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A strategy for European competitiveness – Caribbean News Global

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– IMF Managing Director, to the Eurogroup on a Strategy for European Competitiveness, Luxembourg

By Kristalina Georgieva

… For me, this is a short stop at home, always very pleasant. Yes, Europe is geographically in the middle. But is Europe caught in the middle too? To some extent, one can say Yes.

We see the major shifts underway. We know that many of the geopolitical concerns are real, that economic security actually matters. Across the globe, we see a resurgence in the use of industrial policy. In the US, the Inflation Reduction Act with its local-content requirements. In China, a history of support for various sectors.

Last year alone, we count over 2,600 industrial policy measures worldwide – with the US, China, and the EU making up roughly half of the total. These measures covered at least one-fifth of world trade. More than 70 percent were trade-distorting. Good economic rationale? Often not clear.

Still, some people like to say we live in a world of carnivores and that Europe behaves more like a herbivore. I am not so sure, at least not when I see last week’s tariff announcements on Chinese electric vehicles. You know that some form of retaliation will probably follow. My staff has given me a line on this matter, which I endorse. Let me quickly read it to you:

“The EU and China both benefit from an open trade system; we encourage them to cooperate to address the underlying concerns. Trade restrictions can distort the allocation of investment from where it is optimal, raising the cost of goods and services for final users. They can also slow the green transition and trigger retaliatory actions. We encourage all parties to work within the multilateral framework to resolve their differences.”

So there you have it: our cautionary position on the destructive potential of tit-for-tat protectionist measures.

As a general point, industrial policy can be a powerful tool, one that can, on rare occasion, be put to good use. But remember, history is littered with examples of industrial policy interventions gone wrong – the support for British Leyland in the UK, the ailing shipbuilders in Germany, Groupe Bull for computers made in France, BioValley in Malaysia, Solyndra in the United States, and the list can go on an on. In my personal experience looms large the former Soviet bloc: an entire economic system built around party functionaries deciding how to allocate the people’s savings. We know how that ended.

It is clear to see: technocrats picking winners and interfering in markets is a risky business – costly and distortionary. Design with care, handle with care. Use only when no better tools are available.

Full disclosure: this is personal for me. Having grown up on the other side of the Iron Curtain – the colder side of the Cold War – I much prefer the invisible hand of the market to the heavy hand of big government.

And a side comment: we know that with the pandemic shock and the energy shock governments everywhere have become much bigger. Debt and deficits are high, and now is the time to dial it back, not forward – we need front-loaded fiscal consolidation and lower debt, including to prepare for future shocks.

Coming back to industrial policy, let me briefly unpack when it can be appropriate. Two conditions must be satisfied. First, we must see a clearly identified market failure – the market not properly pricing or delivering a necessary thing. Second, we must assess that a broad-spectrum, less-distortionary, first-best policy approach is either unavailable or unable to deliver the desired outcome on its own.  Only when both conditions are satisfied can the use of an industrial policy intervention be appropriate, and then too, not always.

Three concrete examples of cases where industrial policy may have a role to play:

  • One, climate change. We know that the private sector alone will not deliver enough mitigation, and we know that our best tool, carbon pricing, vital as it is, cannot alone deliver rapidly enough to save us from calamity. There is simply no time to waste. This is existential. It is not something we can afford to take chances on. We at the IMF would argue that there may be a case to bolster mitigation efforts with industrial policy in support of the development and adoption of early-stage clean technologies. But let me be clear: we see no economic case for protecting mature clean tech – let this be produced wherever is least costly, globally. We all benefit from cheaper wind turbines and solar panels!
  • Two, supply-chain resilience. We saw during the pandemic the problems that arose from concentrated microchip supply. Diversification of the supply of critical goods like semiconductors is a real aim, and private firms may not have the incentive to do enough on their own – they weigh the benefits to themselves but not necessarily to the companies that rely on them further down. Does this mean we have a case for intervening to promote domestic chip production? Not necessarily, but perhaps in some circumstances – after careful analysis of the pros and cons, taking care to preserve a level playing field across firms.
  • Third, strategic public goods. Defense-related sectors are a classic example, where safeguarding the national security interest may be seen to require promoting domestic production and avoiding excessive reliance on foreign suppliers.

Let me offer a few words on industrial policy design when deployment is contemplated.

