OECD Economic Surveys: European Union and Euro Area 2025

Executive summary

Key messages

Russia’s full-scale invasion of Ukraine and rising trade tensions have slowed down the economic recovery in Europe and emphasised the need to deepen structural reforms. The geopolitical challenges facing the EU will require robust policy responses from European institutions and national governments:

• Economic policy needs to support growth and make space for new spending needs, such as defence. Monetary policy should ensure the return to price stability.

• Reprioritising and optimising EU budget spending to provide sufficient resources for new challenges.

• A more integrated market for electricity would help lower electricity costs and improve competitiveness.

• Reducing the regulatory burden and removing internal market barriers is key to enhance innovation, business dynamism and productivity.

The energy crisis and geopolitical tensions have weighed on growth

Russia’s war of aggression against Ukraine and rising geopolitical and trade tensions continue to slow down the EU economy. Monetary policy needs to remain vigilant until inflation is durably reduced. Sluggish growth and considerable future spending needs require deepening structural reforms and carefully prioritising public spending.

Economic recovery has been slow. Despite strong policy responses to external shocks, aggregate demand remains subdued. Low confidence and precautionary motives hold back consumption and high uncertainty continues to weigh on business investment. Tight labour markets have supported private incomes, but labour demand has recently started to ease, partly reflecting the catch-up of real wages.

Disinflation is progressing. Headline inflation decreased swiftly following monetary policy tightening and services inflation started to ease (Figure 1). As services inflation needs to decrease further, monetary policy would do well to remain vigilant and data‑dependent. There is merit in addressing the vulnerabilities in the non-bank financial sector through macroprudential measures, as needed.

Figure 1. Inflation in services remains elevated

Euro area, y-o-y % changes

Source: Eurostat.

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Growth is projected to improve as private consumption strengthens. The labour market will remain tight with labour shortages slowing down wage growth normalisation. Easing financial conditions will support private investment, while public investment will be boosted by spending from the Next Generation EU (Table 1). Worsening geopolitical and trade tensions could weigh on external demand and, in case of EU retaliation, reignite inflationary pressures.

Fiscal policy should stay prudent. To ensure long-term fiscal sustainability, fiscal tightening needs to continue. Additional spending on priority areas such as defence and innovation cannot be financed by debt in the long term and needs to be accompanied by reprioritisation of expenditures and accelerated structural reforms.

Implementation issues in the new governance framework should be addressed to ensure uniform and equal application of the rules. The strengthening of national fiscal councils should continue to enable effective discharge of responsibilities and improve compliance.

Table 1. Growth is projected to strengthen

	2022	2023	2024	2025¹	2026¹
Real GDP (% change)	3.5	0.5	0.8	1.0	1.2
Private consumption (% change)	5.0	0.6	1.0	1.2	1.2
Gross fixed capital formation (% change)	2.0	1.8	-1.8	1.9	2.5
Harmonised index of consumer prices (% change)	8.4	5.4	2.4	2.2	2.0
Unemployment rate (% of labour force)	6.8	6.6	6.4	6.4	6.2
Fiscal balance (% of GDP)	-3.5	-3.6	-3.1	-3.1	-3.2
General government debt, Maastricht definition (% of GDP)	91.5	89.1	89.2	89.9	90.7

Note: Euro area countries that are also members of the OECD (17).

1. OECD estimates

Source: OECD Economic Outlook: Statistics and Projections database.

Repurposing the EU budget for new challenges

To address new objectives and priorities, including enlargement, the new EU budget will need to involve both increasing the budgetary resources and re-prioritising existing spending in areas such as cohesion and agricultural policy.

The EU budget is small and not sufficiently focused on European public goods. A greater share of public investment could be co-ordinated and financed at the EU level, including defence procurement and cross‑border infrastructure. To meet additional spending needs, EU countries will have to increase the EU budget’s overall envelope and re-prioritise existing budget items.

The financial burden of further EU enlargement under current budgetary rules is limited. The cost of enlargement to Ukraine, Moldova and the Western Balkan countries, estimated in the range of 0.1% to 0.3% of EU Gross National Income (GNI), mainly comes from an increase in Common Agricultural Policy spending. The budgetary impact could be further reduced by the application of long transition periods, as done in previous enlargements.

Cohesion policy is complex and insufficiently targeted. Many regions struggle to spend the cohesion funds, due to insufficient administrative capacities at national and regional levels, while the broad scope of cohesion policy complicates its evaluation. The cohesion policy targeting should further increase, while the new Competitiveness Fund, to come in 2028, needs to ensure efficient involvement of regional and local authorities.

The distribution of direct payments under the CAP is uneven and could be more efficient. Direct payments under Pillar 1 of CAP (Figure 2) often benefit other stakeholders than farmers and leave the variation of incomes over time unaddressed. Spending reviews, administrative simplification and national co-financing on all CAP spending would ensure more effective oversight, while releasing budget resources for new EU priorities.

The control and prevention of corruption still poses challenges. EU institutions should continue to coordinate national efforts to ensure public spending effectiveness and adopt the full 2023 anti-corruption reform package.

