United Against a Fragmented World

IMF News, May 4, 2023

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Lecture delivered as the Tommaso Padoa-Schioppa lecture at the Brussels Economic Forum.
Date and format: May 4, 2023 — As Prepared for Delivery.
Central warning: after decades of increasing global integration, there is a growing risk that the world may split into rival economic blocs, which would be bad for everyone, including people in Europe.

Global growth projection: "we project global growth will remain around 3 percent over the next five years—our lowest medium-term forecast since 1990."
Monetary policy trade-off: central bankers must keep focus until stubborn inflation is firmly under control; required monetary tightening is weighing on growth and exposing some financial vulnerabilities.
Geoeconomic fragmentation amplifies downside risks by "throwing cold water on already weakened global growth."

EU growth projections: "we project EU growth would fall from 3.7 percent last year to 0.7 percent this year before modestly recovering afterwards."
Inflation trajectory in EU: expected "to decline from over 9 percent last year to over 6 percent this year and, in most countries, not to return to targets until 2025."
Recent shocks and response:
- Russia’s invasion of Ukraine caused energy prices to spike and exacerbated a cost-of-living crisis, hurting low-income households most.
- Policymakers secured alternative gas supplies and supported households and businesses.
- "The EU banking system has entered monetary policy tightening with solid buffers."
Structural constraints: subdued productivity growth and demographic challenges (declining labor force) limit income growth and opportunity creation.

1. Improving productivity and opportunities for all

Required actions: structural reforms and investing in people, technology, and innovation.
Specific measures recommended:
Streamline regulations, improve education, spend more on research and development, and expand digital and green infrastructure.
Make labor markets agile to match workers with firms and ensure people willing to work hard can find good jobs.
Invest more in education and skills; reduce labor market duality (example: young workers stuck with temporary contracts).
Modernize social safety nets as labor markets change (rise of self-employment).
Provide incentives for higher female labor market participation and for older workers to stay employed longer.
Address demographic challenge via child care, flexible work arrangements, pension and labor market reforms to incentivize longer workforce participation by older workers.
Ensure fast-growing firms have access to enough capital by addressing fragmentation of capital pools along national lines; "Accelerating the European Commission’s Capital Markets Union plan would help address these barriers."

2. Step up climate action to ensure sustainable recovery

Rationale: accelerating the green transition boosts energy security and investment opportunities.
Recent progress: "Last year, as Russian gas imports plummeted, the EU ramped up renewables at a record pace and increased energy efficiency, causing carbon emissions to fall 2.5 percent."
Key bottlenecks: long build times for renewables—"difficult if it takes seven years to build a wind or solar farm."
Policy tools and implementation steps:
Implement the proposed Net Zero Industry Act to streamline regulatory and permitting processes for clean-tech projects.
Build "one-stop shops" and coordinate regulatory and permitting bodies on new digital platforms (example cited: Germany’s experience building new LNG terminals in record time).
Extend carbon pricing to buildings and road transport to incentivize emissions reductions and efficiency; note provisional agreement and the plan to create a Social Climate Fund to soften impacts on poorer households and smaller firms.
Create an EU Climate Investment Fund to centrally finance public investment needed to decarbonize the economy.
Caution on industrial subsidies: EU Green Deal Industrial Plan subsidies must be "well-designed and carefully applied" to avoid sizable fiscal costs, trade and investment distortions, and making the green transition more expensive for everyone.
Distributional risk: emerging market and developing economies could fall behind on adopting green technologies if they lack investment, undermining global climate goals.

3. Revive multilateral cooperation to reduce costs of fragmentation

Drivers of fragmentation: pandemic-era reshoring/friend-shoring and national security–driven investment decisions after Russia’s invasion of Ukraine.
Quantified long-term costs from IMF research:
"Trade fragmentation could cost up to 7 percent of global GDP in the long term—roughly equivalent to the combined annual output of Germany and Japan."
"If technological decoupling is added, some countries could see up to 12 percent of GDP losses."
Policy implication: while domestic gains from protectionist or inward-looking policies are alluring, in the long term "everybody loses from global fragmentation."

Call for European leadership: invoke Tommaso Padoa-Schioppa’s vision of defending and improving multilateral approaches to global economic governance; urge similar ambition today, including in the fight against climate change.
Inspirational close: quote from Toni Morrison — "If there’s a book you really want to read, but it hasn’t been written yet, then you must write it." Europe after the Second World War demonstrated the will to "write the book Europeans wanted to read;" the speaker urges the same determination to "write the book we want our children to read."

Lecture by the Managing Director at the Brussels Economic Forum - "United Against a Fragmented World" (May 4, 2023) — As Prepared for Delivery.