Structural Reckoning

On November 14, 2024, Chinese President Xi Jinping and Peruvian President Dina Boluarte inaugurated the Chancay Port—a $3.5 billion megaport in which COSCO Shipping holds a 60% stake. The facility will become South America's largest deepwater port, capable of accommodating vessels carrying up to 24,000 containers.

  • By reducing shipping times from South America to China from 35-40 days to just 23 days, the port fundamentally reshapes trade patterns between Asia and Latin America.
  • The timing underscores a broader pattern. While the European Union spent 25 years negotiating the EU-Mercosur trade agreement—finally reaching political agreement in December 2024—China was building infrastructure across three continents.

The data from recent years suggests that Europe faces not merely cyclical economic challenges but structural pressures that demand serious attention.

The Great Divergence: A Tale of Two Decades

Begin with the most striking statistic: since 2008, Europe's GDP per capita has been essentially flat. Meanwhile, the United States went from roughly $48,000 to over $85,000 in 2024. This is not a gap—it is a chasm that widens every year, and it reveals the fundamental difference between an economy that generates value and one that primarily redistributes it.

  • The problem is productivity. Between the fourth quarter of 2019 and the second quarter of 2024, US labor productivity per hour worked increased by 6.7%. In the Eurozone, it crawled forward at just 0.9%. In 2024, EU hourly labour productivity reached $72/hour (PPP) compared with $116/hour in the United States—a 38% gap.
  • Over the past 25 years, economy-wide hourly labour productivity has grown by an average of 1.7% per year in the US, compared to just 1% in the EU. This is not a temporary lag—it is the mathematical signature of an economic model struggling to adapt.

For the past fifteen years, Europe's growth has rested on two pillars, both of them fragile. The first was immigration—importing workers to inflate GDP numbers without actually increasing output per capita.

  • This was "labor padding" disguised as growth, a demographic arrangement where adding more workers created the appearance of expansion without corresponding productivity gains.
  • The second pillar was exports. Unable to generate robust internal demand, Europe became structurally dependent on selling to the rest of the world. German automakers needed Chinese buyers. Italian machinery manufacturers needed German orders. French luxury brands needed American and Asian consumers. The entire continental economy was an export machine built on the assumption that external demand would grow forever.

Both pillars are now weakening simultaneously. Immigration has become politically contentious. And export markets are disappearing—not to recession, but to permanent displacement by China.

China's Existential Offensive

To understand what is happening to Europe, you must first understand China's position. China has no choice but to flood the world with its production. This is not opportunism—it is necessity.

China built the world's largest manufacturing capacity during its boom years, but its domestic consumption cannot absorb it. Overcapacity in steel, electric vehicles, solar panels, machinery, and consumer goods means China must export or face mass unemployment and social instability. The Belt and Road Initiative, the massive infrastructure spending across Africa and Latin America, the Chancay Port—these are not gestures of generosity. They are pressure-relief valves for an economy that cannot function if it cannot offload its production.

China is spending hundreds of billions on ports, railways, highways, and power grids across the Global South for one reason: to create the logistics infrastructure necessary to move Chinese goods to every corner of the planet. Every port China builds is a pipeline for Chinese exports. Every railway line is a distribution network. Every power plant enables a factory that will buy Chinese equipment.

And it is working. The transformation has been dramatic. In 2010, the EU and China maintained a nearly balanced merchandise trade with Mercosur, with the EU holding approximately 20% of the bloc's external trade while China held roughly 14%. By 2015, China surpassed the EU to claim the position of Mercosur's top trading partner.

By 2017, the EU lost its long-standing first-place position entirely. By 2023, China controlled 26.7% of Mercosur's external trade (up from 24.1% in 2018), while the EU's share had fallen to just 16.9% (down from 20.1% in 2018). The US share also declined, from 14.4% in 2018 to 13.9% in 2023. China's trade with Mercosur reached roughly $190 billion in 2023—about 18 times the total in 2003. Trade between China and Latin America grew 26-fold between 2000 and 2020, from $12 billion to $315 billion, and projections suggest this will reach $700 billion by 2035.

In Southeast Asia, Africa, and the Middle East, the story is similar. Chinese firms are not just winning market share—they are building the entire ecosystem of trade, from production to financing to logistics, creating structural advantages that European trade negotiations struggle to overcome.

