Faced with the risk of losing investments in the technologies of the future, due to subsidies that its global competitors are pumping into their economies, the EU is forced to rethink its industrial policy.
The US and Europe risk entering into a subsidy war, each trying to support the competitiveness of their economies… their market economies… with public money. Meanwhile, member states expect from Brussels solutions that will allow them to remain relevant in a world where interventionism is the order of the day.
Marie Krpata (foto), Research Fellow at the French Institute for International Relations (IFRI), discussed the implications of these major shifts, as well as others, in the interview below.
This interview appeared in the 83rd issue of the magazine Chronicles Course of Governance.
Chronicles: Over the last couple of years, we have seen major events with huge implications in the way our economies will function. There was a lot of talk about rethinking supply chains, about friend-shoring, about reducing dependencies, increasing defense spending and so on. In your opinion, what are the main changes that will shape and impact European policies in the next three to five years?
M.K.: The economic situation is, of course, very important. Protectionism grew in the USA, as we saw with Donald Trump already, with the America First policy, with the trade war in 2018 between China and the US, that would also have consequences on the European Union, with tariffs on steel and aluminum and also threats against the German car industry, for instance. Protectionism is something that still applies with Joe Biden, that is still perpetuated with Joe Biden, because he talks about the foreign policy for the middle class. The goal is that globalization shouldn’t happen to the detriment of the US middle class.
The US-China rivalry is one about technological leadership in the future. America tries to avoid China becoming an equal partner. But in some domains, it is already a peer partner, if you look at artificial intelligence, facial recognition, 5G, for instance. There are also politics like restriction of market access and export control, which also have consequences on the European Union, on players such as the Dutch company ASML in the semiconductor industry. So I think that these are changes we have to bear in mind. And also, there are security concerns linked to that with the protection of critical infrastructure, with 5G, of course, playing a major role and the question of Huawei and cyber espionage and cyber criminality that is linked to that. These are very important things to bear in mind.
And then, of course, as you mentioned, the disruption of supply chains. We saw that with the COVID-19 crisis, which led to whole industries coming to a halt. This led to revenue losses. Logistic routes and transportation routes became very important. We saw the impact of the Suez Canal blockage, considering that trade between China and Germany happens mainly via the maritime route.
There is also the war in Ukraine, which led to sanctions imposed by the West. For Germany, this is a major shift in its economic model, it’s completely rethinking its economic model. And the credo ”change through transformation”, retrospectively, seems to have been naive. So the fact that interdependencies will reduce conflict and that interdependencies will create a good frame for peace, this seems to have been naive, because interdependencies also increase the dependencies of Germany toward its main suppliers and main export markets. And this may be used as a weapon. That’s what we currently see with regard to Russia and as far as energy is concerned.
But also Germany is currently looking at what this may mean for the long term relationship with China, another autocratic regime. The dependencies are not the same between Germany and China as they were between Germany and Russia. They are much more complex with China and both economies are much more entangled. This is also why Germany is currently working on a national security strategy, with a China strategy embedded. The whole idea is how to reduce dependencies of German companies from the Chinese market and also how to anticipate a conflict such as a violent conflict in Taiwan, which would oblige Germany to impose sanctions. What would then be the room for maneuver? What would then be the leverage Germany would have if China retaliated against those sanctions? This is currently something that Germany is working on.
The economic impact would be far greater than from the Russia conflict, which is also bigger than actually anticipated. I think the Russia fallout is quite big, given that it’s a very small economy compared to China, for instance.
Chronicles: From what it’s being discussed, debated, what are some of the economic policies the European Union must undertake to remain relevant, given this very accurate and complicated picture that you have painted regarding global risks?
M.K.: The fact that production happens in those places where production factors are available and this helps produce in an efficient way and scarcity is dealt with through trade – this is something that is put into question in this context of disruption of supply chains.
Industrial strategy becomes more and more important. And we can see that the most important trade partners of the European Union, China and the US have industrial strategies. So China with the Made in China 2025 strategy and the Dual Circulation strategy, the US with the Strategic Competition Act, with the 100-day supply chain review, but also with the Inflation Reduction Act. So these show that these major trade partners of the EU have their own industrial strategies. And the European Union is also working on its own. So France and Germany actually agreed to a manifesto of the industrial policy of the 21st century, which then led to an EU industrial strategy.
