Europe's Post-War Growth Model Eroding, Says ECB President

Christine Lagarde, President of the European Central Bank (ECB), has warned that Europe's post-war growth model is eroding due to changes in the international environment.

The European economy is facing significant challenges as its post-war growth model begins to erode. According to Christine Lagarde, President of the European Central Bank (ECB), the model, which was built on three mutually reinforcing pillars, is weakening as the international environment changes.

The first pillar of the model was expanding global trade. Europe became one of the world's most open economies, benefiting greatly from globalisation. However, expanding trade can no longer be taken for granted, with over 2,500 trade restrictions implemented globally last year.

The second pillar was Europe's strength in mid-tech manufacturing, supported in part by access to relatively cheap energy. However, this advantage is being eroded as China moves up the value chain and competes directly with the euro area in close to 40% of the sectors in which it has a comparative advantage.

The third pillar was a stable, rules-based global order, underpinned by a US security umbrella. However, this environment is under pressure, with geopolitical tensions bringing critical dependencies and chokepoints into sharper focus.

Despite these challenges, Europe still has substantial strengths to build on. The EU has the world's largest network of trade agreements, which is expanding, and it retains world-class manufacturing capabilities, including global leadership in areas such as lithography and precision optics.

The task now is to turn domestic resilience into a more durable source of growth over the long run. This requires Europe to make better use of the scale of its home market, allowing firms to grow across the EU and invest more efficiently.

However, there are barriers to overcome. Fragmentation in the Single Market and fragmented capital markets are holding back the spread of new technologies and the growth of innovative firms.

To address these barriers, Europe is moving to integrate its capital markets and remove internal barriers to the Single Market. The aim is to make it possible for young firms to start European and scale European, rather than having to navigate different national regimes as they grow.

The challenge lies in turning knowledge into commercial success and ensuring that new technologies diffuse across the economy. Europe has a world-class research and knowledge base, but it needs to create the conditions for that knowledge to be commercialised and spread.

Turning European Size into European Scale

Europe has the potential to become a global leader in new technologies, but it needs to create the conditions for that to happen. The two main barriers to overcome are fragmentation in the Single Market and fragmented capital markets.

Fragmentation in the Single Market means that firms still compete too much within national borders, which weakens the competitive pressure to adopt new technologies. Recent research finds that a 1 percentage point rise in the perceived share of domestic competitors investing in AI raises a firm's own expected AI investment rate by around 0.6 percentage points. However, those competitive effects still largely stop at national borders.

Fragmented capital markets can also incentivise young, innovative firms to vote with their feet. Some 12% of EU scale-ups have relocated outside the EU, most notably to the United States.

To address these barriers, Europe is moving to integrate its capital markets and remove internal barriers to the Single Market. The aim is to make it possible for young firms to start European and scale European, rather than having to navigate different national regimes as they grow.

Removing Barriers to Growth

The task now is to remove the barriers that fragment the Single Market and fragmented capital markets. This requires creativity and urgency, as well as a commitment to creating the conditions for growth.

Europe has the potential to become a global leader in new technologies, but it needs to create the conditions for that to happen. The two main barriers to overcome are fragmentation in the Single Market and fragmented capital markets.

Source: European Central Bank