Figure 2. Common Agricultural Policy spending mainly goes to direct payments

CAP expenditure

Note: Next Generation EU funds are excluded when calculating CAP's share of EU budget.

Source: European Commission, CAP expenditure database (accessed on 28-Jan-2025), https://agriculture.ec.europa.eu/data-and-analysis/financing/cap-expenditure_en#:~:text=2018%2D22%20average)-,CAP%20expenditure%20in%20the%20total%20EU%20expenditure,to%20about%2024.6%25%20in%202023

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Strengthening electricity markets

High energy costs reduce the EU’s competitiveness, reflecting its dependence on fossil fuel imports. Lowering electricity costs requires structural reforms to lower electricity taxation, extend cross-border interconnections and strengthen competition to better align supply with demand.

The EU aims to lower energy costs through electrification and the decarbonisation of electricity generation. However, generous fossil fuel subsidies and relatively high electricity taxes reduce incentives for electrification. To further encourage electrification, reduced rates and exemptions for fossil fuels, including gas, need to be phased out. Taxation of fuels should be based on carbon content, with fossil fuels being taxed most heavily, to encourage the uptake of low-carbon electricity.

Renewable support such as feed-in tariffs and production-based contracts for difference reduce the responsiveness of energy supply to demand. Ensuring that state-aid goes to low-carbon technologies without distorting market price signals would help improve such supply flexibility. Raising the responsiveness of demand to energy prices will be essential as well.

Further progress is needed to connect electricity grids between countries. However, EU funding for cross‑border grid investment is limited and the dominance of national interests in project selection of EU-funded cross-border grid investment is not optimal from an EU-wide perspective. To identify the most efficient investment, the EU Agency for the Cooperation of Energy Regulators (ACER) could be tasked to propose specific cross-border grid connection projects that meet cost-benefit analysis criteria. A more integrated electricity grid would allow countries to export their surplus energy, helping to ensure security of supply and lowering energy costs elsewhere. An integrated electricity grid also allows for smoother integration of renewables, helping to achieve climate targets more efficiently.

Strengthening productivity and the Single Market

Long-term productivity growth has been weak, reflecting persistent internal market barriers (Figure 3). Higher productivity can be achieved through structural reforms to reduce internal market barriers, cut regulatory burdens, deepen capital markets, and strengthen competition to unleash business dynamism.

Market integration remains particularly low in services, where many EU countries have implemented the EU Services Directive in national law while foregoing the full potential of streamlining national services regulation. A fragmented Single Market puts European businesses at a disadvantage as firms operating in larger markets can more easily build economies of scale and tend to be more innovative and productive. Stronger productivity requires a more integrated Single Market for services with fewer regulatory roadblocks for companies to scale up and innovate.

A growing regulatory burden is constraining business dynamism. This reflects that recent regulation in digital sectors, including the General Data Protection Regulation, as well as sustainable reporting and due diligence rules were added to older ones, leading to a higher combined burden of regulations. Subjecting regulations to rigorous cost benefit analysis would help to reduce documentation requirements and reporting obligations.

Figure 3. Productivity growth has been weak

Labour productivity growth, y-o-y % changes, five-year moving average

Note: Labour productivity is measured as real GDP per hour worked, USD PPP-adjusted.

Source: OECD Productivity database; and OECD calculations.

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Capital markets remain underdeveloped. This reflects limited long-term capital provided by institutional and retail investors. The failure of high savings to flow into productive investment is related to insufficient risk taking by the largely bank-based financial system. Bank savings products continue to benefit from tax benefits compared to bonds and equity in many countries, further entrenching banks’ incumbent position. Stronger competition for savings products would help deepen long-term capital available for investment in young and innovative firms. At the same time, pension reforms that support a stronger uptake of private funded pensions would help expand the retail and institutional investor base.

Despite recent harmonisation efforts of EU capital market regulation, supervisory practices differ across countries. Convergence in supervisory practice and rules would help to reduce regulatory fragmentation and raise cross-border investment. Such convergence in national practice would constitute an incremental approach to capital market integration. Alternatively, a bigger push for a more unified European framework for supervision of capital markets could follow from the ambition to unify the Single Market for capital. This could be done by moving supervision of pan-European actors and infrastructures, such as pan-European stock exchanges, to the European level.

Cross-border labour mobility is hampered by limited mutual recognition of qualifications and other barriers. Service providers still face a wide array of barriers when they want to establish themselves in another EU country. Recognition procedures remain costly and lengthy, and the mutual recognition of qualifications is also not yet fully achieved. Removing unjustified and disproportionate restrictions on professional service providers would boost cross‑border mobility. Another way of improving cross‑border labour mobility is faster exchange of information on pension rights through the Electronic Exchange of Social Security Information. There is also room to improve the Blue Card scheme, which aims to attract high-skilled workers to the EU.

While the EU’s science base is strong, a major weakness lies in the translation of science into breakthrough innovation. However, EU public R&D spending is limited and not consistently directed at addressing this innovation deficit. Limited EU resources mean that the focus should be on raising the effectiveness of EU R&D support in encouraging innovation. This calls for rigorous evaluations of R&D programmes based on clear key performance indicators and for following up by closing under-performing programmes and shifting funding to well-performing programmes.

