The US decision to abandon core principles of the global multilateral trading system and to withdraw from the Paris Agreement were further shocks for the EU and the world.
For the EU, this new linkage across policy areas is deeply destabilising. Its own rules, and the organisation of its governance, were designed under the assumption that external economic relationships would be preserved from the interference of geopolitics. In this new context, the EU must redefine its concept of economic sovereignty and the instruments it intends to use to defend and promote it.
This is not an easy challenge, but the problem is manageable. There are strategic opportunities for measures the EU can take at national and EU levels to enhance its economic sovereignty without resorting to US-style protectionism and decoupling. But two great powers — China and the United States — represent specific and particularly difficult problems for the European Union because of their unique capacities and approaches to the international economic order.
The two countries present distinct challenges, but overlap in one important respect: both increasingly link their international economic policies to their geopolitical goals and seek to use economic tools to secure geopolitical advantage. It does not treat the economic realm as separate from the political and geopolitical realms. It simultaneously seeks economic growth, technological development and geopolitical influence.
For this reason, the acquisition of a European company by a Chinese company might be motivated by long-term national or even CCP priorities rather than private profit-making objectives. On the first, the influence that China can acquire over individual EU countries through its foreign investment might can become an obstacle to effective foreign policymaking in the EU. For example, China might seek to use economic tools to mute European opposition to its policies for example in the South China Sea and its domestic human rights record.
Chinese economic influence in Europe has already meant that, for example, Hungary, Greece and Slovenia have blocked or diluted resolutions relating to international arbitration over the South China Sea and on human rights. Second, China has an ambitious strategy to gain economic leadership. From a historical standpoint, this is a normal goal for a rising nation, but it nevertheless poses challenges for the EU.
Winning the global competition over emerging technologies such as artificial intelligence, big data and biotech are stated national security and economic imperatives for China. Many emerging technologies have dual uses and the old paradigm that technologies designed for military use will trickle down into civilian applications often works the other way in China. Chinese plans for industrial and technological development are also based on the premise that civilian companies help with military development and applications. Its resolute industrial policies and subsidies to key sectors solar, batteries, autonomous driving and 5G are prominent examples represent a clear strategy to gain competitive advantage in key sectors that China sees as critical for future geopolitical and economic advantage.
Of course, technological competition as a part of geopolitical struggle is nothing new. During the cold war, military-technological competition with the USSR provoked great fear in the West. But the current situation is vastly different. The huge degree of interconnection means there are many more channels through which each sides can hurt the other. China has some structural advantages in that competition. Important parts of the digital infrastructure are controlled by large multinational corporations, which are subject to pressure and control from their home countries. The Chinese National Intelligence Law enables the government to force private companies to collaborate with Chinese intelligence services.
Restrictions on foreign investment between the EU and China are asymmetric in favour of Chinese companies entering the EU market.
In China, there are all kinds of problems for European investors, including the near impossibility of securing arbitration, difficulties in moving capital back from China and challenges to intellectual property rights. China also leverages market access to force companies to transfer technology, a practice incompatible with the spirit of World Trade Organisation rules.
Finally, China heavily subsidises its own national champions and favours their access to credit, distorting the level playing field. This asymmetry means China can gain influence over technology from the European economy, but this does not work the other way around.
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Chinese state-owned enterprises, with their enormous financial muscle, are well equipped to use western openness to gain leadership in key sectors of the global economy. There is also a problem with transparency in that it is not always clear which Chinese funds are used to raise ownership stakes.
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EU countries have adopted measures on making Chinese investment in the EU subject to screening. It will be important to monitor progress in these areas. It is legitimate and normal for China to increase its global footprint. It is also understandable that China does not simply accept multilateral standards that were largely shaped by the US and the EU in the post-war period. Nevertheless, the fact that China has now the economic and political muscle to do so requires strategic thinking in the EU. The BRI is explicitly not created as a multilateral framework of trade, investment and financial relations but is centred on China, which creates frictions with the existing multilateral system.
Chinese BRI investment can be hugely beneficial for the recipients, offering opportunities for trade and investment for companies around the world: an airport or port, once built, facilitates trade and creates jobs. This has led the US and the EU to express concern that China does not follow the principles of the Paris Club, which aims to provide multilateral solutions to problems of overindebtedness. For the EU, it is important to clearly establish the facts and not fall into the trap of just repeating US official statements.
China has also become an important economic partner and investor in African countries. This investment, if well executed, might boost much-needed growth, to the benefit of Africa and also the EU, which could find new trading opportunities. But it also means Europe faces more competition in advancing its policies on Africa. The lack of transparency over Chinese funding could also make it more difficult for Western multilateral development banks to lend in the region and carry out any subsequent debt restructuring. In short, China is a major rising power with increasingly global interests that might collide with European interests.
The EU has awakened to the challenge but it has not yet defined its response. It needs to shape a strategy for its foreign policy, its technology and investment policy and its policy on China in third markets and multilateral institutions. Naturally, the problems that it poses for European economic sovereignty are of a very different nature than those posed by China.
