The current US administration’s willingness to weaponise trade makes clear that transatlantic economic relations have become entirely transactional. This column, taken from a CEPR book on the economic consequences of the second Trump administration, argues that Europe must respond to US tariffs, which target weakness, with economic strength: faster productivity growth, cheaper energy, a genuine continental market, and tech leadership.
The return of Donald Trump to the White House confronts Europe with an existential challenge. His administration’s willingness to weaponise trade – treating even NAFTA partners as adversaries – makes clear that transatlantic economic relations have become entirely transactional. The same is true for all the other aspects of the US–EU relationship, including the critical security dimension. Europe faces this challenge from a position of weakness, after two decades of relative decline. Hence this shock demands a fundamental economic renewal. Without addressing the structural causes of this weakness, Europe cannot achieve the strategic autonomy it desperately seeks.
The actions of the European institutions – the Commission, the Council and the Parliament – must respond to the Trump shock along three dimensions:
- Growth: Europe’s stagnation undermines the continent’s ability to respond to external shocks. Europe must grow again.
- Trade: The best response to the increasing world fragmentation and difficulty of trading outside the EU is to deepen the Single Market and eliminate the many remaining barriers to trade between member states.
- Defence: While there is a role in defence for the EU and its institutions, the EU must concede that main action here must take place at a broader level.
The Trump shock meets European economic weakness
In May 2025, President Trump proposed a 50% tariff on EU imports. Whether this ends up being imposed or not, his administration’s economic attack has arrived at Europe’s most vulnerable moment. As Draghi (2024) points out, the EU–US gap in GDP per capita widened from 15% in 2002 to 30% in 2023, and 70% of the shortfall reflects weaker European labour productivity. Italy’s performance is an extreme example: its 2023 real GDP per head remained at 2000 levels. 1
This dismal performance has multiple origins, but four merit special attention: energy costs, innovation, regulation, and the Single Market. I discuss the first three in this section.
Energy
In 2024, EU firms faced industrial electricity prices 2.5 times higher than the US and natural gas prices five times higher (Heusaff 2024). While this gap partly reflects Europe’s lack of natural resources and Russia’s weaponisation of gas flows after the 2022 invasion of Ukraine, fundamental market design and regulatory choices exacerbate the problem. The April 2025 Spanish blackout – when the country lost all electricity for hours – demonstrated how renewable integration without adequate grid stability can create catastrophic vulnerabilities (Garicano 2025b). The Europe-wide Dunkelflaute (the winter doldrums with no sun, no wind, and lots of heating demand) is likely to become a feature of the transition. High and unpredictable energy costs have contributed to the loss of over 500,000 European manufacturing jobs since 2022, accelerating deindustrialisation in sectors that once formed Europe’s industrial backbone. According to a Financial Times article, German energy-intensive firms are producing 20% less than before the Covid-19 pandemic and corporate distress is at levels last seen during the height of the pandemic.
Europe must deal with its energy problem. Approving the 25,000 km of pending cross-border transmission lines would cut wholesale prices by double digits and harden the grid against blackouts. Moreover, Europe must adopt a much more pragmatic posture concerning nuclear energy and gas. Both will be necessary for stability.
Innovation
Europe’s innovation deficit further weakens its position. Only four of the world’s 50 largest tech companies are European. No firm founded in Europe in the past half-century has reached a €100 billion valuation. EU startups attract just 6% of global AI funding, versus 61% for the US (Draghi 2024). This innovation gap means Europe increasingly depends on foreign technology for its digital transformation, creating new vulnerabilities.
The response to this problem has two main axes. We must improve our innovation system, and we must facilitate creative destruction. I focus here on one useful solution to the innovation finance gap proposed by both Draghi and by Enrico Letta (Letta 2024): a single ‘28th regime’ corporate statute covering venture financing, stock-option taxation, and insolvency would allow start-ups to scale across the continent.
Regulation and compliance
As Draghi (2024) documented, Europe’s weakness is in part the result of the increasingly complex regulatory environment. These regulations, often well-intentioned, serve some potentially important purposes from privacy protection to environmental standards. But it is increasingly recognised that they impose large cumulative costs on EU companies and make market entry and exit, as well as firm growth, extremely hard. The Corporate Sustainability Reporting Directive (CSRD) alone requires companies to track 1,052 data points, with compliance costs estimated at 12.5% of mid-cap firms’ annual investment budgets. During 2019-2024, the EU passed approximately 13,000 Acts compared to 3,500 pieces of legislation at the US federal level. This regulatory density, combined with national variations in implementation, creates a complex operating environment that particularly burdens smaller firms.
