Europe’s Road to Net-Zero; Companies on a trade war footing, the Fed’s wishful Xmas cut and 2024 corporate insolvencies

Amid growing economic pressures and geopolitical tensions, there is a risk that the green transition could lose momentum, even though it plays a crucial role in driving economic growth and enhancing competitiveness. As we head into the winter season - where energy bills and holiday shopping might compete for our attention - our analysis explores how Europe can navigate these challenges by lowering energy costs, bolstering strategic autonomy, and promoting global cooperation to reduce green fragmentation our deep dive this week.

In the final edition of our What to Watch publication for 2024 - with our comprehensive quarterly scenario forecast coming next week - we examined the outlook for global trade growth, which is expected to slow, with volumes projected to rise by +2.8% in 2025 and +2.3% in 2026, down from earlier forecasts. However, we also highlight how temporary surges in export orders could help offset the ongoing challenges posed by tariffs, currency fluctuations, and changes in free trade agreements. We explore the possibility of the Fed delivering its third consecutive rate cut, despite the persistence of inflation and rising unemployment, and consider the potential for tighter conditions to return in 2025. Additionally, we took an in-depth look at 2024 data on corporate insolvencies, which have seen a significant rise of +48% year-on-year, reaching EUR40bn, and analyze how increased economic uncertainty and sectoral shifts could heighten the risk of a broader ripple effect.

Divided We Fall The Risks of Competitive Fragmentation on Europe’s Road to Net-Zero

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The green transition is a motor for economic growth. In 2023, the clean energy sector alone added USD320bn to the global economy in value added, accounting for 10% of global GDP growth. Worldwide, the momentum toward net zero has pushed up clean energy investments by over 80% in the past decade, surpassing USD2trn in 2024. China and Europe have been leading this transformation. But while Chinas green investments continue to grow, reaching USD676bn in 2024 (3.7% of its GDP), Europe's investment levels have begun to plateau at almost USD500bn, and even decreased relative to its GDP from 1.9% to 1.8% in the last two years following the onset of the global energy crisis.

In green manufacturing, China has leveraged increased investments, economies of scale and low-cost energy, capital and labor to secure a dominant position. In the photovoltaics sector alone, China accounts for approximately 80% of global production of polysilicon, solar cells and modules, as well as 97% of wafer production. The existing market dominance is reinforced by recent developments for manufacturing capacity additions. In 2023, around 70% of global clean manufacturing capacity was added in China while the EU and the US only added 13% and 8%, respectively. In 2030, Chinas green manufacturing capacity is likely to be 74% higher than that of the rest of the world. With domestic demand expected to account for only one-third of this supply, it is evident that most of the expanded capacity will target global markets, further cementing Chinas role as the worlds clean tech manufacturing powerhouse.

In response to Chinas dominance in manufacturing and trade, the EU is increasingly adopting green protectionism. In Europe, the share of green imports from China have increased sharply from 2.3% in 2014 to 13.6% in 2023 while in the US this share remains much lower at 4.6%, the result of its protectionist stance. But Europe, too, is increasingly shifting towards protecting its (green) industries through tariffs and non-tariff measures (NTMs). New green NTMs in the EU surged from just one case in 2017 to 119 by 2023, with the bulk of new green trade restrictions (tariffs and NTM) directed at China, growing from zero in 2017 to 46 in 2023. Tariffs on Chinese EVs are just the most recent example.

At the same time, the EU is scaling up its green industrial policy to boost domestic production and safeguard strategic competitiveness. As a response to the US Inflation Reduction Act (IRA), which pledged over USD360bn in tax credits, grants and loans to enhance clean-tech manufacturing, the EUs Green Deal Industrial Plan aims to boost the competitiveness of Europe's net-zero industry, with REPowerEU allocating over EUR250bn for approvals, tax incentives and workforce reskilling. However, actual green subsidies are even higher than these flagship programs imply. In 2023, the US allocated USD220.5bn (0.8% of GDP) in green subsidies (88% of total subsidies). In comparison, the EU dedicates 62% of its subsidies related to industrial policies to green technologies, amounting to USD156.5bn and constituting 0.9% of total EU27 GDP.

