Christine Lagarde: Can Europe's economy withstand Trump 2.0?

0:00This BBC podcast is supported by ads outside the UK. If journalism is the first draft of history, what happens if that draft is flawed? In 1999, four Russian apartment buildings were bombed, hundreds killed. But even now, we still don't know for sure who did it. It's a mystery that sparked chilling theories. I'm Helena Merriman, and in a new BBC series, I'm talking to the reporters who first covered this story. What did they miss the first time? The History Bureau, Putin and the Apartment Bombs. Listen on BBC.com or wherever you get your podcasts. I am Nina Khrushcheva, the great-granddaughter of Nikita Khrushchev, the leader of the Soviet Union in 1962.

0:47And I'm Max Kennedy, the nephew of US President John F. Kennedy. We explore what was a terrifying moment in history. The story of the Cuban Missile Crisis. How close the world came to nuclear war. And what they had to do to pull it back. from the brink. The bomb, Kennedy and Khrushchev. All episodes available now, wherever you get your BBC podcasts.

1:13Welcome to Hard Talk from the BBC World Service with me, Stephen Sacker. My guest in this interview recorded in Frankfurt on the 12th of March has been a fixture in lists of the world's most powerful women for two decades. Christine Lagarde rose to prominence as a successful corporate lawyer. She became a highly regarded minister in France's centre-right government after 2005 and was very quickly installed as finance minister. Some saw her as a future French president. Instead, she moved to Washington as managing director of the International Monetary Fund. In the middle of her second term at the fund, she quit in order to return to Europe and become the first woman to head the European Central Bank.

2:00So now she is a key player in management of the European economy at a time when the continent is facing severe economic headwinds. Not only is there a long term problem with low growth, low productivity, which has left Europe struggling to compete with the US and China. But now there are huge new political challenges, too. Donald Trump has fired the opening shots in what could be an extremely damaging global trade war. And Trump's determination to see Europe's democracies pay for their own defence rather than rely on American largesse has got governments across Europe anxiously trying to figure out how they can rebuild their militaries without ruining the public finances.

2:45Europe desperately needs massive investment in technology and infrastructure to make it globally competitive. Has that just got a whole lot harder? Well, Christine Lagarde joins me now. Welcome to Hard Talk. Lovely to see you again. It's great to have you on the show. I have to begin in the United States. We're just weeks into Trump's second term. As you look at what he is doing, particularly in terms of his economic measures right now, how big a threat do you believe he poses to the health of the global economy? His decisions, his counter-decision, are a cause for concern, are a cause for us to be extremely vigilant, are a cause for us to be monitoring, trying to project and to anticipate what the consequences will be.

3:39Not only the decisions, but the sheer indication that there will be a decision is causing a level of uncertainty that we haven't seen in a long time. You used the phrase cause for concern. Would you go as far as threat? You know, as economist and now as president of the European Central Bank, I don't think in terms of threats. I have to think in terms of positive, negative consequences, upward, downward pressure on inflation, consequences in terms of growth, both in the global economy and more specifically, what are the consequences for Europe? That's what I have to look at. So let's talk trade.

4:22Donald Trump has pulled the trigger on what could become a spiralling global trade war. It's going to hurt Europe, isn't it? Any trade war is going to hurt the global economy. So the initiator, the retaliator, the re-retaliator, and so on and so forth, all of that is going to hurt growth at large. Everybody will suffer from that. This is a constant in history of trade. Some countries will be hurt more than others. Some countries will see inflation move more than others. But everybody is to lose as a result of that. And we are speaking just hours after Washington imposed global steel and aluminium tariffs at some 25%.

5:09We then saw the European Commission immediately retaliate by imposing roughly 26 billion euros worth of tariffs on US imports into Europe. Would you have retaliated in the way that the Brussels Commission has chosen to? I think it had no choice. But in trade, precision matters. So what have they announced? They've announced retaliation as of the 1st of April on 8 billions first, and then an additional 18 billions of goods to be covered subsequently. And I'm saying that not to contradict what you said, but simply to indicate that between now when it's announced and the time when it's implemented, there is a lag during which, possibly, not certain, but negotiations can take place.

6:02But I guess this is a question... And the target of those tariffs also matters. Targeting what? Bourbon, whiskey, soybeans, Harley-Davidson, Levi's jeans? This is not a random choice, and it's not across the board all aluminium and steel. It's specific classes of products. Sure, but we seem to be heading down a track now which could go much, much further. Donald Trump is indicating that he's still minded to impose much broader tariffs on goods coming from the European Union in April that could do serious damage to the European economy. And so what I'm interested in is politics and I'm interested in tone.

