In the first year of the war in Ukraine the lights started to go out across Europe as the consequences of cutting off Russian trade and gas began to kick in. The end of cheap Russian energy imports was disastrous, causing an energy crisis but that quickly spilled over into Europe’s economy as the biggest chemical and metallurgical plants ceased to be economically viable and were shuttered. “De-industrialisation” has become the buzzword but Europe’s problems run deeper than the economic shock caused by the war and were well entrenched long before Russian President Vladimir Putin ordered the invasion of Ukraine. Europe had already lost its competitive edge.

Two and half years on and the energy crisis has receded but not the de-industrialisation. Indeed, sanctions on Russia have catalysed the other problems and made them more visible. Sanctions are doing as much damage to the EU as they do to Russia, or more.

Europe became bloated on cheap energy, but innovation was stifled by reams of Brussels’s red tape. The Union is half baked with federated trade and monetary policy, but the administration of regulations and fiscal policy remain under the control of national governments. The need for unanimity on all EU legal decisions works well in quiet times, but has proved cumbersome in times of crisis.

A year ago European Commission President Ursula von der Leyen commissioned former Italian Prime Minister and ex-European Central Bank boss Mario Draghi to compile a report on Europe’s competitiveness, which was released last September.

And its conclusions have been a bombshell. Draghi outlines in detail the structural problems and shortcomings of the European system and says the EU now needs to invest more money to reinvent itself than it spent on repairing the damage from WWII.

The boomerang effect

Within days of the invasion of Ukraine on February 22, 2022, von der Leyen took to the podium and announced the most extreme set of sanctions ever imposed on another country. There have fourteen rounds since then, targeting everything that makes Russia money. The problem is that Russia used to make money from selling products and materials to Europe, inputs that are essential to European business.

As bne IntelliNews reported, the boomerang effect of the sanctions is weighing very heavily on Europe and comes on top of the polycrisis that included the global pandemic that had already knocked the EU for six. The one-time engine of Europe, Germany, is spluttering and has become the weakest economy in the G7. The sanctions have cost Russia a lot of money, and probably doom it to long-term stagnation, but it is currently flourishing and one of the fastest growing major economies in the world. Things are going so well that a new war middle class has emerged in Russia who are enjoying a period of unprecedented prosperity.

Europe had already fallen behind the US and the other G7 countries before the war started. It was feeling the growing pressure from the US and rising emerging markets before the war started. In 1995 European productivity was 95% of America’s; today it is less than 80% and falling, says Draghi. The US and China continue to attract the bulk of global financing for tech frontiers that will fuel future growth, whereas Europe only gets the crumbs. That has already led to a European collapse in productivity over the last three decades.

 

The hourly productivity of the EU has fallen behind that of most of the other major economies

“While the US productivity upturn is partly cyclical, it is also experiencing an underlying productivity renaissance. The country will continue to outperform most advanced economies, but we don't think much stronger GDP growth or far higher neutral rates are coming,” Oxford Economics said in a note on September 20, adding that both the UK and the Eurozone have underperformed compared to their peers.

The developed nations can no longer compete with emerging markets in more complicated sectors as the combination lower wages, but rising skills, in medium- and heavy-weight industries has already made the developed world companies uncompetitive.

US manufacturing employment has fallen by a third from its peak in 1979, even as the population has grown by nearly 50% over the same period as the US also deindustrialises. Boeing and Intel are struggling; machine tools through industrial robots to consumer electronics are under increasing pressure. The list of American industries where manufacturing capability has been eroded is long.

The US has increasingly exported its manufacturing capacity and is no long competitive against the Emerging Markets ​

Commercial shipbuilding in the US is particularly telling and now virtually non-existent. In 2022, the US had just five large oceangoing commercial ships on order, compared to China’s 1,794 and South Korea’s 734. The US Navy estimates that China’s shipbuilding capacity is 232 times larger than in the US and it costs 2-4-times more to build a ship in the US than it does in the Global South, Construction Physics reports. The story is the same in the navies where China is building the equivalent of the entire French naval fleet every four years, but orders in Europe for new battleships are a fraction of those in the developing world.

Year End Orders for Large Oceangoing Ships
	2022	2021	2020
China	1794	1708	1216
South Korea	734	626	441
Japan	587	612	533
Europe	319	288	284
United States	5	3	4
source: Table: Brian Potter, Congressional Research Service

By contrast, as bne IntelliNews reported, China is the most powerful manufacturing country in the world, and, thanks to its industrial Soviet legacy, Russia is the manufacturer powerhouse in Europe, beating even Germany. Investment is now pouring into all these facilities as both Russian and China prepare for a possible global war.

Draghi has spent the last year studying the reasons for Europe’s decline and released a 400-page report in September, “The future of European competitiveness”, calling Europe to action.

De-industrialisation

Draghi’s drill-down highlighted the ageing populations and the need to revamp defence and decarbonise economies. He especially highlighted the lag in technology. And he said all this need to be fixed just to keep growth standing still.

EU is sliding into a "slow agony" and is “ignoring obvious problems” according to the former Italian prime minister. On top of these structural problems, the lack of cheap resources from Russia adds salt to the wound.

The nature of the European economy has been fundamentally changed by the sanctions and the wholesale remake for global trade and energy markets, as Russia rapidly and successfully reoriented its oil trade from west to east. Over the last two years Putin has been remaking Russia’s trade and diplomatic focus, cutting off Europe and rebuilding in the Global South. The balancing point in the cost-profit divide has slid dramatically to the cost end of the beam for Europe as a result. Energy prices have doubled and the prices of inputs and commodities across the board have increased. The chemical giant BASF has shuttered or reduced the output of hundreds of its European factories and 15% of German industrial companies have left the Continent and full half are saying they are considering the same option.

A miasma is hanging over European business, and industrialists see little prospect of a return to the status quo unless the sanctions on Russia are dropped and the gas is turned back on, according to bne IntelliNews’ conversations with the members of the German industry lobby in Berlin.

But it is not just big business of heavy industry that has been affected; Germany is worst off as it is the most vulnerable to these changes. Manufacturing is the backbone of its economy and makes up around 20% of GDP – up to twice as high as the 10%-15% in countries such as France, Italy and Spain. Energy costs are now double their pre-war prices, thereby putting swathes of once profitable German export-orientated Mittlestand small- and medium-sized enterprises (SMEs) firms out of business.

Those that can are leaving the country in search of cheaper energy and labour homes. But they are less welcome than they used to be. China is tightening its grip as part of a fight for control over key resources in a slowly escalating tit-for-tat trade war. The West is responding to China’s mounting challenge to Europe’s long-standing lead in the automotive and renewables sectors by imposing trade tariffs to shield its increasingly flabby industries. Resource prices in Europe are 4-5 times higher than in the autarkic US, bureaucracy is more complex and taxes are exorbitant, says Draghi, putting further pressure on Europe’s companies.

A miasma of despondency is descending on Europe as the scale of the challenge ahead becomes increasingly clear. 

“Eurozone flash PMIs sank into contraction territory in September as the effect of the Paris Olympics faded, underlining the weak – and apparently deteriorating – economic conditions in the bloc. This was reinforced by another drop in Germany's ifo index and a still tepid credit flow to households and companies. The near-term outlook for the eurozone economy is bleak,” Oxford Economics said in a note on September 27.

September’s Eurozone composite PMIs paint a bleak picture

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German’s falling IFO index shows economy is stuck in doldrums

Draghi’s solution is to throw money at the problem – massive amounts of money – and slash the red tape. He suggests annual investments of €800bn to stimulate EU industry over many years – 5% of the EU's GDP and significantly higher than the 1-2% spent on post-World War II recovery. But even Draghi admits that change will not be fast.

It remains to be seen how long this new reality will last and if or when European economies can adjust to the new realities. In theory the revolution in clean energy could provide the cure for Germany’s Russian gas addiction, but on this score the global green energy champion China is already way ahead of Europe – two thirds of all solar panels in existence are in China – which will reap the benefits of “free” energy long before Europe does. And the lack of minerals and other inputs in “deficit Europe” can never be solved. Europe has to turn to innovation and services as the only long-term option to retain its leading position, says Draghi.