Most Mercosur member states have emphasised their desire to boost ties with China. Uruguay has been in negotiations with China over a bilateral trade deal since 2021, with Montevideo pushing for a broader Mercosur trade agreement with China. [...]. Additionally, two Mercosur member states, Argentina and Uruguay, are participants in China's BRI.

"China's increasing presence in Latin America: Implications for the European Union" by Marc Jutten (2025)

The Mercosur Delusion: Negotiating Yesterday's War

The EU-Mercosur deal, given tentative approval in late 2024 after 25 years of negotiations, is a clear example of Europe's strategic confusion. It is an attempt to solve a 2010 problem with 2026 tools—except that 2010's problems no longer exist, and 2026's tools no longer work.

When these negotiations began in 2000, the EU was Mercosur's dominant trading partner. Between 2000 and 2020, EU-Mercosur trade grew at an average annual rate of just 3%, which was less than the growth rate of each region's trade with the rest of the world (8.2% for Mercosur and 3.6% for the EU). The fall in their relevance to each other was exacerbated by the rise of China. Today, China has systematically displaced Europe across Latin America. The deal that Brussels finally approved is not a path to recovery—it is a monument to irrelevance.

Consider the asymmetry:

The Chinese Offer: State-subsidized electric vehicles (BYD, Great Wall) and industrial machinery delivered via Chinese-owned logistics infrastructure (Chancay Port) at prices 30-40% below European equivalents. The entire value chain—production, financing, shipping, and after-sales service—is controlled and optimized by Beijing. Chinese firms can offer five-year payment plans at below-market rates because Chinese state banks provide the financing. They can guarantee delivery times because they own the ports and shipping lines. The two Chinese development banks—the China Development Bank and the Export-Import Bank of China—have loaned over $141 billion to Latin American countries since 2005, more than the World Bank, the Inter-American Development Bank, and the Latin American Development Bank combined.

The European Offer: A modest reduction in tariffs that comes bundled with demanding environmental compliance requirements (EUDR regulations), effectively neutralizing any price advantage. Europe is asking Latin American importers to pay more for German machinery and then navigate a maze of Brussels bureaucracy to prove their supply chains meet European sustainability standards.

Germany is bringing a regulatory handbook to an infrastructure competition. China isn't just selling goods—it is exporting entire economic ecosystems, complete with the financing and logistics to make them function.

For a factory owner in São Paulo deciding between a German machine tool and a Chinese equivalent, the calculation is straightforward: the Chinese option is 90% as good, costs 60% as much, can be financed over five years at 3% interest, and will arrive in half the time. The marginal quality advantage of German engineering no longer justifies the premium—especially when credit is expensive and Chinese suppliers can deliver faster.

The EU-Mercosur deal cannot change this calculus. It addresses yesterday's competitive landscape.

Germany: The Engine Has Seized

Germany's economic model was built on a simple premise: manufacture the world's best machinery and cars, sell them globally, and use the export surplus to fund a generous social contract at home. For three decades, it worked brilliantly. Now it is faltering.

The numbers tell the story:

In 2024, the United States overtook China to become Germany's largest trading partner for the first time in nine years.

Kaput

This is significant for an economy where trade represents around 83% of GDP, with exports accounting for approximately 43% of GDP. Germany is an export-oriented economy that is both the world's third-largest importer and exporter. But the real challenge is occurring in Latin America, Southeast Asia, and Africa, where Germany is being systematically displaced by Chinese competitors.

The problem is not temporary. German manufacturers face a difficult trilemma:

  • They cannot compete on price without undermining their business models.
  • They cannot compete on speed because Chinese supply chains are faster and more integrated
  • They increasingly cannot compete on quality because the performance gap has narrowed to irrelevance for most applications.

A Chinese CNC machine may not match a German equivalent in precision or longevity, but for 90% of manufacturing applications, it is more than adequate—and it costs 40% less. In a world of tight credit and thin margins, "good enough and affordable" beats "excellent and expensive" most of the time.

Germany's response to this pressure has been hesitant. Rather than investing massively in automation, artificial intelligence, and the productivity tools that could restore competitiveness, Germany spent the last decade on "labor padding"—using immigration to fill low-productivity service jobs to keep aggregate GDP growth nominally positive. This created the appearance of growth without corresponding increases in output per worker.