6:41Would you go so far, for example, as the new prime minister of Canada has gone and say that tariffs are going to be imposed on the United States until Donald Trump shows Canada respect? Is that kind of language wise? I think it's a reciprocated language. All parties want respect. Respect and reciprocity are the two big themes of the public positions that have been taken by US authorities at this point in time. But do you know any representative of any country in the world who does not expect respect? So I think it's going sort of back and forth, back and forth, tit for tat. But we know Donald Trump's mindset toward Europe.

7:25Quote, the European Union was formed to screw the United States. That is the purpose of it. They've done a good job of it. That's a mindset. Forgive the language. Forgive the language, not mine, his. But my point is, if that's the mindset in Washington, and that is a pretty settled mindset, we've heard it from Donald Trump many times, there's only one way this is going to go, and it's going to get worse. Well, first of all, I think history matters. And when you look back at when Europe was formed, it was largely formed at the instigation of the United States of America, who wanted stability in our part of the world after the first and then the second world war that we went through.

8:03So the United States was encouraging very strongly the steel and coal union that was the initial formation of the European Union. So to argue that it was set up to screw the United States, I think is not just bad language, but it's an abuse of history. This is not how it worked, number one. Number two, you know, at the moment, everybody is positioning. So when there is a very strong position expressed by one of the parties, such as the one expressed by President Trump, Then on the other side of the pond or on the other side of the border for Canada, it's obvious that there will be positioning as well.

8:39What I suspect is that in the meantime and until there is implementation, parties are going to sit down and negotiate. This is what usually happens in trade matters. If we were to go to a real trade war where trade would be dampened significantly, that would have severe consequences. It would not be cause for concern. It would be severe consequences for growth around the world and for prices around the world, but particularly in the United States. But also in Europe. It would push Europe into recession, wouldn't it? You know what it's doing at the moment? Stirring European energy. It's a big wake-up call for Europe.

9:17Maybe this is a European moment yet again. Just one more specific on tariffs and trade. You've suggested in the past that it may be time for what you called a checkbook strategy to offer America some sort of metaphorical carrots to say that Europe will commit to importing more liquefied natural gas, for example, or other products which America wants to sell to Europe and which it's currently difficult to sell. Many in Europe are saying far from making nice, they need to get much tougher. It's a sequencing issue in my view. And it's often the case that you have to appear or be much tougher and show what cards you have and you're prepared to play before you actually sit at the table to negotiate.

10:04It might be going towards negotiations with what you call the checkbook approach. it might be a lot worse than that and end up in much more retaliatory process which is effective and which in that would have very severe consequences. Just a quick thought on the way this works for people like you. I mean you have one of the most important management of the economy jobs in the world. How can you develop a strategy when there is so much unpredictability and uncertainty coming out of what the greatest economic power in the world is actually going to do? Yeah, that's a really good question. Our job is to procure price stability in Europe.

10:43This is the best we can contribute to help people make investment decisions, hiring decisions and whatever. And in the context of high uncertainty, it's extremely difficult when on the top of it, you have unpredictability and repeated unpredictability. So what we do, we do scenario planning, we do sensitivity analysis. So, for instance, we say, OK, what if tariffs were to move by 25 % across the board? What if China was subject to 60 % tariffs? So we do lots of what if, what if, what if to see what impact it has on our economies, what impact it has on prices, and as a result, what kind of monetary policy anticipation we can have.

11:24That's what we do. You've said in recent days that you're happy, that you feel inflation in Europe is going to stick around 2.5%. You seem to believe that growth, although it's very slow, possibly on an upward curve. Modest recovery, yes. All of those projections could be completely destroyed if we get into a long-term spiralling trade war. Let me give you an example. We could have that, as you said, in a worst-case scenario. But at the same time, as I said, we have this wake-up call in Europe. The announcement, it's not yet voted yet, but you have the announcement of significant military expenditure and the financing of it by countries that up until now were very prudent and very reluctant to move the needle of their debt-to-GDP ratio, to increase the deficit that they have.

12:14And from my position as president of the ECB, I witness this collective waking up of European leaders, including, by the way, the United Kingdom, which is part and parcel of that security effort, which will counteract from an economic point of view. Imagine a big fiscal input if properly applied with the innovation that results from those investments in military expenses. And on the other hand, the spiraling trade war. What will be the outcome? This is for us to try to decipher. It intrigues me that you are welcoming what are these round Europe promises of massive new expenditure on defence and security.