​

Europe vs US total investment excluding residential investment as percent of GDP

“One reason why eurozone investment may have lagged is that it suffered from two major regional crises – the fiscal crisis in the early 2010s and, more recently, the Russian energy crisis. Accordingly, since 2010 there have been more reasons for eurozone firms to be cautious about the outlook for demand and, by extension, investing than their US counterparts. It is worth noting that crises tend to sap productivity as management is forced to spend less time innovating and more time 'fighting fires',” says Oxford Economics.

By contrast Russia is now investing heavily. The Kremlin has reversed its Putinomics, that effectively ran an austerity budget for the last decade, hoarding cash and paying down external debt while it built up the military, to pouring money into fixed investment and spending freely, especially on the military.

Businesses starting to downsize

The European deindustrialisation began with companies that directly bought Russian gas as a major input or used a lot of energy, representing about a tenth of Europe’s GDP, but now the malaise is spreading further afield.

In September Germany’s VW announced it will close plants in Germany for the first time in its 87-year history and is scaling back its EV ambitions. In a double whammy for Berlin, US chip-maker Intel has also decided to put plans for a new €30bn German gigafactory on ice and other new plants in Poland, Ireland, Spain, France and Italy. A question mark also hangs over a mooted Tesla gigafactory in Berlin as demand for the cars softens, but the company’s gigafactory in Shanghai is going gangbusters.

The steel sector is also in trouble. Germany’s steel industry employs about 80,000 workers, but most producers have reduced output due to high energy costs, a growing glut due to weakening Germany’s car sales and falling machinery demand that is exacerbated by Russian sanctions, formerly a major client; pre-war machinery made up 45% of all Russia's imports, predominately from Germany. The story is the same in Germany’s chemical industry, where a brief uptick faded away in August as the economy teeters on the edge of recession.

Nearly a third of major car plants from Europe’s five largest automakers were underutilised last year. Stakes are high for EU economies: the automotive sector accounts for about 7% of EU GDP and more than 13mn jobs.

American brands Ford and General Motors, as well as Swedish Volvo, have found themselves in the same boat, announcing large-scale revisions of their plans to produce fully electric models in an effort to cut costs. In the US things have got so bad that in addition to a hefty import tariff, the Biden administration moved to completely ban all Chinese cars from the road with rules that "prohibit car manufacturers from selling cars in the US with important components or software from China", The Guardian reported on September 23.

“This effectively is the US admitting it is too weak to compete and retreating by shielding itself with protectionist rules under the guise of "national security". But paradoxically this will undoubtedly make it even weaker, as firms that are protected will have even less incentives to be competitive,” China watcher Arnaud Bertrand said in a post on social media.

 

A third of Europe’s main car plants are at half capacity of less

 

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Idled steel plants as of September 2022

German is not the only one that needs to pull its socks up. A revamped industrial policy is essential for the Central and Eastern European EU members (EU-CEE) if they are to escape the so-called "middle-income trap”, says a new report from the Vienna Institute for International Economic Studies (wiiw).

Having served as an "extended workbench" for Western firms by hosting labour-intensive production, the EU-CEE countries must now pivot toward innovation to maintain economic momentum. “The old model is exhausted,” wiiw says.

Like the rest of Europe, one of the key challenges facing EU-CEE countries is insufficient investment in research and development (R&D). While R&D expenditure is slowly rising, particularly in Poland, Czechia and Croatia, the region remains far behind the EU target of spending 3% of GDP on R&D.

“Above all, they are spending nowhere near enough money on research and development, which impairs their ability to innovate,” Zuzana Zavarská, economist at wiiw and co-author of the study, told bne IntelliNews.

Only Slovenia and Czechia currently exceed 2% of GDP R&D expenditure, with other countries such as Slovakia, Bulgaria, Latvia and Romania spending less than 1%. Although some countries export medium- to high-tech products, much of this is driven by foreign multinational companies, and domestic firms struggle to benefit from advanced technological expertise.

In a rough comparison of unit costs in Germany against those of the US and China, and assuming that it takes one hour to make a widget out of one kilo of steel, using 5kWh of power, then assuming average 2023 industrial wages in Germany were €23.73 per hour, in the US the figure was $18.31 and in China $6; Germany’s unit cost for the widget is €26.73, the US’ $20.16 and China’s $7.55.

Defence and the peace dividend

Europe is at war with Russia, even if it doesn’t want to admit to it. The economic war began in the first week of the invasion, but as the Nato allies have scaled up their military support to Ukraine, this war has become increasingly classical and kinetic.

Europe has already dug deep into its stockpiles of weapons and ammunition and is now scrapping the barrel – a problem that is being made worse by the US’ increasing reluctance to supply Ukraine from its own extensive stockpile. New deliveries of things such as tanks or Patriot missile batteries, and especially F-16s, are all coming from Europe, not the US, despite the fact it maintains a huge surplus of nearly 1,000 planes vs the 72 in the EU. So far a total of only 10 F-16s have been sent to Ukraine, one of which was immediately destroyed.

Europe’s industry in general is under pressure, but the war has only highlighted the even more decrepit state of the European defence sector. It has atrophied after decades of sheltering under the US security umbrella through under-investment and preparing for the wrong war – the so-called “peace dividend.”

With a major war in its backyard and the real possibility of a Nato conflict with Russia, scarce resources are being channelled away into the defence sector where the spending needs run into the hundreds of billions of euros, not to mention the ongoing drain on the EU and national budgets for supporting Ukraine’s war effort. Ukraine needs some €100bn a year of funding – two orders of magnitude more than the EU was providing pre-war – which is increasingly being funded by the EU, as the US starts to back off. Russia, on the other hand, has put its whole economy on a war footing, is massively outproducing Europe and is preparing to rebuild its military. Draghi included a whole section on modernising Europe’s defence sector, which is a necessary security component to the economic prosperity plan.

“The world is heading into a period where foundational rules once taken for granted no longer apply. The EU urgently needs to emerge from its peace dividend softness and build a power model that allows it to shape new alliances and deter adversaries,” political analyst Rym Momtaz wrote in a recent paper for Carnegie Endowment for International Peace entitled “Europe’s Choice: Adapt or Atrophy.”

As bne IntelliNews reported, the lack of investment in infrastructure and technology in business is mirrored by the chronic underinvestment in defence. Most of Europe is facing a serious materiel shortfall. Germany, in particular, will not be able to return to pre-war levels of armament for decades despite having earmarked a special €100bn in defence spending and formerly having one of the most powerful militaries on the Continent.

“Western Europe is at a particular disadvantage, having uniquely benefited, for nearly three generations, from a US-provided peace dividend, which exempted it from engaging in hard-power politics while allowing it to reap the rewards of global economic integration and cooperation,” said Momtaz.

A clear example of Europe’s military impotence was that in 2023 it promised to manufacture and deliver over 1mn shells to Ukraine by March this year. As bne IntelliNews reported, the EU has been very slow to sign military procurement contracts with weapons makers. The result: less than 200,000 shells were produced by the deadline. Currently Russia is firing ten shells for every one Ukrainian shell in Pokrovsk at the epicentre of the current battle. For comparison, Russia has raised its shell production from 1.7mn rounds a year in 2022 to 2mn last year. And it has sourced an additional million shells from allies such as North Korea.

"Russia’s [military] is getting larger, and they're getting better than they were before. … They are actually larger than they were when [the invasion] kicked off," Air Force General James Hecker told reporters at the Air & Space Forces Association's annual Air, Space & Cyber Conference on September 19.

Russia’s military is now estimated to be 15% larger than it was at the start of the war, while Ukraine is suffering from a chronic lack of men, money and materiel. And on September 16, Putin ordered that the Russian army be expanded by 180,000 active-duty troops for a total of 1.5mn soldiers, making Russia's military the second largest in the world, behind China.

China is likewise investing heavily into its military and its navy is now larger than that of the US, as it adds the equivalent to the French navy to its fleet every four years, among other things. And now China is chasing the US submarine fleet, rapidly ramping up its submarine production.

Bankruptcy and recession

Europe is teetering on the verge of recession, while the Russian economy is booming – for now. That is sending more and more European companies into insolvency, as the economies adjust to a lower growth trajectory. Over the past three years the EU has seen a significant rise in bankruptcies, reaching record levels in 2023. What started in heavy industry becoming unprofitable has now spread to the lighter end of the industrial spectrum.

