Europe’s Geoeconomic Revolution By Matthias Matthijs

Europe’s Geoeconomic Revolution By Matthias Matthijs

The European Union once preached a tripartite gospel: monetary orthodoxy, fiscal austerity, and free-flowing trade and investment, with multilateral institutions watching and guiding from above. That was before its faith in the survival of the liberal economic order was shaken by Chinese mercantilism and, to a lesser extent, by the trade wars of U.S. President Donald Trump. In recent years, and with increasing zeal over the course of the pandemic and the war in Ukraine, the bloc has undergone nothing short of a conversion. Like much of the rest of the world, EU policymakers and politicians now pray at the altar of geoeconomics. They have rediscovered the economy as a battleground for geopolitical competition—and industrial policy as a weapon for states to wield against one another. In the process, European leaders have abandoned, in part or in whole, the economic and ideological principles they once held sacred.

The EU’s executive body, the European Commission, has been central to this reformation. When its president, Ursula von der Leyen, took office in 2019 and announced that hers would be a “geopolitical” commission, reactions in Beijing, London, and Washington ranged from polite skepticism to quiet snickering. National security was by definition a national matter, and the EU simply was not in the business of geopolitics, certainly not when it came to wielding economic tools for political purposes.

Four years on, von der Leyen has transformed her Brussels shop from a bureaucratic secretariat implementing the will of European national leaders into a major macroeconomic and geoeconomic actor in its own right. As a result, the bloc is today more cohesive and better prepared to navigate growing geopolitical rivalries. Von der Leyen is a frequent visitor at the White House, in contrast to many of her predecessors. She is now widely seen as the answer to Henry Kissinger’s famous question, “Who do I call when I want to call Europe?”

Several conditions and crises combined to make this transformation possible under the unlikely leadership of the historically archliberal technocrats in Brussels. There was the impact of the pandemic, which saw the European Commission emerge as the guardian of European solidarity after EU leaders agreed to set up a large-scale macroeconomic recovery and resilience instrument to accelerate Europe’s long-overdue break with austerity. There was also a growing belief that the EU needed better answers to counter unfair competition and aggressive pressure tactics from China and the United States. These shifts coincided with rapid technological advances in clean energy, big data, and artificial intelligence, which the EU now seeks to harness through industrial policy—in concert with the rest of the world or, if necessary, against it.

Anyone who has taken a college course on European politics knows that EU bureaucrats do not typically think of the economy as being downstream from geopolitical competition. To do so would run counter to the bloc’s history and unique institutional structure, which have instilled in European leaders a lasting belief in the benefits of economic interdependence and strict rules—including steadfast fiscal and monetary orthodoxy—to prevent unfair competition. The same precepts anchor the modern EU’s crowning achievements: the single market and the euro. One is based on the free trade of goods and services, the unrestricted flows of capital and people, and fair competition; the other is based on a joint commitment to price stability and a belief in fiscal discipline. Both ensure that Europe will thrive 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 flows of capital.

To be sure, the EU (or European Economic Community, as it was formerly known) started as a political peace project intended to forever prevent another Franco-German war. But its method of choice was invariably regional economic integration. Interdependence, the thinking went, would yield prosperity and act as a pacifying force. Giving up national sovereignty in economic and trade affairs was therefore a winning game that would leave everyone better off. The resulting changes were unprecedented. Nowhere else had nation-states ever relinquished as much control over their economies to a supranational institution as they had in Europe.

EU policymakers and politicians now pray at the altar of geoeconomics.
In the process, European leaders turned the continent into a bastion of market liberalism and deregulation. With the passage of the 1987 Single European Act—an imperfect compromise between the socialist French President François Mitterrand, who wanted stronger EU institutions, and the conservative British Prime Minister Margaret Thatcher, who touted the virtues of freer markets—European policymakers radically eased trade restrictions, prohibited state subsidies, and opened public procurement tenders to competition from across the bloc. To build a genuine single market, member states either adopted joint product standards or agreed to recognize each other’s national regulations. To preclude gridlock, moreover, almost all guidelines and regulations relating to the single market would be approved through qualified majority voting among member states rather than the unanimity required for decisions in most other domains, such as taxes or foreign and security policy.

A road map to the euro was finalized in 1992. At Germany’s insistence, the new currency was orthodox and austere in design. It would come with an independent central bank whose sole mandate would be to keep inflation below but close to the two percent mark. There would be a strict “no bailout” rule. Eurozone members were expected to maintain low public deficits and declining sovereign debt-to-GDP ratios. These stipulations were often ignored in the early years of the euro. But the rules were tightened, once again at Germany’s urging, after the Eurozone crisis in 2010–12, when European leaders were forced to come up with emergency bailout packages to prevent several member states from defaulting on their debts. It was now practically illegal for member states to adopt activist fiscal policies that could stimulate domestic demand.

