Ten Questions on the European Economy

Di Dongsheng, The China Academy, April 20, 2026 —

Europe’s gloomy economic future: the north–south divergence, the rugged path of EU fiscal and monetary integration, and its struggle to adapt to digital-era competition.

1. What is the current performance and development trend of the European economy?

The European economy is currently overall relatively weak, with significant internal divergence.
Among them, Southern European countries that were once deeply trapped in the sovereign debt crisis—Spain, Portugal, Greece, and Italy—have shown relatively strong economic recovery momentum and are performing fairly well.

From 2021 to 2024, the compound annual growth rates of these four countries reached 4.1%, 4.2%, 4.6%, and 3.2% respectively, significantly higher than the eurozone average of 2.4%.

In 2025, eurozone growth slowed to 1.4%, with Germany at 0.2% and France at 0.9%, while Spain, Portugal, and Greece recorded 2.8%, 1.9%, and 2.3% respectively.

Italy remained somewhat weak at 0.5%, but overall, Southern European countries have shifted from being “dragging forces” to important drivers of regional growth.

Looking ahead, according to the European Commission’s Autumn 2025 forecast, EU economic growth in 2026 and 2027 will be 1.4% and 1.5% respectively, while eurozone growth will be 1.2% and 1.4%.

Spain’s growth will be 2.3% and 2.0%, Germany’s will be 1.2% in both years, and France’s will be 0.9% and 1.1%.

However, in the medium to long term, Southern European countries still lack sufficient growth momentum due to weak industrial competitiveness.

The reason for the current “north–south divergence” in Europe mainly stems from the combined effects of multiple structural shocks and policy differences.

On the one hand, “northern countries” were more severely impacted by the energy crisis triggered by the Ukraine crisis.

Economies highly dependent on Russian energy faced soaring energy costs after the sharp reduction in EU–Russia energy trade, which increased burdens on both manufacturing and households.

On the other hand, their products often compete directly with those of emerging economies such as China, resulting in more pronounced market pressure.

The most obvious example is Germany.

As one of the world’s three major production network hubs (East Asia centered on China, North America composed of the U.S., Mexico, and Canada, and Europe centered on Germany), its pillar industries such as automobiles and chemicals have been significantly affected by China’s industrial upgrading.

This effect has also spread to other countries within Germany’s supply chain network.

For example, during a recent delegation visit, I met Czech European Parliament member Dostál.

When I asked him about the Czech economy, he said it was “not doing well.”

The Czech Republic is an important part of Germany’s production system, and its economic performance is affected by Germany’s downturn.

By contrast, Southern European countries have performed relatively well in recent years mainly due to two factors:

First, their economic structures make them less affected by the energy crisis and external industrial competition.

Overall, Southern European countries are less dependent on Russian energy, and their industries are mainly labor-intensive, with less overlap with China’s capital- and technology-intensive industries.

Second, the EU’s €750 billion recovery fund launched during the COVID-19 pandemic played a key role.

The fund tilted toward Southern Europe, effectively alleviating economic pressure in those regions.

After the pandemic, the recovery of the service sector—especially tourism—also provided strong support for Southern European economies.

Looking ahead, Europe’s economic prospects will mainly be influenced by three factors:

First, the development of the defense industry.

At present, Europe’s defense industry is generally expanding, but internal divisions remain large and no real unified force has formed.

The continuation of the Ukraine crisis, combined with the shift of the United States from “protector” to “extractor” and “regional hegemon,” has forced Europe to rethink its defense autonomy strategy.

Compared with past discussions of strategic autonomy mainly targeting China and Russia, Europe is increasingly viewing the United States as a potential object of concern.

Its strategic autonomy discussion is increasingly directed at the U.S., with the core demand being autonomy and controllability of the military-industrial system.

In recent years, I have attended the Berlin Global Dialogue multiple times and have repeatedly heard European politicians express hopes of revitalizing European manufacturing through military reconstruction.

This idea aims to use the spillover effect of the defense industry to upgrade manufacturing and reshape Europe’s position in global industrial chains—from a production partner in the globalization era to a key force capable of responding to major global changes and geopolitical conflict.

In addition, changes in the transatlantic partnership and the development of right-wing political forces in Europe (i.e., whether far-right leaders will come to power in some countries) will also have significant impacts on Europe’s economic future.