The right mix makes the difference. Protectionist measures to safeguard local industries pose risks to the green transition and international relations. Isolationist approaches could constrain the production and export of essential goods critical for the global green transformation, leading to higher prices and potential delays in decarbonization goals. A +1% increase in tariffs reduces trade flows of green products by an average of 4.3%, with impacts varying significantly from 1.2% for batteries and up to 9.8% for electric vehicles. For solar products, raising EU tariffs on Chinese imports from 0.78% to 10% could cut trade by 12.2%, increasing costs on a EUR19.7bn market and threatening to delay critical decarbonization efforts.

Overall economic losses in a fragmented climate transition dwarf energy costs. While short-term gains from lower electricity costs may appear advantageous for some, the long-term repercussions of a fragmented transition stemming from unaddressed climate risks, economic inefficiencies, and geopolitical tensions paint a far more concerning picture. A fragmented transition could cost China an additional USD13.9trn (2017 prices) and the US USD6trn compared to the below 2C scenario, representing 1.1% (0.7%) of cumulative GDP for the period 2022 2050, respectively. These losses are primarily driven by increased geoeconomic risks, such as disruptions in global supply chains, alongside escalating physical damages from unmitigated climate impacts. Though losses in European economies would be lower, ranging from USD0.7trn to USD1trn, no country is immune to the economic consequences of a fragmented climate transition.

To prevent a harmful cycle of fragmentation and to restore competitiveness, Europe must strengthen the transition instead of weakening it. While short-term competitiveness gains from increased protectionism are tempting, governments need to strike a balanced approach in order to avoid green fragmentation, which would delay the transition and harm Europe’s domestic industry in the long run due to higher energy costs and diminished global competitiveness. For sustainable green growth, Europe must carefully evaluate which sectors can compete globally, where protective measures are justified and where raising barriers to green trade would cause more harm than good. Wind power and hydrogen are two key sectors where Europe already holds a strong position and can capitalize on green growth opportunities, in particular if it starts thinking beyond its borders.

The comprehensive report for you here.

What to Watch this week

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• Companies on a trade war footing. Despite a brief boost as exporters rush to get in orders before higher tariffs kick in, global trade growth is likely to slow in 2025-2026. We now expect global trade in volume to grow by +2.8% in 2025 (-0.2pp from our previous forecast) and +2.3% in 2026 (-0.5pp). In USD value terms, the downside revisions to our forecasts are even larger, with growth reaching +2.3% in 2025 (-1.7pp) and +4.1% in 2026 (-0.8pp). Marine cargo and trade data confirm that exporters are frontloading shipments (Chinese exports were up +6.7% y/y in November, supported by orders from the US (+8% y/y)) and air cargo is also skyrocketing (+9.8% y/y in November). Ultimately, factors such as FX adjustments and upcoming free-trade agreements may bring a little relief to global trade but they are unlikely to neuter the impact of the renewed trade war.
• The Feds wishful Xmas cut. Though a close call, we think the Fed will deliver its third consecutive rate cut next week. Since June, measures of underlying inflation have remained stuck at around +3.3/3.2% y/y and have even accelerated on a sequential month-on-month basis. At the same time, the unemployment rate is picking up, though primarily driven by strong labor force growth rather than weakening job growth. Persistent inflation and wage pressures suggest that the natural rate of unemployment may be a bit higher than the Feds current estimate of 4.2%. In this context, we think the Fed will eventually have to accept a higher unemployment rate to tame inflation. Looking ahead, tight immigration policy and tariff hikes could increase inflationary pressures in 2025. We thus expect the Fed to pause rate cuts at the January meeting, before delivering a final 25bps cut for the year in March, pushing the Fed funds rate to the 4-4.25% range.
• 2024 going in the books as a record year for insolvencies. Insolvencies of companies with over EUR50mn in turnover hit a new record high in Q3 2024 at 127 cases, +17 compared to Q2 2024 and +42 compared to the pre-pandemic average of 82 over 2017-2019. Additionally, the combined turnover of insolvent major companies has increased by +48% y/y to EUR40bn. Western Europe leads the rebound in the number of cases, but the Americas are home to the biggest cases. In terms of sectors, services and retail have been hit the hardest, particularly in Western Europe and North America, along with construction, especially in Western Europe and Asia. With 344 cases recorded in the first three quarters, this year's total of major insolvencies already exceeds those for 2015 to 2019, 2021 and 2022. Lingering economic uncertainty, structural changes in sectors and the reshaping of supply chains and global trade could certainly push the final count of major insolvencies to a new record in 2024, raising the risk of a domino effect on suppliers and subcontractors.

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