When the heads of cabinets of the EU’s 27 commissioners huddled in the Belgian countryside in late August for their back-to-work retreat, all were invited to talk about what they thought should be the priority for the autumn.

The standout theme was clear, and unexpected.

“People mentioned ongoing support for Ukraine, but it wasn’t top of anyone’s list,” says a person present in the room. “Everyone, over and over again, kept on coming back to competitiveness, and fixing the state of the EU’s economy.”

Three weeks later, Ursula von der Leyen, the commission president, took to the dais in the European parliament in Strasbourg and delivered her annual State of the Union speech, a laundry list of past accomplishments and future ambitions for the EU’s executive branch.

The headline announcement was a surprise initiative: former Italian prime minister and European Central Bank chief Mario Draghi was returning to the fray to write a report on the state of the EU’s competitiveness and how to fix it.

While acknowledging “the birth of a geopolitical Union”, citing support for Ukraine and a tougher line against China, von der Leyen dedicated around a third of her speech to reshaping the EU’s economy.

“We need to look further ahead and set out how we remain competitive,” she said, introducing Draghi by rehashing his 2012 declaration that is seen as the turning point in the eurozone sovereign debt crisis: “Because Europe will do ‘whatever it takes’ to keep its competitive edge.”

The headline numbers are stark. The EU economy, in dollar terms, is 65 per cent of the size of the US economy. That’s down from 91 per cent in 2013. Per capita, US gross domestic product is more than twice the size of the EU’s, and the gap is increasing.

Drill down into the details and the story is the same. Take the list of the global top 20 technology companies; or the world’s top universities; or semiconductor manufacturing capacity: Europe lags behind.

Longstanding structural issues undermining the effectiveness of the EU’s single market, which is theoretically supposed to make 27 individual markets into a single frictionless one, have been compounded by years of crisis.

The Covid-19 pandemic, which bled into Russia’s war against Ukraine, pushed up energy prices and costs. Demographic pressures and educational bottlenecks have created a skilled labour shortage. And there is a burden of red tape and bureaucracy that small and medium business owners and EU diplomats both say crushes growth potential.

“There needs to be seriousness [in Brussels] about fixing the single market, because you cannot just talk about it as the ‘crown jewels’ of the union without treating it like that,” says Markus Beyrer, director-general of BusinessEurope, which represents business lobby groups from across the EU. “People don’t understand at the moment how important it is . . . both the general public and policymakers.

“We will need to find a narrative and a way to make it exciting again,” adds Beyrer. “Because the real technical work is unexciting, to go through all the regulations, and the barriers, and work out the things that would reverse the negative trends.”

At the same time, efforts to help the EU weather the worst short-term impacts of the twin Covid and Ukraine crises have created medium-term risks.

An outpouring of state aid and financial support from Brussels to European companies has radically altered the “level playing field” between countries and their businesses once guarded as the central pillar of the single market. EU state aid expenditure rose from €102.8bn in 2015 to €334.54bn in 2021. Between March 2022 and August this year, Europe approved €733bn in state support, according to unofficial commission figures seen by the FT.

That push has been exacerbated by a desire to speed up the continent’s green transition away from fossil fuels and to invest in new, low-carbon technologies. It is also a response to competing programmes such as Joe Biden’s $369bn Inflation Reduction Act (IRA), and longstanding state support offered by Beijing to Chinese rivals.

As such, while Draghi assesses competitiveness, another former Italian prime minister, Enrico Letta, is preparing a separate report on the state of the internal market, due to be presented in March.

Letta, the president of the Jacques Delors institute, has embarked on a tour of European capitals to, as he puts it, “come out of the Brussels bubble to listen to worries on the ground”.

Europe’s dilemma is preserving the strength of the single market, and the freedoms of movement, capital, goods and services, while competing with America, China, India and others, says Letta.

“How do we push on the power button while developing the four freedoms and not destroying the spirit of the four freedoms? Because we want to work on European sovereignty, on a new industrial policy, on a strong capacity for Europe to flourish and be powerful,” he says.