In 2023, EU bankruptcies surged for the sixth consecutive quarter, with an 8.4% increase in the second quarter compared to the previous quarter, reaching the highest level since data collection began in 2015, reports the European Commission. The number of bankruptcy declarations at the end of 2023 was above the pre-pandemic period levels recorded between 2016 and 2019, although the pace of bankruptcies started to slow towards the end of 2023.

Notably, industries such as accommodation and food services, transportation and storage have been hit hard this year, with increases of up to 82.5% compared to pre-pandemic levels in 2019 across the EU.

 

European bankruptcies surged in 2023 while new business registrations remained stable

Some of these bankruptcies are a result of the slowdown or high energy prices. Others are due to the growing competition from emerging markets, which are going up the value chain. Germany invented commercial solar panels and was home to a vibrant automotive sector. Both are now in trouble as they are overtaken by Chinese producers. Germany’s solar panel business is now a wasteland after the government decided not to bail it out with subsidies, conceding defeat in the face of an unwinnable fight against higher Chinese quality and lower prices. As previously mentioned, China has become a manufacturing powerhouse and beats Germany not only on the technology of the panels themselves, but also with superior solar panel manufacturing technology to make them.

The double whammy of higher costs at home and increased competition abroad has put the export-orientated Germany SMEs in the front line. Many of them work in light manufacturing, whereas elsewhere in Europe SMEs are dominated by services. In 2021, the average number of bankruptcies in Germany was 1,000 per month. In 2024, this figure is approaching 2,000 per month.

The number of major bankruptcies in Germany also grew by 41% year to date. Household names that were set up over hundred years ago have gone bust in the first half of this year. Amongst the collapses were paper manufacturer ISHPaper, founded in 1828; shipyard Meyer Werft, founded in 1795; the butcher’s chain Holzapfel Thüringer, founded in 1827; and the brewery Brauerei Bruch, founded in 1702, to name a few.

The story is the same in France, the UK and US. American bankruptcy filings surged over the past three years, reaching a 13-year peak in 2023. High inflation, high interest rates and the after-effects of the COVID-19 pandemic have contributed to this trend. The healthcare, consumer discretionary and industrial sectors were among the hardest hit. The number of corporate bankruptcies in France has surpassed the record set after the 2008 financial crisis. And the UK currently has the highest number of bankruptcies in 30 years after 25,158 registered companies became insolvent in the 2023, Bloomberg reports.

 

The number of French corporate bankruptcies has surpassed the record set after the 2008 financial crisis

All the main European economic sentiment indicators are falling, according to Oxford Economics. “The September decline in the ZEW Index provided another gloomy signal for the eurozone's near-term outlook. The drop was particularly large in Germany, where the assessment shows current conditions are now close to the lows of the pandemic,” Oxford Economics said in a note in September.

The same goes for Emerging Europe, where the EBRD just downgraded its economic forecast for the entire region. In the latest Regional Economic Prospects report released on September 26, the EBRD projects growth of 2.8% for 2024, a slight reduction from its previous estimate of 3.0% in May 2024. The forecast for 2025 has also been revised downward by 0.1 of a percentage point to 3.5%. EBRD chief economist Beata Javorcik warned that "ongoing vigilance will be required as economies adapt to challenges related to renewed inflationary pressures, energy security, trade and financing conditions".

All the main economic European sentiment indicators are falling

 

GDP growth for leading economies of the world % y/y
Country	2020	2021	2022	2023	2024 (Forecast)
Germany	-4.6%	2.6%	1.8%	0.2%	0.6%
France	-7.9%	7.0%	2.6%	0.7%	0.9%
Italy	-9.0%	6.6%	3.7%	0.6%	0.8%
Spain	-10.8%	5.5%	5.5%	1.9%	1.5%
UK	-9.3%	7.6%	4.1%	0.1%	0.6%
Russia	-2.7%	4.7%	-2.1%	3.2%	2.6%
China	2.2%	8.4%	3.0%	5.3%	4.7%
Japan	-4.6%	1.7%	1.0%	0.9%	1.0%
Canada	-5.2%	5.0%	3.4%	1.5%	1.4%
source: National governments

Even Russia is not getting off scot-free. Due to the exceptionally high key rate (19%), with which the Central Bank is trying to combat inflation, Russian companies are finding it increasingly difficult to service loans, according to a recent report by the Centre for Macroeconomic Analysis and Forecasting (CMAF). After unexpected strong growth over the last two years thanks to the war spending bump, Russia’s economy is cooling as the military Keynesianism boost starts to wear off. The Central Bank of Russia (CBR) issued a pessimistic medium-term macroeconomic outlook at the start of August that predicts growth and consumption will slow dramatically starting in 2025.

On average, every fourth ruble of profit in the manufacturing industry goes to pay interest, analysts calculated. In 2023, the profit of Russian companies grew by 35%. But in the first quarter of 2024, compared to the same period last year, the figure fell by almost 4%.

But Russian companies are not going bust. In 2021, corporate bankruptcies in Russia increased modestly, up 3.9% from 2020, as part of a post-pandemic bounce back. In 2022 and 2023 there was a sharp decline in corporate bankruptcies, primarily due to government interventions such as a moratorium on insolvencies for key industries. By 2023 the number of company bankruptcies had dropped even further, by nearly 30% year on year, as the war boom got under way. Russia’s economy still has a lot of leeway, despite the global slowdown, thanks to good management and lots of cash in reserve.

The current growth decline for the G7, on the other hand, is far worse – worse than in the drubbing it took during the pandemic and the financial crisis of 2008.

In 2023, the combined GDP of the seven leading countries was estimated at 1.5% compared to the previous year. And the EU only just managed to avoid recession in 2023, achieving an average growth rate of a mere 1%. The fastest growing economy in Europe in 2023 was the small Balkan country of Montenegro, which expanded by 4.5%, but almost all the big EU members were growing at less than 1%.

The EU governments and the economic press talk about a European “recovery” that assumes a return to the status quo and doesn’t acknowledge the fundamental changes that have happened to Europe’s economic makeup as a result of the polycrisis.

The economic pain is already having political consequences that make implementing reforms hard. Across Europe there is a swing to the right, such as AfD’s (Alternative für Deutschland) recent victory in German’s eastern state regional elections that is splitting German Chancellor Olaf Scholz’s ruling coalition, and a new right-wing government in France, the most right-wing since the Republic was founded, to name only two recent examples.

While the rich world is getting poorer, the poor world is getting richer and starting to overtake its more advanced peers. Russia overtook Germany to become the fifth biggest economy in the world in PPP (purchase power parity) terms two years ago and surpassed Japan to become the fourth largest economy in the world in adjusted terms this year. China is now the largest economy in the world in PPP terms, followed by the US and then India and Russia. Germany has fallen down the rankings and is now number six, while the birthplace of the industrial revolution, the UK, has been pushed out of world's top ten manufacturing nations by Russia and Mexico for the first time in decades.

And with India's GDP growth projected at 8.2% in the current fiscal year 2024-2025, the country's economy could become the third largest in the world in nominal terms by 2030-2031, S&P Global said on September 19, provided that reforms critical to improving business operations and logistics, stimulating private sector investment and reducing dependence on public capital continue. Both China and India are expected to become number one and two in nominal GDP terms sometime in 2070.

Other up and comers from the EMs include Indonesia and Mexico, which have been shooting up the rankings in recent years. Bangladesh is also an unsung success story (population 171mn) after per capita GDP in the country overtook that of India in the last few years, until the former was plunged into chaos after its Prime Minister Sheikh Hasina was ousted in August by violent protests.

Top 15 countries GDP in PPP terms
Rank	Country	2023 GDP (PPP) ($bns)
1	China	34,643.71
2	United States	27,360.94
3	India	14,537.38
4	Russia	6,452.31
5	Japan	6,251.56
6	Germany	5,857.86
7	Brazil	4,454.93
8	Indonesia	4,333.08
9	France	4,169.07
10	United Kingdom	4,026.24
11	Turkey	3,767.23
12	Italy	3,452.51
13	Mexico	3,288.67
14	South Korea	2,794.20
15	Spain	2,553.11
Source: World Bank

At the geopolitical level there are also consequences to this game of economic musical chairs. The attempts to sanction Russia’s economy into oblivion have backfired and catalysed China and Russia into beefing up their non-aligned multinational alternative centres of power, such as the BRICS+ and the G20.

Worried by the US decision to weaponise the dollar and freeze international reserves, the countries of the Global South are de-dollarising and flocking to these organisations, simply as a counterweight to an increasingly unpredictable America.

