European Economic Outlook 2025: Multiple Crises Dampen the Upswing

My European Economic Outlook 2024 article, which was published in December 2023, identified geopolitical conflicts as the biggest economic risk for 2024. Unfortunately, these risk factors have not declined. And the election of Donald Trump as US President – and his political plans – bring additional uncertainty.

First, let’s examine European economic development in recent years in an international comparison. The starting point is 2019, the last more-or-less crisis-free year before the Covid-19 pandemic.

Below-average economic growth in the EU since 2019

If the nominal gross domestic product (GDP) of various countries and regions in 2019 is standardised to 100 percent, we see weaker growth in the EU-27 between 2019 and 2024 (estimated value) than, for example, the aggregate of the major industrial nations, including the G7 countries – and the US.

Sluggish EU growth can be partly explained by the low economic dynamic of Germany, the largest economy in Europe. Consequently, below-average growth in Germany weakens the economic development of the entire EU.

Geopolitical uncertainties reduce trade and investment

Geopolitical tensions have a negative impact on economic growth and employment. The most important effects include:

• The loss of individual countries as suppliers of raw materials, components and final products. This can cause supply bottlenecks in the countries that import these goods, leading to production losses. In the worst case scenario, these losses and bottlenecks might cause GDP to shrink in importing countries.
• The disruption of transportation routes, such as that caused by military conflicts, can cause a shortfall of essential imports.
• If an importing country produces its own essential goods itself to avoid critical import dependencies, this security comes at a price. The country has to utilise scarce production resources to meet new production capacities. Consequently, these input factors are lacking in the manufacture of other products. From an efficiency perspective, it does not make sense to build these production capacities when there are already sufficient capacities abroad.
• Last but not least, geopolitical tensions increase uncertainty – and uncertainty is poison for investments. A general decline in investment is to be expected which weakens long-term production potential.

Increasing climate-related disruptions to global supply chains

Global warming and man-made climate change are increasingly becoming an economic risk.

Extreme weather events, such as floods and forest fires, can destroy production facilities. As a result, global supply chains are further disrupted, with the aforementioned negative impact on the global economy. Additionally, low water levels in rivers, for example, can cause shortages of cooling water during hot spells, leading to production cutbacks.

And even if production facilities remain unaffected, weather extremes can affect the efficient delivery of imports. This is because of impaired transport routes, such as washed-out roads, flooded railroad lines, and lack of water rendering shipping routes impassable.

Trump’s economic policy increases uncertainty

The policies expected to be adopted under the second Trump presidency are putting additional pressure on the global economy. In particular, a protectionist course by the US is damaging the international division of labour and, as a result, the growth effects associated with this division of labour.

Trump wants to increase tariffs on imported products to protect domestic companies. This will reduce export prospects for European companies. It is unclear how many trading partners and how many specific products will be affected. And the level of the tariffs is unclear. It is possible that Trump will initially threaten to impose high tariffs on individual countries. However, if these countries then behave favourably towards the US and its political goals, he may respond with lower tariffs.

US tariffs on Chinese goods worsen the sales opportunities of Chinese companies. As a result, they will try to sell more of their goods in Europe. This will increase competitive pressure on European companies.

Ultimately, China will likely respond to the US tariffs with their own tariffs. This could trigger a global trade war. The EU’s export-oriented companies would suffer particularly badly.

Loss of peace dividend

Increasing geopolitical tensions are likely to lead to a further increase in the production of military goods worldwide.

In terms of GDP, it doesn’t matter whether tanks or consumer goods are produced. But it does make a difference to people’s living conditions. If scarce factors of production flow into the armaments industry, this has a knock-on effect by reducing these resources for consumer goods production. These goods become scarcer, so prices increase, resulting in a new rise in inflation. Therefore, central banks must raise key interest rates, which has a negative impact on companies’ investment activities.

Long-term growth is dampened as a consequence of increased military production. If technicians, engineers and other skilled workers are increasingly producing and maintaining tanks and missiles, they will not be able to manufacture capital goods. This weakens companies’ investments, which has a negative impact on long-term growth prospects.

Economic rays of hope for the EU

However, there are some rays of hope for Europe’s economic development in 2025.

• The relatively strong growth of the US economy will increase income for American consumers, which will likely increase demand for consumer goods. This will lead to higher demand for products from the EU and may in itself increase EU exports.
• Easing inflationary pressure in Europe is likely to prompt the European Central Bank to cut interest rates further during 2025. Lower interest rates increase demand for capital goods. This strengthens economic growth within the EU on the demand and supply side because investment increase production capacities.
• Trump wants to boost US fossil fuel production. Higher oil production increases global oil supply. The resulting excess supply on the oil market lowers oil prices, which benefits all oil-importing countries, including EU member states.
• Trump’s planned corporation tax cuts are likely to lead to a surge in investment in the US, including money from foreign investors. The result is stronger demand for the dollar, which leads to an appreciation of the US dollar. The mirror image of the dollar’s appreciation is a devaluation of the euro. This makes European products cheaper for the rest of the world and can therefore boost EU exports.

On balance, however, the economic risks are likely to prevail for Europe.

Conclusion and outlook

2025 will be another year of considerable economic risks. The US economy is likely to grow faster than the EU economy because of expected tax cuts and improved sales opportunities for domestic companies, which will benefit from less foreign competition.

A rapidly growing economy generally generates high profits for domestic companies. This will make investment in the US more attractive. As a result, European investors are likely to invest more of their capital in the US. This capital will be lacking in the EU, dampening already weak investment activity.

Overall, it can be assumed that economic growth in the EU will be lower than in the US in 2025. These are the expectations from the latest economic forecasts of the International Monetary Fund, the EU Commission and the OECD.

After all, the EU’s expected growth in 2025 will be stronger than in 2024. But this will only happen if current geopolitical conflicts do not escalate any further. The greatest sources of danger at present are the ongoing Russian war of aggression against Ukraine, the Middle East conflict, which involves Israel and Palestine, as well as other states such as Iran, and the threat of China invading Taiwan. Unforeseen escalations of these tensions would upset the cautiously optimistic economic outlook for the EU.

About the author

Thieß Petersen is Senior Advisor at the Bertelsmann Stiftung, specialising in macro-economic studies and economics. His focus lies on the causes and effects of financial and economic crises, as well as the chances and risks of globalisation. Most recently, he worked on the effects of carbon pricing and the benefits of a potential global climate club.