Europe’s Economic Challenges Discussed at the European Forum Alpbach

Economic

Summary:

At the 2024 forum (17-30 August 2024), Bruegel participated as a Track Reporting Partner covering the finance and economy track.

Introduction

The European Forum Alpbach is an annual conference, staged since the 1940s in Austria, where the challenges faced by Europe and the European Union are discussed. At the 2024 forum (17-30 August 2024) , Bruegel participated as a Track Reporting Partner covering the finance and economy track. This article summarises the discussions relating to six issues within that track. The six issues, which are in line with Bruegel’s Research Programme 2024/2025, were:

The evolution of inequality

Within-country inequality has been increasing for the last two to three decades. Meanwhile, convergence between poorer and richer countries may have slowed because of conflicts or the impact of automation and technological change. Different levels of inequality within market economies show that some governments are more willing to deploy the tools to address this challenge. While still very limited, wealth taxation is often seen as a possible tool to tackle the problem.

Financing the green transition

Europe has a long-term strategy for the green transition and is starting to implement it. The strategy requires significant investment, which neither the public nor private sector can provide alone. The European Union needs to complete its capital markets union and increase the attractiveness of investment through better regulation.

The future of work: artificial intelligence and automation

Employment rates remain high, and the predictions that technological change will destroy jobs have yet to materialise. Given the rapid take-up of new technologies in recent years, Europe should focus on regulations that protect consumers and their personal rights, while protecting innovation and economic growth.

Defence

Russia poses the biggest threat to the security of democratic European countries. European defence needs greater transnational cooperation and more integration, so that European defence companies can achieve bigger scale and remain competitive globally. Unified capital markets will again be important in stimulating greater levels of short- and long-term investment.

Finance

Demographic change challenges the sustainability of European pension systems and welfare states more generally. Governments must design systems that guarantee both intergenerational fairness and fiscal sustainability, while encouraging financial literacy.

Digital currencies, specifically the digital euro, present new challenges and opportunities. Europe could reduce its reliance on foreign providers through the use of digital currencies. New digital payment methods may play a geopolitical role by making it easier to circumvent international financial sanctions.

Making economics useful for the modern world

Economists seek to anticipate and understand socioeconomic interactions. In the modern, data-rich world, the field has developed rigorous quantitative tools to improve fact-based policymaking. However, economists should also work collaboratively with other social scientists to offer more holistic approaches to complex problems.

Inequality

Challenges

The COVID-19 pandemic deepened inequality. The world’s five richest people have doubled their wealth since 2020, and the richest 20 percent own 80 percent of total wealth. Inequality can lead to undesirable social outcomes and have negative effects on economic growth. It is linked to the rise of extremism and social backlash. It also affects socioeconomic indicators such as childhood poverty rates, affecting future economic growth and productivity.

Among the drivers of inequality, one factor explaining wealth inequality is different investment returns across the income distribution. People at the top own financial assets, those in the middle own houses, and the poorest households own barely anything. Risk preferences explain part of these differences: poorer households have a greater chance of being affected by unemployment, so they do not want risk buying a house and being unable to pay for it. Wealth inequality is thus self-reinforcing: returns are higher for those who already have substantial assets. Other factors deepening inequality include the rise of monopolistic markets, the non-mobility of labour and the anti-union movements in certain countries.

Inequality is growing within countries, and some factors may be slowing down the convergence between poorer and richer countries that has taken place in the last few decades. Within countries, demographic change affects inequality and wealth, as people live longer and their descendants inherit their assets later in life. Between countries, military conflicts stop growth for some emerging economies, widening the gap between high- and low-income countries. Changes in AI and robotics might also constrain the convergence of developing countries as some growth opportunities may no longer need to be located in poorer countries.

Potential solutions

High inequality is not an inherent characteristic of market economies. This is shown by the existence of market economies with both higher (United States) and lower (Nordic countries) levels of inequality. Governments have tools to reduce inequality. Advances in economic research and the availability of rich data can help address these issues. Leading institutions and organisations are developing new projects with this purpose.

Inequality and technological developments are leading to a rethink of the role of taxation and wealth taxation specifically. Wealth taxation has changed significantly over recent decades. While previously a number of Organisation for Economic Co-operation and Development countries had wealth taxes, currently only about four do. In Austria, for example, capital gains taxation has been rather flat for the last 20 years. Most wealth is concentrated at the top of the distribution. Even at the top, wealth is skewed towards the very rich.