2. How does the EU’s unique institutional system constrain Europe’s economic development?

The EU consists of 27 countries, with significant differences among member states, and its unique institutional structure undoubtedly constrains economic development.

First, fiscal integration is absent, which restricts the large-scale development of the digital economy.

In 2017, I published a paper in World Economics and Politics, arguing that “Europe’s traditional industries are stagnant and it is comprehensively lagging in the digital economy.”

This was arguably the first time this view was proposed globally.

I believe the reason Europe’s digital economy is weak is not only due to the then-prevailing neoliberal ideology limiting industrial policy, but more fundamentally due to structural reasons.

The digital economy has a strong power-law effect, characterized by “the strong getting stronger and the weak getting weaker.”

Its core logic is that digital industries require huge upfront investment in R&D and platform construction, but have extremely low marginal costs, making scale and network effects extremely strong.

Once firms reach a critical scale, they can serve massive users at near-zero marginal cost, creating a winner-takes-all market structure.

Therefore, digital industries have extremely high market concentration, with exponential gaps between leading firms and followers, forming a steep power-law distribution.

By contrast, traditional manufacturing industries such as automobiles also have economies of scale, but their marginal cost reduction is limited and physical capacity constraints remain significant, making it difficult to form such extreme monopolistic structures.

For Europe, digital economy development requires a unified large-scale market, but fiscal sovereignty is fragmented among member states, making coordinated regulation and redistribution difficult.

For example, if a startup in Frankfurt develops a ride-hailing platform similar to Didi, it cannot achieve sustainable profitability within Germany alone.

Cross-border expansion is necessary, but it creates asymmetric distribution effects: high-value-added jobs and technological gains concentrate in core cities and capital holders, while traditional industries such as taxis face widespread disruption across member states.

Because the EU is similar to a confederation, with fiscal sovereignty dispersed, it creates a “localized gains, externalized costs” dilemma.

When German firms create digital platforms that impact other countries, in the absence of supranational redistribution mechanisms, governments naturally impose implicit barriers to protect local employment and tax bases.

This “beggar-thy-neighbor” regulatory competition constrains the scaling of Europe’s digital economy.

China, by contrast, has a unified national market and fiscal transfer system that balances regional interests.

The United States is a federal system, where capital can generally deal directly with the federal government.

Second, the accession of Central and Eastern European countries has squeezed Southern Europe’s position in supply chains.

European integration has followed a clear “core–periphery” structure.

Early on, Western Europe formed the core, followed by Northern Europe, while Southern Europe occupied a secondary core position.

After the Cold War, Central and Eastern European countries joined the EU, reshaping this structure.

These countries are highly similar to Southern Europe in industrial structure, as both can absorb manufacturing and service transfers.

However, Central and Eastern European economies have stronger competitiveness due to lower labor costs, lower land costs, higher efficiency, and policy incentives.

This has created structural substitution pressure on Southern Europe.

I believe one of the root causes of the European debt crisis was precisely this dynamic.

Third, monetary integration—i.e., replacing national currencies with the euro—has led to two consequences.

First, member states lost exchange rate tools, leading to divergence in competitiveness.

Germany’s competitiveness was strengthened due to the euro’s relative depreciation effect, consolidating its export advantage.

In contrast, Southern Europe’s real exchange rates became overvalued, weakening export competitiveness.

Without exchange rate flexibility, countries like Greece became locked into low value-added industries.

Second, peripheral eurozone countries carry a form of “monetary original sin,” as they cannot borrow internationally in their own currency.

Since the European Central Bank sets unified monetary policy, national central banks cannot independently issue currency or adjust interest rates.

Thus, countries like Greece cannot use monetary expansion to ease fiscal pressure or adjust debt costs.

They lose monetary sovereignty without gaining equivalent policy coordination, resulting in a situation of nominal currency sovereignty but no real monetary autonomy.

3. How will U.S. politics and the Ukraine crisis affect Europe’s economy?

I believe that under current conditions, U.S. political evolution has at least three scenarios:

First, President Trump may attempt to reshape the rules of the political game to sustain an extremely conservative policy system.

He has pushed immigration enforcement agencies into “non-compliant” states, increasing the use of force in daily enforcement.

This reflects both the MAGA movement and preparations for potential “lame duck” constraints if Republicans lose midterm elections.