During 2024, the German economy experienced its second consecutive year of contraction—Europe's largest economy declined by 0.2% over the year, following a 0.3% contraction in 2023. Germany is caught in a challenging cycle where declining competitiveness leads to reduced investment, which leads to lower productivity, which leads to further competitiveness decline.

Italy: The Derivative Challenge

If Germany is experiencing a gradual slowdown, Italy faces a more immediate challenge. Northern Italy—Lombardy, Veneto, Emilia-Romagna—effectively functions as an outsourced manufacturing wing of Bavaria. Italian firms produce brake components, precision valves, hydraulic systems, specialized fasteners, and hundreds of other components that feed German assembly lines.

This integration creates significant vulnerability through operating leverage. Italian manufacturing is characterized by high fixed costs and substantial debt loads. Unlike services or software, manufacturing cannot easily scale down—factory leases must be paid, equipment must be maintained, and core staff must be retained even when orders decline.

This creates nonlinear risk. A 5-10% decrease in German demand for Italian components does not result in a 5-10% drop in Italian profits—it can eliminate 50-60% of free cash flow because fixed costs remain constant while revenue falls. When margins shrink, Italian firms struggle to service their debt, cannot invest in modernization, and face increasing financial pressure.

And then there is the sovereign debt problem. Italy holds the second-highest debt-to-GDP ratio in the EU, at approximately 138% (Eurostat Q2 2025 data). Public pension expenditure stands at about 15-16% of GDP, second only to Greece in the OECD, with at least one-quarter not being financed by pension contributions. Pension spending is projected to rise to 17.3% of GDP by 2036 before gradually declining. The country's solvency depends on maintaining nominal GDP growth above its refinancing costs—the familiar "g > r" condition. Italy cannot afford prolonged stagnation.

But stagnation is what Germany's decline makes more likely. As German industrial production contracts, Italian exports follow. As Italian GDP growth slows, bond markets reassess Italy's fiscal sustainability. The spread between Italian government bonds (BTPs) and German Bunds widens, raising Italy's borrowing costs. Higher debt service costs further depress growth, widening the spread more—a self-reinforcing dynamic.

France, with debt at approximately 114-116% of GDP (Eurostat Q2 2025 data), faces a similar dynamic on a slightly longer timeline—its debt increased by 3.2-3.5 percentage points in the past year, the largest increase among major EU economies. Spain and Portugal remain vulnerable. The entire southern tier of the Eurozone could face significant stress from a sustained German slowdown.

The Impossible Equation: Europe's No-Win Trap

Here is where Europe's predicament becomes genuinely difficult to solve. The continent faces a clear diagnosis: it must reduce its dependence on external demand by substantially boosting internal consumption. Only by building a robust domestic market can Europe insulate itself from Chinese displacement in export markets and create sustainable growth.

The solution is theoretically straightforward: increase disposable income so European workers and consumers can spend more. This means cutting taxes substantially, reducing social contributions, and leaving more cash in people's pockets to drive consumption-led growth.

But this solution is extremely difficult to execute because of one constraint: pensions.

Europe's demographic structure presents significant challenges. The ratio of retirees to workers is rising steadily. Pension obligations—both public and private—consume an enormous and growing share of national budgets. Public spending on pensions is highest in Greece and Italy at over 16% of GDP. In France, Austria, and Portugal, it approaches 13-14% of GDP. Even in fiscally disciplined Germany, it exceeds 10%. Public pension spending increased from an OECD average of 6.7% to 8.1% of GDP between 2000 and the latest available year.

These pension commitments are difficult to modify. They are contractual obligations to voters who have paid into systems for decades. Any government that attempted significant cuts to pension benefits would face substantial political opposition.

But pension spending limits flexibility elsewhere. Combined with healthcare costs for aging populations, these mandatory expenditures consume the majority of government budgets. There is limited room for the substantial tax cuts that would be needed to boost disposable income and consumption.

The arithmetic is challenging:

To boost consumption enough to offset lost export demand, Europe would need to cut taxes by 5-10% of GDP. Current pension and healthcare obligations already consume 20-25% of GDP and are rising. Total government revenue is approximately 45% of GDP. Debt levels (138% in Italy, 114% in France, 80%+ across most of Europe) mean borrowing significantly more risks triggering bond market concerns.

