ep BANCA D'ITALIA

WP EUROSISTEMA

The future of Europe's economy amid geopolitical risks
and global fragmentation

Lectio Magistralis by Fabio Panetta,

Governor of Banca d'Italia,

on the occasion of the conferral of an honorary degree

in Juridical Sciences in Banking and Finance by the University of Roma Tre *

23 april 2024

I am deeply honoured to receive this honorary degree in Juridical Sciences in Banking
and Finance from the University of Roma Tre.

The profound links between law and economics have been studied by eminent scholars.'

Laws and legal institutions shape economic interactions, aligning them with the needs
and aspirations of citizens. At the same time, economic transformations - especially when
accompanied by technological progress - are powerful drivers of change in legal norms.

Law is therefore an essential part of any economist's cultural and professional playbook.

My knowledge of the legal system and my belief in its importance for the economy and
finance stem from my experience as a central banker. As a civil servant, over the years
I have dealt with the implementation of monetary policy, the safeguarding of financial

This lecture is part of a reflection on European governance carried out during the years I was a
member of the Executive Board of the ECB, and follows other public speeches on the same subject.
Its preparation began when I was at the ECB and continued at Banca d'Italia. I wish to thank the
following colleagues for their valuable insights and contributions: M.G. Attinasi, M. Ca' Zorzi, E.
Dorrucci, C. Grynberg, D. Kapp, J.F. Jamet, D. loannou and B. Meunier at the ECB; P. Alessandri, L.
Bellomarini, A. Borin, L. Carpinelli, F. Colonna, I. Faiella, V. Memoli, R. Pisano and P. Rizza at Banca
d'Italia.

Ronald H. Coase, winner of the Nobel Memorial Prize in Economic Sciences, underlined how 'the
rights which individuals possess, with their duties and privileges, will be, to a large extent what
the law determines. As a result, the legal system will have a profound effect on the working of the
economic system and may in certain respects be said to control it.' (R.H. Coase, 'The Institutional
Structure of Production', Lecture to the memory of Alfred Nobel, Stockholm, 9 December 1991).
Cesare Vivante, one of the founding fathers of commercial law, advised his students about how to
approach their legal dissertations at the dawn of the twentieth century, 'Never venture into a legal
discussion without thorough knowledge of the technical structure and economic function of the legal
institution that is the subject of your studies. [...] If it is the task of law to regulate the effects of such
an institution, it is clear that the practical study of its nature must precede that of the law.' (C. Vivante,
Prefazione a Trattato di diritto commerciale. Vol. I: I commercianti, Milan, Vallardi, 4° ed., 1911).

stability, and the supervision of intermediaries. I can thus safely say that I have always
been immersed in economic, banking, and financial law.

Along the way, I have had the privilege of serving two prestigious institutions - Banca
d'Italia in the first place, and then the European Central Bank - which have contributed
to my understanding of the links between law and economics. Today I would like to
express my sincere gratitude to all those who work in these institutions for the loyal
cooperation and friendship they have shown me over the years.

KKK
My lecture will touch on some of the most pressing issues we face today.

The rules governing international relations are being severely tested by tensions and
conflicts that have erupted almost simultaneously in many parts of the world: from
Eastern Europe to the Middle East, and from Asia to Africa.? The number of violent
conflicts in 2023 was the highest since the Second World War.?

Geopolitical disputes have repercussions far beyond the borders of the countries
directly involved. Conflicts generate economic risks and hinder international trade
and the free movement of capital, potentially splitting the global economy into
opposing blocs. The weaponization of trade and financial policies exacerbates these
risks.4

The European economy is particularly exposed to the consequences of a fragmentation
of world trade, both because of its close productive and financial integration with the
rest of the world and because of its growth model, which relies heavily on the import
of raw materials and the export of final goods and services to foreign markets.°

How can we, as Europeans, respond to a level of uncertainty that seems destined
to remain 'higher-for-longer'? What measures must we take to strengthen the
competitiveness, strategic autonomy and international standing of the European
economy? To answer these questions, I will analyse the recent upsurge in geopolitical
tensions and their impact on the global economy, on policies, and on European
governance.

