Political consensus needed to boost intra-EU trade

We have cut our long-term trade forecasts for the EU considerably due to escalating global trade tensions. Tariffs alone could shave around 8% off total EU trade volumes over the next five years. European growth would benefit notably from coordinated supply and demand-side actions to boost intra-EU trade. But political hurdles and the scale of the global demand shock will limit the offset.

• Replacing lost US and global demand with intra-EU trade will be difficult. It can be boosted by lowering nontariff trade barriers, completing the capital union, and firm nearshoring. But these would require substantial policy action at the EU-level which will be difficult to obtain consensus for. Nearshoring efforts would also raise concerns surrounding lower productivity and would be politically contentious.
• Stronger domestic demand would help absorb excess productive capacity. Huge German fiscal spending is an opportunity to drive a new political consensus around public investment. But the growth boost will be constrained by import leakage from higher defence spending, and further rounds of public investment by fiscal sustainability concerns. We think it will offset lost trade volumes by only around 10%.
• Any implementation of needed reforms will take time to materialise. But there are upside risks if German fiscal spending is more frontloaded and larger than we currently assume, potentially signalling greater policy urgency. Nevertheless, a sizeable near-term boost to European growth is unlikely given the highly uncertain trade policy environment that will weigh on business investment decisions.