Transcription
Christine Lagarde, it is wonderful to have you with us again. The floor is yours.
[applause] [applause]
Dear Lord Mayor, dear Mike, dear co-host of the Frankfurt European Banking Congress, esteemed guest from the financial sector and beyond. I would like to start as I occasionally do with reading for you a quote. It goes that way.
"The world around us does not stand still. In recent years, the global environment has been transformed in ways that none of us could have imagined. We have seen the postwar global order fracturing, the rise of new and some old powers, rapid changes in technology, and an uncertain outlook for global trade and finance."
Sounds familiar. It should, because I'm just quoting myself. And that was here six years ago, November 2019. And November 2019 was before the use of AI or the rise of AI. It had been launched, but ChatGPT was a teeny tiny little thing that nobody really knew about. It was before the reelection of President Trump and his projects. It was before the unjustifiable, brutal invasion of Ukraine, and it was before COVID.
And yet, so in that speech, what did I do? Betina, you're right. I urged Europe to recognize that its old growth model, built on export-led growth, was coming under strain. And I called for a shift to focus instead on developing our domestic economy. And when I use "domestic," I talk about Europe. A domestic economy as a source of resilience in an uncertain world. And my point was not, if you remember, to argue for protectionism or inward-looking policies. It was about realism. It was about recognizing that the world was as it is and not as it was. And it was about acknowledging that the solution was already in front of us. And Jean alluded to it, the untapped potential of our own internal market.
Six years on, a lot has happened, but the diagnosis that we had back in 2019 has become just clearer, stronger, and more urgent. Europe has become more vulnerable, also due to our blatant dependency on third countries for our security and for the supply of critical raw materials. Global shocks have intensified with rising US tariffs, Russian aggression, and stiffening competition from China, to name a few. And at the same time, during the same period, our domestic internal market has stood still, especially in the areas that will shape future growth: digital technology, artificial intelligence, and in the areas that finance these shaping growth sources, our capital market.
And as Galileo said, "Yet it moves." Europe continues to show resilience, revealing sources of strength that could grow if only we allowed them to do it. So the two questions that I would like to discuss today is number one, how do we move from being vulnerable yet resilient to being strong? And what will it take to achieve this goal? And I think we have what it takes. And it is not as complicated as we think it is when we bash our head against the walls of complexity in Europe. More on that later.
So let's look at the vulnerabilities that you all know about, but I'm going to try to give you some specific examples so that it gives credit to the ECB research and our staff, which is working hard on those issues. So those vulnerabilities stem from having built a growth model around the world that is gradually disappearing under our eyes. We embraced globalization more than anyone else in the world. Well, China probably embraced it a bit more than we did. But in the advanced economy, certainly, we were the most advanced. In the two decades before the pandemic, external trade as a share of GDP almost doubled in the European Union; it didn't move an inch in the US. And this deep integration brought significant benefits. The number of jobs supported by EU exports rose by 75%, reaching almost 40 million people working for export. And for many years, this was a great source of resilience. But today, that same openness that we celebrated for two decades has become a vulnerability. Exports have become a far less reliable engine of growth, reflecting the changing global landscape.
Just recently, because we have seen amplification of most phenomena that were in the works for a long time. In mid-2023, for instance, the ECB expected exports to grow by around 8% by mid-2025. You have the same numbers coming out from the WTO. In reality, they have not grown at all. And looking ahead, exports are projected to actually subtract from growth over the next two years. This has been felt more accurately in those countries that relied more on that export model and that were active, in particular, in those manufacturing sectors that were export-driven. As a result, growth across the Euro area has become more uneven.
At the same time, this export-led growth model has resulted in persistent current account surplus, increasing our reliance on other countries to generate our wealth, especially to the United States. Euro area residents hold nearly 10% of their total equity portfolio investment in US stocks, totaling $6.5 trillion, about twice the amount that they held back in 2015. Why? Well, this has been a very rational response by the Europeans because US markets have delivered returns that were roughly five times higher than Europe's returns since 2000. But it has created, as a result, a vicious circle. As US markets channel European savings into high productivity sectors, the performance gap between our economies, Europe and the United States, widens, prompting yet more Europeans to channel their savings across the Atlantic. The result is stagnating productivity at home and growing dependence on others.
Finally, we now face a new form of vulnerability. Not just us, we share it with others, which is the weaponization of dependencies on key raw materials and technology. Our analysis at the ECB is that 80% of large Euro area firms are no more than three intermediaries away from a Chinese rare earth supplier. Recent supply shocks, for example, the shortage of automotive chips or the threat of it, have shown how a single choke point can stall entire sectors, the automotive industry, notably.
Now, these vulnerabilities do not trigger massive, dramatic crises. Instead, they quietly erode growth as each new shock nudges us into a slightly lower trajectory. And over time, the cumulative effect of this lost growth and lost productivity becomes material. That's for the vulnerabilities. And we are all saddened by this state of affairs.
