Economic statecraft: is this the moment for the EU to roll it out?

The imminent arrival of Donald Trump in the White House has swung transatlantic relations back to issues of economic policy. This may seem surprising at a time when a major war in Europe is soon to enter its third year and Russia increases its threats against NATO allies with every passing day. Just across the Mediterranean, there is finally a ceasefire in Lebanon but the conflict and humanitarian crisis in Gaza continues with no end in sight. Israel now says it wants to focus on Iran which presupposes at the very least more Israeli strikes against Iran’s proxies in Syria, Iraq and Yemen if not against Iran itself (two have taken place already). The North Korean entry into the Ukraine conflict and Iran’s military help to Russia have globalised the Ukraine conflict and tied Russia, China, Iran and North Korea closer together. The deteriorating security environment certainly makes it more important for the EU to use all its instruments of power and in a better coordinated way to push back against the advances of the authoritarians. In this context economic measures alongside investment in military capabilities have played an increasingly important role. If the worst happens and Europe is dragged into new conflicts, victory in the long run goes to the side that keeps its own economy and productive output afloat while forcing the adversary’s economy, deprived of trade, raw materials, machinery and workers, to collapse. This was certainly the tactic that Britain used successfully against Napoleon’s Continental System in the early 18th century and again against the Kaiser’s Germany with its maritime blockade during the First World War.

Since February 2022 the EU has adopted no fewer than 15 packages of sanctions against Russia in response to Moscow’s invasion of Ukraine and a sixteenth is currently under discussion. One element of this package would be more EU confiscation of Russian business assets inside the bloc to compensate European businesses which have had their assets frozen or confiscated in Russia. Moreover, the EU has persuaded many of its partners to work with it and adopt similar sanctions, including neutral Switzerland, but not the candidate countries of Serbia or Turkey. Economic measures have also been useful to prevent authoritarian powers gaining too much control over the EU’s critical infrastructure, such as ports, transport or energy supplies, by screening and limiting direct foreign investment. The EU has enhanced its strategic autonomy by diversifying its critical supply chains for oil and gas, precious metals, chemicals and pharmaceuticals, and to manufacture more key ingredients of the 21st century economy at home, through for instance the EU Chips Act. Brussels has also devised an anti-coercion instrument to impose economic counter measures against third parties abusing their economic power to bully or intimidate individual EU member states. It was used to take China to a World Trade Organisation panel after Beijing halted trade with Lithuania which had allowed Taiwan to open a trade office in Vilnius. But economics can be used to pursue other political objectives as well. For instance, the EU has introduced a carbon border adjustment tax to penalise goods imported into the EU which were manufactured with a disproportionate use of carbon and fossil fuels. It is one way of financing the green energy transition within the bloc as well as incentivising its major economic competitors to convert faster to green manufacturing and renewable energy as well.

Consequently, economic statecraft is not a new concept for the EU as it looks to make its diplomacy more geopolitical and geared to a more competitive and confrontational world. But it will be a priority for the new Commission which took office on 1 December. Granting access to the EU’s single market of over 500mn consumers is a powerful lever when it comes to negotiating trade agreements. It is also the basis of the EU’s role as a regulator when it comes to issues such as challenging monopolies, enforcing competition and setting standards as in its General Data Protection Regulation (GDPR) of 2018 or the Digital Services Act of 2022. The EU’s openness to trade and investment (with the notable exception of its protectionist and heavily subsidised farm policy) makes the EU a good economic partner for other countries to work with. Its own investments overseas in car factories, supermarket and hotel chains, high speed trains and nuclear power plants keep thousands of local workers employed. So it is a clear imperative for the EU, to date lacking the military power projection of the US, Russia or China, to integrate its economic levers as closely as possible into its foreign policy. So although economic statecraft is not new, it does mean achieving a better balance and synergy among three imperatives: competitiveness, sustainability and security. First and foremost, it has to defend the EU’s own interests but it is also a powerful tool to persuade others to drop their protectionist barriers and open up their own economies and sign up to a common set of rules, as in the settlement of disputes. In this way, the EU can use its position in the global trade system to expand and reinforce the multilateral rules based order which in turn buttresses its own role and influence on the world stage. This approach also reflects the fact that the rule of law, common standards and open trade are the glue that holds this union of 27 EU members states together politically. So the better the global multilateral system functions, the easier it is for the Brussels institutions to persuade the EU member states to uphold the EU integration treaties and stick to its internal rules. A truly virtuous circle. Yet the task is made much easier if the EU has partners who share its vision of an open, rules-based trading system and reject mercantilist and protectionist policies. Top of the list here is the United States.