Three guiding principles:

  • First, know that picking winners and losers is inherently difficult. So, use industrial policy judiciously.
  • Second, as a European specificity, be sure to not undermine the single market. It is the EU’s greatest achievement. It is what gives the EU its economies of scale and scope, its heft on the global scene. Consider the externalities of state aid, for example: recent analysis by IMF staff finds that, while state aid may encourage the firms that receive it to hire more workers or invest more, it actually reduces, by a larger margin, jobs and investment in other firms in the same sector and in other EU countries that do not receive the aid. State aid may still be justified from a social perspective to redress a market failure and deliver benefits in the medium term but beware the potential for collateral damage. Thus, in Europe even more than elsewhere, use industrial policy with caution.
  • Third, let not industrial policy erect trade barriers that do more harm than good. Favoring domestic firms by relying on tariffs, discriminatory public procurement, or investment-screening controls is not only distortive, it tends to trigger retaliation, leading to less-efficient resource allocation globally. Recent history tells us that when one country introduces protectionist measures, there is about 75 percent probability of retaliation within a year. Ultimately, we get higher prices and fewer choices for consumers, self-defeating. When I think about the new tariffs on electric vehicles, I ask myself: to protect whom? Not today’s grass-roots consumer, who will probably pay more for green transportation. Not climate and the environment. Perhaps there is some intertemporal argument, but we at the IMF are unconvinced, watch out for some new analysis, coming soon.

Given the IMF’s role as guardian of the international monetary system, let me repeat the last point: a global escalation of tariffs can only make us collectively worse off while also undermining our existential struggle against climate change.

Finally, following on from the principles, a few specific recommendations for industrial policy interventions:

  • (A) Keep them temporary and try to preserve competition – in the free-market system, competition is what encourages firms to innovate, fostering a dynamic and resilient economy in the long run. Public policy interventions should endeavor to work with, not against, commercial incentives – for instance, by embracing public‒private co-investment where possible. And a clear exit strategy is imperative. Don’t just go in, know how you will get out!
  • (B) Keep them limited in scope to contain the fiscal costs and distortions, and coordinate at the EU level to protect the single market. Avoid national subsidies for national champions, complex and varied tax incentives, and divergent regulatory standards that lead to intra-EU fragmentation. Please: keep national politics out of it!
  • (C) Design and deliver national state-aid measures in ways that limit the adverse spillovers and fiscal strains on other member states. Your neighbour may not have your fiscal space!

In a nutshell: minimize distortions to international trade, avoid protectionist measures, comply with WTO rules, and protect Europe’s most precious economic asset: the single market. Whenever and wherever possible, choose cooperation over conflict!

Before I end, let me go back to where I began: advocating for a high-level competitiveness strategy. Let me list some critical aspects of that strategy – ot things you shouldn’t do, things you should do!

Fundamentally, as I noted, Europe’s competitiveness derives from its cohesion. Your strategy, therefore, must center on strengthening the single market.

Many parallel efforts will be needed, it brings me back to the concluding messages of our euro area policy consultation. You need to remove trade barriers within the EU. You need to strengthen the labor market by allowing workers to move more freely with skills that are continuously upgraded and recognized across the union. You need to invest in EU infrastructure, including cross-border electricity grids for energy security. And you need to mobilize unprecedented volumes of money for the green transition.

I have spoken separately about the need for a more ambitious EU budget and the savings of centralizing some projects of common interest. Hugely important.

Finally, you need to build a single European financial system, comprising both a banking union and a capital market union. Ultimately, this is about improving the allocation of savings to enhance productivity and growth potential.

I have said this before: Europe is rich, but it suffers from what I call “lazy money” – across the Atlantic, savings work much harder. Total financial sector assets in the euro area amount to about 60 trillion euros, not far short of the US’s 80 trillion euros. But, whereas in the US only one-third of the total sits in banks, in the euro area the banking share is two-thirds. Two implications to highlight today as I close:

  • One, while it is vital to press forward on capital market union, Europe cannot afford to neglect banking union – banks are where most of the money is. Please work together, in a cooperative spirit, to resolve the home‒host issues – I’m sure we can all agree that it is unacceptable that people can cross borders within the EU more easily than bank liquidity and capital!
  • Two, with banks being inherently less well suited to financing innovation – startups need long time horizons, and they often have no physical collateral to offer – targeted capital-market interventions may be necessary. I alluded to this earlier: the possibility of focused actions to support innovation and early-stage clean-tech. One specific idea from us: more action to support Europe’s under-developed venture capital industry. Again, we have a paper coming out soon. Among other things, its authors find that the European Investment Bank and European Investment Fund play a very constructive role in supporting financing for innovative European startups.

We are all familiar with the narrative of bright ideas being born in Europe but then migrating away to grow up elsewhere – Europe as someone else’s innovation supermarket. Europe needs a stronger venture capital industry, better able to support the best European startups so they can scale-up at home.

To sum it up: be generous in protecting and building the single market. Be stingy in using industrial policy. Promote the ideas of the future, not the industries of the past. Have a comprehensive strategy for competitiveness.

IMF Communications Department

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