As the leading emerging markets climb up the GDP rankings, the appeal of the Moscow and Beijing-run clubs increases, as not only do they show that sanctions don’t work if enough of the rest of the world ignore them, but that the Global South now represents the richer and faster growing half of the world. Collectively the BRICS alone account for 35% of global GDP in nominal, not adjusted, terms, whereas the G7 accounts for 30%, as Putin keeps pointing out. And the BRICS have ten times the population of the G7. Russia remains by far the largest consumer market in Europe with 145mn people, followed by Germany with 83mn.

The BRICS+ club has already been expanded to include 10 members at last year’s gathering and 17 more countries have applied to join at this year’s summit hosted by Russia in Kazan in October, with another 22 countries in the wings. Azerbaijan, Indonesia, Malaysia and Turkey are amongst those that are expected to join this year. One of the first things the expanded BRICS+ intends to do is build a BRICS currency to replace the dollar in international trade.

 

The BRICS+ group now contains 10 countries with another 41 either applying or interested in membership

Colonialism and comparative advantage

The French are good at making champagne and the most profitable British export is the Rolls Royce car. A basic tenant of economics is “comparative advantage”: instead of Frenchmen making champagne and cars, they should put all their effort into just making champagne and leave the Brits to make the Rolls Royces, who can import all the champagne they need. The net result is both the French and the British net-net have more champagne and cars. Sanctions have destroyed this equation that is at the heart of the globalisation.

Running even deeper than comparative advantage is the net transfer of wealth from the Global South to the rich markets of the North. As bne IntelliNews reported, for the last 500 years or so there has been a net transfer of wealth from the Global South to the developed world, pioneered in the empire-era. Economists say there have been three globalisation periods: 1870-1914, 1944-1971 and the most recent, which is still ongoing, started in 1989 but is winding down now.

The West exports some 90% of its manufacturing capacity to the Global South but the Global South only receives 21% of the revenues generated, according to a study published in Nature Communications in July.

In effect, the Global South has exported its human capital to the West and, thanks to the huge discrepancy between wages, it is very badly paid for it, according to the study. This colonialist transfer is the basis of the West’s relative wealth compared to the Global South and the raison d'etre for empires, which have been replaced by multinationals.

This set-up is starting to finally break down, first due to the onshoring due to the pandemic and then to the “friendshoring” due to the geopolitical tensions in an increasingly fractured world. The same study found that not only are the manufacturing exports no longer just targeting low-cost, low-skill manufacturing, but increasingly the emerging markets are providing high-skilled production, and wages are rising in these countries.

This story has already played out in Poland, where wages have risen to match the EU average as firms have gone up the value chain, making Poland one of the most robust economies in Europe. And it also played out in Russia, where wages have risen relentlessly from next to nothing in 1991, after Putin spent a decade boosting public sector wages by 10% a year in the noughties to close the burgeoning gap between the public sector and private to avoid social unrest. The average salary in Russia today is just under RUB90,000 ($964) a month, which is $2,185 in PPP adjusted terms, which is almost exactly the same as the EU average salary of €2,006 ($2,240). However, there are still significant regional differences. In particular, salaries in Moscow are much higher and can reach RUB360,000 ($4,700) a month and more for things like IT experts, bankers and other professional jobs, according to the Average Salary Survey. Overall, Russian’s incomes are now on a par or higher than that of the EU and salaries in the capital are on a par with those in cities like London, Paris and Berlin. 

China is also well advanced in this process. Its rapid catch-up in the last few decades has been driven by being the “factory of the world,” but the relentless rise of wages means about a third of the population now earn Western standard middle-class wages. China has gone from “made in China” to “created in China.”

Russia used to import its manufactured goods from China like everyone else, but in the boom years of the noughties, Chinese wages overtook Russian wages, spurring an expansion in light manufacturing investment in Russia as it became cheaper for Russians to make the goods themselves. Under China’s new economic development plan the emphasis has switched from an export-orientated model to an innovation-orientated model. The share of Chinese GDP from high tech is expected to exceed that of real estate in the next two years, when just six years ago real estate was still twice that of high tech, Bloomberg reports.

The share of real estate vs high tech in China’s GDP

All of the countries of the Global South are being lifted by the same tide, but increasingly they resent the colonialist model that has robbed them of their human capital wealth, and they are starting to push back, which is also fuelling the gravitation to things like the BRICS+ and G20 groups.

A former colony, Niger has long been a French client in Africa, but earlier this year a new government kicked France out of the country, despite Paris’ loud prostrations. Niger also happens to be a major source of uranium and 80% of France’s power is nuclear. But France was reported only playing a fraction of market prices of supplies of uranium from Niger.

The countries of the Global South are becoming increasingly resentful of this colonialist model, particularly in Africa, that has been sanitised in the West with the “globalisation” label. The wealth transfer remains an exploitation of labour and a theme that the Kremlin plays on constantly to a warm reception outside the Western world. As bne IntelliNews reported, French President Emmanuel Macron got roasted by Felix Tshisekedi, the president of the Democratic Republic of Congo, live on TV last year during an official visit as the French president tried to shore up relations with France’s former colonies.

“This must change, the way Europe and France treat us. You must begin to respect us and see Africa in a different way,” Tshisekedi told Macron to his face with the cameras rolling. “You have to stop treating us and talking to us in a paternalistic tone. As if you were already absolutely right and we were not.”

The same resentment is behind Russian Foreign Minister Sergei Lavrov’s “new rules of the game” speech in February 2020, which was the starting point of an escalation in tensions that ended in the invasion of Ukraine two years later. Lavrov said that Russia would no longer tolerate the West’s dual approach of sanctioning Russia with one hand but doing business with the other. He threatened to break off diplomatic relations if this didn’t change. Russia and much of the Global South object to the right the West gives itself to lecture and sanction them on things like LGBT rights, but at the same time ignore all criticism on issues like US’ material support of Israel’s bombing of Gaza.

This dichotomy is increasingly seen by many in the Global South as the hypocrisy of a two-speed world, divided into the haves and have-nots, and was made doubly poignant when the US was downgraded to “flawed democracy” by the respected EIU in 2016.

“The war in Ukraine is a European problem, caused by Europeans. Let Europe fix it! I don’t think that India should become involved at all,” Bhaswati Mukherjee, former Indian ambassador to the EU and UNESCO, told bne IntelliNews in a recent interview, following suggestions that Indian Prime Minister Narendra Modi is the best placed international statesman to mediate a peace between Ukraine and Russia.

The Kremlin became equally fed up with being talked down to but after three decades thanks to the stability Putin brought it is more or less a normal country in terms of income, on a par with the rest of Europe in real terms and increasingly on nominal terms too.

As wages rise relentlessly in the Global South, the wealth transfer from south to north will slow as the income gap closes, pushing up the cost of imported goods, while the profits from the export of manufacturing slowly fall. There is little the West can do to prevent this change other than keep its technological and productivity lead.

But it is going to be a long, slow and difficult process. The Global South is already trying to coordinate this change with a raft of new non-aligned organisations such as the BRICS+, the G20, the Shanghai Cooperation Organization (SCO), MERCOSUR, ASEAN, the African Union and many others, but it is still early days and regional rivalries, such as those between China and India, remains problems.

Food price inflation

Food price inflation is one the permeant changes that will only make the cost-of-living crisis worse thanks to a combination of Climate Crisis-related falling agricultural yields and disruptions to trade with Russia and Ukraine – the two largest tradable food producers in the world.

Russia is commonly seen as a provider of oil and gas, but thanks to a decade’s worth of heavy investment it has also become a global agro-power. In 2023, the volume of agricultural supplies to foreign markets amounted to $43.5bn. In total, Russia exported more than 100mn tonnes of food. But, like oil, those exports are now going to new markets.

The cost of Britain’s iconic fish & chips has doubled as it remains heavily dependent on the import of Russian cod, while German fishmongers are preparing for thousands of layoffs.

"The German market depends on fish from Russia. We cannot do without saury and cod," explained Steffen Meyer, director of the Federal Association of the German Fish Industry and Wholesale Trade. Russia itself set a record for seafood exports in 2023 and is projected to earn $5.6bn in 2024, after exports were redirected to Asia.

