The Capital Markets Union: Overcoming Political Challenges to Revive Europe's Sluggish Economy

Written by Alexis Cartier (BSc Economics and Economic History)

Christine Lagarde suggested a major shift for Europe’s Capital Markets Union (CMU) initiative, first introduced in 2014 by then President of the European Commission Jean-Claude Juncker. Europe currently suffers from weak growth and slumping productivity relative to the United States. This worrying pattern is partly due to the limited means available to finance the EU’s economy. Implementing the CMU, which aims at unifying European capital markets would facilitate investments in mid-sized and high-growth companies, hence fostering significant innovation and growth. However, the project appears stuck in political dynamics inhibiting action towards its long-term implementation. Overcoming political challenges amidst the CMU will require reframing its narrative to make inaction politically costly for European leaders, hence progress towards its completion.

Bridging the gaps with the CMU

Europe was on par in GDP with the US until 2011. However, since then the latter greatly prospered while the former stagnated. These two economic zones show salient financial differences explaining part of Europe’s lag. A larger share of Europe’s economy is financed through bank loans compared to the US’ which rests more extensively on equity and corporate bond financing. This difference is partly explained by the better integration and access to capital markets in the US, which lowers the cost of access to capital and provides effective alternatives to mid-size companies and start-ups.

The fragmentation of the EU’s capital markets is partly to blame for its limited depth when compared to the US. Such depth denotes the variety and volume of actors and financial products available to companies, which condition an economy’s ability to finance growth-leading investments. European capital market fragmentation is partly due to the multiplicity of national frameworks, which limit cross-border exchanges and market depth. Limiting the deepening of capital markets, hence, restricts their ability to sustain high-risk investments and a large volume of transactions. This inability of Europeans is highlighted by the inexistence of worldwide tech champions in the EU, where human capital is not to blame but rather ineffective means of financing, which often result in the foreign ownership of European start-ups or the underdevelopment of mid-size businesses.

Building up a union of capital markets, as suggested by the CMU policy initiative would partially resolve this financial limitation for EU’s start-ups and mid-size businesses. This reform suggests homogenising legal frameworks of the multiple capital markets of the EU, facilitating cross-border exchanges and the mobility of capital. It would limit the cost of accessing capital markets for mid-size businesses, which often do not have the required size to face the expenses of accessing equity or securities financing, widening their scope of accessible capital.

Implementing the CMU would in turn favour market depth by facilitating access to capital markets to investors and companies alike. Such deepening leads to better stability, increasing capital markets resilience and their ability to sustain shocks and high-risk investment. The latter is crucial for start-ups who rely essentially on risk-exposed investment strategies, which are facilitated by deeper, hence more risk-willing capital markets. Facilitating start-ups’ development favours high-growth businesses benefiting directly the economy through wealth creation, and indirectly through innovations.

Reframing the CMU's political narrative to make it a reality

Since its announcement in 2014, the CMU initiative has seen little tangible action towards its implementation. Some momentum was perceivable during the mid-2010s, though the current President of the European Commission shows little interest in advancing this major policy framework. Pushes are often attempted by the European Central Bank, chiefly through Christine Lagarde, though she lacks the political weight and prerogatives to engage in the required structural reforms. When assessing the economic benefits that could arise from making the CMU, it appears that the political challenges inherent to the project are to blame for its non-implementation, that is its challenge to national sovereignty and its inability to rise on top of national political agendas.

Homogenising capital markets’ legal frameworks and supervisory bodies within a common European initiative would limit participating countries’ national sovereignty. Building a union of capital markets suggests integrating each national supervisor within an EU-wide Securities and Exchange Commission (as suggested by Christine Lagarde), effectively transferring supervisory and regulatory powers to a single supra-national body. Such trade-off of national sovereignty to better the common good lies at the core of the European Union’s foundation. Though, unlike granting peace post-WW2, or responding to the Covid-19 pandemic, the CMU lacks the perceived urgency that allowed such a trade-off to occur during Europe’s history.

Currently, acting toward the CMU would be perceived as out of place in most European nations. The project currently lacks the narrative making it politically worthy to engage with for the EU’s political leaders. However, demonstrating the significant wealth creation that could arise from its implementation could turn the economic cost of inaction into a political loss. Those economic benefits should fit a narrative featuring the wider socio-economic objectives of the European Union, such as achieving Net-zero carbon emission by 2050 or implementing an EU-wide minimum wage. Framing the CMU as the facilitator of tangible positive evolutions in the EU could in turn make inaction politically costly for European leaders, as it would suggest disinterest in the fate of their citizens.

As Jean-Claude Juncker framed it, “We all know what we need to do, but we don’t know how to get re-elected after we have done it”. This suggests that the shorter-term political agenda of European democracies needs integrating the CMU, to make it a short-term political cost to ignore its long-term implementation. Lagging investments in the European Union could be partly reversed by the implementation of the CMU. However European political leaders have not effectively integrated the CMU within a narrative capable of unlocking further European integration and fostering EU-wide economic benefits. Reversing this dynamic by exposing the gains from better cross-border integration and capital market deepening is crucial to addressing part of the EU’s structural economic weaknesses and favouring its socio-political ambitions and geo-strategic interests.