Second, in the 2028 election, Trump may promote a preferred ticket—currently Vice President Vance and Secretary of State Rubio are seen as leading figures—and continue conservative policies.

Third, the Democratic Party could return to power, although it currently lacks strong core leadership.

These developments in U.S. politics will affect Europe through external channels.

On one hand, continued Trump dominance and use of tariffs as economic coercion will place systemic pressure on Europe.

On the other hand, Trump-aligned forces may attempt to dismantle Europe’s “firewall” against right-wing populism.

At the Munich Security Conference last year, Vance already expressed support for removing such constraints.

If Europe’s political ecology is reshaped, its economic trajectory will be significantly affected.

Meanwhile, a potential ceasefire in Ukraine would also have profound economic implications.

If a Russia–Ukraine truce is reached, European energy prices would fall and sanctions would gradually be lifted.

The current sanctions regime has a strong backlash effect, effectively acting as self-imposed economic punishment for Europe.

A resolution of the crisis would reduce energy costs and trade barriers, easing inflation and improving supply chain stability, thereby supporting recovery.

4. Can fiscal expansion truly revitalize Germany and Europe?

In 2025, Germany’s growth rate is 0.2%, ending two years of negative growth but still weak.

Private and public consumption are the main drivers, while investment and exports remain weak, reflecting geopolitical pressure and external competition.

To address this, Germany has launched a fiscal stimulus package, including a €500 billion infrastructure fund (2025–2036), relaxation of the debt brake, and expanded borrowing capacity for states.

As a result, German debt could rise by €850 billion by 2029.

Government spending will increase significantly in nominal terms in 2025 and 2026.

However, Germany still faces uncertainty due to rising deficits and structural constraints.

Future risks include debt repayment pressures starting in 2028 and continued U.S. tariff shocks.

Therefore, while fiscal expansion may boost growth in the short term, optimism should be limited.

5. Can Europe balance “guns and butter”?

There is ongoing debate in Europe about whether defense spending will crowd out welfare spending.

This is a painful trade-off.

Europe’s postwar model relied on U.S. security, Russian energy, and Chinese markets.

All three foundations are now weakening.

The ability to maintain balance depends on fiscal capacity, EU-level coordination, and new financial instruments.

6. Can Europe catch up with China and the U.S. in the digital economy?

This is difficult.

The U.S. and China dominate platform ecosystems such as Google, Amazon, Tencent, Alibaba, which function as data and AI infrastructure.

Europe lacks such platforms due to structural fiscal fragmentation.

Regulation also suppresses innovation, and politically it is unlikely to be relaxed.

Moreover, digital platforms shape information flows, meaning Europe has effectively lost part of its digital sovereignty.

7. Which political forces can effectively boost Europe’s economy?

Right-wing populism and left-wing populism are both rising, with the former stronger.

From an economic effectiveness perspective, right-wing populism may have greater potential.

In practice, figures like Italy’s Meloni are more pragmatic than extremist.

These forces are less ideologically constrained and more focused on practical governance, which may help economic performance.

8. How does Europe now view globalization?

Europe was once a major beneficiary of globalization, but is now experiencing its structural pressures.

Globalization is increasingly associated with industrial adjustment, social fragmentation, and political polarization.

Europe is shifting from a globalization champion to a more cautious actor.

9. Under what conditions might Europe “move closer to China”?

Three conditions:

First, achieving relative defense autonomy.
Second, building an independent information ecosystem.
Third, China demonstrating tangible economic goodwill.

Currently, Europe’s “turn to China” is largely reactive, driven by U.S. pressure.

China also needs to take proactive steps, including addressing European concerns in practical ways.

10. Has the meaning of “learning from Europe” changed for China?

Although China has surpassed Europe in some areas such as the digital economy, Europe still has many lessons worth learning.

Today, “learning from Europe” should mean learning from its experiences and mistakes rather than imitation.

For example, China could draw lessons from Europe when designing a welfare system suited to the AI era.

Artificial intelligence will disrupt employment structures and destroy more jobs than it creates in the short term.

Unlike past technological shifts, this is more structurally disruptive.

Therefore, China could consider establishing a “starter income” system to support young people, improve fairness, and encourage education and family formation.

This would help avoid welfare dependency and prevent problems seen in parts of Southern Europe.

Similarly, Europe’s immigration policies—intended to address aging—have produced unintended social tensions.

This experience may also serve as a lesson for China.