The FAO Food Price Index (FFPI) has been declining since its spiked in March 2022, caused by the start of the war in Ukraine. However, while global prices have eased, food price inflation remains a serious problem, particularly in low- and middle-income countries. For example, food price inflation was still above 30% in several nations, such as Ethiopia, Ghana and Sudan, by late 2023. High-income countries have seen a slower rise in food costs, with inflation dropping to around 3.8% by late 2023​, according to IFPRI, but the relentless rise is adding to the cost-of-living crisis in Europe.

FAO Food Price Index
Year	FAO Food Price Index (2014-2016 = 100)
2015	93.0
2016	91.9
2017	98.0
2018	95.9
2019	95.1
2020	98.1
2021	125.7
2022	160.3
2023	124.7
2024 (YTD)	120.7
Source: UN Food and Agriculture Organization

As bne IntelliNews reported, over a billion people's food supplies around the world are threatened by the accelerating climate crisis and up to 4bn people are now suffering from poor nutrition in some of the poorest countries in the world.

India suffered from a rice crisis last year, adding to the overall price increases as extreme temperatures saw yields plunge there too, causing the government to ban exports to prevent a price spike. The tomato crop in India failed completely. Food insecurity is not only caused by the lack of food, but also spikes which increase food prices to beyond the level the poorest members of society can afford to pay. Grain yields in both Ukraine and Russia have been falling in the last two years.

Russia brought in a record harvest of 153mn tonnes, smashing even Soviet-era records, in 2023, but this year the harvest is expected to fall back to 132mn tonnes as yields retreat due to the extreme temperatures following the hottest summer on record in 2024. The way agricultural markets work, if Russia's export grain price firms then grain prices around the world rise as well.

 

Climate crisis-driven global food security has already deteriorated between 2019 and 2022 and is even already affecting the US and Europe, where agricultural yields are down by more than 30%, according to scientists. Storms in Europe destroyed €9.1bn worth of property in 2023, while the US saw 28 separate weather disasters costing at least $1bn a piece. When the results come in from this year, including the destruction caused by Storm Boris, they are likely to be worse. Scientists predict that the frequency and power of extreme weather events during what will now be an annual disaster season will only get worse from here.

Estimates vary, but recent studies published in Nature Food, NASA and Springer Link, estimated strained population will demand 35% – 56% more food from crops that will yield dramatically less and be less dense in key nutrients. After some short-term gains for Europe (as a warmer Europe means more winter crops), food security is only going to become a bigger issue as time goes on and Russia’s massive surplus of grain production more important.

The record-breaking heatwaves and prolonged droughts in Europe in the last two years have hit Southern and Eastern Europe more than the North, reducing yields in crops like wheat, maize and barley. The European Commission reported that the 2022 drought reduced cereal yields by 10%, with maize production falling by nearly 16%​, according to the World Bank.

Some regions, particularly in Northern Europe, may initially benefit from warmer temperatures, allowing for extended growing seasons. However, the long-term consequences of more frequent extreme weather events outweigh these benefits​, says IFPRI. Wheat yields have been particularly vulnerable to heatwaves and droughts. France, one of the EU’s largest wheat producers, has seen reduced yields in recent years. The drought of 2022 was particularly damaging, with wheat yields falling by 5-10% across Europe​.

Cost-of-living crisis

The rising food prices are already affecting consumer behaviour. In the US, the Dallas Federal Reserve released a study that found the sale of sausages has soared; economists say the reason is because the price of meat has risen so much that punters are trading down to sausages as the cheapest form of meat on the market.

At the same time, the US Restaurant Performance Index (RPI) fell -1.3% in July to 97.7 points, the lowest level since the 2020 lockdowns, as punters stay in more. Since 2021, this metric has fallen by ~8.0%, marking the largest drop since it was launched in 2002. Since 2020, food prices away from home have gained 27.0%, and fast-food prices have jumped by 31.0%, far in excess of the rise in basic inflation.

US Restaurant Performance Index (RPI) fell -1.3% in July to 97.7 points

In general inflation in the G7 is running much higher than the developing world, although thanks to overheating Russia’s inflation is a persistently higher, at around 9%, but still less than the rising in nominal wages of 12%, resulting it soaring real disposable incomes up to a record 9.6% in July. The upshot is that while prices are rising fast, income is rising faster and instead of a cost-of-living crisis, Russia is enjoying a consumer boom.

Inflation rates in leading economies
Country	Inflation Rate (2023-2024)
United States	3.2% (2024 projection)
Canada	3.3% (2024)
United Kingdom	6.8% (2023)
Germany	6.1% (2023)
France	4.9% (2023)
Italy	5.6% (2023)
Japan	3.1% (2023)
Russia	9.1% (August 2024)
China	0.6% (August 2024)
Source: Trading Economics

The Eurozone retail sales continued to flatline in the second quarter with a negatable 0.1% rise in retail trade for July, adding to the cost-of-living pressures, according to ING. Draghi says that real disposable incomes in the US have grown twice as much as in the EU since 2000.

Inflation has outpaced wage growth, resulting in a decrease in real wages – the purchasing power of incomes adjusted for inflation. For example, in the United States, while nominal wages increased by about 5% in 2022, inflation was higher at 6.5%, leading to a decline in real wages​.

One of the areas where the cost-of-living crisis is being felt most acutely is in the rapid rise in housing prices. Frustrated US millennials, who need to earn at least $110,000 a year to be able to buy a house, complain that they cannot afford to buy anymore. House prices climbed by 6.6% over the last year, with a 5-year growth of 7.1%, driven by high demand despite rising mortgage rates​.

In Europe real wages actually fell by 2.4% in 2022, the steepest decline in decades,​ that came on top of soaring food prices. Yet house prices continue to climb strongly, outpacing the increases in average incomes over the last five years, despite softening somewhat in the last year due to the economic slowdown. Germany has been one the most affected, where house prices jumped by 56% between 2010 and 2022.

Major economies housing prices, change in income 2019-2023 change
	Year-on-Year Change in House Prices (2023)	5-Year Change in House Prices (Inflation-Adjusted)	5-Year Change in Average Income
Germany	-2.0% (Decline due to economic slowdown)	+16.88%	+9.1%
France	+3.1% (Urban demand)	+16.22%	+8.2%
Italy	-8.0% (Weaker demand)	-5.16%	+2.5%
Poland	+13.0% (High demand)	+11.86%	+10.2%
Hungary	+9.5% (Strong rise in Budapest)	+13.41%	+8.9%
Czechia	+4.8% (Stable increase)	+13.13%	+7.5%
United Kingdom	+4.5% (Limited supply)	+9.48%	+4.6%
China	-5.3% (Decline amid real estate slowdown)	-3.7%	+7.8%
Russia	+9.7% (Housing boom in urban areas)	+23.1%	+12.5%
United States	+6.6% (Steady appreciation)	+7.1%	+9.0%
Source: national statistics offices

 

Over the last two decades house prices in the major economies have soared

Italy is the exception, where house price inflation has fallen over the last two decades, but young would-be homeowners are facing a different set of cost-of-living problems that have depressed fertility rates to become the lowest in Europe: the Italian replacement rate is currently running at only 1.2 as young couples simply can’t afford to have a second baby. Draghi pointed out in his report that Europe is suffering from a demographic crisis, as no country has a replacement rate of over 2.1 births needed to keep the population stable.

Unsurprisingly the demographics in Ukraine are a catastrophe: Ukraine has the highest mortality rate and lowest fertility rate in the world – three deaths for every birth – according to the CIA factbook.

China is also suffering from a low fertility rate thanks to its previous “one child” policy, but Russia has seen its fertility rate increase in recent years from 1.4 to the current 1.83 thanks to Putin’s babies, the Kremlin’s highly successful natal support reforms that Putin introduced in his first term in office. As detailed in bne IntelliNews’ latest despair index (the sum of poverty, unemployment and inflation), Russia currently has its lowest level of despair since 1991 despite the strains of war, and is well ahead of most of Europe.

Major economies fertility rates, births per women
	Fertility Rate (2024)
France	1.9
Germany	1.5
Italy	1.24
Spain	1.16
EU Average	1.46
UK	1.6
United States	1.84
Russia	1.83
China	1.5
Source: World Population Review, Our World in Data, CIA

 

Russian demographic pyramid 1950-2023​

European demographic pyramid 1950-2023​

US demographic pyramid 2000-2023​

Permanent increase in energy costs

Rising energy prices are the obverse side of the coin to the rising food prices that have been permanently changed but the polycrisis. The cost of power in Europe spiked 20-fold in in 2022 but has since fallen back. But it has not fallen back to where it was in 2021.