Labour income used to be enough to climb the income ladder, but now reaching the top of the income distribution only with labour revenues would take more than a lifetime. Capital income has become more important, but taxing wealth is different to taxing labour income, and it might be difficult to make it effective. Assets are sometimes highly illiquid, and it is often possible to restructure assets to avoid taxation (eg through investing in art).

Wealth taxation is thus an instrument to consider when trying to reduce inequality. However, difficulties arise in terms of the practical details of taxing capital in ways that are both effective and economically efficient.

Financing the green transition

Challenges

Climate change is already being felt and the cost of inaction is huge. No short-term solution will work, so Europe needs to effectively and efficiently implement its long-term strategy: the European Green Deal.

The European Green Deal lacks the resources required to deliver this transition. Some estimates, cited at the forum, point to €700 billion needed per year, while the Green Deal has around €170 billion per year. The big investment gap needed to be filled from both public and private sources. Europe therefore needs to attract more private capital, and to develop fully a capital markets union, while also changing the investment culture and moving to long-term money.

Some aspects of the green transition do not necessarily carry a cost. For example, evidence is lacking for the assumption that the transition will have an overall negative impact on labour markets. The green transition affects labour markets in different ways, creating opportunities for green jobs but also destroying or modifying carbon-intensive jobs.

Potential solutions

The EU should prioritise the completion of the capital markets union so funding stays in Europe and remains available to European companies and to meet European needs. Governments need to maintain their efforts to increase levels of financial literacy, so that new financing channels will open up and be used by private individuals. The EU should also deploy its soft power and EU regulation as a global standard for climate finance, while easing bureaucracy.

AI and automation

Challenges

The predicted collapse of the labour market because of AI has not materialised yet. Employment has actually increased in companies with high AI exposure. Furthermore, employees in these sectors tend to have a positive view of AI: it helps their work and makes them more productive.

However, the pace of AI development and adoption is very fast. Implementation of these technologies will happen sooner or later in every sector or application, and companies will need to integrate these technological advances wherever they can.

Policymakers must navigate this trade-off. While AI can lead to productivity and welfare gains, the fast pace of AI development and adoption also shows the importance of protecting both people and innovation. Innovation must not be undermined by allowing AI to carry out tasks that might breach social rights and European values, such as surveillance or propagation of biases based on race or gender.

Potential solutions

EU regulation should aim at increasing trust in AI, which in Europe is currently lower than in other major economies including India and China. Effective regulation can increase trust and encourage consumers and businesses to use AI.

Similarly, the risks of AI and its possible undermining of privacy or personal rights should be addressed through smart regulation. This would allow users to use AI tools confidently, while protecting an innovative and productive business environment.

The future of work is uncertain, but so far, employment levels remain at record highs in many economies. It seems that as long as there are problems to solve, jobs will be needed.

Defence

Challenges

Russia’s invasion of Ukraine threatens European democratic countries, and should be a wake-up call. It requires a European response but most European countries still take national approaches to the problem. This is mostly reflected on the production side, with countries usually preferring to buy military products from their national companies. The EU does not have common public procurement for defence, resulting in 27 different procurement systems. As pointed out in several discussions, European nations need to show greater willingness to defend Europe and European values, including through military means.

Underinvestment in the defence sector has lasted for decades. Furthermore, the fragmented defence market means the EU does not have the scale and level of specialisation necessary to spend money efficiently, make essential investments and achieve higher productivity. Underinvestment is even more worrying on the R&D side, in particular startups and venture capital.

Collaboration with the US within NATO is indispensable, especially given the immediate threat from the war in Ukraine. However, Europe is still too reliant on foreign providers, especially the US. Even for some European products (eg drones), manufacturing takes place abroad (for instance in China), posing risks to economic security.

Potential solutions

European defence needs new reliable and long-term frameworks for common procurement, together with better integration of national defence sectors. This would increase the attractiveness of the European defence market and facilitate the scale and necessary investments needed to increase national and continental security.

Europe needs to maintain its cooperation with international partners, especially within NATO. Deepening the single market for defence would be a way to increase Europe’s competitiveness and production, resulting in less security reliance on foreign providers and enhancing Europe’s strategic autonomy.