And I think there are three points that are important. First is an analysis of dependencies that was carried out to see on which third markets we are dependent for which goods. Second, there is a definition of ecosystem. So it’s a definition of the most important industrial sectors where the European Union wants to maintain its leadership or it wants to become a leader in cutting edge technologies and notably within the dual transformation, the green transformation and the digital transformation. And the third one, to complement that analysis, is trade defence mechanisms to protect the European Union against ill-intended practices from third countries and third country actors.
The IPI, the International Procurement Instrument, intends to create a level playing field, the same kind of market access, the same degree of facility to the access of a market in the EU and in third markets. Also, the FDI screening instrument is meant to protect critical infrastructure in Europe against ill-intended takeovers from third country actors. These are also anti-dumping measures, anti-subsidy measures. If you take the photovoltaic sector, the European Union was a leader in that domain, but because of dumping practices from China, it was outcompeted and this industry was depleted by China. So I think that these are major steps which the European Union is currently taking.
Chronicles: Do you think there is a problem within the EU. National leadership is very important and it’s quite difficult to reach an agreement between all 27 member states and thus decision making tends to lag behind. China, for instance, and the US, tend to move quicker than the EU. Do you think we have a leadership problem or?
M.K.: Well, I mean, the construct of the European Union is much more complex than in countries like China and the US, because we are 27 states. When you talk about industrial policy, if you talk about state aid, then there’s the question, well, where does the money come from? Who has to pay for it? It’s a very complex issue.
So does it really make sense that every industrial sector gets subsidies or is it only in case of market failure, when the market doesn’t provide the necessary setting for innovative technologies to flourish?
So we have to be clear on the ambitions of the European Union. Mariana Mazzucato (professor in the Economics of Innovation and Public Value at University College London and founding director of the UCL Institute for Innovation and Public Purpose) talks about this mission driven economy. So perhaps find missions which we more clearly communicate also and which make decisions easier for investors.
Because as you know, there’s also this debate about which energy is to be regarded as being green. The French said nuclear energy is green, the Germans said, well, gas is a transition energy, and we don’t seem to agree on that because every country has their own vision. And in energy, every country has their own strategies and it’s their own sovereignty.
And then if you take industrial policy, I think there are some states which do not welcome industrial policies the same way as France would. If you take the Netherlands, they have given birth to their own cutting edge technology actor, ASML, in the semiconductors industry. In Sweden, there’s Ericsson. And it wasn’t the states that gave a concept. So we have to find a right balance between state intervention and the intervention of companies, because eventually it’s them who know what technologies are going to be innovative. They need to have the means to stay innovative.
Member states could act as facilitators. The state provides an infrastructure and a regulatory and a legal setting for these companies to thrive. But this requires a change in mindset.
Chronicles: There is also a risk. Commissioner Margrethe Vestager has pointed out that within the EU, there are different means of achieving this. So, for instance, yes, Germany and France are able to offer a lot of state aid towards new technologies and new investment and so on. Smaller countries like Romania, who have little fiscal space, do not have the means to offer the same benefits. So there’s a fragmentation problem, a unity problem. Do you think this might encourage states to act alone, to find individual solutions?
M.K.: In the last year there was a mini crisis between France and Germany, where Emmanuel Macron said that Germany runs the risk of isolating itself within the European Union because it decided about these 200 billion euros, to help, you know, the households and companies to better cope with the rising energy prices, with energy insecurity, with inflation and the prospect of recession.
This is a very complex setting and the competitiveness of the European Union is at play. And so Macron criticized Germany, but at the same time, France also provided subsidies and provided aid and help to households and so on.
I think there is a centrality of Germany within the European Union because it’s the strongest economic performer. And if you look at the figures, 16 member states within the European Union have Germany as the main importer. So I think it’s really in the interest of everybody that Germany is performing well. And if it’s not performing well, nobody is going to perform well, especially because of the value chains within the European Union that are very intricate.
So if you take, for instance, the car industry, I know that Central and Eastern European countries are very much entangled with the German car industry. So if you take Hungary and Slovakia, for instance, and Romania as well, in the same position, a huge share of the experts is actually also linked to the car industry.
The scale at which we have to think is the European scale, because otherwise we are too small in a bigger US-China rivalry. A smaller state within the European Union does not have the same size and the same room for maneuver than the European Union.
And if you take the car industry, for instance, we are shifting from the thermic vehicle to the electric vehicle. This may create tensions within the European Union because you need one fourth less workforce for producing an electric vehicle. There needs to be European policies to cope with these challenges.