Research by the Oregon State University political scientist Alison Johnston and one of us (Matthijs) has shown that these rules were an uneven bargain—ideal for the export economies of Germany and several small northern countries but a disaster for almost everybody else in the eurozone. The problem was that the euro had taken away the traditional mechanisms with which states absorbed economic shocks at the national level, including currency devaluation and demand-side fiscal stimulus, without replacing them with new mechanisms at the European level. The default response to any crisis was therefore austerity (usually through tax increases and cuts to public spending) or internal devaluation (through public- and private-sector wage restraint). Yet Berlin remained firm, insisting that fiscal discipline and the lack of commonly issued debt at the EU level reduced moral hazard—that is, the risk that certain member states would live beyond their budgetary means.

The eurozone’s fiscal straitjacket was loosened somewhat under Jean-Claude Juncker, who served as president of the European Commission from 2014 to 2019 and favored a more flexible interpretation of the rules. He was joined in this effort by Mario Draghi, then the president of the European Central Bank (ECB), who in 2015 embarked on a program of quantitative easing. But it took a devastating pandemic for the EU to fully turn its back on austerity and monetary orthodoxy.

In a cruel twist of fate, the first member states to feel the full force of COVID-19 were Italy and, soon thereafter, Spain—the two economies, besides Greece, that had struggled the most during the sovereign debt crisis. As casualties rose and a local quarantine in the northern Italian region of Lombardy turned into a nationwide lockdown, the EU initially struggled to come up with a reasonable collective response. The first reaction of most member states in March 2020 was to close their borders, despite calls from the European Commission not to do so. The ECB, too, fumbled its early reaction to the pandemic. Christine Lagarde, the ECB president and a lawyer by training, stated that it was not the bank’s role to close the spreads in yield between German and Italian bonds. Her words predictably sent financial markets into a tailspin.

By mid-April 2020, however, the contours of a more coordinated strategy were emerging. European Union states still set their own public health policies, but they agreed to cooperate closely in managing international travel and supply chains. The commission, at the same time, negotiated with vaccine manufacturers on member states’ behalf. The ECB recovered from its earlier misstep and began fighting the pandemic’s economic fallout with overwhelming monetary firepower. On the fiscal front, meanwhile, the idea of a more activist EU-wide approach gained traction. In May, German Chancellor Angela Merkel and French President Emmanuel Macron announced a set of proposals for the EU’s long-term economic response to the pandemic. Among them was a 500 billion euro (about $550 billion) COVID recovery fund, which would be financed through bonds issued jointly at the EU level. This was a first, since Germany had always been strongly opposed to issuing EU-wide, rather than country-level, bonds. (Merkel had vowed back in 2012 that Europe would not share debt liability: “Eurobonds? Not as long as I live!”)

At a high-level EU-Chinese economic dialogue, Beijing, June 2018
Jason Lee / Reuters
Some observers hailed the eurobonds proposal as a historic “Hamiltonian moment” for the EU, in reference to Alexander Hamilton, the eighteenth-century U.S. secretary of the treasury, under whose tenure the federal government assumed the wartime debts of individual U.S. states. In truth, however, the transformative power of the Franco-German foray lay elsewhere: in the more proactive role that Macron and Merkel envisioned the EU could take whenever economics and geopolitics shaded into each other. The French and German leaders called on the EU to conceive a joint health strategy, speed up digitalization and the green energy transition, and adopt a more deliberate industrial policy. This level of interventionism, much like the eurobonds, was something Germany had long balked at. It was less a Hamiltonian moment than a throwback to the dirigisme of former French President Charles de Gaulle.

The European Commission took up Macron and Merkel’s ideas by designing a massive stimulus plan, with 500 billion euros in grants and another 250 billion euros in loans. Roughly two-thirds of the money would aid individual member states’ economic recovery from the pandemic. The rest would flow into an EU fund for environmental and digital policies and into a broad array of existing EU economic and social programs. Few expected such an ambitious plan to pass muster with EU national leaders, who would need to sign off on it. But to everyone’s surprise, leaders in the European Council agreed on a final package—christened “Next Generation EU”—totaling more than 800 billion euros, roughly half of which would consist of grants raised from jointly issued debt.

The stimulus package secured the commission’s position as the EU’s central guarantor of economic solidarity and social cohesion, not least because the lion’s share of the grants would go to the poorest member states in Europe’s south and east. It marked what appears to be a lasting break with fiscal austerity. (Just this April, the commission proposed more flexible fiscal rules, which would give national governments more leeway to reduce budget deficits and sovereign debt at their own pace). And just as Next Generation EU has already done, the commission’s newfound flexibility in fiscal policy could allow Europe to put real money behind its ambition to remain a heavyweight in a more competitive global economy.

