The European Union has a problem that it has been trying to cure for three decades with ever larger doses of the same medicine. More rules, tighter fiscal constraints, greater harmonisation and supranational control, and less room for independent national industrial policies were supposed to raise productivity and competitiveness. The opposite happened. Europe is falling further behind the United States and China, investment remains weak, productivity growth is anaemic, and the industrial base is shrinking across much of the EU.

Italy is perhaps the clearest example of what happens when the European medicine intended to modernise an economy begins to kill the patient. A recent study by Dario Guarascio, Philipp Heimberger and Francesco Zezza on Italy’s long-term economic decline is particularly instructive. In the 1950s and 1960s, Italy was one of the world’s most dynamic industrial economies. Even in the 1970s, its productivity performance was stronger than that of Germany, France and Spain. After 1990, however, the country began to fall sharply behind: productivity stagnated, industrial production lost ground, and per capita income increasingly diverged from German and French levels.

The standard explanation is that Italy simply failed to reform. The evidence suggests otherwise. Italy was among the most aggressive European countries in privatising state assets, liberalising markets and deregulating its economy. Between 1973 and 2013, it implemented substantially more market-liberalising reforms than Germany, France or Spain. The reforms were implemented. The promised productivity gains never materialised.

The decisive break came in the 1990s, during the preparations for monetary union. Following the 1992 currency crisis, the depreciation of the lira quickly restored Italy’s price competitiveness. Entry into the euro eliminated that adjustment mechanism. External devaluation was replaced by internal devaluation: wage restraint, labour-market flexibilisation, fiscal austerity and privatisation. To satisfy the Maastricht criteria, Italy generated large primary budget surpluses while attempting to preserve competitiveness by containing labour costs. But lower wages weakened domestic demand, cheaper labour reduced incentives for automation and technological investment, and weaker investment depressed productivity growth.

The result was a vicious circle. Low wages constrained consumption, weak demand discouraged investment, low investment depressed productivity, and poor productivity then became the justification for further wage restraint. By 2021, real wages in Italy were actually lower than in 1990. Instead of competing through innovation, technology and capital deepening, the institutional framework pushed Italy towards competing through cheap labour.

This brings us to the core problem of European integration. Very different national production structures were subjected to the same institutional framework. The Single Market restricted state aid and selective industrial policies, Maastricht and the fiscal compact constrained national fiscal policy, while the euro eliminated national monetary and exchange-rate policies. For Germany, with its large industrial corporations, technological advantages and powerful export sector, these constraints were manageable. For Italy, which had historically compensated for its structural weaknesses through public investment, state-owned enterprises, industrial policy and exchange-rate adjustment, European integration removed many of the key instruments of economic development.

This is not merely an Italian problem. It is a design flaw in the European model. Integration was built on the assumption that the Single Market, a common currency and tighter fiscal discipline would generate economic convergence almost automatically. Instead, they reinforced the cumulative effects of initial differences. Capital, technology, research and high-productivity activities tend to concentrate where agglomeration economies and technological advantages are already strongest. The periphery is left to adjust through lower wages, weaker domestic demand and the erosion of productive capacity. Rather than generating additional economic dynamism, the deepening of European integration has pushed parts of Europe into a development trap.

If Europe wants to restore its competitiveness, it has to stop prescribing more of the medicine that contributed to its stagnation. Europe does not need another layer of uniform rules and centralised supervision of national economic policies. It needs more room for national development strategies and substantially greater fiscal space for investment. Member states need to regain the ability to pursue their own industrial policies, support strategic sectors, build technological capabilities and use public investment to transform their productive structures. European state-aid and fiscal rules should be subordinated to these objectives, rather than the other way around.

This would inevitably mean a less uniform Europe. French industrial policy would differ from Italian industrial policy, just as Slovenian policy would differ from German policy. Economies with different productive structures, technological capabilities and stages of development cannot rationally be expected to pursue identical development strategies. Competition between national strategies may ultimately prove far more productive than the harmonisation of constraints.

The EU would consequently become formally less integrated but potentially much more economically dynamic, closer in this respect to the model that existed before 1994. Brussels should concentrate primarily on maintaining the Single Market, financing strategic cross-border infrastructure and supporting large-scale research programmes, while returning more development instruments to national governments. This does not require dismantling the European Union. It requires dismantling the idea that more integration automatically means more Europe.

If Europe wants to become one of the world’s most dynamic economic regions again, it will eventually have to do something that remains close to heresy for today’s European political establishment: reverse integration in selected areas, return key economic-policy instruments to member states and allow them once again to pursue their own development strategies. The paradox is that less Europe may ultimately be what is needed for Europe to rise again.

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* Slovenian version was published in Dnevnik