How the EU can turn challenges into opportunities 1

We live in a world of major geopolitical and technological change. The EU is currently facing a series of challenges that, according to its leaders, threaten its very existence. But these challenges also represent important opportunities that this political generation is either seizing or wasting, leaving us in a position of great economic and political fragility. The policy measures proposed by the Draghi Report, published in September 2024, have already been partly overtaken by the dizzying geopolitical developments of recent months, especially by the policy measures taken by Trump since the beginning of 2025. The trade war, the upheavals within NATO and the escalation of Russia’s war against Ukraine and the Middle East, as well as the threats they pose to the EU, not to mention the threats from China, are the greatest threats the Union has faced since the end of the Cold War, and we could even say since the Second World War.

In this first essay, we will address the challenges posed by the new international economic order in the area of ​​international trade by Trumpism, which was addressed in our last four essays. First, we will look at bilateral relations with the US and then bilateral and multilateral relations with the Rest of the World. We will then address the issue of building a Single Capital Market, which would allow greater financial autonomy and one of the main bases for accelerating growth. Finally, we will address an important opportunity, which refers to some of the most relevant policies to increase the relevance of the Euro as a reserve currency at a global level. This is clearly an opportunity that the EU can seize to increase the capacity to diversify the portfolios of large international investors, allowing the EU to greater mobilize financial resources at an international level. And, not least, to increase the capacity to finance its security and economic growth.

In the second essay we will address the issue of security and defense industries and the topic of industrial policy and production chains.

1. Establish balanced trade relations between the EU and the US

In 2024, the EU imported €334 billion from the US and exported €532 billion to the US, representing a surplus of around €200 billion. It is no wonder that Trump, in a mercantilist mindset, has singled out the EU as one of his main targets of attack. In the first wave of tariffs, Trump imposed 25% tariffs on imports from all countries of steel, aluminium and cars. In the meantime, tariffs on steel and aluminium have been raised to 50%. In response, the EU imposed tariffs on a package of €21 billion worth of US imports, affecting politically sensitive products such as soybeans, poultry, motorcycles and other agricultural products.

In early April, as part of the so-called “reciprocal tariffs,” the US imposed a blanket 10 percent tariff on all imports. In response, the EU imposed a 25 percent tariff on 99 categories of US imports. Sectors such as automobiles, pharmaceuticals and machinery, which were heavily dependent on the US market, have already started to see export losses.

The highest level of tariffs imposed on the EU, 25%, has been suspended for 90 days. Negotiations have been underway between the parties, but Trump has already expressed his displeasure with the developments. He suggested that the EU should commit to buying 350 billion dollars of oil and gas in order to reduce the EU’s surplus immediately. Should the negotiations fail, the EU has already prepared a list of tariffs that will affect 95 billion euros of US exports, including cars, planes and bourbon. In addition to these measures, others have been discussed in the area of ​​large digital companies and services, where the US has a large surplus over the EU.

The EU has sought to retaliate within WTO rules, as a sign of respect for multilateral organisations. The impact on EU GDP has been estimated by international organisations at 0.2 to 0.8%.

The recent trade agreement in principle between the US and the UK, hailed by Trump as historic and a “ Foundation for Economic Prosperity ”, could serve as a reference for EU negotiations. [1] For now, Trump has set a universal 10% tariff on US imports. The EU will have great difficulty in opening agricultural markets, due to the anachronistic Common Agricultural Policy. The automotive sector, which accounts for 60% of the EU’s trade surplus with the US, is one of the most critical and important. The UK has only managed to reduce the tariff from 25% to 10% on current export volumes. EU steel and aluminium exports are of low value in the global context. Particularly important areas, and ones in which even the UK has not yet managed to close the deal, are services and digital trade.

