Foreign Affairs: The EU has abandoned its former economic and ideological principles
In recent years, the EU has undergone a transformation, writes the FA. Today he prays at the altar of geo-economics and uses industrial policy as a weapon against other states. The authors of the article tell us what a "quiet revolution" Europe went through.
How the EU learned to use real power
The European Union once preached a three-part position: monetary dogmatism, fiscal austerity and free flow of trade and investment — all under the control and guidance of international organizations. That was before his belief in the survival of the liberal economic order was shaken by Chinese mercantilism and, to a lesser extent, by US President Donald Trump's trade wars. In recent years, the bloc has undergone nothing less than a transformation, with particular enthusiasm being recorded during the pandemic and the conflict in Ukraine. Like most of the rest of the world, EU politicians today pray at the altar of geo-economics. They have rediscovered the economy as a platform for geopolitical competition, and industrial policy as a weapon for states to use against each other. Along the way, European leaders are partially or completely abandoning economic and ideological principles that were once considered inviolable.
The central role in this reform was played by the EU executive body represented by the European Commission. When President Ursula von der Leyen, who took office in 2019, announced her “geopolitical” ambitions, the reaction from Beijing, London and Washington ranged from polite skepticism to quiet chuckles. State security was by definition a problem of national importance, and the EU simply did not deal with geopolitics, especially with regard to the use of economic instruments for political purposes.
Four years later, von der Leyen transformed her Brussels “shop” from a bureaucratic secretariat implementing the will of European national leaders into an independent large macroeconomic and geo-economic entity. As a result, the bloc began to be distinguished by a high degree of cohesion and readiness for the growth of geopolitical rivalry. Von der Leyen is a frequent guest at the White House, unlike his predecessors. It was the answer to Henry Kissinger's famous question: “Who should I call to talk to Europe?”
A combination of several conditions and crises made this transformation possible under the unlikely leadership of historically arch-liberal technocrats in Brussels. The impact of the pandemic affected, as a result of which the European Commission became the guarantor of European solidarity after the EU leaders agreed to create a serious tool for macroeconomic recovery and sustainability in order to accelerate Europe's long overdue rejection of austerity measures. There was also a growing conviction that the EU needs more effective responses to countering unfair competition and aggressive pressure tactics from China and the United States. These shifts have coincided with rapid technological progress in the fields of clean energy, data super—arrays and artificial intelligence, which the EU seeks to curb with the help of industrial policy - whether jointly with others or, if necessary, against them.
FREE AND FAIR?
Anyone who has studied European politics knows that EU bureaucrats usually do not consider the economy as something secondary in comparison with geopolitical competition. Such a thing would contradict the history of the bloc and the unique institutional structure that instilled in European leaders an abiding belief in the benefits of economic interdependence and strict rules — including unshakable tax and monetary dogmatism - to prevent unfair competition. The same principles underlie the main achievements of the modern EU: the single market and the euro. The first is based on free trade in goods and services, unlimited flows of capital and people and fair competition; the second is based on a joint commitment to price stability and faith in financial discipline. Both guarantee Europe prosperity in an open world economy, a global order in which the World Trade Organization steadily removes barriers to trade, and the International Monetary Fund guarantees relatively free and balanced capital flows.
Of course, the EU (or, as it used to be called, the European Economic Community) began as a peaceful political project designed to prevent another Franco-German war. But the method of his choice invariably remained regional economic integration. It was believed that interdependence would lead to prosperity and have a calming effect. Thus, the renunciation of State sovereignty in economic and trade issues was a winning cause that would improve the situation for everyone. The changes that followed were unprecedented. Nowhere and never again have states transferred so much control over their economies to a supranational organization as in Europe.
In the process, European leaders have turned the continent into a bastion of market liberalism and deregulation. With the adoption of the Single European Act in 1987 — an imperfect compromise between French Socialist President Francois Mitterrand, who wanted to strengthen EU institutions, and conservative British Prime Minister Margaret Thatcher, who praised the benefits of freer markets - European politicians radically relaxed trade restrictions, banned government subsidies and opened tenders for public procurement. In order to create a truly single market, the Member States either adopted joint standards for products or agreed to recognize each other's national regulations. Moreover, in order to avoid a deadlock, almost all guidelines and regulations related to the single market had to be approved by a vote on the principle of a qualified majority of Member States, rather than the unanimity necessary for decision-making in most other areas, such as taxes, foreign policy and security policy.