Partners are never perfect even when they share your values, and especially when it comes to trade competition. The EU and the US have long been involved in disputes over aircraft subsidies, steel and aluminium, genetically modified crops and even chlorinated chickens. What has seemed a precautionary health regulation to one side has been interpreted by the other as thinly veiled protectionism. And despite being each other’s primary trading partners, the EU and the US have not been able to start negotiations on a new, updated trade agreement (formerly referred to as TTIP) because parliaments on both sides of the Atlantic were unlikely to ratify it. All the more so if Biden could not get fast track authority from Congress under which trade agreements cannot be amended but have to be either approved in full or rejected. The less ambitious trade agreement that the EU concluded with Canada (CETIP) was held up for months in the regional parliament of Wallonia in Belgium. When it came to TTIP, lobbies in Europe and the US were gearing up to oppose more free trade in their sectors, whether farmers or health providers on this side of the Atlantic or car and wine and spirits producers on the other side. Indeed, although Biden has put some transatlantic trade disputes pending in the World Trade Organisation on hold, as with airplane subsidies and steel and aluminium tariffs, he has very much followed an America First policy. His Inflation Reduction Act has pumped billions of dollars into US companies to finance green energy and infrastructure investments. European governments have worried that their companies would relocate to the US or move more projects there to benefit from the subsidies. For the EU, this is a distortion of fair competition. It is an irony that the Biden Administration, which has been one of the most supportive of Europe’s security and defence, has shown so little interest in a transatlantic trade agreement which could boost trade and investment, and open up new areas such as digital, insurance and financial services. Even easier bilateral deals, with non-EU allies like the UK post-Brexit or Norway have not moved forward. Biden has given the priority to the Asia-Pacific. Although he did not try to revive the Trans Pacific Partnership abandoned by Trump in 2017, he did propose a more modest Indo-Pacific Economic Framework for Prosperity in May 2022. 14 countries in the region have signed up to this. Yet the Biden administration and the EU have been able to follow more or less the same approach towards China, imposing tariffs on Chinese subsidised electric vehicles and solar panels and being wary of Chinese investments in land, critical infrastructure and strategic industries; but at the same time wanting to cooperate with Beijing where possible and following a policy of derisking rather than decoupling.

Yet despite this mixed bag, and the inevitable inconsistencies and contradictions when it comes to invocations of the benefits of free trade, the EU and the US have been partners in upholding the multilateral economic system. They both emphasise the benefits of free trade in lifting populations out of poverty, work together in the G7 and G20 on issues like debt relief for the poorest countries and climate adaptation finance, recapitalise the international lending institutions like the World Bank, act against money laundering and tax havens, and support the reform of the World Trade Organisation to cover more products and services, to better protect dwindling fishing stocks, and to adjudicate disputes more rapidly. By setting the agreed international standards and drawing other countries into their economic orbit, the EU and the US have kept the international open trading system alive against all those using protectionism, mercantilism and closed regional trading blocs in an effort to bring it down. EU economic statecraft has been about tearing down barriers rather than putting them up while trying to ensure that trade respects certain norms when it comes to data and internet and social media security, environmental protection, avoiding slave or forced labour and human rights abuses and non-transparent rules of origin. The EU has put import restraints on Chinese cotton and tomatoes precisely because it suspects Beijing of using forced labour in Xinjiang province. The EU’s economic clout and the prized access to its single market give the bloc both soft and hard power instruments to achieve these goals.