High energy costs are a serious problem for Europe, but not for the self-sufficient US and Russia. The end of cheap Russian gas supplies, particularly to Germany, has caused a permanent change to the structure of Europe’s energy market and power prices remain double what they were pre-war.

“The price differential vis-à-vis the US is primarily driven by Europe’s lack of natural resources, as well as by Europe’s limited collective bargaining power despite being the world’s largest buyer of natural gas,” says Draghi. “However, the gap is also caused by fundamental issues with the EU’s energy market. Infrastructure investment is slow and suboptimal, both for renewables and grids. Market rules prevent industries and households from capturing the full benefits of clean energy in their bills. Financial and behavioural aspects of derivative markets have driven higher price volatility. Higher energy taxation than other parts of the world adds a tax wedge to prices.”

To highlight the increased energy uncertainty, Europe may see a large 66-78mn cubic metres a day shortfall – equivalent to a third of the UK’s consumption – this winter after Norway announced unscheduled pipeline maintenance work on September 26, coupled with Armed Forces of Ukraine (AFU) advances in Russia’s Kursk region near the Sudzha gas pumping station and disruptions to global LNG supplies due to hurricane Helene in Mexico.

In 2023, Germany consistently had the highest household electricity prices in the EU, reaching €0.40/kWh. Nuclear-powered France, on the other hand, maintained lower prices but saw a significant increase due to the energy crisis. Spain saw a large rise in 2022 but experienced a decrease in 2023, aided by government measures. The UK also saw steep rises during this period.

While prices moderated in 2023, high volatility persisted, particularly in the day-ahead and intraday markets. Negative prices (where electricity prices fall below zero) have occurred frequently, reflecting supply-demand imbalances, especially during periods of excess renewable energy production.

In countries where natural gas is a primary source for electricity generation, the wholesale electricity prices used by industry also surged, with some industries seeing wholesale electricity prices jump by 300% to 500% by the end of 2022 in certain countries. To mitigate the effect of rising energy costs on industries, many governments introduced subsidies, price caps and financial support, but that has not shielded industry entirely from the price hikes.

Wholesale electricity prices in 2023 began to stabilise but remained elevated compared to pre-2020 levels, particularly in Europe and Asia. Businesses in the UK currently pay the most for wholesale power, whereas Germany is somewhere in the middle of the range. In the US and some other regions, prices for industrial power remained lower due to a more diversified energy mix and access to domestic energy resources like shale gas. Industrial power costs in Europe are anticipated to remain volatile in 2024.

Germany’s industrial sector is highly energy-intensive, with demand patterns that can shift rapidly, so as industry recovered in 2023 it putting further strain on the supply side of the market and increased price volatility that the US and Russia don’t suffer from.

Average cost of electricity per kilowatt-hour (kWh) for the period between 1995 and 2020
Country	1995-2020 Average (€/kWh)	2020 (€/kWh)	2021 (€/kWh)	2022 (€/kWh)	2023 (€/kWh)
Germany	€0.23	€0.30	€0.32	€0.34	€0.40
France	€0.15	€0.18	€0.19	€0.21	€0.25
Italy	€0.19	€0.23	€0.23	€0.32	€0.35
Spain	€0.18	€0.23	€0.24	€0.31	€0.24
EU Average	€0.19	€0.21	€0.23	€0.28	€0.29
UK	€0.16	€0.21	€0.22	€0.28	€0.34
US	€0.11	€0.13	€0.14	€0.15	€0.17
Russia	€0.05	€0.06	€0.06	€0.07	€0.08
China	€0.07	€0.08	€0.09	€0.10	€0.11
Source: European Commission

 

The US and the leading emerging markets of Russia and China enjoy energy costs that are half of what the EU pays

The EU is the largest global gas and LNG importer. It has little gas of its own and what it does have is in decline now The Netherlands’ large Groningen natural gas field and the UK’s North Sea fields are exhausted. The differences in what Europe pays for energy and what the US and emerging markets pay is a millstone around European companies’ necks. Russia has always enjoyed cheap energy, but now it is selling it to the friendly countries at a steep discount, handing them an extra competitive advantage on top of their already low labour costs. The US also enjoys much cheaper energy.

Russia, with its copious supplies of gas and nuclear power plants (NPPs), has long enjoyed an energy dividend in manufacturing. And since China became the global green energy champion producing the majority of the world’s renewable energy, it is seeing its energy costs tumble.

“EU companies face electricity prices that are two to three times those in America. Natural gas prices are four to five times higher. Over time, decarbonisation will help shift power generation towards secure, low-cost clean-energy sources,” says Draghi. “But fossil fuels will still set the energy price for most of the time for at least the remainder of this decade. Unless Europe better transfers the benefits of clean energy to end-users, energy prices will continue to dampen growth.”

Germany has been particularly hard hit, as since it phased out its six NPPs in 2023 – the largest and most efficient in Europe – it has gone from a net exporter of electricity to a net importer of around 11.7 TWh a year. The German shortage is indeed a problem for Germany, but it is an even bigger one for Italy, Austria and Luxembourg that have all become dependent on German power exports to cover their own deficits.

SMEs have been particularly hard hit in Germany, France and other EU states, making formally profitable businesses loss-making.

Mittelstand firms are highly export-oriented, which exposes them to global market competition. Economic disruptions, like supply chain bottlenecks due to the war in Ukraine and trade disputes with China, coupled with rising energy prices and a labour shortage thanks to the poor demographics, have all combined to hurt their operations and profitability. The Mittelstand is in the backbone of Germany’s economy, making up 52% of GDP in 2023, and now company after company, particularly in light manufacturing and machine building, is going bust.

“Electricity prices [in Germany] have stabilised somewhat, partly because gas prices have become more stable and because of a decline in industrial activity. The cost of CO₂ emissions permits has also dropped significantly. However, electricity prices are still two to three times higher than they were before 2021,” says Holger Zschaepitz, the markets editor at Die Welt. “That’s hurting everyone.”

European vs German power prices 2019-2023 (EUR/kWh)
	EU Average Price (EUR per kWh)	Germany Average Price (EUR per kWh)
2015	0.205	0.295
2016	0.206	0.298
2017	0.208	0.303
2018	0.212	0.305
2019	0.215	0.308
2020	0.22	0.319
2021	0.235	0.323
2022	0.3	0.405
2023	0.2847	0.392
2024 (YTD Estimate)	0.27	0.375
source: European Commission

That is not going to change, as Russia is in the process of switching its energy export infrastructure – 70% of which used to go to Europe – from west to east. Moreover, this permanent change to the global energy markets, coupled with sanctions means the Global South now enjoys a discount while Europe is stuck paying a premium.

Russian gas to Europe is gone, but the oil sanctions have failed to stop Russia making money from exports. They are not sanctions, but a huge market distortion. Oil that used to travel a week from Primorsk in the Gulf of Finland to the ports in Rotterdam now takes a four-month journey to refineries in India and China before returning to the European markets as petrol. It’s the same Russian oil, but the trip whitewashes its identity in the name of “sanctions” designed to reduce the Kremlin’s income. Russia is still earning hundreds of billions of dollars from oil exports and is running a healthy current account surplus and a small budget deficit that is paying for its war.

The upshot is that the West is now paying a premium for its oil, whereas the friendly countries in emerging markets are now enjoying a discount on the most basic input: energy. According to the last KSE study, the discount Russia offers its friends in Asia has tightened recently but it’s still $11 on a barrel of oil, or about 10% less, which a major competitive advantage. And as Russia continues to build its new distribution system these changes will be hard baked in and will not only apply to oil, but a whole smorgasbord of essential commodities.

Deficit Europe

Food and energy prices are up, and now key raw materials are going missing. Putin demanded that the government draw up a roadmap to restrict strategic raw materials to external markets on September 14, including uranium, nickel and titanium, just as the US was mulling granting Ukraine permission to use its long-range missiles to strike targets deep inside Russia.

“This marks the beginning of Russia’s transition from exploiting energy dependence on the West to manipulating the market for critical raw materials. As the EU is set to gradually abandon Russian energy resources, Putin is trying to spot other vulnerabilities in the strategic dependence on the West. This could be inspired by the Chinese approach, which restricted the export of processed graphite in 2023. Controlling 90% of the supply, China's decision came at a high cost for global EVs production,” says political analysts and bne IntelliNews columnist Denis Cenusa.