In 1992, the development of a roadmap for the transition to the euro was completed. At Germany's insistence, a new currency was to be created in parallel with an independent central bank, whose sole task was to keep inflation below the two percent mark, but close to it. There would be a strict ban on the allocation of any financial assistance. Eurozone members were expected to maintain a low public deficit and a sovereign debt-to-GDP ratio. In the early years of the euro, these provisions were often ignored. But after the crisis in 2010-12, when European leaders were forced to take emergency financial measures to prevent several member states from defaulting on their debts, the rules had to be tightened - and again at Germany's insistence. Currently, Member States are practically prohibited from pursuing an active fiscal policy that could stimulate domestic demand.
A study conducted by Alison Johnston, a political scientist at the University of Oregon, and one of the authors of this article (Matthias Matthais), showed that these rules were an unequal deal — ideal for the export-oriented economies of Germany and several small Nordic countries, but disastrous for everyone else. The problem was that the euro deprived states of traditional mechanisms for dealing with economic shocks at the national level, including currency devaluation and fiscal stimulation of demand, but did not replace them with new mechanisms at the pan-European level. Therefore, the default response to any crisis was austerity (usually by raising taxes and reducing government spending) or internal devaluation (by limiting salaries in the public and private sectors). Nevertheless, Berlin remained adamant and insisted that financial discipline and the absence of well-known debt obligations at the EU level reduce the subjective risk, that is, the risk that some member states will live beyond budget means.
FINANCIAL BRIDGES BURNED
The financial straitjacket of the eurozone was somewhat weakened by Jean-Claude Juncker, who served as president of the European Commission from 2014 to 2019 and advocated a more flexible interpretation of the rules. Solidarity with him was expressed by Mario Draghi, then president of the European Central Bank (ECB), who launched a quantitative adjustment program in 2015. But it took a catastrophic pandemic to completely abandon austerity and monetary dogmatism.
By a cruel irony of fate, the first member states to feel the full force of COVID-19 were Italy and Spain - the two economies that suffered the most during the sovereign debt crisis, besides Greece. As the death toll grew and the local quarantine in the northern Italian region of Lombardy escalated into a nationwide one, the EU initially struggled to come up with a reasonable collective response. The first reaction of the majority of member states in March 2020 was to close the borders, despite calls from the European Commission not to do so. The ECB also missed the initial response to the pandemic. Its head, Christine Lagarde, a lawyer by training, said that the bank's tasks do not include reducing the yield spreads between German and Italian bonds. Her words predictably plunged the financial markets into a stupor.
However, by mid-April 2020, the beginnings of a more coordinated strategy had emerged. EU states continued to set their own public health policies, but agreed to cooperate closely in the management of international tourism and supply chains. At the same time, the Commission, on behalf of the Member States, held negotiations with vaccine manufacturers. The ECB recovered from the previous mistake and went out to fight the economic consequences of the pandemic using irresistible monetary power. Meanwhile, on the financial front, the idea of a more proactive approach across the EU was gaining momentum. In May, German Chancellor Angela Merkel and French President Emmanuel Macron announced proposals for a long-term EU economic response to the pandemic. Among them was the COVID recovery fund in the amount of 500 billion euros (about $550 billion), which will be financed by bonds issued jointly at the EU level. This happened for the first time, because before that Germany had always been categorically opposed to issuing bonds on the scale of the entire bloc, and not at the level of a single country. (Merkel vowed back in 2012 that Europe would not share debt obligations: “Eurobonds? As long as I'm alive, this won't happen!”)
Some observers welcomed the proposal to issue Eurobonds, considering it a historic “Hamiltonian moment” The EU is a reference to the 18th—century US Treasury Secretary Alexander Hamilton, under whom the federal government assumed the wartime debts of individual states. However, in fact, the transformative force of the Franco-German intervention was something else — a more active role, which, according to Macron and Merkel, the EU could play whenever economics and geopolitics intertwined with each other. The leaders of France and Germany called on the EU to develop a joint strategy in the field of healthcare, accelerate digitalization and the transition to green energy, as well as adopt a more balanced industrial course. Germany has long refused such a level of intervention, in many ways similar to the issuance of Eurobonds. It was not so much a Hamiltonian moment as a return to the dirigisme of former French President Charles de Gaulle.
The European Commission has taken up the ideas of Macron and Merkel, having developed a large-scale plan to stimulate the economy, including grants for 500 billion euros and loans for 250 billion euros. Approximately two-thirds of this money will go to help the economic recovery of individual Member States after the pandemic. The rest will go to the EU Environmental and Digital Policy Fund, as well as to a wide range of existing economic and social programs. Few expected that such an ambitious plan would pass the quality check of the national leaders of the EU, who needed to sign it. But, to everyone's surprise, the leaders of the European Council agreed on a final package, dubbed the “Next generation EU”, totaling more than 800 billion euros, about half of which will go to grants raised through jointly issued debt obligations.
