Germany is in the throes of an industrial nightmare. Two economic stalwarts, automaker Volkswagen and steel fabricator Thyssenkrupp, are shedding workers and threatening plant closures. In the case of Volkswagen, this is something unseen in the 87-year history of the company. Workers just staged a practice two-hour strike and threatened far longer ones unless planned job cuts and wage rollbacks are rescinded.

At least the German annual budget deficit is under 3 percent, so the actions do not threaten borrowing costs.

What is behind this industrial discontent with its very serious political ramifications are several factors, all of which point to the day of reckoning coming soon.

First, Europe has been in a slow-growth mode for well over a decade, lagging far behind Asia and especially China. Even compared to the U.S., the continent has consistently experienced lower growth coming in around 0.9 percent annually over the last decade.

The European recovery from the COVID lockdowns has also lagged behind the U.S. According to the Brookings Institution, every facet of the recovery is lower in Europe: labor participation, industrial output and GDP growth.

Simultaneously, the demands of an aging population, immigrants’ needs and the war in Ukraine have placed unprecedented strains on social services and defense budgets.

European workers, and the population in general, expect a continuation of the social benefits they have grown accustomed to in the heady post-war years. Needless to say, governments are very reluctant to cut these benefits and have chosen to finance them via deficit spending.

On top of this, Europe is under assault on several economic fronts from Chinese overcapacity. Be it autos, solar panels, electronics of all makes and models, textiles or toys, China is exporting around $300 billion more in goods and services than Europe sells to China. As recently as 2022 it was significantly higher.

The plain fact of the matter is that there is nothing Europe can make cheaper than the Chinese can. While the German workers were on strike, China’s 200+ auto factories were humming along without a hiccup, churning out advanced EVs destined for Europe.

Adding insult to injury, Germany and the other high-tech countries exported lots of machine tools, cutting-edge industrial know-how and even patented biotech processes to China, under the gun of forced technology transfers and required “joint venturers.”

Now in an “All About Eve” moment, the Chinese understudy no longer needs the aging European diva and can outperform in engineering prowess any continental company (see auto battery makers like CTAL, the world’s largest). If that fails, China just uses industrial espionage to steal whatever tech it wants.

The doom loop can now be seen in its entirety in Italian statesman Mario Draghi's recent paper on “The Future of European Competitiveness.” Europe’s aging and declining population cannot produce the growth necessary to support the social services and defense budgets. Workers experience declining living standards. In order to cushion this fall, they look for less expensive everything, from clothes to cars.

This benefits China and other low-wage countries, yet results in more unemployment and underemployment as aggregate domestic spending is reduced. This results in more massive deficits as governments refuse to cut services or place trade barriers on imports.

Rinse and repeat until governments fall or strikes cripple output. This results in higher borrowing costs and even larger budget deficits. There’s darkness at the end of the tunnel.

There is little hope of a way out. Like Great Britain after World War II, the restoration of global importance is in the past. Europe is constitutionally unsuited for a Reagan or Thatcher moment. The spark of a new dawn is not in the DNA of the populace.

If you doubt this, recall the 25-year-old French men protesting the raising of the retirement age a few years back. They took to the streets, horrified they would lose pension benefits 40 years into the future. In 2023, European start-ups raised $52 billion vs. the $138 billion in the U.S., even though Europe's population is larger than America’s.

So as far as this eye can see, China will continue to drain Europe's jobs and GDP. Any attempt to rectify this will be met with countermeasures against cherished EU products like Brandy or Iberian ham. There is little else China can threaten, as they already produce everything they need of any real value.

Europe’s sclerotic left will continue to wage strikes and slowdowns as if this were a Marxist struggle from two centuries ago. The newly threatening ascendant right, now in almost all EU countries, will point the finger at immigrants and cultural decadence. Their nationalism will threaten the very economic cooperation that lifted a country like Spain from a quaint tourist backwater to a full member of the global order.

The goal of these nationalist movements will be aided and abetted by Russia through social media plus under-the-table cash. The weaker the EU is, the more the Russians gain. The EU's resurgent right doesn’t see this as a problem, since it harbors nostalgic longings for strong men and scoffs at the democratic process.

Sooner or later, something will break. All those who are going to be crushed by the falling pieces will wish they had compromised earlier, worked toward a coherent industrial policy, and stopped believing in the myth of free trade.

Jonathan Russo writes about entrepreneurship, economics, domestic and foreign policy and cultural issues.

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