Yet now there is a high risk that the EU’s economic statecraft will be needed more for self-defence and damage limitation than for a more forward looking strategy to expand the multilateral trading system. Donald Trump’s first move on returning to the White House next January will be to issue an executive order imposing swingeing tariffs on America’s major trading partners. Trump has singled out Mexico and Canada for an overall 25% tariff, and said that he will impose a further 10% levy on Chinese imports. The EU was not mentioned in this first phase but no doubt it will be in Trump’s sights as the large US trade deficit with the EU was a particular bugbear of Trump the last time round that he was president. That deficit has not changed much in the meantime. Indeed Trump has called the EU a “mini China”. In the past he has talked about a 10% or 20% tariff on EU imports. It is not certain at the moment if this is just a negotiating tactic to force the EU to make unilateral trade concessions or a blanket and long term tariff strategy that Trump is determined to stick to. European Commission President, Ursula von der Leyen, has for instance suggested that Europe should buy more US liquified natural gas once Trump lifts the export restrictions imposed by Biden. The President of the European Central Bank, Christine Lagarde, in a similar vein has proposed that Europe could buy more defence equipment from the US, although EU armies already source 40% of their equipment across the Atlantic. Or the EU may wait and see how the tariff debate in the US plays out, given the opposition to tariffs from American economists and business leaders who well remember the disastrous impact of the notorious Smoot-Hawley tariff act of 1930 in exacerbating the Great Depression, particularly in Germany, while doing little to boost economic activity and employment in the US itself. It took Roosevelt’s New Deal to make this happen. Fiscal conservatives worry about the US national debt which now stands at $36tn. Under the first Trump administration, that number rose significantly. In 2020 the US had to pay $345bn on debt servicing. By 2025, that figure will rise to $1tn according to the Congressional Budget Office. This will mean that one in every five dollars of federal government spending will go on paying down the debt. The annual debt bill will be higher than US defence spending or the education and Medicare budgets. The Trump tax cuts and massive government borrowing to deal with the COVID-19 pandemic have pushed the debt level sharply upwards. But Trump has already signalled his intention to prolong his 2018 tax cuts (mainly benefiting wealthy Americans) when the current package expires next year; and he is proposing to cut corporation tax to 15%. Yet during the campaign he committed to keeping the Medicare and Medicaid programmes (commonly known as Obamacare) intact despite trying to terminate them during his first stint in the White House. What Trump is thinking of doing instead is adding work requirements for Medicaid beneficiaries. Back in 2020, during the COVID-19 pandemic, US Treasury bonds carried an interest rate of 0.6%. Today the yield is 4.4%. This rate has increased since last September when investors, anticipating that Trump will add trillions to the US national debt, demanded broader spreads. As James Carville pointed out during the days of the Clinton administration, the superpower US can defeat all its adversaries, except the bond market.