For more details, see the page, 'Fragility, Conflict and Violence' on the World Bank's website.

United Nations, 'With Highest Number of Violent Conflicts Since Second World War, United Nations
Must Rethink Efforts to Achieve, Sustain Peace, Speakers Tell Security Council', Press Release, SC/15184,
26 January 2023.

'Beyond money: the euro's role in Europe's strategic future', address by F. Panetta at the 'Ten years
with the euro' conference, Riga, 26 January 2024.

For an analysis of the EU's economic interdependencies and their macroeconomic implications, see
'The EU's Open Strategic Autonomy from a central banking perspective. Challenges to the monetary
policy landscape from a changing geopolitical environment', European Central Bank, Occasional Paper
Series, 311, 2023.

1. Globalization after the Second Word War

Economic shocks can lead to geopolitical clashes and conflicts.

The Great Depression, for example, contributed to the political, economic and social
tensions that led to the outbreak of World War II.° More generally, empirical analyses
show that large terms-of-trade shocks caused by higher commodity prices increase the
likelihood of conflict.'

The causal link works both ways: geopolitical disputes, in turn, often lead to economic
upheaval.

The two World Wars, for example, caused the largest decline in GDP per capita and the
greatest destruction of physical capital in modern history. The 1973 Arab-Israeli war triggered
a series of oil price hikes that ultimately destabilized the global economy.' More recently, we
have witnessed the inflationary and recessionary effects of Russia's attack on Ukraine.

Geopolitical tensions and trade are also closely linked. Throughout human history, territorial
expansion by the great powers of the day - from ancient Rome to the colonial era - has
often been followed by economic integration.

Because of these links between the economy and trade on the one hand, and geopolitical
hostilities on the other, a paradigm took hold in Western democracies after the devastation
of World War Il, whereby only close international economic integration could ensure lasting
peace.'

The relationship between economic integration and peace is explicitly mentioned in the
Havana Charter, which in 1948 envisaged the creation of an international organization
for world trade, in line with the United Nations' determination to create the conditions of
stability and prosperity necessary for peaceful and friendly relations among nations. The
Charter never came into force, but the talks led to the General Agreement on Tariffs and
Trade (GATT), which was replaced in 1995 by the World Trade Organization.

EJ. Hobsbawn, Age of Extremes. The Short Twentieth Century 1914-1991, published in Italian by Rizzoli,
1995; S. Broadberry and M. Harrison (eds.), The Economics of the Second World War: Seventy-Five Years
On, London, CEPR Press, 2020.

P. Leepipatpiboon, C. Castrovillari and T. Mineyama, 'Macroeconomic Shocks and Conflict', IMF
Working Papers, 68, 17 March 2023.

Another example is the Iranian revolution in 1979 and the Iran-Iraq War in 1980, which led to a
collapse in oil production and a rise in crude oil prices, pushing many countries into recession; see F.
Corsello, M. Gomellini and D. Pellegrino, 'Inflation and energy price shocks: lessons from the 1970s',
Banca d'Italia, Questioni di Economia e Finanza (Occasional Papers), 790, 2023.

On the fiftieth anniversary of the General Agreement on Tariffs and Trade in 1998, President Bill Clinton
recalled the principles on which the post-war economic order was built: 'And so, at mid-century, a
farsighted generation of leaders acted on the bitter lessons of protectionism, devastating depression
and war. They embraced the revolutionary idea that freedom - free democracies, free markets, the free
flow of ideas, the free movement of people - would be the surest route to the greatest prosperity for
all. They were confident that growing economic interdependence would lead to greater peace among
nations. And the economic alliances and institutions they created - the IMF, the World Bank, the GATT
- built a platform for prosperity that has lasted to this day'. A. Wolff, 'Trade for peace', speech at the
Graduate Institute, Geneva, 28 September 2022.

In 1944, the Bretton Woods Conference established a multilateral system based on a
common set of rules, a system capable of promoting cooperation and trade on a global
scale.'° Other multilateral institutions followed over time, such as the World Bank (1944),
the International Monetary Fund (1945), the OECD (1961), the G20 (1999) and the
Financial Stability Board (2009).

