Wednesday, July 24, 2024

Europe’s Vulnerable Economy

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The challenge of a more geopolitically turbulent world comes as Europe’s economic model is showing signs of stress. GDP growth has lagged that of the United States since the 2010 European debt crisis. Within the EU, markets fragmented along national lines, the lack of a well-functioning financial system, inadequate macroeconomic policies, and an underdeveloped high-tech industry have all meant subpar growth. Externally, the decoupling from Russian energy supplies and uncertain prospects for trade with China weigh on the highly globalized European economy as well. China’s economic model, with its high subsidies for the manufacturing industry—which then exports its growing overcapacity abroad—represents a particular challenge for many European economies, especially those, such as Germany’s, that compete with China in the same industries.

The challenge of a more geopolitically turbulent world comes as Europe’s economic model is showing signs of stress. GDP growth has lagged that of the United States since the 2010 European debt crisis. Within the EU, markets fragmented along national lines, the lack of a well-functioning financial system, inadequate macroeconomic policies, and an underdeveloped high-tech industry have all meant subpar growth. Externally, the decoupling from Russian energy supplies and uncertain prospects for trade with China weigh on the highly globalized European economy as well. China’s economic model, with its high subsidies for the manufacturing industry—which then exports its growing overcapacity abroad—represents a particular challenge for many European economies, especially those, such as Germany’s, that compete with China in the same industries.

A more America First president in the White House and a more aggressive stance from China as it seeks to dominate Taiwan would further undermine the stability of global trade and hit Europe hard. That said, for all the talk of economic de-risking, both the United States’ and Europe’s trade with China remains strong. A decoupling is not visible in the data, still documenting the benefits of trade.

For Europe, the shift to more antagonistic, security-driven economic relations will not be easy—not least because the European Union has no tradition of incorporating security strategy into economic policy. Assessing security risks remains the domain of national governments with diverging views on what constitutes such risks, whereas economic policy is largely handled by the EU.

Despite these odds, Europe has made some progress in preparing for a new era of geopolitical conflict and increased weaponization of economic interdependence, including creating programs to build advanced semiconductors, promote domestic mining of critical minerals, and advance green supply chains. Still, the work of diversifying trade relations, including away from China, is progressing too slowly. Too often, vested interests in member states block critical policies. One such victim is the proposed trade agreement with the South American customs union Mercosur, which would greatly help the EU diversify trade but has been scuttled by opposition from French farmers and others.

Europe needs to address its vulnerabilities with three major policy agendas. First, it needs to focus on growth. Advancing EU-wide capital markets and other ways to secure funding for growth will be crucial for Europe to catch up on technology and project economic power. Second, the bloc needs to address vulnerabilities in its digital infrastructure and services. Cloud computing, in particular, is extremely dependent on U.S. companies—a major vulnerability if a new U.S. president escalates the conflict over data privacy rules. Finally, and perhaps most existentially, Europe needs to strengthen its defense industry and improve the efficiency of military procurement. There is an acute scarcity of weapons and ammunition, and production still has not reached necessary levels after more than two years of war in Ukraine. A major EU push to boost the defense industry would not only help make Europe more secure but advance European technology as well.

Europe will remain dependent on the United States for security and strategic leadership for some time. But the EU will need to steer its own course instead of copying a U.S. protectionist agenda that will only hurt its citizens. Instead of leaving the profitable China market, it needs to incentivize firms to organize their business in such a way as to withstand possible geopolitically driven disruptions. Tariffs are part of the toolbox and should be based on the EU’s own assessment of the harms caused by subsidies. Even more importantly, Europe needs to break taboos on debt financing to boost strategic industries and prioritize growth while sustaining its social model. Finally, it needs to partner with countries that share its interest in maintaining global trade openness while improving its capacity to project power to protect trade and the international rules-based order.

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