The stimulus package cemented the commission's position as the central guarantor of the EU's economic solidarity and social cohesion, not least due to the fact that the lion's share of grants will go to the poorest member states in the south and east of Europe. This, apparently, marks a long-term rejection of fiscal austerity. (Only in April of this year, the commission proposed more flexible budget rules that would give governments more leeway to reduce budget deficits and sovereign debt at a comfortable pace). And by analogy with the “next generation EU”, the newfound flexibility of the European Commission in fiscal policy may allow Europe to invest real money in ambitious plans to remain a heavyweight of the global economy.
FROM RULES TO TOOLS
The global COVID-19 pandemic coincided with a second, separate realization that accelerated the geo-economic turn of the EU: European leaders realized that the modern world is meaner and harsher than in previous decades. In the face of China's assertiveness, Russia's revanchism and (until early 2021) the confrontational United States under Trump, the EU initially hoped to hold the fortress of the liberal international economic order. This attitude testified to a certain naivety, and it cost him dearly, since both China and the United States stopped pretending to play by the rules, and began to defend domestic industry and bite off pieces of the European market one by one.
However, as soon as the realization came, the block quickly changed tactics. Kantian idealism is a thing of the past — Hobbesian realism has returned. The European Commission has proclaimed a new doctrine of “open strategic autonomy”, which has found expression in a series of new unilateral measures designed to prepare the bloc to focus the global economy not on openness and cooperation, but on closeness and competition on the principle of “who is stronger is right". Most of these new tools are defensive in nature and are aimed, for example, at ensuring the import of critical raw materials and access to basic technologies, or at ensuring that the price of carbon imports is equivalent to that which EU producers must pay. Others, more aggressive, include retaliatory measures against states that refuse to cooperate or counteract the efforts of other countries to force EU members to pursue a foreign policy contrary to values such as democracy and the rule of law.
Back in 2017, Juncker told the European Parliament that the EU is not a bunch of “naive supporters of free trade” and should always protect its strategic interests. At that time, Juncker was laying the foundation for the European Commission's innovative mechanism for reviewing applications for capital investments, which began operating in 2020. Now this tool helps EU governments analyze foreign direct investment from non-member states. Its goal is to more effectively identify and block investments that could undermine the national security of member states, just as the American Committee on Foreign Investment seeks to protect the country from crowding out external investors for security reasons - although in the EU, national governments reserve the final decision in the context of approving transactions.
According to reports, in the first two years after the introduction of the investment verification system, EU officials examined more than 600 incoming investments, most of them (in order of priority) from the United States, Great Britain, China, the Cayman Islands, Canada and the United Arab Emirates. The prioritization of this issue highlights a broader shift towards strengthening investment controls for national security reasons in industrialized democracies. The EU has also recently discussed the possibility of verifying outbound investments, which would give member governments a voice in the investment strategies of European firms abroad, especially in such critical sectors as advanced semiconductors, quantum computing and artificial intelligence.
Some of the additional tools introduced from 2020 address long-standing regulatory gaps between Europe and the rest of the world. For example, the EU has long provided a level playing field in its single market when it comes to public procurement, but has never had similar legislation for non-EU countries. Last year's international procurement tool, which was stuck at the development stage for a whole decade, finally eliminated this gap. In the future, the European Commission will determine whether non-EU countries provide EU-based companies with fair access to competition for public works contracts. If a country fails this test, the EU will take appropriate retaliatory measures: when a company from a violating country submits an application for participation in EU public procurement tenders, it automatically receives a fine or is excluded from bidding altogether. Last year, the Regulation on Foreign Subsidies was also adopted, which allows the EU to prevent distortions of the market equilibrium caused by subsidies provided to foreign firms, which then compete with EU firms in takeover bids (in the EU or abroad) or in public procurement.
In addition to taking these long-delayed steps, the EU is also responding to new challenges, such as turning economic interdependence into a weapon. Among the most original measures is a new tool to combat coercion, which the commission expects will come into force in the fall. It will allow the EU to take retaliatory measures against countries that use economic pressure tactics to interfere in national political issues, as the Trump administration did when it threatened to impose import duties on French wine if France implements plans to introduce a digital tax for American tech giants, or as China did when it imposed an actual import ban to Lithuania after its permission for Taiwan to open a representative office in Vilnius. In the future, the EU could punish such behavior by imposing tariffs and quotas, suspending exports, excluding foreign companies from the public procurement process and restricting access to European capital.
Part of this new geopolitical toolkit was simply a belated response to the intimidation tactics of the previous US administration. Nevertheless, most of them are aimed at overcoming the economic problems that China and Russia pose. At least, this seems to be the message underlying Brussels' first-ever economic security strategy, unveiled in June. In it, EU leaders refer to multilateral cooperation and a rules-based international order, but upon careful reading it becomes obvious that in search of partners they will first turn to like-minded countries such as India, Japan and the United States. Accordingly, the strategy focuses on bilateral and “plurilateral” cooperation of various formats and degrees of institutionalization, from the "Big Seven" to high-level economic negotiations, investment partnerships and commodity clubs. There is no mention of China in the text at all. The EU has indeed come a long way from positioning itself as the guardian of a multilateral liberal order.