In Europe, the creation of the European Coal and Steel Community in 1951 and the
European Economic Community in 1957 were inspired by Robert Schuman's statement
that European economic integration would make war 'not merely unthinkable, but
materially impossible'."'

Thanks in part to these institutions, the world economy became increasingly integrated
in the post-war period. The share of world trade in GDP rose from 20 per cent in 1950 to
34 per cent in 1975 (Figure 1).

Globalization continued with the end of the Cold War and the participation of new
countries in international trade - notably China, which joined the WTO in 2001. By 2021,
trade accounted for 57 per cent of world GDP.

The dismantling of trade barriers and advances in transport spurred the development of
global value chains, which were designed to exploit cross-country differences, in both
specialization and the cost of production factors.'*

Trade expansion was concentrated in goods, but was also significant in the services
sector.'? The most surprising development was in finance: from the 1990s until the global
financial crisis of 2007-08, the foreign financial assets held by G20 countries doubled."*

This open, multilateral trade system has been an engine of prosperity.'® The freedom to
trade goods and services, to invest across borders, and to share knowledge and ideas

B. Eichengreen, Globalizing capital: a history of the international monetary system, Princeton, Princeton
University Press, 1966; M. Obstfeld and A.M. Taylor, Global capital markets: integration, crisis, and
growth, Cambridge, Cambridge University Press, 2004.

For more information, see on the ECB's website, 'Schuman's declaration in May 1950', and F. Panetta,
'Europe's shared destiny', Lectio Magistralis marking the conferral of an honorary degree in Law by the
University of Cassino and Southern Lazio, 6 April 2022.

In 2007, almost half of the international freight transport was due to trade within global value chains;
see A. Borin, M. Mancini and D. Taglioni, 'Economic Consequences of Trade and Global Value Chain
Integration: A Measurement Perspective', World Bank, Policy Research Working Paper Series, 9785,
2021.

The share of trade in services in world GDP rose from 8 per cent in 1990 to 14 per cent in 2019.

Net foreign direct investment also continued to grow strongly, driven by the expansion of multinationals'
networks of foreign affiliates; see P.R. Lane and G.M. Milesi-Ferretti, 'The External Wealth of Nations
Revisited: International Financial Integration in the Aftermath of the Global Financial Crisis', /MF
Economic Review, 66, 2018, pp.189-222.

Since World War Il there has been a strong positive link between trade openness and GDP growth;
see J. Feyrer, 'Trade and Income-Exploiting Time Series in Geography', American Economic Journal:
Applied Economics, 11, 4, 2019, pp. 1-35; S. Aiyar, et al., 'Geoeconomic fragmentation and the future of
multilateralism', IMF Staff Discussion Notes, 1, 2023.

has fuelled growth for many countries and for much of the world's population."® Workers,
especially women, have moved into more productive jobs.'" Hundreds of millions of
people in developing countries have been lifted out of poverty. Worldwide, inequality
has declined since the 1980s, thanks to greater convergence among countries."®

Despite the sometimes strong social tensions it has generated due to fierce competition,
globalization has proven beneficial overall, especially when accompanied by investment
in education, healthcare, and social safety nets.'? International competition and the
dismantling of trade tariffs have pushed down the prices of imported goods - mostly to
the benefit of low-income consumers in advanced economies."°

2. Geopolitical risks and economic fragmentation

The three pillars of the post-World War II multilateral order - trade openness, economic
growth and geopolitical stability - are all being tested today.

First, globalization is facing opposition in many advanced economies.?'This backlash
reflects perceptions that it leads to inequality; the growth of imports from, and offshoring
of production to, low-income countries is often blamed for reducing real wages and
employment opportunities for low-skilled workers.

J.A. Frankel and D.H. Romer, 'Does Trade Cause Growth?', American Economic Review, 89, 3, 1999, pp.
379-399; D. Rodrik, One Economics, Many Recipes: Globalization, Institutions, and Economic Growth,
Princeton, Princeton University Press, 2007; M.J. Melitz and S.J. Redding, 'Trade and Innovation,' NBER
Working Paper Series, 28945, 2021.