In a global world, it is clear that there is always the possibility of accessing alternative markets, although substitutability will vary depending on the size and type of products sought by different markets. The EU should therefore seize the opportunities created by Trump's trade war by lifting barriers to imports from the rest of the world, negotiating agreements to reduce barriers and even free trade with countries and regions where there is great potential. In particular, with Mercosur, Mexico, Canada, Australasia, Japan and Korea, as more mature markets. Among the emerging markets, India, Vietnam and other countries in Southeast Asia are of great importance to the EU. And let's not forget the African markets, where China has made a major effort to penetrate. Foreign trade services, together with domestic services, have a huge role to play here.

3. Creation of a Community Capital Market

One of the reasons why the EU lags behind the US, not only in terms of GDP per capita but also in terms of productivity growth, is the fragmentation of Europe’s capital markets and the way savings are channelled into investment. The differences are abysmal. The US stock market capitalisation is USD 56.55 billion (Figure 1), while the largest market in the EU is France with USD 3.46 billion, followed by Germany with USD 2.183 billion! In total, the EU’s market capitalisation is USD 13.9 billion, about a quarter of that of the US.

And European stock markets create much less value: between 2015 and 2024 the American market appreciated by 288%, while the European market grew by 139%.

The structure of household assets (Table 1) reveals the differences in the use of household savings in the EU compared to the US. While in the US bank deposits (and money market funds) represent only 14.6% of total assets, in the EU they represent 30.6%. However, this difference is largely due to the accounting of pension funds, which in the EU take the form of Pay-as-you-Go. Substituting an estimate of their value in the EU* column, there is still a substantial difference in favour of investments in the capital markets in the US, and in banking and pensions in the EU.

These differences are even more striking in absolute terms, as household wealth in the EU is only 30 to 45% of that in the US (at a 1:1 exchange rate). Total household capital market investments amounted to USD 107 billion in the US, compared to just EUR 25 billion in the EU!

This is the first time that this type of analysis has been carried out, and in our humble opinion, it deserves an in-depth study. This abysmal difference is due to institutional, geographic and regulatory factors. The most important institutional factor is that pension systems in the EU are largely public, based on PAYG, while in the US pension funds are mostly private, which explains at least €20 billion of the capital market difference. The geographic differences result from the fragmentation of markets at national level, which will explain between €30 and €40 billion. And the rest are mainly regulatory: between 2019 and 2024, the EU issued 13,000 regulatory acts compared to just 5,500 in the US. There are also other factors of a behavioral nature, or risk aversion, which result from the previous factors (they are endogenous) and cultural (entrepreneurship spirit).

Neglecting these factors will doom capital market development policies to failure or to mere superficial aspects without much impact. But reforming institutional factors is a Herculean task, and one that may take decades.

It should be noted that the objective of capital markets reform policy should not be to bring the European system closer to the American one, but rather to increase its efficiency in terms of (i) achieving savings levels by economic agents in line with the optimal long-term growth of the economy; (ii) maximizing the efficiency of investments so that they contribute to achieving that optimal growth, and (iii) channeling savings into investments efficiently, in order to achieve (i) and (ii).

From this perspective, there is ample evidence that the US is able to achieve greater marginal capital efficiency from its investments, which has led to a total economy productivity rate around 1.5 to 1.7 percentage points above the EU over the last two decades.

There are three fundamental channels: (a) fiscal and budgetary policy; (b) the banking system; and (iii) the capital market. The EU has a high proportion of state intervention, mainly because many countries, including Portugal, do not base their pension systems on the three pillars: public, corporate and family, with a capitalisation component, which is a clear incentive to save and a better intertemporal distribution of income. The EU has a strong banking sector, with strong regulation and disincentives to risk-taking, which does not allow for an appropriate allocation to innovation and investment. There is a significant shortage of venture capital in the EU. The volume of venture capital in the US in 2024 reached USD 368 billion compared to USD 61.5 billion in the EU, almost three times more.