Europe has a raw materials deficit. After 500 years of wealth flooding into the Continent from colonialism, Europe is extremely densely populated – too densely. Western Europe ranks second in terms of population density among continents after Asia, with 180 people per square kilometre, but less in the south and east of the region.

The Continent doesn’t have anywhere near enough natural resources to sustain itself and so has to import a large part of what is needs. The EU relies heavily on imports of agricultural and energy commodities to meet its demand, as well as metals and chemicals from Russia and food stuffs like cocoa and soyabeans from the rest of the world.

For other products like timber and sugar, domestic production covers a larger share of demand, but not all. For example, the EU needs to import 86% of its soyabean needs, essential animal feed, while its own timber resources have long been maxed out and any growth in demand has to be sourced from elsewhere – previously from Russia’s leading wood products giant Segezha.

The EU produces around 160mn tonnes of steel annually but imports significant quantities from countries like China and Russia, which account for around 18-20% of its total steel consumption.

The situation with more specialist metals is more dramatic. Production of titanium, essential for aircraft production, is minimal, and 90% of the EU’s titanium consumption is imported from Russia. Power-hungry aluminium is a little better, and the EU produces around 7mn tonnes per year (tpy), but another 45-50% of its needs is met by imports, mainly from countries like Norway, China and Russia, according to the European Commission.

Russian aluminium is another “unsanctionable” export item: “The EU is toying with the idea of slapping sanctions on one of Russia’s most important exports to Europe: aluminium. If it happens, the end of aluminium deliveries to Europe could cause prices to spike and drive smaller companies out of business, as there are few alternatives to Russia’s aluminium,” says Chris Weafer, the founder and CEO of Macro Advisory and former head of research at multiple Moscow-based investment banks.

The US doesn’t suffer from these problems, as it is almost entirely self-sufficient in everything, with a few notable exceptions like uranium.

 

European commodities production and import data 2023
Commodity	EU Production Volume	EU Import Volume	Import Value (€)	Import Share (%)
Crude Oil	~20mn tonnes	~425mn tonnes	€22.9bn (Q2 2023)	~95%
Natural Gas (inc LNG)	~50bn m³	~330bn cubic metres	€150bn	~85%
Coal	~60mn tonnes	~140mn tonnes	~€16bn	~70%
Soybeans	~2.5mn tonnes	~15mn tonnes	~€3bn	~86%
Palm Oil	Minimal	~7mn tonnes	~€3bn	~95%
Coffee	Minimal	~3.5mn tonnes	~€4bn	~100%
Cocoa	Minimal	~2.5mn tonnes	~€6.5bn	~100%
Sugar	~20mn tonnes	~3mn tonnes	~€2bn	~13%
Timber	Significant domestic	~5mn cubic metres	~€8bn	~20%
Steel	~160mn tonnes	~36mn tonnes	~€40bn	~18-20%
Titanium	Minimal (mostly imported)	~13,000 tonnes	~€1.8bn	~90%
Aluminium	~7mn tonnes	~5.5mn tonnes	~€10bn	~45-50%
Electronic Components	Limited	Significant imports	~€50bn	~85%
Fertilisers	~17.3mn tonnes	~10mn tonnes	~€12bn	~30-35%
Source: Eurostat, European Commission (EC), Centraal Bureau voor de Statistiek

This list of commodity imports was collectively worth €212bn in 2023, which was about 10% of the total EU import business from external markets of €2.75 trillion, according to European Commission.

The ineffectiveness of sanctions and the West’s continued dependency on some key Russian inputs can be illustrated by the trade in LNG, fertilisers and uranium.

LNG: The European Parliament called for an embargo on Russian LNG and sanctions against Gazprom on September 19 by adding Russia’s Arc-7 ice-class ships that export Russian LNG and the rest of the world. However, as bne IntelliNews reported, Europe remains hooked on Russian gas, still buying 25 bcm of gas (18 bcm of LNG, 8 bcm of piped gas) that still makes up some 20% of the EU’s total gas imports, down from 45% pre-war. Russia is successfully replacing the gas that used to be piped via Nord Stream with LNG shipments.

LNG imports to the EU took off in 2022, according to Gas Infrastructure Europe (GIE), up 1.7-fold compared to the 2021 level to 127.2 bcm from all sources (mostly US and Qatar) – almost as much as Europe imported from Russia pre-war.

Fertilisers: Russian fertiliser sales to the EU are also booming as Europe has few alternative sources. From January to May 2024, Russia exported 1.9mn tonnes of fertilisers to the EU, driven largely by high natural gas prices that have forced European chemical factories to reduce their own fertiliser production.

Fertilisers remains a business dominated by Russia and Belarus. Previously Europe imported a third of its fertiliser needs, but as gas is a major input and gas prices have soared, Europe’s own fertiliser makers were amongst the first heavy industry facilities to shut down during the energy crisis of 2022. In 2022, the value of fertiliser imports reached approximately €12bn, with imports making up about 30-35% of the total fertiliser consumption in the EU. The list goes on.

The demand for Russian nitrogen fertilisers rose by 39%, amounting to 1.1mn tonnes during the first five months of 2024. Poland emerged as the largest importer, accounting for 25% of these imports, followed by France (12%), Germany (11%) and Italy (10%). In addition to nitrogen fertilisers, there was a significant increase in the import of potash and complex fertilisers. Potash fertiliser imports from Russia to the EU quadrupled to 182,500 tonnes, while complex fertilisers saw a twofold increase, reaching 619,600 tonnes. The EU has accounted for approximately 20% of global fertiliser imports over the past five years.

Historically, Russia has supplied about 13% of the EU's fertiliser imports between 2018 and 2021. Although this share dipped to 8-9% in 2022-2023, recently they have started to grow strongly as the EU’s own production falls away. The EU initially included Russian fertilisers in its fifth sanctions package in April 2022, but quickly dropped the idea as unworkable. Projections suggest that Russian fertiliser exports could reach 44mn tonnes by the end of 2024, marking a 10% increase from 2023.

Uranium: Likewise, the US recently “banned” the import of Russian uranium; however, as the US doesn’t produce any enriched uranium of its own to speak of, a system of waivers was introduced in parallel with the sanctions that allow US firms to continue to import Russian uranium until 2028. The US is at least five years away from becoming self-sufficient in the nuclear fuel.

Globally, Kazakhstan leads in the mining of uranium, but enrichment is currently dominated by a few key players. Russia holds about 40% of the global enrichment market, primarily due to its state-owned company, Rosatom. Other major players include Urenco in Europe and Orano in France, which account for about 12% of global enrichment capacity. The US currently produces only a small fraction of its needs domestically, relying on imports for around 30% of its enriched uranium, but recent efforts aim to expand domestic production.

No decision had been made at the time of writing, but even if Putin doesn’t use uranium as a tit-for-tat political weapon, the threat highlights Russia’s monopolistic power in the international commodities markets.

Global uranium mining production 2021

Tech race 

Draghi’s report puts technology prowess at the heart of his proposed solution to Europe flaccid growth. And it needs to be. The cost of production in Europe is twice as high as in the US and over three times more than in China, but the EU is badly trailing behind both the US and China on innovation, and China is rapidly catching up with the US.

“The report proposes a fundamental reform of the innovation lifecycle in Europe: from making it easier for researchers to commercialise ideas, to joint public investment in breakthrough technologies, to removing barriers to scaling up for innovative companies, to investing in computing and connectivity infrastructure to lower the cost of developing AI,” Draghi said. “A weak tech sector will not only rob it of the growth opportunities of the coming AI revolution. It will also hinder innovation in a wide range of adjacent sectors – such as pharmaceuticals, cars and defence – where integrating AI into operations will be critical for the EU to remain competitive.”

Top ten countries patent filings 2019-2023
Rank	Country	Number of Patents Filed (2019–2023)
1	China	6,900,000+
2	United States	2,700,000+
3	Japan	1,900,000+
4	South Korea	1,400,000+
5	Germany	700,000+
6	European Patent Office	600,000+
7	India	500,000+
8	Russia	400,000+
9	France	300,000+
10	United Kingdom	250,000+
source: World Intellectual Property Organization (WIPO) and other patent offices

Draghi focused on the competition between the US and Europe in his report, but it is the emerging markets that are the real competition. And Draghi is right: the only place Europe can compete, given its fixed material and power costs, is on productivity – labour is by far the biggest contributor to unit costs. Staying ahead in the technology race is the key to keeping Europe competitive.