The equation has no easy solution. Europe cannot cut taxes enough to drive consumption without reducing social spending. It cannot cut social spending without modifying pension commitments. It cannot borrow much more without risking a debt crisis. And it cannot grow through exports because those markets are being captured by China.

The available options are all constrained.

The American Divergence: Why the US Doesn't Face This Trap

The contrast with the United States illuminates why Europe's trap is uniquely European. America faces its own challenges, but it retains strategic flexibility that Europe has lost.

First, the US economy is far less dependent on exports. If exports are about 15% or less of GDP, an economy is considered relatively closed—and that applies to the United States. In contrast, Germany's exports represent approximately 43% of GDP, with total trade representing around 83% of GDP. America can adapt to a global trade realignment more easily; Germany cannot.

Second, the US labor market rewards productivity. While Europe was importing workers to support GDP figures, the United States was importing capital to fund technological innovation. American firms invested heavily in automation, artificial intelligence, and productivity-enhancing tools. In 2019, ICT services contributed only 1.7 percentage points to value added growth in the EU compared to 11 percentage points in the US. The result: a 38% productivity gap that continues to widen.

Third, US demographics, while not ideal, are more favorable than Europe's. Immigration has been politically contentious but economically positive, bringing younger workers into the labor force. America's dependency ratio—retirees to workers—remains more manageable.

Fourth, US fiscal flexibility is greater. While American debt levels are high, the dollar's reserve currency status provides breathing room that European nations lack. The US can finance deficits at lower rates and for longer periods without triggering market concern.

The divergence in outcomes is clear: US GDP per capita has grown from roughly $48,000 in 2008 to over $85,000 in 2024. Europe's has barely moved. This is not a temporary gap—it is a structural divergence that compounds annually.

Europe's Difficult Choice: Relations with America

Faced with these constraints, some European leaders have begun discussing "strategic autonomy" and positioning Europe as a counterweight to American power. This approach carries significant risks.

Europe is simultaneously losing ground to China in export markets while remaining fundamentally unable to boost internal demand. The prudent response is not to distance itself from the one major economy that still functions effectively—it is to recognize that Europe benefits from American dynamism, American capital, and American consumers.

Positioning Europe in opposition to the United States while China systematically captures European export markets is strategically questionable. Europe would be limiting its options at precisely the moment when it needs more of them.

The Hard Truth: Limited Options

Europe is not facing a cyclical recession or a temporary competitiveness challenge. It is caught in a structural difficulty:

  • Externally, China is directing its excess production to the world through massive infrastructure investments that Europe cannot match. Chinese firms are not just winning on price—they are building entire ecosystems of trade, from ports to railways to financing mechanisms, creating structural advantages that are difficult to overcome. Chinese exports were up 12% or more in volume terms in 2024, while global trade grew far more slowly.
  • Internally, Europe's growth model—immigration plus exports—is weakening. Immigration has slowed and become politically contentious. Export markets are being captured by Chinese competition. The alternative—consumption-led growth—is constrained by demographic realities and pension obligations that consume available fiscal space.
  • Demographically, Europe faces headwinds. The ratio of workers to retirees is declining, and with it the ability to fund social commitments without either raising taxes (which suppresses consumption) or cutting benefits (which is politically difficult).
  • Fiscally, there is limited room to maneuver. Debt levels and tax rates across major economies are at or near concerning levels. Significant additional borrowing to fund a consumption boom would risk bond market reactions and wider spreads, making the debt burden more difficult to manage.

The EU-Mercosur deal is not a solution—it is a diplomatic achievement that does not change the underlying dynamics. The deal cannot make German machinery cheaper than Chinese alternatives. It cannot create the logistics infrastructure that China has already built. It cannot overcome the structural advantages of Chinese state financing. It addresses yesterday's competitive environment.

A Change Is Gonna Come?

The adjustment will likely come in stages. First, Berlin will recognize that Latin American markets have shifted—not temporarily disrupted, but structurally captured by Chinese competitors who offer better terms, faster delivery, and integrated financing. Then Rome will recognize that without steady German orders, Italian manufacturing will face debt servicing challenges. Then bond markets will reassess Italian and French fiscal positions, potentially widening spreads and raising borrowing costs. Then the adjustment accelerates.

