Welfare state at risk unless Europe halts decline in growth, says Lagarde

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Europe will not be able to afford its generous welfare state provision and increased investment in defence and in tackling climate change unless the region fixes a persistent decline in growth, the European Central Bank’s president Christine Lagarde has warned.

Without bold economic policies, the EU “will not be able to generate the wealth we will need to meet our rising spending needs to ensure our security, combat climate change and protect the environment”, Lagarde warned in a speech in Paris on Monday.

She added that the bloc was at risk of facing “a future of lower tax revenues and higher debt ratios” which would result in “fewer resources for social spending”.

A potential trade war, deemed more likely by analysts after Donald Trump won a second US presidential term this month, could further damage the wider region’s economy, Lagarde warned.

Without directly addressing the risk of US tariffs against imports from the EU and China, she stressed that the “geopolitical landscape” was “fragmenting into rival blocs, where attitudes towards free trade are being called into question”.

“We need to adapt quickly to a changing geopolitical environment and regain lost ground in competitiveness and innovation,” said Lagarde.

Joachim Nagel, Bundesbank president and a member of the ECB’s governing council, also warned that the world might be “on the brink of significant escalation” of “geoeconomic fragmentation”. “This is a concerning development, and we should all strive to restore co-operation and free trade,” he said in a speech earlier on Monday in Tokyo.

Even without a trade war, the gap between European and US GDP is set to widen further by the end of the decade, the IMF said last month in a report that sounded an alarm about the continent’s “lack of business dynamism”.

Europe’s ageing workforce and low productivity growth would reduce the continent’s average annual GDP growth for the 10 years until 2029 to just 1.45 per cent, compared with 2.29 per cent for the US over the same period. US growth has outpaced Europe’s since the global financial crisis, particularly since the Covid-19 pandemic.

In September, a report by former ECB president Mario Draghi argued that the EU had to invest more in a bid to tackle the bloc’s lagging competitiveness.

Europe was particularly exposed to the fallout from a potential trade war as it was “more open than others”, Lagarde said, pointing to the fact that trade accounted for more than half of Europe’s total economic output.

At the same time, the continent was “falling behind in emerging technologies that will drive future growth” such as artificial intelligence.

“We are specialised in technologies that were mostly developed in the last century. Only four of the world’s top 50 tech companies are European,” she warned.

The EU needed to respond to this by defining itself as a “single, large economy with predominantly shared interests” that should be pooling its resources in areas such as defence and the green transition, the ECB president said, adding that Europe’s “large, rich economy” had the necessary tools to “adapt” to the challenges.

“We can no longer see ourselves as a loose club of independent economies,” the ECB president said, adding that this view was “outdated in a world that is fragmenting into geopolitical blocs centred around the largest economies.”