N. Rocha and D. Winkler, 'Trade and Female Labor Participation: Stylized Facts Using a Global Dataset',
Policy Research Working Paper, 9098, World Bank, 2019.

18 L. Chancel, T. Piketty, E. Saez and G. Zucman, World Inequality Report 2022, World Inequality Lab, 2022.

J. Bhagwati and T.N. Srinivasan, 'Trade and Poverty in the Poor Countries', American Economic Review,
92, 2, 2002, pp. 180-83; D. Dollar and A. Kraay, 'Trade, Growth, and Poverty', The Economic Journal, 114,
493, 2004, pp. F22-F49.

P.D. Fajgelbaum and A.K. Khandelwal, 'Measuring the Unequal Gains from Trade', Quarterly Journal
of Economics, 131, 3, 2016, pp. 1113-80; L. Bai and S. Stumpner, 'Estimating US Consumer Gains from
Chinese Imports', American Economic Review: Insights, 1, 2, 2019, pp. 209-224; X. Jaravel and E. Sager,
'What are the price effects of trade? Evidence from the U.S. and Implications for Quantitative Trade
Models', Board of Governors del Federal Reserve System, Finance and Economics Discussion Series,
2019-068, 2019.

This is not a new phenomenon. Resistance to international openness has emerged in the past when
trade created competition between countries with different endowments of production factors, such
as capital, labour and natural resources. In the late 1800s, Europe, which had limited land resources,
became more integrated with the Americas, which had an abundance of land. This led to resistance to
globalization in Europe and led to the introduction of tariffs on agricultural products. See H. James and
K.H. O'Rourke, 'La prima globalizzazione e i suoi contraccolpi', in G. Toniolo (eds.), L'italia e leconomia
mondiale. Dall'Unita a oggi, Venice, Marsilio, 2013 (Collana storica della Banca d'Italia. Contributi, 12),
pp. 53-95.

'Fostering Inclusive Growth', IMF Staff Note prepared for the G20 Leaders' Summit held in Hamburg
on 7 and 8 July 2017, pp. 7-8; P. Saumik, 'Understanding the global decline in the labor income share',
IZA World of Labor, 472, 2020. Another criticism is that the expansion of global value chains could have
come at the expense of an environmental deterioration; see World Bank, World Development Report
2020: Trading for Development in the Age of Global Value Chains, 2020.

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To some extent, these perceptions reflect the temporal overlap between the growth of
international trade and the rise in inequality, and are partly unfounded.

Inequalities between countries have been falling steadily since the early 1990s, while
income disparities within countries have been rising (Figure 2). However, these differences
reflect several factors, most of which have little to do with globalization. For example,
technological progress is much more likely to affect wage differentials than offshoring or
firms' participation in global value chains."

Furthermore, the tendency to relocate production is mostly due to advances in transport
and telecommunications rather than to trade liberalization.4 The best way to fight
domestic inequalities is through domestic policies - especially education, healthcare, the
protection of workers' rights and social security policies.

Second, the decline in economic growth in advanced economies compared with the
post-war boom, which was exacerbated by the global financial crisis, can sometimes lead
to the misconception that development is a zero-sum game, with gains for one group of
workers coming only at the expense of another.*° This stokes up social divisions and spurs
anti-globalization and anti-immigration measures, fuelling the geopolitical polarization
we are witnessing in many countries today."°

Finally, global geopolitical conflicts often stem from the insecurity and consequent
social unrest experienced by large sections of the population, as well as from the loss of
economic and political standing of some countries and regions of the world (Figure 3).
They are probably the most insidious threat to the post-war multilateral order.

In recent years, geopolitical instability has been accompanied by a fragmentation of
world trade. There have been several examples of this, including waning US support for
the WTO, protectionist disputes between the US and China,"' Brexit, and the opposition
of many Western countries, including from within the EU, to Chinese investors acquiring

23 R.C. Feenstra and G.H. Hanson, 'The impact of outsourcing and high-technology capital on wages:

estimates for the United States, 1979-1990', Quarterly Journal of Economics, 114, 3, 1999, pp. 907-940;
R.C. Feenstra and G.H. Hanson, 'Global production sharing and rising inequality: a survey of trade
and wages', in E. K. Choi and J. Harrigan (eds.), Handbook of international trade, Oxford, Blackwell
Publishing, 2003, pp. 146-185; 'Fostering Inclusive Growth', 2017, op. cit.