12:56I mean, you at the ECB are supposed to be the bulwarks of economic stability in Europe. and you have to look at the fiscal position of the member states of the Eurozone very carefully. I mean, let's take France, for example. I was talking about Germany. Well, I'm talking about France. You can talk about Germany because they have very low deficits and they have plenty of room to borrow lots of money to spend on weapons. I understand that. But let's talk about France because there the situation is very different. Mr. Macron is talking about expanding French expenditure on defence to 3 % to 3.5 % of GDP.

13:28At the very same time, the annual deficit in France is running at close to 6%. The national debt is heading towards 120 % of GDP. All of the rules are going to be broken, aren't they? If you listen carefully to what the President of the European Commission indicated, she has precisely mentioned that a particular envelope would be available as loans to member states which were going to invest in defence. In addition to that, she has indicated that up to a certain amount, the spending on defence would not be counted for the purposes of defining the debt to GDP. That's under the... Wait, wait, wait, wait.

14:11That's an accounting procedure, but the debt is rising and going to rise further. And you have good and bad debt. If you incur debt because you have to pay more sort of day-to-day expenses, the run of the mill business as usual, that is not good news. But if you raise your debt in order to invest in defence, in order to stir innovation in that respect, that's a different old game. So as head of the ECB, you are saying to Europe and to the wider world that you are not worried about the Eurozone essentially suspending, some could say even junking, its fiscal discipline. No, this is not what I'm saying.

14:54As president of the ECB, I say that there should be the right structural reforms, the right investment program, the growth enhancing investment in order to collectively build security, defense and stability in the current circumstances. but equally there is a framework within which all this happens and there are requirements in terms of authorized deficit in terms of long-term sustainability and there is something that is called an escape clause that can be used in case of emergency it was used during covid in order to keep the economy afloat i think it is very likely to be used and proposed by the commission and decided by the European Council at large in order to resist the current circumstances.

15:42Let's talk bigger picture. We've already discussed the uncertainty and the alarm that you've expressed about what Donald Trump is doing in terms of tariffs and trade. We've talked about the vast expenditure that Europe is having to contemplate to counteract new security needs, given what Donald Trump is saying about Europe and the United States' partnership with Europe. All of that means that the vision of massive investment in European infrastructure, particularly in technology, which you've talked about, which your predecessor Mario Draghi said was crucial to get Europe out of the economic slow lane, it's not going to happen, is it?

16:22Why do you say that? Because you can't do everything. If there's now 800 billion being discussed as an investment in security and defence, if you don't know what the long-term impact of trade wars is going to be, how are you going to meet this commitment of, what was it Draghi talked about, 800 billion euros going into new investments, particularly into technology? I just don't see how Europe can come up with the money. Well, first of all, you have to think about timing. So when you look at, for instance, the 500 billion infrastructure fund that has been identified by the to-be-new German chancellor, it's for a program of investment over a period of 10 years.

17:00When you think about the additional defence effort that is granted under the escape clause. You're talking about 1.5 % GDP on an annual basis. It's a big amount. Don't get me wrong. And I appreciate that it's going to be a big burden on the public finance. But it has to be done. No, no, no, no. I wouldn't say no growth environment. Sorry, because our forecast for next year, for instance, is 1.2 % growth, Right. If, on the other hand, you have a strong fiscal stimulus that really is invested with the right target with a purpose to enhancing growth, improving productivity, investing because you can combine those things.

17:42You know, when Mario Draghi rightly says you have to digitalize, well, investing in defense at the moment has a lot to do with digital investment and using artificial intelligence. So I'm not suggesting that you can, you know, with one euro reach the three targets. But if it is smartly done and properly financed, that also matters. But let's be real. I mean, the Draghi report came out, what, six months ago. He pointed out that AI investment, for example, in Europe is dwarfed by that that we see in the US, but also by the Chinese, too. He looked at the very significantly lower amount, by the way.

18:19Remember, DeepSeek was set up with much less. But still, the Chinese commitment dwarfs that that we see in Europe right now. And then we look at the regulations in Europe, the Digital Markets Act, the AI Act, the fact that America's big tech companies look at Europe and think, that's not an environment which is going to allow innovation to flourish. We have money problems. We have structural problems, mindset problems. People like you and Draghi can say, we have to change. But how do you get the change? Okay, I'll take you through from the Draghi Rock report to where we are today. Because of the wake-up call, because of this European moment, which I really think is happening at the moment, the European Commission has now identified a list of about 20 key things that need to be done and changed.

