More Europe. The recipe of the International Monetary Fund (IMF) to try to close the gap in growth, productivity and income that the United States has opened is to promote regional integration. The organization advises against entering into a subsidy war and considers that advancing market unity is the way to improve growth. “Low potential growth continues to be Europe’s Achilles heel,” say the Fund’s experts in a report on the region published this Friday.
“Ensuring the soft landing will be difficult, but what comes next is even harder. “Europe needs to increase its growth potential,” Alfred Kammer, the director of the Fund’s European department, indicated this Friday. “Unfortunately, declining productivity growth, an aging population and lack of investment are formidable headwinds.” In his opinion, the gap is not only large, but will not be closed unless new policies are addressed.
“Our message on this front is clear. Trying to solve competitiveness problems by engaging in a subsidy race with trading partners will harm Europe more than it will benefit it. Instead of resorting to measures that break up the single market, we must begin to deepen it now,” Kammer stressed. The aid, she specified in a press conference, must in any case be limited, temporary and at the European level.
The IMF admits that overdependence on foreign supplies or economic specialization are legitimate economic security concerns, but says domestic subsidies similar to current U.S. policies under the Inflation Reduction Act would undermine the single market. “By giving rise to a less efficient allocation of resources, they would reduce real income in net terms by around 0.6%,” calculates the Fund.
According to the director of the European department, greater European integration, inside and outside the EU, is what would allow enormous untapped productivity gains. Jammer has put figures to that recommendation: reducing internal barriers by 10% could raise the level of gross domestic product by 7%. In his view, a stronger and deeper single market is also the right response to strengthen resilience against the risks of further global fragmentation.
“Combined with complementary measures at national level, all these reforms would demonstrate once again that Europe can overcome even the most serious obstacles if it acts decisively and together,” he indicated.
The report published this Friday by the IMF develops the recipes to increase the prospects for potential growth, with efforts at both national and European levels. Measures must be aimed at increasing labor force participation, preparing workers for the structural changes ahead, creating an environment conducive to private investment and promoting innovation on a level playing field at European level, especially as regards regards the ecological transition, maintains the Fund. But, above all, he assures that “greater European integration would amplify the effect of these reforms.”
The IMF stresses that formulating an ambitious set of growth-enhancing reforms should be a key priority of the new EU Commission. “By working together, EU member countries could substantially increase per capita income by removing internal barriers that continue to hamper the single market,” the report says.
According to the IMF, to better allocate capital, banking and capital markets unions will have to be completed. Measures would include further harmonization of national tax and subsidy rules, improving insolvency regimes and reducing administrative burdens. There is also scope to reduce effective barriers to labor mobility and trade in goods and services. Some of these reforms, however, have collided with resistance from some small countries, which see the homogenization of policies as an obstacle to their attempts to differentiate themselves and attract investments with certain regulatory and fiscal advantages.
The report also analyzes the differences in per capita income levels with the United States. The IMF points out that they are due to deficits in labor, capital and productivity, but highlights the contribution of the latter. The capital stock of the European Union is estimated to be 88% of that of the United States, and the labor input of the European Union is 92% of that of the United States. Although these are significant differences, total factor productivity in the European Union is only 78% of that of the United States. Therefore, he points out that to improve its growth prospects in the medium term, Europe must increase its productivity.
According to the Fund, obstacles to the movement of factors appear to remain particularly high, and their elimination could bring great benefits. He also believes there are notable untapped productivity gains through trade. “Trade integration in the European Union is greater than in other regional agreements, but only a fraction of the level observed between the United States. Although part of this situation reflects permanent national characteristics such as language, there is evidence that policies can further increase integration to the benefit of everyone in Europe,” he maintains.
The Fund applauds some integration initiatives and calls for more ambition with them. He cites the common digital repository for companies’ financial information and the proposal to harmonize elements of insolvency procedures. It calls for expanding the role of venture capital to finance innovation and growth, proposes designing portable pension products and rationalizing cross-border tax withholdings to make it easier for households to invest in capital markets. It also calls for progress in the liberalization of services, particularly in telecommunications. “All of these reforms will require political determination to overcome vested interests, relinquish control of segmented markets, and address the costs of adjustment,” he acknowledges.
Beyond this far-reaching diagnosis with medium and long-term proposals, the Fund sees it likely that the European economy will achieve a soft landing, the return of inflation to the target with a moderate economic cost in terms of growth. “Europe has done extraordinarily well in a turbulent context. After years of crisis and its aftermath, a soft landing for the continent’s economies is within reach,” Kammer admitted. “However, just because it is within reach does not mean it is a fact,” she added.
In his opinion, it will be essential to get the combination of macroeconomic policies right. In advanced European economies, “the easing of monetary policy should be adjusted to the evolution of the situation, that is, it should be neither too fast nor too slow,” he said. Across Europe, the pace of fiscal adjustment must also accelerate, he added.