The global COVID-19 pandemic overlapped with a second, separate awakening that accelerated the EU’s geoeconomic turn: the sobering realization by European leaders that they were living in a meaner and harsher world than in prior decades. In the face of an assertive China, a revanchist Russia, and, until early 2021, a confrontational United States under Trump, the EU initially hoped to hold down the fort of the liberal international economic order. That attitude revealed a certain naiveté, and it started to cost the union, as both China and the United States—no longer even pretending to play by the rules—championed their domestic industries and ate away at Europe’s market share.

Once the realization hit, however, the bloc swiftly changed tack. Kantian idealism was out; Hobbesian realism was back in. The European Commission declared a new doctrine of “open strategic autonomy,” which has found expression in a series of new unilateral measures meant to equip the bloc for a global economy headed not for growing openness and cooperation but for closure and zero-sum competition. Most of these new instruments are defensive in nature: they seek, for instance, to secure the bloc’s supply of critical raw materials and access to essential technology or to guarantee that the carbon price of imports is equivalent to the one EU producers must pay. Others are more offensive: they include retaliatory measures against states that refuse to act reciprocally or counter efforts by other countries to coerce EU members into adopting foreign policies that conflict with EU values such as democracy or the rule of law.

As early as 2017, Juncker told the European Parliament that the EU was not a bunch of “naive free traders” and that it “must always defend its strategic interests.” At the time, Juncker was laying the groundwork for the European Commission’s new and innovative mechanism for investment screening, which went live in 2020. This tool now helps EU governments review foreign direct investment by states outside the union. Its goal is to better identify and block investments that could undermine a member state’s national security, much as the Committee on Foreign Investment in the United States seeks to protect the country from the predations of outside investors on security grounds—although in the EU, national governments retain the ultimate say over which transactions to approve.

Von der Leyen in Brussels, July 2023
Johanna Geron / Reuters
In the first two years after the investment screening framework was introduced, EU officials reportedly examined more than 600 inbound investments, most of them, in order of importance, from the United States, the United Kingdom, China, the Cayman Islands, Canada, and the United Arab Emirates. The EU’s prioritization of this issue highlights a broader shift—also evident in a dataset compiled by one of us (Meunier) and the Indiana University political economist Sarah Bauerle Danzman—toward greater investment scrutiny on national security grounds across industrialized democracies in recent years. Lately, EU officials have discussed the possibility of screening outbound investments, too, which would give member governments a say in European firms’ investment strategies abroad, especially in critical sectors such as advanced semiconductors, quantum computing, and artificial intelligence.

Some of the additional tools introduced since 2020 close long-standing regulatory gaps between Europe and the rest of the world. For instance, the EU has long enforced a level playing field in its single market when it comes to government procurement but has never had similar legislation for non-EU members. Last year’s International Procurement Instrument, which had been stuck in development hell for a full decade, finally closed this gap. Going forward, the European Commission will determine if non-EU countries grant EU-based companies fair access to compete for public works contracts. If a given country fails this test, the EU will retaliate in kind: when a company from the offending country makes a bid for the EU’s own public procurement tenders, it will suffer an automatic price penalty or may be excluded from bidding altogether. Last year also saw the adoption of the Foreign Subsidies Regulation, which enables the EU to prevent market distortions caused by subsidies given to foreign firms that then compete with EU firms on takeover bids (in the EU or abroad) or for public procurement.

In addition to taking these long-delayed steps, the EU is also reacting to newer challenges, such as the growing weaponization of economic interdependence. Among its more original measures is a new anti-coercion instrument, which the commission expects to enter into force in the fall. It allows the EU to retaliate against countries that use economic pressure tactics to interfere in national political matters, as the Trump administration did when it threatened to impose import tariffs on French wine if France went ahead with plans for a digital tax on U.S. technology giants or as China did when it imposed a de facto import ban on Lithuania after it allowed Taiwan to open a Taiwanese Representative Office in its capital, Vilnius. In the future, the EU could punish such behavior by imposing tariffs and quotas, withholding exports, excluding foreign companies from public procurement, and restricting access to European capital.

Some of this new geopolitical equipment is simply a belated response to the bullying tactics of the previous U.S. administration (and preparation for a possible future U.S. administration with similar policies). Yet most of it is meant to overcome economic challenges from China and Russia. This, at least, seems to be the message behind Brussels’s first-ever economic security strategy, unveiled in June. In it, EU leaders make the usual references to multilateral cooperation and the rules-based international order, but it is obvious from a close reading of the text that in their search for partners, they will first and foremost look to like-minded countries such as India, Japan, and the United States. Accordingly, the strategy emphasizes bilateral and “plurilateral” cooperation of varying formats and degrees of institutionalization, from the G-7 to high-level economic talks, investment partnerships, and raw materials clubs. There is no reference to China. The EU has indeed come a long way from presenting itself as a guardian of the multilateral liberal order.