I think that France and Germany, given the geopolitical context, are currently very much criticized by Central and Eastern European countries with regard to their support to Ukraine, which some find too hesitant. And also for keeping up dialogue with Vladimir Putin, while they’re in a very critical and delicate situation with the return of war on the European continent, with threats of nuclear strikes.
Germany is in a very complicated situation. Central and Eastern European countries had warned it that Nord Stream 2 could be used as a weapon against it. Germany for a long time considered that this is just an economic and energy project that cannot be used as a geo-strategic asset or weapon.
So I think we are in a situation where both France and Germany also have to turn to Central and Eastern Europe and to include them in a constructive dialogue. There’s a problem with trust at this point, because especially this region seems to feel a bit betrayed by Germany and France looking after themselves and leaving them sort of behind and dependent on Russia.
And of course, also there’s the US playing a major role because. Today, nobody would say that NATO is obsolete. Nobody would say that NATO is brain dead anymore. The eastern flank of NATO is stronger. NATO has found its raison d’être, so it’s the reason for being, which is the defense of the alliance.
France for a long time has been defending strategic autonomy, which is seen as an autonomy in defense and as opposed to the US. But from a German perspective, strategic autonomy also includes the US. I think we are now in a moment where we cannot cope without the US from a security perspective. So we have to take that into consideration, too.
I think France is certainly marginalized with this concept of strategic autonomy. But at the same time, we have to bear in mind that Joe Biden is not there forever. So if somebody like Donald Trump comes back, we are not sure whether the US would support Europe in a conflict such as the one we are currently living in. It makes sense that the European Union develops its own defense capacities. But in complementarity, I think, with the US. And the US has already announced during Barack Obama that there is also an Asian pivot and that the US is going to pivot toward the Indo-Pacific. And of course, we have to understand that also within the global context of the China-US rivalry.
So the EU also needs to take more responsibility for the security of its own neighborhood. And that’s why Germany now invests in the military sector, 100 billion euros in the modernization of the army, and also by bringing defense spending to 2 percent of its GDP. So there is a will to take more responsibility and a responsibility
Chronicles: Coming back to this idea of reducing dependencies and building strategic partnerships, both the US and China have a big strategy regarding Africa, especially for their critical raw materials. Europe seems to be behind the curve here as well. Do you think it’s important to strengthen ties with African countries?
M.K.: I know there’s a problem regarding totalitarian regimes. Europe cannot endorse leadership in many of these countries that are vital for some of the materials.
There is the EU-US Trade and Technology Council where the US and the European Union work together to render supply chains more resilient and also to become more independent from those suppliers which are totalitarian regimes. And they try to find substitutes as well by doing research and development and developing substitutes for those materials that come from third countries which cannot be trusted the same way as the EU and US trust each other. So there’s this common dependence analysis that the US and EU do toward third countries.
But the EU is by no means the only partner of the US. The US also looks at other countries in the Indo-Pacific via the Quad format, for instance. And China has its own policy with the Belt and Road Initiative where it also builds infrastructure projects. And this is a means to build closer ties in terms of suppliers but also in terms of export markets.
And now, in Europe there is the question of bringing activities back to the European Union with the reshoring, but then there’s also near-shoring and then there’s diversification. France is very much in favour of reshoring activities and becoming stronger from an industrial perspective within the European Union. Germany is currently very much diversifying. So there’s this China plus one strategy where it tries to find other markets. If you read the media you can see how much Germany’s representatives were travelling around the world in the past year. So certainly they are looking at the Indo-Pacific. They are looking for critical material, for rare earths in the Indo-Pacific. Usual suspects would be Taiwan, Singapore, Australia, Japan. Then in Africa they would look at energy corporations, at cobalt. In Latin America they would look for lithium and copper in Chile. And also the Mercosur countries may be interesting for the German car industry and pharmaceutical industry. Central Asia is interesting for energy corporations and rare earths. And the Balkan countries also become much more important.
Chronicles: Given all the difficulties that the European industry has faced, how difficult is it to undergo this major green transformation? How difficult, how many years will it take for Europe to reinvent its industry, its car industry and other industries as well?
M.K.: The deadlines are pretty ambitious. This triggers a lot of concern. So in addition to inflation, prospect of recession, mounting energy prices, energy insecurity, inflation reduction acts, industrial policies, which render the regulatory framework more interesting in other countries, there are also the climate ambitions of the European Union.