No one who has read the Draghi Report can have any doubt that Europe must significantly reduce its regulation. At a minimum, the Omnibus proposal now in Council would trim mandatory CSRD data points and defer low-materiality disclosures. But Europe must go much further. The entire regulatory apparatus must be examined and pruned – particularly to facilitate competition inside the Single Market, as I discuss next.
Europe’s interconnected weaknesses – high energy costs, innovation deficits, and regulatory complexity – make it particularly vulnerable to Trump’s economic coercion. Europe’s response to the Trump shock must begin with economic renewal. Without internal economic strength, Europe cannot credibly pursue strategic autonomy or maintain its social model. But there is one more critical element to the response: the Single Market.
The trade shock and the Single Market crisis
The best response to the sudden increase in external barriers and the consequent external trade fragmentation would be to reduce internal barriers. Yet the EU’s crowning achievement – the Single Market – is deeply flawed. The IMF calculates that hidden barriers within the EU are equal to a 45% tariff on goods and a 110% tariff on services, exceeding the Trump administration’s most aggressive China tariffs.
Figure 1 Barriers to EU internal trade: 2020 tariff equivalent
Source: IMF (2024).
Also according to the IMF, since the mid-1990s, trade costs for goods have dropped 16% for non-EU imports but only 11% for trade within the EU. Intra-EU trade intensity remains 50% lower than that between US states (IMF 2024). This means European companies often find it easier to expand in America than in neighbouring EU countries. As a result, according to the IMF, the EU’s internal services trade and its external services trade are roughly the same size as a share of the EU economy. In a true single market, internal trade should be much larger. In a world where scale is ever more vital (services include such scale-intensive business as AI, finance and IT), this fragmentation of the Single Market is very damaging.
Figure 2 Intra- and extra-EU trade in the European Union
Source: IMF (2004).
The harmonisation trap
EU legislation frequently worsens rather than solves market fragmentation. New directives pile atop existing national rules rather than replacing them. Research on capital market regulation shows countries actually diverge more after EU harmonisation attempts (Ewens and Farre-Mensa 2020) – stronger regulatory countries maintain their standards while weaker ones add EU requirements without removing national ones.
Banking illustrates this layering problem. The Single Supervisory Mechanism oversees banks, but national central banks impose additional capital and liquidity requirements. French banks operating in Belgium, for example, face French, Belgian, and European regulators simultaneously, eliminating cross-border synergies.
Data protection creates similar absurdities. Despite the General Data Protection Regulation (GDPR) being an EU regulation, Austria banned Google Analytics while neighbouring countries permit it. Italian authorities threatened US data transfers that remain legal elsewhere. Publishers operating EU-wide must maintain separate systems for different countries.
Professional mobility remains constrained despite decades of EU directives. Portuguese engineers with EU-recognised qualifications face lengthy German equivalency checks. Architects and other professionals navigate regional requirements within single member states. Small firms often abandon cross-border expansion rather than fight bureaucratic battles.
Enforcement collapse
The European Commission has abandoned its treaty duty to police the Single Market. Infringement cases dropped to 658 in December 2024, down 21% since 2020. New cases fell to 173 yearly, one-quarter the volume from a decade ago. At the same time, case duration stretched to 46 months, up 31% since 2019.
Figure 3 Total infringement actions of the European Commission, by year
Source: European Commission Single Market Scoreboard.
This decline reflects the Commission’s evolution. Styling itself as “geopolitical” (von der Leyen 2019), it seeks influence in defence, housing, and foreign policy while neglecting core obligations. Confronting member states over market violations undermines the political cooperation needed for these expanded ambitions.
Without enforcement, the Single Market erodes. Small companies in particular cannot afford legal battles against national authorities claiming health or safety exceptions. The original mutual recognition principle – that products legal in one member state should circulate everywhere – has become meaningless without credible enforcement.
Europe must restore mutual recognition as the default rule and dramatically increase enforcement actions. Products and services legal anywhere in the EU should face no additional barriers elsewhere unless governments prove concrete risks. The Commission must choose between political expansion and its constitutional duty to maintain Europe’s economic foundation.