In sum, the US is caught in a vicious triangle of spiralling debts and deficits, unfunded government programmes and overreliance on external finance and borrowing to keep the government afloat. Biden did not try to tackle this problem, leaving the Trump tax cuts in place and ramping up federal spending through his Inflation Reduction Act subsidies. This situation is worrying to many fiscally conservative Republicans who fear the burden it will impose on future generations of Americans. Their advocacy of a smaller federal state and civil service is driven as much by a desire to make spending cuts as by ideological opposition to an over reaching government. The former White House Budget Director, Russell Vought, has proposed a plan to cut federal spending by $11tn over 10 years, while Elon Musk and Vivek Ramaswamy have been put in charge of a new Department of Government Efficiency to identify cuts in public administration. Musk has set a target of a one-third reduction (or $2tn) in government spending. He has advised Trump not to spend money even when it has been appropriated by Congress. Trump will almost certainly terminate Biden’s Inflation Reduction Act to recuperate the funds still allocated to it, and even though this Act has benefited mainly red Republican states,tariffs are one way of trying to break through this Gordian knot as they avoid hard and painful decisions within government on putting the public finances in order. Tariffs encourage foreign businesses to set up within the US, and US companies in Mexico or China to return home to avoid them. This can stimulate investment and jobs. And because of its continental size, the US economy is less dependent on exports than smaller, more export-driven countries such as Germany, France or Italy. Yet, as a Chinese economist has pointed out, tariffs are like giving a thirsty man a glass of poisoned lemonade. The liquid quenches his thirst immediately but a few hours later he is in hospital and at death’s door. So over the long run, it is not just the global economy, but the US as well that will emerge poorer from tit-for-tat tariffs and trade wars with its major trading partners. Complex global supply chains with goods and components moving back and forth across borders several times before the production process is completed will be disrupted. It will be costly and time-consuming for US companies to replicate these supply chains in the US itself. With less overseas competition as a spur to innovate, US industry will become complacent, more backward and less efficient. Product quality will decline and prices for the US consumer will go up, recreating the inflationary spiral that engendered so much anti-incumbent anger during the recent US election. As America’s trading partners retaliate by imposing counter-tariffs (as the EU did last time round on US motorcycles, jeans and bourbon whisky), US farmers could see China buying soya beans from Latin America instead of the US, and the US airplane industry might see more orders going to Airbus or Brazil’s Embraer rather than to Boeing. Fearful of US sanctions or tariffs, countries will try to reduce their dependence on US technology or components and find other sources. Furthermore, US tariffs are bound to intensify the efforts led by China, Russia and most recently the BRICS to move away from the US dollar in international oil, gas and commodities trading and to use the Chinese Yuan or a new BRICS currency instead. Trump has threatened the BRICS countries with 100% tariffs if they try to undermine the US dollar as the global reserve currency. Regional and closed trading blocs based on preferential arrangements and high-tariff rules and other impediments to open trade (such as quotas, excessive regulation and bureaucracy or rules of origin stipulations) will break up the global trading system leaving those on the outside forced to choose their partners and at a negotiating disadvantage in a system without rules or enforcement.

So how can the EU’s economic statecraft adjust and respond to the Trump tariffs, if indeed the incoming President goes ahead with them? A number of steps are being considered by the new Commission and the EU member states working together.

First is political conditionality. Trump wavers between presenting his proposed tariffs as an economic measure and as a political form of pressure to force other countries to crack down on what he sees as the threat to the US from illegal migrants, drugs, organised crime and gangs, and social media platforms that are controlled or misused by foreign governments to collect information on Americans. Chinese land purchases in the US, media outlets or cultural foundations as agents of foreign influence also come into this category. The US will also pinpoint Chinese cyber-attacks after the FBI has just accused China of one of its largest cyberattacks ever against US telecommunications. So one response is to test with Trump and his economics team their willingness to drop or moderate their tariff plans in exchange for action in these areas. This is precisely what the Canadian Prime Minister, Justin Trudeau, did this past weekend in flying to Mar-a-Lago to talk to Trump and offering to tighten border controls to reduce the flow of illegal migrants. As 70% of Canada’s foreign trade is with its southern neighbour, it is hardly surprising that Trudeau made this effort. Of course, it is harder for Europe to make similar moves as it does not send illegal migrants or narcotics to the US. But history gives us a guide here. In the 1970s, the Mansfield Amendments in the US Senate threatened to withdraw US troops from Europe if European governments did not pay more of the host nation costs of stationing those US troops in West Germany and elsewhere or buy US goods, including military equipment. These came to be known as “offsets”. Given that the US currently has 100,000 troops permanently based in Europe and is building reinforcement infrastructure and supply depots, the EU working with NATO could try something similar again. Trump likes political wins and given his criticism of European defence burden sharing this kind of arrangement might appeal to him.