And yet, as Jean indicated, yet we are resilient. And I'm going to borrow from him and go a little deeper in some examples without taking too much time, I hope, because 2025 has exposed Europe's latent strength. Our experience this year has shown that a resilient domestic economy can shield Europe against global turbulence. And I will mention three sources of domestic strength that have helped cushion the shocks that we've suffered. I will quote, just like Jean, people, our potential, and our policies. I have to do that, right?
But first, our people. We have benefited from an unusually strong labor market, one that has remained remarkably resilient even as growth has slowed.
[snorts]
Typically, employment tends to grow at roughly half the pace of real GDP growth. And yet, since the end of the pandemic, that relationship has been almost not half, but one to one in Europe. And this strength has created a virtuous circle. Rising employment participation has increased as unemployment has reduced, but rising employment has supported consumption, which in turn has sustained services, in particular, and created even more jobs, particularly in labor-intensive sectors. And all of that despite an aging phenomenon that is very specific to the advanced economies but particularly acute in Europe, and immigration, which is a polarizing and devising phenomenon. People.
Second, our potential. Despite the notion that Europe is lagging behind in AI, European firms are moving quickly through the digital transition, and that is making investment more resilient to global uncertainty. And while tangible investment has reduced in the past two years as manufacturing has weakened, intangible investment has risen sharply, keeping overall business investment broadly stable. Firms continue to invest in AI and digital infrastructure because for any company that wants to survive, this is just not optional. People, potential, policies.
Fiscal policy, in particular, has acted counter-cyclically, buffering the economy rather than amplifying downturns, as happened after the financial crisis. The fiscal packages now being implemented for defense and infrastructure, especially here in Germany, are coming at the right time for Europe and will have a measurable effect on growth. It has to be done and implemented. ECB staff estimate that higher government investment between now and '27, so over two years, will offset around one-third of the trade shock that we are suffering. Keep that number in mind, one-third, because I'll come back to it later.
Monetary policy, the ECB is also playing its part by delivering price stability. A few years back, we were talking a lot more about inflation and interest rates. I haven't heard anything yet. We have cut interest rates by 200 basis points from their peak, and this is increasingly feeding through into easier financing conditions, which is helpful to support demand. We will continue to adjust our policy as needed to ensure that inflation remains at our target.
So together, these three sources of resilience will help anchor growth at home. Domestic demand is set to become the main engine of expansion in the years ahead. And this shift should also help narrow Europe's current account surplus, which has already halved since its peak in 2018. This experience underlines the power of a resilient domestic economy, strengthened by open strategic autonomy, a concept much discussed six years ago. Great speeches were given. I think we're now beginning to see it in action.
But it also exposes how much potential Europe continues to leave untapped today. Despite more than 30 years of the single market, intra-EU trade barriers in key areas remain too high. So you might remember the analysis that was conducted by the IMF about two years ago that indicated that services were prevented from circulating within the single market, and that that was the equivalent of about 110% of tariffs, and the same for goods, about 40% of tariffs. And everybody at the time said, "Oh, this is a questionable piece of research." So I asked my teams at the ECB to just go a little deeper into it to see whether it was questionable or not questionable, because I was quoting those numbers from my previous place. Well, they did thorough work on this, and the analysis that they produced is that internal barriers in services and goods markets are equivalent to tariffs of around 100% for services, so slightly more, less than the IMF research, and 65% for goods, a little more than the 40% of the IMF. This is what we produce and that we inflict on ourselves.
Now, let's be realistic again. We should not expect those barriers to disappear all of a sudden. Why is that? Because not all products are equally tradable. Because not all professions are the same. And because national and cultural preferences will continue to play a role in Europe, because Europe is based on diversity. Policy can reduce certain frictions. It's not going to eliminate them entirely. But we should expect at least two things.
First, that barriers are low enough for the sectors that will shape future growth to operate in a truly European market. And this is clearly not the case, in particular for digital services, which will drive future innovation, and this is certainly not yet the case for capital markets, which must finance it.
The second expectation that we should have is that being inside the single market, part of the club, offers a clear advantage over being outside the single market. In other words, that internal barriers are lower than external ones. But this is also not currently the case for services. Barriers to cross-border trade within Europe have been declining just as much as the barriers to operating from outside into Europe. So this helps explain why, even though services now account for three-quarters of Europe's economy, intra-EU trade in services makes up only about one-sixth of our GDP, which is roughly the same as our trade in services with the rest of the world. There's no competitive advantage to actually providing services within Europe. So this is a colossal waste of potential, especially at a time when we must rely more on ourselves than on others.
And the key point is that achieving these gains does not require radical changes. I know exactly what some of you think. "Oh, it's going to require treaty change. It's going to require a massive political push." You might be right on the latter, not right on the first. Our analysis shows that if all EU countries were to lower their internal barriers only to the level of that of the Netherlands, internal barriers could fall by about 8 percentage points for goods and 9 percentage points for services. I don't pretend that the Netherlands is the panacea for everything, but their barriers are significantly lower than most of the other EU members. So remember, 8% for goods, 9% for services. And if we were to only do a quarter of that, that would be enough to boost.