Defence and strategic autonomy: Finding the right division of labour
As with trade, the Trump administration has made clear that its approach to defence is transactional. This shock demands European strategic autonomy, including in defence. The question this raises is how to organise this effort most effectively.
Arguments for greater EU involvement in defence rest on solid economic logic made in this book, for instance, in the chapter by Armin Steinbach, Guntram Wolff, and Jeromin Zettelmeyer and in the chapter by Ethan Ilzetzki. Defence procurement shows significant economies of scale, and defence R&D generates substantial spillovers to civilian technology. The current fragmentation – Europe operates 12 different main battle tanks compared with America’s one – creates inefficiencies that weaken collective defence while raising costs. Coordinated procurement could deliver better capabilities at lower cost.
However, effective European defence faces structural challenges that EU institutions cannot easily overcome. First, the EU is a diverse bloc with very different security and defence postures among its members. It includes traditionally neutral states (such as Ireland, Austria, and Malta) that have not been in NATO or any other military alliance. Member states also hold varied threat perceptions and foreign policy leanings, sometimes influenced by historical or economic ties that can complicate unified action, particularly concerning large powers like Russia. With respect to this crucial player, the EU members’ attitudes run the gamut from slavish submission (Hungary) to bold defiance (Poland and Estonia). Foreign policy and defence decisions typically require unanimity – a high bar that often leads to slow or lowest common denominator outcomes, ill-suited to the pace of geopolitical events
Second, a successful defence posture requires including NATO and non-EU actors. Key European security actors, including the UK (a major military power), Norway (critical for North Atlantic security), and Turkey (a large NATO ally in a strategic region), are outside the EU. Canada, another G7 nation, is also a vital NATO partner currently with one foot outside of the US defence umbrella. An EU-centric defence policy risks duplicating efforts and alienating these crucial allies.
Third, the EU treaties offer a limited basis for a common defence policy in the traditional sense. While initiatives like the European Defence Fund, the Permanent Structured Cooperation (PESCO), and the European Peace Facility represent important steps in bolstering defence industrial cooperation and supporting partners, they do not equate to a centralised EU defence command or foreign policy execution power vested in the Commission.
A more effective approach to European security involves ‘coalitions of the willing’ within NATO or through ad-hoc groupings. Guntram Wolff, Armin Steinbach, and Jeromin Zettelmayer (2025) have recently proposed a groundbreaking European Defence Mechanism (EDM) that exemplifies this approach (Wolff et al. 2025). Their proposal envisions an intergovernmental institution open to all European democracies – both EU and non-EU members – where participants would pool resources to collectively procure defence equipment and services. The EDM would issue bonds to finance joint defence procurement and common defence assets, with members paying for their shares of jointly procured defence goods when delivered.
The proposal addresses both fiscal and operational realities. It provides a framework to integrate national and EU defence policy through flexible interpretation of fiscal rules, collective arms procurement, and centralised investments. By allowing non-EU states like the UK, Norway, and potentially Switzerland to participate, it acknowledges that European security transcends EU membership.
The key insight is that European security requires flexible geometries. The EU can contribute significantly through defence industrial policy, research coordination, and single market benefits for defence firms. The European Defence Fund and PESCO represent important steps. But operational defence coordination must include all European security stakeholders, not just EU members. Forcing defence into EU structures risks excluding key allies and creating inefficient parallel organisations.
Conclusion: Economic power or strategic irrelevance
Trump’s return makes European strategic autonomy not just desirable but necessary. Yet, autonomy without economic strength is an illusion. A Europe that cannot compete economically cannot defend its interests or values globally. The mathematics are simple: declining GDP and innovation ability equals strategic irrelevance.
The Trump administration’s tariffs target weakness. Europe can answer only with economic strength: faster productivity growth, cheaper energy, a genuine continental market, and tech leadership. Every hidden barrier, every reporting burden, and every fragmented defence project hands leverage to Washington. Completing the tasks above would add at least 8% to EU GDP within five years and narrow the strategic gap with the United States.
Europe has the talent, resources, and institutional framework to compete globally. Its universities produce excellent graduates, its companies hold leading positions in many industries, its legal framework provides stability and predictability. What it lacks is the political will to dismantle internal barriers and create the conditions for growth. Given the external pressures Europe now faces, it is, truly, now or never.
Source : VOXeu