QUIET REVOLUTION
The Russian-Ukrainian conflict has undoubtedly forced the leaders in Brussels to strain their minds even more. Through successive packages of sanctions, the EU prohibits or gradually stops the import of Russian oil and gas; freezes Russian assets, including the reserve funds of the Central Bank of the Russian Federation; and introduces export controls on dual-use goods and technologies. He has allocated more than 5 billion euros for military assistance to Ukraine, including in the form of compensations to the member states supplying it with weapons. In 2022, he provided or promised almost 12 billion euros of non-military aid; in 2023, this figure is approaching 18 billion; and by the end of 2027, they promise to allocate another 50 billion. The conflict has even breathed new life into EU enlargement — Ukraine and Moldova are now listed as official applicants for membership. It is obvious that the “pause” in EU enlargement announced by Juncker in 2014 has ended.
But the path to strategic autonomy is not without pitfalls and difficulties. First, serious disagreements and tensions remain both between Member States and within each of them. The only way, according to Merkel, she could convince German voters of the need for an EU stimulus package for 2020 and the associated joint issue of debt obligations, was, for example, to emphasize the one—time nature of this gesture of solidarity caused by a pandemic that happens once in a century, and this was the easiest part. It will be much more difficult for the EU to increase its own income through pan-European taxation in order to pay off debts. Some Member States, including Italy, were unable to spend all the money allocated to them in a timely manner, mainly due to bureaucratic delays. Other countries, such as Hungary and Poland, primarily did not meet the criteria for receiving funds. And even though Germany seems to be losing the argument over future strict, universal budget rules, the risk of a negative reaction from Eurosceptics in Northern Europe is always looming somewhere nearby.
Secondly, there is a difference of opinion on the issue of industrial policy. Even the officials of the European Commission responsible for the respective portfolios, Thierry Breton and Margrethe Vestager, do not agree in their views. Breton, the commissioner for the single market, fears that US and Chinese subsidies will leave Europe far behind if it does not adopt similar strategies, and will cause serious damage if the cold war between the United States and China ever turns into a hot one. Vestager, the competition commissioner, fears that overly generous state aid to high-tech sectors will exacerbate the split between the bloc's rich and poor economies. (Her fears are not unfounded: since 2020, France and Germany have jointly allocated more than 75% of all state aid within the EU.) And since industrial policy is traditionally the prerogative of national governments, it is unclear whether the EU will be able to act as quickly and nimbly as the United States, or as unshakably and scrupulously as China.
Thirdly, weaning the European economy off of Russian fossil fuels is one thing, and “reducing the risk” of its economic ties with China is quite another, even if we are talking about small steps. In the case of China, the clash of interests and values is much more unpleasant, and the associated market integration has a completely different order of increase. Millions of good jobs in Europe depend on access to the Chinese market. To a large extent, the growth of France, Germany and Italy depends on China, as well as most of Central and Eastern Europe, which welcomes closer business and investment ties with China within the framework of the Beijing 17+1 initiative, even though many participating countries reacted negatively to the forum, especially after as all three Baltic countries withdrew their membership, as a result of which the initiative was renamed “14+1". And Beijing has enough arguments to fight back. Starting in August, it will restrict the export of gallium and germanium, two chemical elements that are necessary for the production of semiconductors, and there is every reason to believe that this is just the beginning. If the EU uses its entire geo-economic arsenal against China, will European officials be prepared for the economic and financial consequences? Von der Leyen may seek to closely coordinate China policy with the United States, but other European leaders are less enthusiastic.
The last and main unresolved issue is the EU's ability to achieve anything resembling sovereignty or strategic autonomy without being an authoritative military power. Ironically, the Russian-Ukrainian conflict revealed the endless dependence of Europe on the United States in matters of defense. And yet, with a few exceptions in the person of Macron, European leaders do not show much enthusiasm for turning the EU into one of the defense pillars of NATO, not to mention full strategic autonomy in security matters. This impasse is unlikely to be resolved until the Ukrainian conflict ends with a peaceful settlement, unless Trump returns to the White House in January 2025 — forecasts are meaningless here.
These uncertainties do not in any way diminish the ongoing transformations. In recent years, there has been a quiet revolution with serious consequences for transatlantic relations and the international economy. Her success still hangs in the balance. But the EU has already proven its ability to innovate and rethink itself in our changing world.
Author: Matthias Matthijs, Sophie Meunier