A second approach is to make pre-emptive counter-offers before Trump has announced his tariffs or signed them into US law. As this would need to be done quickly given that inauguration day is less than two months away, low-hanging fruit will be required. For instance, the EU could offer Trump to make permanent the provisional freeze on penalties that the Biden and EU agreed to in addressing the subsidies that they provide to Boeing and Airbus. They halted proceedings against each other in the World Trade Organisation. Given the difficult commercial challenges that Boeing is facing at the moment after a number of accidents, quality control issues and a workers strike, Trump may see an advantage in this sort of proposal. Furthermore, the EU could discuss a reduction or deferral of the large fines that it has imposed on Google or Microsoft for abuse of market dominance. Or a temporary quota on some of its most sensitive exports to the US such as luxury cars, wines and spirits or luxury goods. For the companies concerned these would not be easy things to swallow, and the Commission might need to look at offsets, such as a reduction on VAT for these products within the EU single market. A temporary adjustment of the EU’s carbon border tax for certain US products like cars and steel might also be considered. But what matters is that EU negotiators do not go to Washington to offer these goodwill concessions unilaterally, allowing Trump to pocket them while offering nothing in return. A bilateral tariff truce for the duration of the administration would need to be agreed and formalised, giving both Brussels and Washington assurances. As in any negotiation, who gives what for what will be fundamental, and not easy with a President who prefers to deal with countries bilaterally, rather than big multilateral institutions; one who doesn’t like equal outcomes where both sides win (and lose) at the same time. And who is interested above all in scoring quick political victories to present to his core electorate.

The third leg of the strategy is for the EU to prepare a range of response options and get the right instruments and levers in place. We do not know yet what is going to happen, and thus we must be prepared for all eventualities. The Commission has been hard at work on a range of options and potential retaliation measures to put to the new College of Commissioners which took over on 1 December. Naturally, Commission officials have been coy on what measures are under consideration and in which order of priority. They think uncertainty is an important factor in deterrence vis-a-vis the Trump team. Some of the Commission’s instruments are in place (like the one on foreign direct investment), whereas others still need to be fully developed. Together they can help to counteract the weaponisation of interdependence which Trump’s tariffs represent. So the challenge for the EU is to preserve openness while fighting abuses of that openness. Its responses need to be evidence-based and reflect detailed risk assessments of the likely impact and costs of certain measures. One instrument is a set of EU criteria on “permissible subsidies” or those measures that do not engender lasting market distortions but are used to deal with temporary challenges like dumping or heavily subsidised products designed to win a dominant market share. The EU has clamped tariffs on Chinese electric vehicles and solar panels, as with Chinese steel in the past, precisely for this reason. They can be justified to give EU industry time to adjust to a new 21st-century economy where electric mobility with advanced batteries and electric vehicles will be key and European companies need to be in the game. Another instrument deals with anti-coercion. Yet another is aiming to give a more precise definition of the national security opt-out clause which is extremely vague but which Trump invoked frequently in his first term to justify unilateral trade restrictions with no prior consultation. Other EU instruments in the pipeline concern outbound investment, the level playing field where the EU can act in circumstances where the WTO is unable to do so, and international procurement. A new Trade and Economic Security Commissioner will tie the economic aspects together with the more geopolitical economic statecraft. Trump’s tariffs would be the moment to road test these various instruments and assess their individual and collective impact.

The next course of action is to take any new transatlantic trade disputes to the WTO. With the US disengaging, the task of the EU is to uphold the multilateral trade order against the onslaught of the mercantilists and the unilateralists. So its trade policies should be in line with WTO rules and standards and current international trade agreements rather than bilateral deals that break those rules. At the same time, the WTO can be the place where the EU can push its concept of the level playing field in international trade through an agreement on Global Subsidies. Brussels will need to use the G7 and G20 forums and its engagement with the emerging and developing economies to build coalitions to support this and other WTO reforms. For instance, the G7 has set up an observatory on overcapacity in industrial production which leads to dumping and subsidised exports. The EU should certainly not be seen as defending the status quo. The key challenge is to strengthen the current efforts to use trade policy to address climate change. Given the greater impact of extreme weather events, this is not the time for the world to stall or even move backwards on the green energy and green industry transition. With Trump likely to withdraw (again) from the Paris COP Climate Change Agreement of 2015, the EU will have to lead the charge here. The EU must push in the WTO for stronger rules on biodiversity, fisheries conservation, carbon markets and taxes and the scope of industrial subsidies for green energy projects.