Europe has one theoretical path forward: accept a decade of focused restructuring centered on productivity growth. This means substantial investment in automation, artificial intelligence, and high-value manufacturing. It means accepting that the generous social models of the 1990s face constraints in the 2020s. It means prioritizing capital deepening over labor padding, even if it means higher short-term unemployment. It means moving beyond the assumption that trade deals can substitute for genuine competitiveness.

But this path requires political resolve that European governments have rarely demonstrated. It requires telling voters that the past must be left behind. It requires modifying the commitments that politicians have made for decades. And it requires coordination across a continent that is increasingly divided along national lines.

Until Europe confronts these realities, the retreat from Latin America will be just the opening chapter in a longer story of industrial adjustment. The German engine is struggling. Italian manufacturers face mounting pressure. The pension constraint is binding. And China is still building infrastructure.

The question is not whether Europe will face an adjustment—it is whether European leaders will acknowledge it before markets force the issue. Time is passing. And every day of delay makes the eventual adjustment more difficult.

The Political Reality: Why Change Won't Come

The structural reforms Europe needs—productivity-focused investment, pension system modernization, tax reduction to boost consumption—are economically obvious but politically impossible. The costs of genuine change are simply too high for any government to bear.

Consider what real reform would require: telling retirees that their benefits must be trimmed, telling public sector workers that their jobs are not guaranteed, telling voters that the comfortable social model they grew up with cannot survive contact with Chinese competition and demographic decline. No politician who wishes to remain in office will deliver this message. The electoral mathematics make it suicidal.

What we are likely to witness over the next two to three years is not reform but its opposite. Even as right-wing parties rise in polls across Europe—driven by popular frustration with immigration, economic stagnation, and elite detachment—they will find themselves locked out of power. The established parties of the center-left, greens, and hard left will form defensive coalitions specifically designed to exclude nationalist and populist movements from government. We have already seen this pattern in Germany, France, and elsewhere. It will intensify.

These "cordon sanitaire" coalitions will not address Europe's competitiveness crisis. They cannot, because their constituent parties are ideologically committed to expanding the welfare state, not reforming it. Instead, they will reach for the only tool that remains available to governments unwilling to cut spending: confiscatory taxation.

Expect wealth taxes, inheritance taxes, exit taxes, financial transaction taxes, and dramatically higher marginal rates on income and capital gains. The justification will be "fairness" and "making the rich pay their share." The actual effect will be capital flight, reduced investment, and an acceleration of the brain drain that is already hollowing out European innovation. The most mobile capital and talent will leave for the United States, Switzerland, Singapore, and Dubai. What remains will be increasingly unproductive and increasingly taxed.

This is not speculation—it is the predictable consequence of a political system that cannot reform and therefore must confiscate. Europe's leaders will choose redistribution over growth, because redistribution rewards their coalition partners while growth would require confronting them. The path of least resistance leads to higher taxes, lower competitiveness, and continued relative decline.

The tragedy is that Europe still possesses extraordinary human capital, world-class institutions, and deep reservoirs of technical expertise. But these assets are trapped within a political economy that cannot deploy them effectively. The continent that invented the industrial revolution is slowly regulating and taxing itself into irrelevance, while telling itself that it is building a fairer society.

By 2027 or 2028, the gap between European and American living standards will be impossible to ignore. The gap between European and Chinese manufacturing capacity will be equally stark. And Europe's political class will still be arguing about how to divide a shrinking pie rather than how to grow it.

The window for serious reform is closing. It may already have closed. What comes next is managed decline dressed up as social justice—a slow erosion of prosperity accompanied by speeches about European values and solidarity. The voters who supported change will watch their preferences be overridden by coalition arithmetic. The entrepreneurs who might have built the next generation of European industry will build it somewhere else. And the pensioners whose benefits were supposedly protected will discover that benefits paid in a stagnating economy buy less every year.

This is Europe's future unless something fundamental changes. But fundamental change requires political courage that nowhere in Europe is currently visible. The most likely scenario is therefore the least dramatic but most corrosive: not a sudden crisis, but a slow fade. Not a reckoning, but a long goodbye.

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Photo by Vanessa Bumbeers / Unsplash.