Russia’s unprovoked invasion of Ukraine has undoubtedly further focused the minds of the leaders in Brussels. Over the course of successive sanctions packages, the EU has banned or phased out Russian oil and gas imports; frozen Russian assets, including the reserve holdings of Russia’s central bank; and imposed export controls on dual-use goods and technologies. It has committed more than five billion euros in military assistance to Ukraine, often in the form of reimbursements for member states that ship weapons to Kyiv. In 2022, it provided or pledged nearly 12 billion euros in nonmilitary aid; that number is closer to 18 billion euros for 2023, with another 50 billion euros pledged through 2027. Russian aggression has even breathed new life into EU enlargement, with Ukraine and Moldova now on the official list of EU membership applicants. Evidently, the “pause” to EU enlargement that Juncker declared in 2014 is over.

But the path to strategic autonomy is not without pitfalls or difficulties. For one thing, serious disagreements and tensions remain, both among and within member states. The only way Merkel felt she could sell her German constituents on the EU’s 2020 stimulus package and the jointly issued debt it entailed, for instance, was by emphasizing that it was a one-off gesture of solidarity occasioned by a once-in-a-century pandemic—and that was the easy part. It will be much more difficult for the EU to raise its own revenue through EU-wide taxation to pay down its debt. Some member states, including Italy, have not been able to spend all the money they were allocated in a timely fashion, mostly for national bureaucratic reasons. Others, such as Hungary and Poland, have not met the criteria for receiving the funds in the first place. And even though Germany seems to be losing the argument over the future of the bloc’s stringent one-size-fits-all budgetary rules, the risk of a Euroskeptic popular backlash in northern Europe is never far away.

Second, opinions diverge on industrial policy. Even inside the European Commission, the officials in charge of the relevant portfolios, Thierry Breton and Margrethe Vestager, do not see eye to eye. Breton, the commissioner for the single market, fears that U.S. and Chinese subsidies—such as those for their respective electric car industries—will leave Europe far behind unless it adopts similar strategies and will cause serious damage if the cold war between the United States and China ever turns hot. Vestager, the commissioner for competition, fears that too much largesse in public aid for high-tech sectors will exacerbate cleavages between the bloc’s rich and poor economies. (Her fears are not unfounded: since 2020, France and Germany together have disbursed more than 75 percent of all state aid spent across the EU.) And since industrial policy has traditionally been the preserve of national governments, it is not clear whether the EU can be as quick and nimble as the United States or as unflinching and thorough as China.

Millions of good European jobs depend on access to the Chinese market.
Third, weaning the European economy off Russian fossil fuels is one thing; “de-risking” its economic links to China (the European Commission’s preferred term for “decoupling”) is quite another, even if it is done only in small pieces. The clash between interests and values is much more uncomfortable in the case of China; the market integration involved is of a completely different order of magnitude. Millions of good European jobs depend on access to the Chinese market. France, Germany, and Italy rely heavily on China for their growth. So does much of central and eastern Europe, which has welcomed closer business and investment ties to China as part of Beijing’s “17+1” initiative, even though many of the participating countries have soured on the forum, especially after all three Baltic countries withdrew their membership, resulting in the initiative being renamed “14+1.” And Beijing has plenty of ammunition to fight back. Starting in August, it will restrict exports of gallium and germanium, two chemical elements that are essential for semiconductor manufacturing, and there is every reason to believe that this is just the beginning. If the EU deploys its full geoeconomic arsenal against China, will European officials be ready for the economic and financial consequences? Von der Leyen may be eager to coordinate her China policy closely with the United States, but many other European leaders are less than enthusiastic.

The last and most important unresolved question is whether the EU can achieve anything akin to sovereignty or strategic autonomy without being a credible military power. One of the ironies of the Russian invasion of Ukraine is that it exposed Europe’s continued reliance on the United States for its defense. And yet, with the occasional exception of Macron, European leaders have shown little excitement for a proper EU defense pillar within NATO, let alone full EU strategic autonomy in security affairs. This impasse is unlikely to be resolved until the war in Ukraine ends in some sort of peaceful settlement—unless Trump returns to the White House in January 2025, in which case, all bets are off.

These uncertainties do not lessen the transformation underway. A quiet revolution with major consequences for transatlantic relations and international economic affairs has taken place in recent years. Its success still hangs in the balance. But the EU has already proved capable of innovating and reinventing itself in a volatile world.

Europe’s Geoeconomic Revolution By Matthias Matthijs


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