As its new legislators assemble following June’s European Parliament election, The EU is facing major economic challenges. Europe enjoyed steady growth of 2-3% in the 1990s and early 2000s but hasn’t fully recovered since the 2008 financial crisis. Although demographic challenges in Europe contribute to some of this underwhelming performance, a significant portion arises from lower productivity of labour and capital, driven by more profound structural issues. These dynamics, coupled with the current geopolitical fragmentation and the lack of external demand are now leading EU policymakers to focus on strengthening the single market to boost productivity and growth.

The need for more economic integration is highlighted in Enrico Letta’s April 2024 report, Much More Than A Market. Mario Draghi’s report on improving the EU’s competitiveness, expected in July, will likely echo this sentiment.

While the single market entails significant advancements for economic integration, it is far from complete. Moving ahead with “more single market”, as advocated by Letta, comes with significant implications.

With the Centre for European Reform, we address these implications in our new study Why Cities Must Drive Growth in the EU’s Single Market. In this report – which is the first to comprehensively assess the winning and losing regions from trade within the EU – we identify crucial insights that policymakers must consider to effectively pursue deeper market integration.

Trade in Europe: Clustering and Compensation

The single market has helped spread the benefits of goods trade markets across the EU to the benefit of poorer, more distant and less populous regions (Figure 1). Between 2008 and 2018, these regions increasingly attracted factories thanks to cheaper land and labour, which translated into lower production costs.

Our findings reveal that manufacturing, traditionally linked to goods trade, has significantly shifted from affluent, densely populated, knowledge-intensive areas in Western and Southern European regions to the newer member states in Central and Eastern Europe. In that sense, the single market has indeed acted as a convergence machine.

Figure 1: EU manufacturing activity is shifting to peripheral EU regions with lower GDP and smaller populations

But since 2012, goods market trade has stagnated, following rapid expansion after the 2004 eastward enlargement. Intra-EU goods-trade has slowed even more than global trade, and this trend is only likely to continue.

With the Central and Eastern European regions catching up in terms of GDP per capita, the convergence effects in the goods trade, created by lower land and labour costs, are slowing as well. In light of this, no significant convergence gains from goods sector market integration can be expected until a further enlargement round.

Meanwhile, trade in services within the single market has been growing rapidly over the past decade – much faster than in goods and significantly faster than global services trade (Figure 2). By value, services exports within the EU have grown from one-third of goods exports in 2012 to half in 2022.

The relative ease of moving skilled workers and capital within the EU compared to outside it has facilitated this growth. Yet the single market for services is far from complete. Reducing barriers to services trade could accelerate it further and significantly boost economic growth.

Figure 2: Intra-EU services trade is growing relatively faster than goods trade

However, services trade is centripetal, meaning that it tends to cluster activity in already large and affluent cities (Figure 3). Additionally, the success of services exports is increasingly correlated with the presence of knowledge workers, efficient transport connections, effective governance and substantial business and public investment in research and development. These are factors predominantly found in dynamic city regions. This trend risks further deepening economic and political divides between liberal cities and conservative hinterlands.

Figure 3: The production of tradable services has not spread to distant or poorer EU regions

A City-led Strategy for EU Cohesion Policy

For the upcoming legislature, the EU’s cohesion policy will have to catch up with these realities. Services trade provides the next opportunity for growth in Europe, but EU cohesion policy has done little to help it along. Cities – the engines of the services economy – have only been a marginal player in EU funding, despite efforts by the European Commission to add a stronger urban dimension to cohesion policy.

A city-led regional strategy should focus on high-potential growth-city regions that are struggling with post-industrial transition. Targeted cohesion investments can leverage their large potential in productive services and help these regions make the most of the single market.

Major investments should focus on:

• Improved transport links: It’s vital to facilitate movement within struggling cities and between cities and surrounding towns. This will improve matches between workers’ skills and employers by creating larger labour markets within commutable distances.
• Increased city density: Better metropolitan transport and concentrating more workers and employers together expands labour markets. EU funds could be used to boost infrastructure that facilitates density, such as water supply, energy and telecommunications.
• Improved energy efficiency and electrification: Cities are more energy-efficient than more sprawling patterns of settlement. However, meeting net zero goals will entail a large rise in electricity demand, as heating, transport and industry become electrified. Lower energy costs will make cities more productive.

Additionally, the EU should establish new agencies and research institutions funded by Horizon Europe in these growth city-regions. This would create clusters of expertise that attract private companies and stimulate local economies.

The decision to locate the European Banking Authority in Paris and the European Medicines Agency in Amsterdam, rather than in second-tier knowledge hubs, was a missed opportunity.

Meanwhile, the EU should not break with the cohesion policiy’s original raison d’etre, which is compensating regions that are losing out on the single market, otherwise risking political instability. The EU elections have highlighted the political divides that follow economic disparity.

But if the EU is serious about securing competitiveness, its regional policy must play a crucial role in fostering growth, while continuing to manage disparities within the single market.

A city-led strategy offers a double dividend. By investing in city-regions with high growth potential that might otherwise miss out on the benefits of the single market, the EU can boost economic growth and spread the positive impact of further market integration. It is time for the EU to put services and cities at the heart of its growth strategy.

About the author

Lucas Resende Carvalho is a Project Manager at the Bertelsmann Stiftung in the Europe’s Future Programme.

Read more about the Single Market

Carving out a Compromise – Negotiations of new Fiscal Rules are Coming to a Close – Global & European Dynamics (globaleurope.eu)

The European Single Market turns 30: Time for Europe to Celebrate but not Rest on its Laurels  (globaleurope.eu)