However, the presidency of Donald Trump has created serious doubts in the EU about the reliability of that alliance. But the primacy of the Atlantic alliance and the strong belief that US national security and long-term prosperity would be best served by the strengthening of a global rules-based economic system meant that infringements of the global rules were the exception rather than the rule. Under Trump, however, US policy has placed much less value on the transatlantic alliance and has demonstrated on issues as varied as Iran and trade that is it willing to leverage its economic position to secure policy outcomes, even if that implies undermining the global rules-based system and EU security.
More broadly, the Trump administration has actively reduced the support it gives to the multilateral order and has sometimes used its advantageous position to extract immediate economic gains from the system. It is also using its unique position within the global economic order to secure its geopolitical goals, for example in the context of Iran. To what extent future US administrations will continue with that policy is an open question, but it is clear that the damage the Trump administration has inflicted on the multilateral trading system is already real and likely to be difficult to reverse fully.
Concerns about US abuse of its special role in the international monetary system are not new. In the post-war period, the built-in asymmetry of the Bretton Woods system implied a special role for the US dollar. Countries that pegged their exchange rates to the dollar were dependent for build-up of foreign exchange reserves on US monetary policy and on the availability of US dollar liquidity. Providing the dollars for these foreign exchange reserves required the US to run a current account deficit, but these deficits undermined trust in the US currency this is the so-called Triffin dilemma.
The end of the fixed exchange-rate regime in the early s and the gradual move to generalised floating rates initially seemed set to reduce, and possibly end, this asymmetry. Although the dollar remained the dominant international currency, a floating exchange rate system looked fundamentally symmetric. Each participating economy could conduct its own monetary policy and freely enter into trade and financial transactions with the rest of the world.
By the late s, financial opening was assumed to be universally beneficial, international macroeconomic and monetary coordination were widely considered unnecessary and the issuance of an international currency was regarded as yielding only minor benefits. The experience of the global financial crisis forcefully challenged this view and provided a stark reminder of the dependence of international trade and finance on the US dollar.
Even though the financial troubles originated in the United States, the resulting global liquidity crisis made a massive injection of US dollars into the global financial system an urgent necessity.
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The US decision to extend dollar swap lines to selected central banks was thus instrumental in containing the effects of the crisis. But this was not done through multilateral institutions, rather on a discretionary basis taking into account the economic, financial and geopolitical interests of the United States.
Ironically, this meant that a financial crisis that originated in America strengthened the value of the US currency and enhanced US influence over the economic policies of other economies. Subsequent research has shown how the US dollar has maintained and has even expanded its exorbitant privilege in the post-Bretton Woods world. The US remains more than ever at the centre of the global financial system. Policy initiatives from the Federal Reserve and the federal government reverberate throughout the world economy.
Similarly, as global growth and investment have boomed , the supply of safe assets, or assets that are expected to preserve their value even during adverse events, has not kept pace with demand until the US massively increased its deficits and bond prices corrected downwards. The central position of the United States in the international financial system has sovereignty consequences for other countries. These consequences often stem from increasing US willingness to use financial sanctions, including secondary sanctions, to support various US geopolitical goals, for example when it comes to isolating Iran or threatening to sanction German companies over the Nord stream 2 gas pipeline project.
When the Trump administration decided in spring to withdraw from the Iranian nuclear deal and to return to a policy of economic isolation towards Iran, the European parties to that deal the United Kingdom, France, and Germany objected and decided that it was in their interests to continue with the deal. But the essence of that deal is that, in exchange for ending its nuclear programme, Iran gets to return to global markets as a more or less normal nation.
The US government sought not only to cut off Iran from US markets but also to ensure that other countries did not do business with Iran, whether or not they shared US goals. To do this, the US used so-called secondary sanctions that threatened to cut off foreign firms that traded with Iran from the US market, the US financial system and the use of the dollar.
The US has supplemented this pressure by threatening to prevent the directors of companies that violate US sanctions from entering the territory of the United States.
But in the context of globalisation, the even more central position of the US financial system now means that such regulations no longer have the same deterrent value. They have pre-emptively complied with US sanctions, even as their governments have urged them not to. In January , France, Germany and the UK announced the creation of a special purpose vehicle called INSTEX that, by netting out exports and imports, would help substitute gross cross-border payments with gross intra-Iran transactions, in theory reducing the need for EU-Iranian trade to access the global payments system.
This vehicle is unlikely to lead to a significant resumption of transactions with Iran, because any company doing business with the United States can be sanctioned directly.
More generally, the provision of payments to Iran has not been stopped by technical problems but by political pressure, as shown by the Bundesbank decision to suspend its rules on the free convertibility of an Iranian deposit in a bank subsidiary located in Germany into cash. The challenge the EU faces in preserving its economic sovereignty is compounded by its security dependence on the US.
These numbers, while high, could without doubt be funded by the rich European countries if there was political will. However, even if military capacity was available, the issue is also of how much solidarity EU countries would be ready to provide. The question is of particular relevance for the central and eastern European EU members. Accordingly, many of the more security-conscious European states reject any sort of distancing from US policy on security issues. Moreover, even with political will, such investments would take ten to twenty years.
It has shown a readiness to address the new challenges in fields including trade, foreign direct investment, finance and currency internationalisation.