J. Amador and S. Cabral, 'Global Value Chains: A Survey of Drivers and Measures', Journal of Economic
Surveys, 30, 2, 2016, pp. 278-301; P. Antras, 'Conceptual Aspects of Global Value Chains', The World
Bank Economic Review, 2020, 34, 3, 2020 pp. 551-574; S. Cigna, V. Gunnella and L. Quaglietti, 'Global
value chains: measurement, trends and drivers,' European Central Bank, Occasional Paper Series, 289,
2022; and C. Freund, 'Intersecting paths', Finance and Development, International Monetary Fund, June
2023.

S. Chinoy, N. Nunn, S. Sequeira and S. Stantcheva, 'Zero-Sum Thinking and the Roots of U.S. Political
Divides', NBER Working Paper, 31688, 2023.

L. Guiso, H. Herrera, M. Morelli and T. Sonno, 'Global crises and populism: the role of Eurozone
institutions', Economic Policy, Vol. 34, 97, January 2019, pp. 95-139.

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7 The US administration imposed tariffs on imports of solar panels (30-50 per cent tariff rate) in January

2018, and on imports of steel (25 per cent tariff rate) and aluminium (10 per cent tariff rate) in March
of the same year. In September it imposed a 10 per cent tariff on around $250 billion worth of imports
of other goods from China.

strategic firms and critical infrastructure.?® More recently, the international community
has responded to the invasion of Ukraine with trade and financial sanctions against
Russia. And there is a risk that the ongoing tragic conflict in the Middle East could end
up destabilizing energy markets.

Trade restrictions, such as tariffs, subsidies, and restrictions on exports and foreign
investment (Figure 4), have exacerbated the disruptions in global commodity supply
chains that emerged in the aftermath of the pandemic.

3. From globalization to fragmentation?

The events I have just described have stimulated debate about the costs and benefits of
over-reliance on third countries for the supply of critical raw materials and inputs.

In an ideal world, trade integration brings undoubted benefits, allowing producers to
rely on the most efficient suppliers and financial intermediaries to diversify their activity
internationally. In our real, geopolitically unstable world, however, interconnectedness
can quickly turn into vulnerability.

The governments of the major countries are responding to these vulnerabilities.2? They
are now less willing to rely on imports of strategic resources - such as food, energy
or technology - from trading partners with whom they do not have stable relations
and political, economic and cultural ties. Some of them are offering incentives to bring
back previously offshored production to their country of origin (reshoring) or to 'friendly'
countries (friend-shoring).*° This is sometimes to the detriment of geopolitical allies.*'

28 See 'The geopolitics of decarbonisation: Reshaping European foreign relations', Climate Diplomacy

Report, Adelphi Research, Berlin, 2020.

The main examples are the Dual Circulation Strategy (DCS) in China, the Chips Act (CA) and the
Inflation Reduction Act (IRA) in the United States, and the Open Strategic Autonomy (OSA) in the EU.
The DCS, passed in 2020, aims to reduce China's dependence on foreign technology, both by vertically
integrating its production and relying mainly on its domestic market, and by internationalizing
Chinese companies and stimulating foreign demand. The CA of 2022 provides subsidies for R&D and
production activities carried out in the US in the technological sector. The IRA grants tax credits for
electric vehicles and renewable energy equipment that meet certain specific technical requirements.
The OSA aims to strengthen the EU's ability to operate in areas of strategic importance by reinforcing
the resilience of the EU industrial sector and its capacity to supply of strategic goods. Similar measures
have also been adopted in the UK (see S. Kinkel, D. Pegoraro and R. Coates, 'Reshoring in the US and
Europe', in L. De Propis and D. Bailey (eds.), Industry 4.0 and Regional Transformations, Routledge,
London, 2020, pp. 176-194) and in Japan (see J.!. Dingel and B. Neiman, 'How many jobs can be done
at home?', Journal of Public Economics, 189, 2020).

