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Europe will damage its economy if it enters a “subsidy race” with the US and China, and policymakers should focus instead on reaping gains from lifting internal barriers to EU trade, the IMF has warned.
Trying to copy the US Inflation Reduction Act, a package that includes $369bn of subsidies and tax credits for clean energy technologies, would permanently knock 0.6 per cent off EU gross domestic product, the fund said in its latest European Economic Outlook published on Friday.
But reducing the cost of internal EU trade barriers by 10 per cent would boost the region’s long-term growth by 7 percentage points, it estimated.
“As a very open economy, our number-one advice to Europe is, don’t become protectionist,” Alfred Kammer, European director of the IMF, told the Financial Times. “Protectionism is going to be damaging globally and a subsidy race is not in Europe’s interest.”
The EU has not proposed a similar scheme to the IRA in the US. However, Brussels suspended many of its state aid rules after the coronavirus pandemic hit, and last year it cleared the way for countries to offer subsidies matching those available for green energy projects elsewhere.
The IMF said trade-distorting subsidies within the EU had increased by two-thirds in 2021-23, compared with the previous three years.
“There is always a tendency to look to help national champions,” said Kammer. “But it leads to a misallocation of capital if you favour one company over others.”
The fund’s report comes as European policymakers are worrying about how the region’s trade-focused economy is being squeezed by mounting tension between the US and China.
“Other regions are no longer playing by the rules and are actively devising policies to enhance their competitive position,” Mario Draghi, a former Italian prime minister and European Central Bank president who is carrying out a review of EU competitiveness, warned in a speech this week.
“At best, these policies are designed to redirect investment towards their own economies at the expense of ours; and [at] worst, they are designed to make us permanently dependent on them,” said Draghi. “We have never had an equivalent ‘industrial deal’ at the EU level.”
EU leaders discussed ways to boost investment and growth at a summit in Brussels this week, including by deepening integration of the region’s financial markets and centralising supervision. But the proposals faltered after significant opposition from a majority of smaller countries.
Meanwhile, Brussels officials are considering imposing tariffs on imports of Chinese electric vehicles, which critics say benefit from state subsidies that allow them to undercut European rivals on price. European Commission president Ursula von der Leyen has also called for subsidies to boost European defence production.
Kammer said harmonising the EU’s single market was the key to boosting the region’s GDP per capita, which has fallen a third below that of the US.
“This wasn’t always the case,” he said. “Productivity is the main cause. The US has an integrated single market, but this still has to progress in Europe. That is the answer to all the pressures coming from outside.”
The IMF said in its report on Europe: “An uncoordinated policy response to structural pressures such as trade fragmentation — the splintering of countries into blocs that trade mostly with each other — could fray the EU’s single market.”
The growing divergence between the US and European economies was underlined earlier this week when the IMF raised its outlook for US GDP growth over the next two years but lowered its predictions for the eurozone.
The fund forecast US GDP would expand 2.7 per cent this year, more than three times higher than the 0.8 per cent growth expected for the eurozone. It said the US would continue to outperform in 2025 with growth of 1.9 per cent, versus 1.5 per cent in the euro area. Last year, the eurozone grew 0.5 per cent, while the US economy expanded 2.5 per cent.
