Europe’s Economy Faces Sink-or-Swim Moment as Trump Returns

Wall Street’s verdict is clear: A second Trump presidency is likely to deliver a blow to an export-dependent European Union that is struggling with sclerotic economic growth and ever-multiplying political crises. Whether it will finally spark some change is the question for patient investors.

Since Wednesday, the day after the election, the S&P 500 has gained 3.7%. Meanwhile, the Euro Stoxx 50 and the FTSE 100 are down. Among those to shed the most market value have been clean-energy firms such as Vestas, carmakers such as BMW , consumer-goods companies such as Nestlé and Unilever and sellers of pharmaceuticals such as Roche. They all sell a lot to the U.S.

The U.S. is the top goods export market for the European Union, and for Germany, with pharmaceuticals, machinery and vehicles topping the export list.

During the campaign, President-elect Donald Trump floated a 60% tariff on Chinese imports and a 10%-to-20% levy across the board. The think tank German Economic Institute estimates that such a measure could make the German economy between 1.2% and 1.4% smaller than it would have been by 2028.

The core of the European Union’s export machine has been plunged into difficulties because of the end of cheap Russian energy, delays in joining the electric-vehicle revolution and an over reliance on selling to China.

Volkswagen last week announced the closing of at least three plants in Germany. According to FactSet, American customers make up 18% of its sales, about the same as the German market.

“I want German car companies to become American car companies,” Trump said last month while holding a rally in Savannah, Ga. “If you don’t make your product here, then you will have to pay a tariff, a very substantial tariff,” he added.

On Wednesday, Oliver Zipse , chairman of German carmaker BMW, underscored that the company has a plant in Greer, S.C.

“The most demanded vehicles in the United States, we produce there,” he told analysts Wednesday in a conference call. “So there is some natural cover against possible tariffs.”

Volkswagen and Mercedes-Benz have factories in Chattanooga, Tenn., and Vance, Ala., respectively. Manufacturers Airbus , Siemens and BASF also service the U.S. market from within, as do Nestlé and Unilever.

Much depends on details. In early 2021, Airbus’s assembly line in Mobile, Ala., was forced to pay tariffs for its shipments of fuselage, wing and tail components from France and Germany, as part of a World Trade Organization dispute. An agreement was quickly reached to suspend them.

Regardless, building up capacity to service all types of American-based demand would be hard. The Mobile plant makes A220 and A320 jets, but A330 and A350 wide-bodies are assembled in France. Volkswagen uses Chattanooga for the Atlas SUV, the Passat sedan and the electric ID.4, but the bestselling Tiguan and Jetta are built in Mexico. Roughly a quarter of U.S. imported cars originate there, and Trump has suggested that a 200% tariff could be slapped on them.

And when it comes to high-performance models, most EU firms still make them domestically and ship them over. Exports to the U.S. amounted to about 800,000 cars in 2023.

To be sure, EU leaders have struck a conciliatory tone with Trump this week, suggesting that a more amicable endgame such as the 2018 trade deal between the U.S., Canada and Mexico is possible.

Another risk is that China would send even more cheap goods to Europe if the U.S. ratchets up its trade war with Beijing. Yes, recent experience shows that China often just reroutes exports through third countries—and, as of recently, faces higher tariffs for electric vehicles in the EU anyway—but even small shifts could have big effects.

For a decade and a half, the 27-nation bloc has limped along, fostering just enough political change to avoid a painful breakup during the debt crisis of the 2010s and the 2020 pandemic, but never enough to truly invigorate its economy. Attempts by France’s Emmanuel Macron and Germany’s Olaf Scholz to change course have ended in paralysis. Scholz’s three-party government collapsed this week, after years that saw the coalition’s pro-austerity member blocking efforts to spur domestic industry with public spending.

Yet the first Trump presidency did galvanise some early support for a cohesive industrial strategy in Europe. The long-term bull case for European equities is that Trump 2.0 will be a catalyst for further transformation. European Central Bank President Mario Draghi published a report in September urging less red tape, state aid to key sectors and, where appropriate, harsher tariffs, all of which has buy-in from officials in Brussels.

On a small scale, the impulse toward a European industrial policy is already playing out. European defence contractors such as BAE Systems, Rheinmetall and Thales have seen their shares jump on the expectation that less American military involvement in Europe will force governments there to rely on their own capabilities. By 2030, the EU wants members to direct 50% or more of their procurement budgets toward European contractors.

Elsewhere, substituting foreign markets for domestic consumers will prove much harder, though providing advantages to buyers of electric vehicles has proved extremely effective in Norway. They now outnumber cars that run on gasoline.

Caught between the U.S. and China, Europe’s economic strategy is soon to face its biggest challenge since the eurozone crisis. Investors are right to be wary.