Finance

a. The future of pension systems

Challenges

Demographic change poses a considerable challenge to the sustainability of public pensions and the overall welfare state if necessary measures are not taken. The current labour force might receive significantly lower pensions than current retirees. This gap between current and future pensions is expected to keep increasing over time.

European consumers are rather risk averse in relation to investment, with their savings mainly in banks and housing. This behaviour should change; consumers should also consider investing in other financial instruments. It is no coincidence that countries with greater risk appetite also have better funded investment and pension systems.

Within the EU the full inter-country mobility necessary to have a real single market in Europe for pensions is still lacking – another missing layer from the capital markets union. Countries should learn from each other and see what has been done wrongly and what could have been done better in other countries.

Potential solutions

Pension systems should build up the different pillar structures: public pensions, private pensions and complementary pensions or private savings and investments, to guarantee the sustainability of pension systems and the adequacy of pensions. Options such as making work and retirement compatible, or incentives for worker to invest, should also be considered and encouraged by public policies.

Governments should increase financial literacy across different socioeconomic groups. Financial literacy is a tool for intergenerational justice that can serve as a catalyst for investment, while also addressing gender and income inequalities.

b. Central bank digital currencies (CBDCs) and the digital euro

Challenges

The digital euro is still in the preparation phase. Different questions are being asked about the EU’s digital currency and CBDCs in general.

The geopolitical component of CBDCs remains under-examined. Recent conflicts have shown the important role played by the international financial system in imposing sanctions. The development of new digital payment systems could allow countries such as Russia to circumvent Western sanctions.

CBDCs can be a way for payment systems to reduce reliance on foreign providers. In Europe for instance, there can security risks if the payment system market is dominated only by non-European companies.

Many people still do not understand what CBDCs are, and how they can or cannot be useful, suggesting a communication deficiency from the institutional side. The same problem applies to anonymity and privacy, as there seems to be no understanding on these aspects of the difference, for example, between cash or private money and the digital euro. The degree of success in communicating to and instilling trust in the public will ultimately determine the usage of digital currencies by consumers.

Potential solutions

European and particularly euro-area institutions should take into account the geopolitical component of digital currencies. It should be possible to continue to enforce international regulations via new digital payment systems – for example the correct application of financial sanctions.

Making economics useful

Challenges

Economics is about anticipating and understanding interactions between different agents that might have opposite interests. Economists need numbers to justify what they say, and every policy recommendation should be fact-based – this is the value added that economic analysis brings.

The task for economists, however, is often not easy. Given the complexity of modern economies, and the difficulties underlying politics, understanding and anticipating the relevant interactions is challenging.

Economists need to remind policymakers that there are usually trade-offs between objectives. This is not always an easy task. Economists need to be innovative and bring new ideas to the trends currently shaping the world, such as the influence of China in developing countries as a global geopolitical player, or the threat of gas shortages in the EU. Economics can provide rigorous quantitative approaches that help tackle such problems, as it did during the energy crisis.

The modern world is data-rich, and data and quantitative skills are key. These allow economics and economists to be more precise and provide critical evidence for modern fact-based policymaking.

Potential solutions

Economists should continue to be rigorous in advising policymakers, so that effective and efficient policies are put in place. Quantitative work is key in a data-rich world, in order to anticipate and understand economic interactions.

Better communication would help both policymakers and the general public to understand the findings and proposed solutions.

Finally, collaboration with other social sciences is important, so that economic analyses improve policies in a holistic manner.

Conclusion

Europe and the EU face multidimensional crises, adding extra layers of difficulty to the rather recent recovery from the financial and euro crisis. Meanwhile, the climate crisis is worsening and action needs to be accelerated, starting with financing for climate policies. The fast pace of development and adoption of new technologies such as AI could bring considerable benefits and growth opportunities, but also poses risks to personal rights. Russia has brought war back to Europe, threatening national and continental security. And demographic change and the digital economy imply challenges to financial systems, affecting the sustainability of welfare states and the structures of payment systems.

Part of the response to the challenge should be European. Economic analysis offers tools that modern policymaking needs. Quantitative and rigorous approaches, combined with inputs from other fields, will help address the complex problems Europe faces in 2024.

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