The desire for Europe to compete with the US, China and emerging powers like India, makes it “easy to destroy what we have built”, he adds. That is in Letta’s view, “this idea of a level playing field and free competition, which has been very, very important until now.”

Disunity in the union

One moment of truth for the EU was in the early 2000s, when the internet technology boom created dozens of major US conglomerates, but hardly any in Europe. In the decades since, EU companies have failed to come even close to the likes of Apple, Alphabet or Amazon, or challenge the scale of Chinese rivals such as Alibaba.

Now EU policymakers are very concerned that the next technology revolution — in artificial intelligence and quantum computing — will similarly pass Europe by and further widen the gulf with the world’s two economic superpowers.

Part of the reason for that gulf, say officials and analysts, is a question of scale, and of failing to fully realise the potential of the EU’s population of 450mn — a group larger than the US population of 332mn. Another part is a lack of co-operation between EU innovators, companies and finance from across the 27-country bloc.

Both are about the failure of the single market to truly function as one entity, rather than 27 individual markets bridged by various agreements, but held apart by national bureaucracy, protectionist policies and poorly-implemented EU rules.

Every industry has its bugbears. Retailers say barriers are ultimately hitting consumer prices. Ahold Delhaize, a Netherlands-headquartered supermarket active across seven European countries, told the FT in May that it regularly noticed different purchase prices on branded products made in the same factories but sold in different countries.

Top of the list of corporate gripes, alongside a shortage of skilled labour and high energy prices, is the regulatory burden imposed by Brussels, says Beyrer.

Many cite an increasing number of reporting restrictions they face as part of the bloc’s “Green Deal” — a push to rapidly transition the EU to environmentally friendly technologies.

“‘Let’s cut red tape!’ they say, and then a day later pass a new set of due diligence legislation,” says one senior EU diplomat with a smile and a shrug.

In her State of the Union speech, von der Leyen acknowledged this complaint, promising that each new piece of EU legislation required “a competitiveness check by an independent board”, and pledging new laws that would reduce “by 25 per cent” the reporting regulations at an EU level for companies.

State aid unleashed

To some member state diplomats, the biggest challenge to the bloc’s competitiveness has not been long-term trends or the inexorable rise of external rivals. Instead, the threat comes from internal decisions made in the heat of crises.

The Covid-19 pandemic and then Russia’s war against Ukraine posed threats to the EU’s economy, society and physical borders that Brussels had never before experienced.

Von der Leyen responded by assuming a more external-facing role than any of her predecessors, taking unprecedented control of the commission’s power levers, and promising a “geopolitical” commission that would see Europe throw its weight around more than ever before.

Some of the French and German actions were outrageous in terms of state aid. And the single market is now really, really frayed

“This geopolitical commission means it hasn’t been an economic commission, and there’s also a lack of natural interest and competence in economic areas at the top of the machine,” says one senior EU diplomat. “Which means areas like competitiveness, single market, etc, haven’t been taken care of.”

To support the fight against Covid, and the war against Russia’s invasion of Ukraine, Brussels threw the economic rule book into the fire. Rules on the permissibility of state aid and national subsidies were lifted and EU oversight of its members’ deficits and debts were suspended.

The EU’s state aid rules were drawn up to protect poorer states with less fiscal firepower from the richer states that would otherwise be able to pump cash into their national champions and give them an unfair advantage.

That, say some officials from mainly southern and eastern countries, is exactly what has happened. Governments in countries such as Germany and France, in the name of economic stability for the entire bloc, have given their own companies the financial clout to outcompete their EU rivals, trampling on the safeguards of the single market in the meantime.

Of the €733bn in state support that Europe approved between March 2022 and August this year, Germany accounted for almost half.

“All of the states did some pretty strange things during the pandemic and the war, and basically all realised they had carte blanche to do what they wanted,” says one official who participated in critical meetings where decisions were taken to effectively relax the rules given the unprecedented crises.