19:07And that includes simplification, not deregulation, because the word is taboo at the moment, But this is bottom line what it means. Less constraint, less declaration, less licensing, less disclosure. And I think there is a real imperative on the Commission to actually produce that. I was at the European Council last time and all the leaders around the table said we want 25 % less bureaucracy applied to our European economy. It has to be delivered. Why is it, do you think, that even when Europe does invest in R &D, there is an astounding amount of R &D in the motor industry in Europe? And lots of patents as well.

19:51But often it goes into the wrong places. I mean, isn't it extraordinary that Germany, for example, where a lot of this R &D takes place, essentially missed out on the electric vehicle revolution? You know, they are way behind China and the United States. So even when Europe invests big money, it does it in the wrong places. Well, sometimes you make the wrong strategic move. Sometimes you miss the beat of the moment and sometimes you catch up. I wouldn't certainly short German industry and the middle chart to sort of bounce back and come back to what is actually relevant nowadays. And a final thought on this desire you've expressed, and Mr.

20:32Draghi, before you did, that is to sort of change the mindset in Europe. There are certain things about what you call the social model in Europe that seem to be a drag. For example, I think in Germany, workers, average workers, work 20 % fewer hours than their counterparts in the United States. And that reflects a lot of different legislation protecting worker rights, etc., etc. Is Europe prepared, do you think, to change its social model? I think there are changes underway. We know that we have a big catch-up in terms of productivity to do relative to the United States. But I think also that Europe has a particular ethics.

21:15Europe has particular principles. Europe is keen to maintain its democratic foundation. Europe is keen to continue to have a social dialogue. So are they going to just reduce that gap and eliminate all the social fabrics that constitutes Europe? Certainly not. They might have to compete. But are they going to address the weaknesses? Are they going to invest in the right places? Are they going to improve productivity? Are they going to reduce red tape? My answer to that is yes, because of that wake-up call. And it's a blessing in disguise. A final thought, and we have spoken several times. We spoke when you were managing director of the International Monetary Fund.

22:00So you know multilateral institutions at many different levels, global level with the IMF, European level here at the ECB, but you've also been a senior minister in the French government. What you see today is an administration in the United States that doesn't appear to believe in multilateralism, in economic affairs or, frankly, pretty much anywhere else. There is now in the US a serious look at whether the United States should remain a member of the IMF or the World Bank. They've already left the WHO. They've withdrawn from the Paris Climate Treaty. How alarmed are you about the prospect of the world's greatest economic and military power abandoning multilateralism and that kind of collaboration?

22:47You know, I'm tempted to quote something that apparently he didn't even say, but which is attributed to Churchill. You can trust the Americans to ultimately do the right things after they've tried everything else. It could well be that we are in such a moment. Doubt about the efficiency of that, doubt about the cost-benefit analysis of that contribution or that membership. But when you look at the issues that the world is facing, they are all of, not all of them, but many of them are of an international nature that need to be addressed on a global collective basis. Look at those pandemics. Look at climate change.

23:29Well, I'm looking and then I'm looking at what Donald Trump actually does, not just says, but does. I just wonder whether you and perhaps Europe is being a little complacent about what is happening right now. No, we're not complacent at all. We have our eyes wide open and we see what is going on. But there are things that, you know, we're going to stay together doing because we believe that a multilateral setting, a regional setting like the one we have here is actually the response to the difficulties that we are facing in the world. Christine Lagarde, thank you very much for joining me on Hard Talk.

24:09Thank you so much. If journalism is the first draft of history, what happens if that draft is flawed? In 1999, four Russian apartment buildings were bombed, hundreds killed. But even now, we still don't know for sure who did it. It's a mystery that sparked chilling theories. I'm Helena Merriman, and in a new BBC series, I'm talking to the reporters who first covered this story. What did they miss the first time? The History Bureau, Putin and the apartment bombs. Listen on bbc.com or wherever you get your podcasts. I am Nina Khrushcheva, the great-granddaughter of Nikita Khrushchev, the leader of the Soviet Union in 1962.

24:53And I'm Max Kennedy, the nephew of U.S. President John F. Kennedy. We explore what was a terrifying moment in history. The story of the Cuban Missile Crisis. How close the world came to nuclear war. And what they had to do to pull it back from the brink. The bomb, Kennedy and Khrushchev. All episodes available now, wherever you get your BBC podcasts.