Christine Lagarde: Panel remarks about the European economy during a discussion on the global economic outlook at the World Economic Forum

Christine Lagarde discussed the European economy during a discussion on the global economic outlook at the World Economic Forum. Europe's post-war growth model relied on three interdependent pillars: an open economy, mid-tech manufacturing strength, and a stable global order. However, all three are weakening as the international environment changes.

Last year alone, over 2,500 trade restrictions were implemented globally, reducing the benefits of globalisation. Europe's advantage in mid-tech manufacturing is also eroding, as China competes directly with the euro area in nearly 40% of sectors. Additionally, cheap Russian energy, once crucial for European industry, has faded, with EU electricity prices for energy-intensive industries now more than twice US levels and over 50% higher than in China.

The global order is also under pressure, with geopolitical tensions bringing critical dependencies and chokepoints into sharper focus, and Europe facing growing security threats. These shifts suggest that Europe's post-war growth model is eroding and unlikely to return to its former form. Despite this, Europe still has substantial strengths to build on.

The EU has the world's largest network of trade agreements, which is expanding with recent agreements with partners like India, Indonesia, Australia, Mexico, and Mercosur. The EU also retains world-class manufacturing capabilities and has a highly skilled workforce, particularly in Germany, where 35% of bachelor's graduates are in STEM fields.

Moreover, the EU's integrated market of 27 Member States and 450 million consumers remains important as the sources of growth shift. Domestic demand is projected to remain the main source of growth for the euro area this year, with growth continuing despite the energy shock. To turn this domestic resilience into a more durable source of growth over the long run, Europe must better utilize the scale of its home market.

By growing firms across the EU, they can invest more efficiently and push innovation further, ultimately making them more productive. This is especially important as new technologies reshape the sources of productivity growth. Europe has a world-class research and knowledge base, but the challenge lies in turning this knowledge into commercial success and ensuring that new technologies diffuse across the economy.

While Europe missed out on the first digital revolution, there are encouraging signs that European firms are investing in AI. However, two critical barriers remain: fragmentation in the Single Market and fragmented capital markets. Fragmentation reduces the returns on scaling in Europe, while fragmented finance makes scaling harder to fund, resulting in fewer firms.