Different national corporate laws increase operating costs for firms that want to scale up activities across the EU. Such barriers to EU-wide business operation limit the contestability of markets. A common EU corporate law (28^th regime) would support scaling up of innovative firms and strengthen business dynamism. Initially, such an EU corporate framework could establish common minimum requirements for business registration and bankruptcy.

Unilateral national industrial policy entails risks for the Single Market. The EU has simplified and temporarily relaxed state aid rules for clean technologies and energy-intensive manufacturing during the energy crisis and announced temporary simpler and more flexible state aid rules for strategic sectors until 2030. Such an approach to industrial policy has risks for the Single Market as countries with more fiscal space may provide excessive support. To protect the level playing field within the Single Market, state aid rules should not be relaxed.

 

Main findings	Key recommendations
Implementing prudent macroeconomic policies
Headline inflation has fallen strongly, but services inflation has been sticky. As inflation normalises, monetary policy will have to become more forward-looking.	Maintain a prudent monetary policy stance to ensure that inflation expectations remain firmly anchored and inflation returns to its medium-term target.
Financial stability risks are increasing in parts of the financial system with exposures to commercial and residential real estate and among non-bank financial institutions.	Address risks to macro-financial stability by using existing macroprudential tools and strengthen macroprudential supervision of non-bank financial institutions.
Spending pressures will increase due to population ageing, the need to increase defense capacity and the green and digital transitions.	Ensure implementation of prudent fiscal policy to rebuild fiscal buffers and prepare for long-term spending needs related to ageing and green transition.
The new governance framework provides for better fiscal policy, but it is untested and could be pro-cyclical under adverse shocks. Its implementation requires additional guidance and supporting policies.	Build credibility of the new governance framework through consistent implementation.
Repurposing the EU Budget for new challenges
The EU’s annual budget is small and could be increased to co-ordinate and finance more public investment at the EU level.	Refocus funds and allocate new resources to priorities best provided at EU level, such as innovation and cross-border infrastructure.
The Recovery and Resilience Facility (RRF) suffers from the risk of delays and non-completion of measures, while its top-down approach may not be suitable for regional development policy.	Design output-based budgeting instruments, using lessons from the RRF. Take action to mitigate the risk of funding non-completed measures.
Almost 30% of the Cohesion Policy spending is channelled to EU regions with GDP per capita above 75% of the EU average.	Strengthen targeting of cohesion policy spending.
Despite mixed empirical evidence on the benefits of Common Agricultural Policy (CAP) payments for agricultural income and employment, direct payments still dominate CAP expenditure.	Free budget resources and improve spending efficiency of all CAP spending.
A strong anti-corruption and public integrity system ensures protection of the EU financial interest and allows citizens to rely on impartial institutions for a fair distribution of resources and a transparent business environment. The European Public Prosecutor's Office (EPPO) is key to investigate and prosecute crimes against the EU’s financial interests, including corruption involving EU funds. It effectively handles cross-border cases involving sophisticated criminal organizations, for which national offices do not often have adequate resources. A broad PIF Directive assessment could consider expanding its scope regarding corruption offenses	Continue to coordinate national efforts to fight corruption and fraud, by speeding up trilogue negotiations for the adoption of the full 2023 anti‑corruption package while also considering expanding the European Public Prosecutor Office's mandate.
Strengthening electricity markets
Renewable support such as feed-in tariffs and production-based Contracts for Difference reduce supply flexibility.	Ensure that the EU state-aid framework targets government subsidies to low-carbon technologies without muting market price signals.
High electricity tax rates discourage electrification.	Phase out reduced rates and exemptions for fossil fuels by adopting the revision of the Energy Taxation Directive.
Cross-border electricity grid connections are limited. The dominance of national interests in project selection of EU funded cross-border grid investment introduces disincentives for most efficient investment.	Task ACER to propose specific cross-border grid connection projects that meet cost-benefit analysis criteria.
Strengthening productivity and the Single Market
The regulatory burden is high. EU regulations are not always subject to a rigorous cost-benefit analysis.	Reduce the EU regulatory burden, including documentation requirements and reporting obligations for businesses. Subject all EU regulatory proposals to a rigorous cost-benefit analysis.
Many existing barriers to market entry and exercise of professional services are unjustified and unnecessary.	Ensure that mutual recognition of qualifications is improved, and all unjustified and disproportionate restrictions on professional services are removed.
The EU Blue Card attracts fewer high-skilled workers than similar national schemes. National requirements for Blue Card eligibility differ.	Relax common requirements for EU Blue Card eligibility and facilitate Blue Card issuance for workers already covered by similar national schemes.
Different national corporate laws raise businesses’ operating costs, limiting the contestability of markets.	Establish a common European Code of Business Law (28th regime) that includes business registration and insolvency.
EU-level public R&D spending is low and not consistently directed at addressing the innovation deficit.	Subject all R&D programmes to evaluations based on clear key performance indicators and follow up by closing under-performing programmes and shifting funding to well-performing programmes.
National industrial policy risks weakening the Single Market.	Enforce state aid rules to protect the level playing field within the Single Market.