Over the past three years, the number of tech IPOs in the US, China and Europe has been very varied.

China has dominated IPO activity globally, especially with its STAR Market and other tech-heavy exchanges. In 2023, there were 42 IPOs concentrated in tech hardware and services. The market saw valuations increase dramatically due to the sheer scale of listings, and in 2023 alone, China raised $45.3bn through IPOs, contributing to its robust tech sector growth.

The US tech ecosystem is much more mature than China’s with a lot more companies coming to market. There was a boom in tech IPOs in 2021, with a record-breaking 126 tech IPOs. However, market conditions in 2022 saw a dramatic slowdown, with only 6 tech IPOs and a slow recovery in 2023 with major listings like Arm and others boosting confidence. Total funds raised through IPOs in the US in 2023 were approximately $17.57bn.

Europe is the laggard. The European tech IPO market is much smaller and any really successful venture usually chooses to list in the larger and more liquid New York market. In the peak year of 2021 there was an average of about 5 IPOs per month and companies like UiPath raised billions of dollars. The total market capitalisation for major European tech companies that went public in recent years is estimated at around €7.5bn.

But the pipeline in the US for more valuable tech IPOs is healthier than in China. As of 2024, the number of tech unicorns (privately owned companies valued at more than $1bn) in the US is the highest globally, with 720. China is in second place with 317 unicorns and the EU is a distant third with around 100 unicorns across the various member countries: UK (53), Germany (30) and France (26), according to PitchBook.

Europe has fallen badly behind the US in the technology race, while China in particular is rapidly catching up, and in some places has already overtaken Europe.

From the world’s 100 most valuable tech companies the US accounts for about 60% and includes such household names like Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta and Tesla, a few of which are worth over $1 trillion. US tech firms are much more profitable and are ten times the size of European tech firms.

Coming later to the game, China is in second place with around 15-20% of the top 100, including major companies like Tencent, Alibaba and PDD Holdings (Pinduoduo).

The EU holds about 5% of the top 100 but has some notable names like ASML from the Netherlands and SAP from Germany, which are both also in the world’s top 20 most valuable global tech companies. Taiwan-based Taiwan Semiconductor Manufacturing Company (TSMC) should also get a special mention, as it dominates the world of very small and highly sought after microchips.

 

Top 20 most valuable tech companies
Company	Country/Region	Market Cap ($bn)
Apple	United States	3300
Microsoft	United States	3300
Nvidia	United States	3200
Alphabet	United States	2200
Amazon	United States	1900
Meta	United States	1300
TSMC	Taiwan	897
Broadcom	United States	778
Tesla	United States	582
Tencent	China	453
ASML	Netherlands	415
Oracle	United States	384
Samsung	South Korea	379
Netflix	United States	281
AMD	United States	258
Qualcomm	United States	243
SAP	Germany	225
Salesforce	United States	222
PDD Holdings	China	212
Adobe	United States	206
Source: Visual Capital

“European firms are smaller and less profitable than US ones. Europe's lacklustre productivity growth and low R&D expenses mean EU firms are lagging behind US peers. The gap with US is most striking among tech firms, which are twice as profitable and ten times bigger in US,” says Agathe Demarais, a columnist at Foreign Policy.

China has been pouring money into R&D to close the gap with the US and has already managed to overtake it in several sectors. Ford CEO Jim Farley travelled to China with his CFO John Lawler in 2023 for the first time since the pandemic. They tested an electric SUV from their Chinese joint venture partner Changan and after thrashing it around a test track, Lawler turned to his boss and said: “Jim, this is nothing like before. These guys are ahead of us.”

The US has tried to protect its technological lead with the Inflation Reduction Act and the CHIPS laws that effectively outlaws the export of advanced technology to China. The measure badly backfired. US export controls on technology exports to China have instead hurt US technology companies, and effectively catalysed a consolidation amongst Chinese tech companies that boosted innovation and competitiveness in China’s technology sector, according to a report from the Federal Reserve Bank of New York. And China has gone from a net importer of US technology, to a net exporter of technology, according to the report.

Russia's progress in technology is much more mixed, but it basically remains stuck in second gear. There are flashes of brilliance like the rapid development and roll-out of the Sputnik V vaccine in 2020, the first and one of the most effective vaccines against the coronavirus that came as a complete surprise to observers.

In a follow-up, Russia says it has developed a promising vaccine against mpox at the end of August, which could potentially provide lifelong immunity against the disease. It also produces state-of-the-art military hardware and has rapidly innovated and produced new high-tech drones and electronic warfare (EW) capabilities over the last two years, overtaking Ukraine’s early lead. And Russia’s nuclear power technology is world class.

But in other sectors is badly behind. As bne IntelliNews reported, it is at least two generations behind the West in the production of precision tools, with little chance of being to catch up any time soon. While the US leads the world on microchips with a well-established 7 nanometre microchip and is chasing a 4nm chip, followed by China that recently commercially produced a 7mn chip, Russia is stuck at the level of a 90nm chip – a brick by comparison. However, the Kremlin is throwing itself at innovation and pouring investment into other directions where it has some prowess, such as software and cyber technology, as part of its National Projects 2.1 programme.

The Kremlin is well aware the current strong growth is temporary so it has finally launched a campaign to modernise the economy both at the public and private levels as well as build up the military industrial complex. Putin told the heads of Russia’s six military districts in May that the country needs to focus on both guns and butter when formulating its long-term economic development plans, enshrined in the updated National Projects 2.1 programme.

Russian companies have also been investing heavily in retooling their production lines to deal with the realities of sanctions. Investments in fixed capital in Russia moved up by 14.5% y/y in the first quarter of 2024, RosStat reported, to RUB5.93 trillion ($66.2bn) over the reported period. Fixed capital investments as of 2023 year-end gained 9.8% y/y and amounted to more than RUB34.04 trillion ($379.6bn). Like the US tech sanctions on China, the Western sanctions on Russia have spurred a period of investment and consolidation that has improved the productive health of the economy. Ironically, the flood of spending and investment has also undone some of the country’s legendary income inequality as Russia's poorest regions have been the biggest winners from the changes.

Draghi’s solution

The outlook for Europe to retain its competitiveness looks bleak but the Draghi report holds out some hope if drastic action is undertaken. The report identifies three main areas for action to reignite sustainable growth.

• Close the Innovation Gap with the US and China: Europe lacks dynamic new companies and invests significantly less in research and innovation than the US, particularly in advanced technologies. The focus needs to shift from mature industries like automotive to emerging sectors, and regulations must be improved to facilitate the commercialisation of innovations.
• Coordinate Decarbonisation with Competitiveness: High energy costs in Europe threaten industrial competitiveness. The EU leads in clean tech, but without a cohesive strategy to manage energy prices and align decarbonisation with growth, Europe risks falling behind, particularly with increasing competition from China.
• Enhance Security and Reduce Strategic Dependencies: Europe’s reliance on external suppliers, especially for critical raw materials from China, poses risks to its security. A stronger EU foreign economic policy, including trade agreements, stockpiling and industrial partnerships, is needed, along with better coordination within the fragmented European defence industry.

And all this comes with a hefty bill: Draghi proposes a €800bn a year industrial makeover – more money than was spent on rebuilding Europe after WWII. He also warns there are several impediments to overcome before the plan will work.

“First, Europe is lacking focus. We articulate common objectives, but we do not back them by setting clear priorities or following up with joined-up policy actions,” Draghi says, adding that overregulation and fragmentation are a major headache.

“Second, Europe is wasting its common resources. We have large collective spending power, but we dilute it across multiple different national and EU instruments,” Dhragi went on. “Third, Europe does not coordinate where it matters. Industrial strategies today – as seen in the US and China – combine multiple policies, ranging from fiscal policies to encourage domestic production, to trade policies to penalise anti-competitive behaviour, to foreign economic policies to secure supply chains. In the EU context, linking policies in this way requires a high degree of coordination between national and EU efforts. But owing to its slow and disaggregated policymaking process, the EU is less able to produce such a response,” adding it typically takes Europe 19 months to agree a new law.