Reshoring is the process of bringing production back to, and sourcing inputs from, its country of
origin. Friend-shoring is the process of producing or sourcing inputs from suppliers in geopolitically
allied countries.

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30

31 In some cases, for example, the incentives provided by the Inflation Reduction Act adopted in the

United States penalize European manufacturers.

Companies are also rethinking their strategies,** reviewing their location choices in order
to repatriate activities, or diversifying their outlet markets and sources of supply to create
regional value chains (regional reshoring).**

Partly as a result of these developments, trade in goods and services relative to world
GDP is stagnating after decades of strong expansion (Figure 5a) and the geographical
distribution of trade is shifting towards new centres of gravity (Figure 5b).

However, these trends have not yet translated into outright deglobalization.**

Reversing the trend of globalization would be costly. Technological advances make it
easier for companies to manage offshored or outsourced production and to trade in
services that once required direct contact between counterparties.*> In addition, cost
and wage differentials continue to make offshoring attractive, although the destination
countries are changing.

The degree of integration in the international monetary system is high: the euro and
especially the US dollar remain the main global reserve currencies.*' However, some
central banks are increasing their holdings of gold and reducing those of major currencies,
and there is an ongoing debate about the risk of trade and financial sanctions affecting
the design of the system.

32 McKinsey & Company, 'Taking the pulse of shifting supply chains', August 2020. A business survey

conducted by the German Ifo institute in July 2022 found that 87 per cent of responding firms had
taken steps to increase the resilience of their supply chains. In the aftermath of the pandemic, European
companies in the health and pharmaceutical sectors have reshored or are considering re-shoring part
of the production previously located abroad.

33 Evidence from a recent Banca d'Italia business survey shows that Italian manufacturing firms that rely

on Chinese inputs are replacing Chinese suppliers with EU-based alternatives; see A. Borin, G. Cariola,
E. Gentili, A. Linarello, M. Mancini, T. Padellini, L. Panon and E. Sette, 'Inputs in geopolitical distress:
a risk assessment based on micro data', Banca d'Italia, Questioni di Economia e Finanza (Occasional
Papers), 819, 2023. A joint survey conducted by Banca d'Italia, Deutsche Bundesbank and Banco de
Espana found a similar pattern for German and Spanish firms.

34 In its 2023 World Trade Report, the WTO notes that trade tensions are starting to affect trade flows,

suggesting potential fragmentation. However, international trade continues to thrive, driven by the
digital revolution, which is facilitating trade in goods and, even more so, in services. Overall, there does
not yet seem to be any evidence of deglobalization. See also M. Di Sano, V. Gunnella and L. Lebastard,
'Deglobalisation: risk or reality?', The ECB Blog, 12 July 2023.

Services such as business consultancy, medical diagnostics, education, translation and marketing. See
R. Baldwin, The Globotics Upheaval: Globalization, Robotics, and the Future of Work, New York, Oxford
University Press, 2019.

35

36 In recent years, many Western companies have shifted production from China to other countries

such as Vietnam and Mexico; see L. Alfaro and D. Chor, 'Global supply chains: the looming "great
reallocation", Harvard Business School, Working Paper 24-012, 2023.

37 ECB, 'The international role of the euro', June 2023.

38 F. Panetta, 'Beyond money: the euro's role in Europe's strategic future', 2024, op. cit.

Overall, there is a clear case for maintaining a global economy that is open to international
trade. Breaking trade links would be costly,?? and would have a strong negative impact on
the welfare of much of the world's population."

4. The euro area: strengthening resilience and competitiveness

At the same time, we cannot ignore geopolitical risks and their implications. We need
to consider the possibility that we may face further protectionist pressures and a
deglobalization of the world economy, and develop appropriate responses.

