Europe’s old growth model is ‘eroding’, warns ECB president Lagarde

Lagarde says Europe must scale up to revive long-term growthEurope’s post-war economic model is “eroding” and unlikely to return in its previous form, European Central Bank (ECB) president Christine Lagarde said on Wednesday, urging the bloc to make better use of its 450 million-consumer single market to build a new and more durable source of growth. Speaking at the World Economic Forum in Geneva during a discussion on the global economic outlook, Lagarde said three pillars that had supported Europe’s economic success were all weakening as the international environment changed. “Europe’s post-war growth model is eroding. And it is unlikely to return to the form we once knew,” Lagarde said. The first pillar was expanding global trade, which had helped Europe become one of the world’s most open economies. Europe is roughly twice as open to trade as the United States and had benefited substantially from globalisation, but Lagarde warned that continued expansion in trade could no longer be taken for granted. “Last year alone, more than 2,500 trade restrictions were implemented globally,” she said. The second pillar was Europe’s strength in mid-technology manufacturing, supported partly by access to relatively cheap energy. “That advantage is also being eroded,” Lagarde said. “China has been steadily moving up the value chain. The country now competes directly with the euro area in close to 40 per cent of the sectors in which we have a comparative advantage, compared with around 25 per cent in the early 2000s.” Europe’s energy advantage has also faded, she added, particularly following the loss of relatively cheap Russian gas. Last year, electricity prices for energy-intensive industries in the EU were more than twice US levels on average and around 50 per cent higher than in China, according to Lagarde. “The cheap energy on which European industry once relied – including that from Russian gas – has faded,” she said. The third pillar was a stable, rules-based global order underpinned by the US security umbrella. That environment allowed European supply chains to deepen and companies to organise investment around efficiency rather than resilience. Lagarde said that system was now under pressure as geopolitical tensions exposed critical economic dependencies and potential chokepoints, while Europe faced growing security threats close to its borders. “When economic dependencies can be weaponised or when perceptions of deterrence weaken, concerns about resilience enter economic decisions directly,” she said. Firms may invest less when capital is perceived as less secure, she added, with weaker investment weighing on both output and consumption. Despite those pressures, Lagarde said Europe retained substantial strengths that could support a different economic model. The EU has the world’s largest network of trade agreements, and that network is continuing to expand through agreements recently concluded or advanced with India, Indonesia, Australia, Mexico and Mercosur. Europe also retains world-class manufacturing capabilities, including global leadership in lithography and precision optics. Its skilled workforce is another strength, with Lagarde highlighting Germany, where 35 per cent of bachelor’s graduates are in science, technology, engineering and mathematics fields, the highest proportion among OECD countries. But the bloc’s biggest advantage could be the scale of its internal market. “Crucially, we have an integrated market of 27 Member States and 450 million consumers – the largest among advanced economies,” Lagarde said. She argued that this market was becoming increasingly important as the sources of economic growth shifted away from the conditions that had powered Europe’s post-war expansion. The euro area economy grew by 1.5 per cent last year, with the expansion driven entirely by domestic demand. The economy has continued to grow in 2026 despite the energy shock, with domestic demand contributing positively to the quarter-on-quarter growth of 0.4 per cent in the second quarter. Domestic demand is expected to remain the euro area’s main source of growth this year. “The task now is to turn that domestic resilience into a more durable source of growth over the long run,” Lagarde said. She said Europe needed to make much better use of the scale of its home market so that companies could expand across the EU, invest more efficiently and push innovation further. This would be particularly important as new technologies increasingly determine productivity growth. Europe already has a strong research base, with the EU accounting for around 6 per cent of the world’s population but 15 per cent of its researchers. It also produces almost one-fifth of the world’s most-cited scientific publications. The challenge, Lagarde said, was converting that research strength into commercial success and ensuring that new technologies spread throughout the economy. “Too often, the barriers that prevent firms from scaling also hold back that diffusion,” she said. Europe had already experienced the consequences of failing to capture enough commercial value from a technological transformation. It largely missed out on the first digital revolution, when the commercial gains from the spread of information and communication technologies were captured disproportionately elsewhere. “We cannot afford to repeat that experience with artificial intelligence, the second digital revolution,” Lagarde said. There are already signs that European companies are investing in AI, with survey evidence indicating that euro area firms expect to devote an average of around 9 per cent of their total investment to AI this year. The key issue is whether Europe can create the conditions for that investment to spread and scale. Lagarde identified two particularly important barriers, namely fragmentation in the Single Market and fragmentation in capital markets. Companies continue to compete heavily within national borders, weakening the competitive pressure to adopt new technologies. Recent research cited by Lagarde found that a one percentage point rise in the perceived share of domestic competitors investing in AI increases a company’s expected AI investment rate by around 0.6 percentage points. However, those competitive effects largely stop at national borders. “Removing internal barriers would allow that competitive pressure to apply across Europe,” she said. The other major obstacle is the difficulty innovative companies face in obtaining sufficient capital as they expand. European firms can often finance their early growth, but a significant gap emerges once they reach the scaling stage. According to the European Investment Bank, EU and San Francisco-based scale-ups raise broadly similar amounts during their first five years of operation. By their tenth year, however, EU scale-ups have raised roughly 50 per cent less. Fragmented capital markets can also encourage young innovative companies to leave Europe. Around 12 per cent of EU scale-ups have relocated outside the bloc, with the United States being the most prominent destination. “Fragmented capital markets can also incentivise young, innovative firms to vote with their feet,” Lagarde said. She argued that the two problems reinforced each other. Fragmented markets reduce the returns from scaling up in Europe, while fragmented finance makes expansion harder to fund. The result is fewer European companies reaching global scale and slower diffusion of new technologies throughout the economy. Europe is now attempting to address both problems, with efforts under way to reduce fragmentation in the Single Market and integrate capital markets more rapidly. One proposal is “EU Inc.”, an optional EU-wide corporate legal form that would allow companies to incorporate once and then operate under a single set of rules throughout the bloc. The aim is to enable a young company to start and expand across Europe without having to navigate different national systems as it grows. Lagarde cautioned, however, that EU Inc. would address only one part of the problem. The broader task is to remove the barriers that continue to fragment the Single Market, allowing competitive pressure and new technologies to spread more widely among existing companies. “Firms that can scale across Europe need capital that can scale with them,” she said. The EU is consequently moving towards greater integration of its capital markets, with European leaders calling for lawmakers to reach agreement on a market integration package by the end of 2026. The goal is to move Europe closer to a genuine single market for capital. Lagarde argued that Europe already possessed many of the ingredients required for stronger long-term growth. “Turning European size into European scale would help innovative firms grow at home, allow new technologies to spread faster and boost productivity,” she said. That, in turn, would help make domestic demand a more lasting engine of growth for the European economy, at a time when trade, energy and geopolitical conditions are making the bloc’s traditional growth model increasingly difficult to sustain.