“Some of the French and German actions were outrageous in terms of state aid. And the single market is now really, really frayed,” the official adds.

Letta says that he is particularly concerned by this: “The key question is how to ensure that there can be common European and not national interventions . . . this sequence of national interventions really risks fragmenting the internal market.”

But commission officials defend their decisions on state aid given the threat they say is posed by the US’s green subsidies, which they say could prompt an exodus of EU companies across the Atlantic if Brussels is not able to at least compete with the cash handouts on offer from Washington.

Such was the panic around the threat posed by the IRA that the commission has been in more than six months of still unresolved talks with the White House over how to give EU companies access to some of the subsidies.

“The rules of the game have changed. Pressing economic security concerns, energy politics and subsidy races have compounded our competitiveness challenges,” says Donald Ricketts, chair of corporate advisory company FleishmanHillard’s EU office. “The defining question for Europe will not just be how countries adapt their current operating models, but whether their answers are collective or national.”

The state aid boom this spring fell during the Swedish six-month rotating presidency of the EU — a role that passes from country to country and involves chairing meetings and setting agendas. Sweden had hitherto been seen as the bloc’s champions of the single market.

“The Swedes oversaw the biggest ever explosion in state aid,” remarks one senior diplomat from another member state. “And for goodness sake, they are supposed to be the ‘competitiveness’ guys!”

Finding consensus

Before Draghi and Letta, there was a third Italian technocrat who sought to fix the ailments afflicting the EU’s competitiveness. That was more than 12 years ago.

Mario Monti, who would go on to become prime minister of Italy just over a year after presenting his report in May 2010, set out 12 recommendations to relaunch the bloc’s single market.

This led to several proposals but, in a telling indictment of the EU’s ability to acknowledge its weaknesses but inability to address them, few were actually implemented.

A suggestion to develop a “European professional card” to enable workers’ qualifications to be recognised across the EU — key to making the internal market more integrated — was introduced for just six professions in 2016. But it has not been expanded beyond this select few groups, which includes nurses and mountain guides.

Brussels has also failed to implement the recommendations of more focused, smaller internal reports. In 2020 the commission published a “communication on single market barriers” that identified several issues relating to services, goods and free movement.

“If we implemented this 2020 report on barriers there would be really significant progress in this area,” says Ieva Valeškaitė, vice minister of innovation for Lithuania. “But the commission chose . . . to find another way to write a report. It kind of adds to the pile.”

Finding political consensus for the necessary reforms proposed by Draghi and Letta is likely to be the toughest challenge for any competitiveness overhaul, EU diplomats warn.

The state aid explosion has given member states, particularly richer ones, the incentive to keep the rules as they are.

“The challenge now is to corral all these countries which have had two or three years of doing what they want back into formation to work in unison,” says one official involved in negotiations between EU capitals. “We need leaders to see competitiveness as a 27 issue, not a national one.”

The most far-reaching impact of both Draghi and Letta’s reports will probably be on the priorities of the next European Commission, which will start work in 2025.

It is unclear whether von der Leyen will remain in office as president, an outcome that is dependent both on her desire for a second term and the willingness of the 27 EU leaders and the European parliament to grant it.

But whoever runs the Berlaymont from 2025-29 will be expected to take on many of the two Italians’ recommendations when drawing up the legislative focus of that term.

Letta is set to present his report in March during the Belgian presidency of the Council of the EU that begins in January. Belgium has pledged to use its six months to focus on competitiveness and the single market. Hungary, which will follow in July, has said it will do the same.

They will have the job of selling the reforms to capitals.

In commissioning the Draghi and Letta reports, the EU has shown a willingness to acknowledge the problems facing its competitiveness. But remedying the situation — and catching up with ever more competitive rivals — will require far greater political will.

“Europe needs an overhaul,” says one economy official inside the commission. “Root and branch.”

Data visualisation by Keith Fray