The solution is to strengthen the European economy along three main directions:
rebalancing its growth model; improving its strategic autonomy; ensuring its capacity
to provide for its external security, and enhancing its role in the international debate.
The aim is not to set itself against others or to retreat behind national borders, but
to become stronger in order to contribute to competition, integration and dialogue
between countries. Achieving these objectives will require structural interventions.

Reducing dependence on foreign demand

First, the European growth model needs to be reconsidered. Over the past two decades,
Europe's economy, unlike that of the United States, has been overly dependent on
external demand, to the detriment of domestic demand (Figure 6).*' But trade disputes
and global shocks are making this growth strategy less sustainable and riskier.

Going forward, the EU must strengthen domestic demand and make the most of the
single market.

This recipe is consistent with current developments in the world economy. For example,
China, long one of the main markets for European exports, is reducing its openness to
trade (Figure 7) as a result of both stronger domestic demand and policies to reduce

39 In the EU the imposition of limits on international trade would have would have negative effects on

exports and on the availability of intermediate inputs. It could also trigger retaliation measures that
could affect the importation of strategic inputs; see U. von der Leyen, speech on EU-China relations to
the Mercator Institute for China Studies and the European Policy Centre, 30 March 2023.

Recent estimates suggest that a fragmentation of international trade would reduce global wealth
by 5 per cent and trade flows by 25 per cent. These effects could be magnified by rigidities, such as
restrictions on the reallocation of production factors or shortages of key inputs, as well as by greater
uncertainty or higher risk premia. If fragmentation were to limit access to technology, the loss of
wealth would rise to 10 per cent; see M.G. Attinasi, L. Boeckelmann and B. Meunier, 'Friend-shoring
global value chains: a model-based analysis', ECB Economic Bulletin, 2/2023, Frankfurt am Main, 30
March 2023, pp. 59-66.

Domestic demand has fuelled growth in the United States; see F. Panetta, 'Monetary autonomy in a
globalised world', welcome address at the joint BIS, BoE, ECB and IMF conference on 'Spillovers in a
"post-pandemic, low-for-long" world', Frankfurt, 26 April 2021.

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42 These considerations are consistent with the main conclusions of the Single Market Report presented

in recent days to the European Council; see E. Letta, Much more than a market: speed, security, solidarity.
Empowering the Single Market to deliver a sustainable future and prosperity for all EU Citizens, April
2024.

dependence on foreign inputs, especially in technological sectors.** But the problem is not
just the drying up of markets: Chinese producers are becoming increasingly competitive
and, in some sectors, are gaining global market shares.

Enhancing energy security

In the current geopolitical context, and in order to contribute to the fight against climate
change, the European economy can no longer rely ona stable supply of energy resources
imported at low cost,*> nor can it continue to depend on fossil fuels.*°

We must increase clean energy production without excluding any technological
option," promote industrial decarbonization and invest in an integrated gas and
electricity infrastructure network.* This will keep energy costs down and improve our
competitiveness.

Yet not even this transformation will entirely free us from dependence on foreign
suppliers of energy inputs: even with a higher share of renewables, the EU will continue
to import key resources from a very small number of countries, which are also subject to
geopolitical tensions.

This is the case for metals and minerals needed for the energy transition, such as lithium,
nickel, cobalt and rare earth elements. Europe currently has less affinity with nations
rich in these input resources than other countries that have established close relations

43 The main instrument used by the Chinese authorities to implement these strategies is the Dual

Circulation Strategy (see Footnote 29).

44 This is true, for example, of electric and hybrid vehicles for which imports to Europe from China are

increasing and the European trade balance is rapidly getting worse.

45 In recent decades, the ample supply and low cost of fossil fuels have made it convenient to specialize

in energy-intensive activities (such as the chemical sector, which in Germany provides essential inputs
to domestic manufacturing) that lose competitiveness as the prices of raw materials go up (e.g. moving
from pipeline gas to the more expensive liquefied natural gas). These inefficiencies are analogous to
the 'resource curse', the paradox whereby countries rich in natural resources are less developed than
countries with very few of them. This can happen if a wealth of natural resources favours income over
productivity and innovation; see S. Mansoob Murshed, The Resource Curse, Newcastle upon Tyne,
Agenda Publishing, 2018.

Fossil f