Capital market reform in the EU should begin with reform of the pension system, following the example of the Nordic countries, developing the three pillars and a capitalisation component. Deregulation of the banking system, with greater consolidation and competition (for example, in the savings bank system in Germany), incentives for greater public disclosure of capital by large companies, integration of European stock exchanges, among many others. Other important supporting reforms are the completion of the Banking Union and the creation of common insolvency systems among the Member States.

4. Creation of Euro Bonds as an international reserve instrument

The doctrine expressed by Trump’s economists aims to preserve the hegemonic role of the USD, which, as we know, facilitates external debt, as a reserve currency. In response to Trump’s “reciprocal tariffs” and fears that fiscal policy would cause US public debt levels to skyrocket, there were signs in the market that Asian countries responded by selling dollar assets on international capital markets. However, these sales would always be limited, as there are still no currencies that are beginning to rival the USD. The BRICs’ attempts have not yet produced any significant effect, and from our point of view, they do not have much chance because the basis of a currency is always the production capacity of an economy and the confidence (stability) it offers. However, these are far from being achieved, despite China having spectacularly increased its share of world production. In a recent book, Ken Rogoff, Our Dollar, Your Problem, Yale University Press, 2025, masterfully addresses the issue of the hegemony of the US dollar and the conditions necessary for a currency to threaten that hegemony. Although his analysis of the Euro is somewhat skeptical, it is a fact that the use of the Euro today is limited to the EU and a few small countries that were linked to European countries by financial and political ties.

And this is where the EU has a unique opportunity to significantly increase its weight among the world's reserve currencies. But to do so, it must create an asset linked to its global production capacity, which can only exist if it is an asset created and guaranteed at the level of the Union (Eurozone). As for the level of trust and stability of value, the reputation already gained by the ECB and the Union's budgetary rules are assured. We are talking, of course, about the well-known "Euro Bonds". Their creation would allow major global investors (central banks, sovereign wealth funds, pension funds) to acquire them to be included alongside US Treasury bonds in their portfolios.

Much ink has been spilled about the creation of Euro Bonds , also known as European Safe Bonds (ESBies), which have been the subject of some of the best economists of the current generation. These would be issued in the name of and guaranteed by the European Union and denominated in Euros, and could cover various maturities of varying length. The problem is that there is still no European Treasury to issue them. In other words, for this to happen, there would need to be a common budgetary policy. In the absence of this, these bonds could be issued by national Treasuries, but in compliance with common rules that ensure that their payment guarantee is extended to each and every member of the Monetary Union. And here lies the crux of the matter: is there enough trust among the members for none to engage in “free riding” and issue bonds to finance its deficit at the expense of the other members? We believe that today, a decade after the Euro crisis, it is possible to establish rules of fiscal discipline that would allow them to be issued by the Eurozone. We also recall that reference was made to the possibility that their issuance can only be made by member countries that have a history of respecting unquestionable budgetary stability. It is time to reassess these alternatives and create Euro Bonds.

Lisbon, 22.6.2025

[1] According to the Associated Press : (i) The US will maintain the 10% tariff on almost all UK imports, imposed by Trump on 2 April; (ii) The US will reduce its tariffs on UK car imports from 27.5% to 10%, but only on up to 100,000 cars. The UK exported 92,000 cars to the US in 2024, meaning the British car industry will not be able to increase its exports without paying higher tariffs; (iii) UK steel exports will enter the US duty-free, rather than face the 25% tariff the White House has imposed on imported steel; (iv) The two countries have agreed to expand market access for some agricultural products; (v) The US will suspend all tariffs on aircraft engines and other aerospace parts from British-made Rolls Royce. In return, a British airline will soon announce a purchase of $10 billion worth of Boeing aircraft; (vi) The UK will reduce its average tariff on American goods to 1.8%, which would represent a $200 million cut in tariffs. Still under discussion are access to the UK’s National Health Service (NHS), the UK’s digital services tax, which hits US tech giants such as Amazon, Alphabet’s Google and Meta, as well as pharmaceuticals, semiconductors and essential minerals.