At the moment it is tempting for EU member states to break ranks and send their trade representatives to Washington or Mar-a-Lago to plead their special interests. Not all the EU member states are running a trade surplus with the US. The US has a surplus with the Benelux and the Scandinavian countries whereas the deficits come mainly from its trade with Germany, France and Italy. EU member states have different interests when it comes to trade with the US. The Netherlands for instance fears the impact of US tariffs on its pharmaceutical industry, whereas France and Italy worry about their wine producers. This past week, the Dutch economy minister, Dirk Beljaarts, went to the US to talk to former US Trade Representative and close Trump advisor, Robert Lighthizer, who back in September drew up many of Trump’s tariff plans. Nothing wrong in taking soundings and informal contacts, of course, but EU economic statecraft will be undermined immediately if EU member states are unable to maintain a united front, and let the Commission take the lead as is its responsibility on trade issues.

China is the EU’s second largest trading partner. In all likelihood, Trump will put pressure on the EU and its member states to align with his own tough policies against Beijing and make that a loyalty test when it comes to his broader attitude towards the EU and NATO. The EU has its own issues with China and the EU- China agreement on investment is still held up in the European Parliament. Electric vehicle dumping and direct investment or critical infrastructure ownership have already been mentioned. Sometimes the EU interests vis a vis China coincide with those of the US, but sometimes they do not. The US is treating China as a systemic challenge that has to be confronted and pushed back across the board, and not only in the trade domain. The Biden administration has introduced harsher measures against Beijing without imposing new tariffs. For instance, the Commerce Department has just imposed an export ban on US products and services going to 200 Chinese chip manufacturers. But the EU has to look for cooperation as much as fair competition. Its interest is in balanced trade rather than less trade or no trade. Chinese green energy technology will be key to the energy transition and its investments in nuclear power and rail and road upgrades can help the EU to improve its basic infrastructure, provided that it is properly regulated and makes sound commercial sense. If Trump does come forward with major tariffs against both Brussels and Beijing, it will be tempting for China to dump products that it cannot sell in the US on European markets. The EU may follow suit by imposing new measures on Beijing in the hope of winning favours from the Trump administration. But economic statecraft is about defending your own interests, not those of others. Trump’s tariffs could instead be an opportunity for the EU to negotiate a more balanced and sustainable trading and investment relationship with Beijing. Reaching an agreement on electric vehicles (where both sides have been negotiating for a long time already) would be an early indication of Chinese flexibility and of a new willingness to work together. On the other hand, a key EU interest is to persuade Trump to keep the Biden Trade and Technology Council with the EU. It has allowed Washington and Brussels to discuss common standards for trade in goods and data services as well as cybersecurity, AI regulation and resilience. It has not produced any formal agreements but it is still a useful forum for the EU and the US to share intelligence and experience and head off potential disputes through early warning and anticipation.

Finally, if the US is becoming a less attractive and reliable trading partner, the EU needs to find new trading partners, particularly in the emerging economies and the less developed countries which now constitute 15% of global imports. It can’t all be about the US and China. The EU is the largest trading partner for 72 countries around the globe and together this volume of trade makes up 40% of the global total, so the EU still possesses significant global clout in the service of its economic statecraft. But if trade agreements with the US are not on the table, the EU has to be able to deliver agreements with other partners across the globe; for instance Japan, Australia and India in the Asia-Pacific. But the way that the EU’s latest trade agreement- with the Latin American countries in Mercosur – is being held up by France and some other member states shows that the EU’s challenge will be to overcome protectionism within its own ranks as much as among its trade partners in the wider world.