The companies have the impression that it is a major burden. Currently there’s a tradeoff between energy security and climate ambitions. So are both compatible or is energy security now to be prioritized given the current geopolitical situation?
There are lots of question marks. I think it’s too difficult now to give a figure for when the European Union might overcome those troubles. I think there were lots of expectations regarding Franco-German relations in terms of how to bring things forward. How can Germany and France be a motor for the European Union?
Chronicles: At the end of January there was an important meeting regarding Franco-German cooperation.
M.K.: There doesn’t seem to be much convergence Yes, it was a lot of communication and protocol. But then if you look at the concrete outcomes, there is not much to be announced on that. And as you said, on the Inflation Reduction Act, there are expectations. How is the European Union going to respond? Are there going to be subsidies? There are different fiscal possibilities for the member states. I mean, even if you look at Germany, they have 70% of indebtedness, whereas France has 112%. So very different in terms of possibilities.
Is there a new common debt going to be created? Germany is rather reluctant to create new common debt. Germany said there are still untapped means available in the Next Generation EU Fund. So we should perhaps use them to develop renewable energy, to reduce dependency on Russia.
Ursula von der Leyen said there’s going to be a fund, perhaps a sovereign fund. So there are currently many, many ideas.
So where could we go? I think perhaps the easiest would be to try to put amendments in the Inflation Reduction Act. And that is something that was also suggested by Joe Biden when Emmanuel Macron went there at the end of last year to Washington to meet with him, that exemptions be negotiated for Europe, as is the case for Mexico and Canada, for instance. This also seems not that easy because amendments would have to be passed before the Congress. And, you know, the Inflation Reduction Act was very much precisely calculated. But this is perhaps the less harmful solution…
Chronicles: … then starting a subsidy war with the US
M.K.: Then starting a subsidy race with the USA… in a geopolitical context where we need the USA anyway to provide us with security on the European continent.
The situation is not easy. But I think for me, the key would be to include Central and Eastern Europe in the dialogue. And I think the war in Ukraine also showed that the neighborhood of the European Union is very important. So beyond Central and Eastern Europe, there’s also, of course, Ukraine and Moldova now, but also the Balkan countries.
We’ve been negotiating or talking with the Balkan countries for the last 20 years, and they have the impression that there is no perspective for membership. And, you know, the influence of other countries, third countries, grows in those countries, the influence of China, Russia, the United Arab Emirates, Turkey. This may be to the detriment of the European Union. So I think we should be able to provide solutions to them in terms of infrastructure projects and so on.
And that’s why I also think this initiative brought forward by Germany at the end of last year with the wind farm and so on, and the lithium mine are positive evolutions in that sense. And this would actually also respond to the ambition that France has, that the EU becomes more geopolitical. But at the same time, it would require that France take a more clear stance on its own position in Central and Eastern Europe and the Balkan countries, because it has been furthering integration before enlargement for a long time. And so this just frustrates countries like the Western Balkan ones.
Then I think there’s also a shift, a possible fragmentation between North and South Europe. I mean, this is nothing new, but it is linked to the fiscal room for maneuver that the countries have. If we are talking about dual transition, digital transition and green transition, then we need to provide funds. And if we need to provide funds, then if we want to get money from markets, then we also have to show that we master our books and we have balanced books.
But this may become very tense with Southern European states. And there’s also a memory that is very vivid of the austerity policies after the financial and banking crisis. And some countries do not understand why they should show solidarity with Germany now that it’s in a dire situation. But I think that France can play a bridging role between those countries and Germany if it wants to. And I think there are also points of convergence.
Chronicles: 2022 was deemed the year of the polycrisis. Do you think that in 2023 we will finally start to implement strategies meant for development and not just putting out the next fire and the one after that?
M.K.: I think that we have seen that France and Germany are able to play a driving role. When you look at the 750 billion euro Next Generation EU Fund, this is something that was a U-turn for German politics because they were against the common debt. So I think that changes are possible if we face challenges such as the one we are facing now.
We saw it also with the Zeitenwende, so the change of epoch or the turning point that Olaf Scholz pronounced in his speech before the Bundestag on the 27th of February. Germany is also able to show itself resilient and to adapt itself. If you look at the energy for instance, it has opened LNG terminals very quickly. It has concluded agreements with the Gulf states, with Norway to get alternatives to Russian fossil fuel. It has brought renewable energy from 40 percent in its energy mix to 48 percent.
So things happen very quickly if you show momentum and if you have political will. And I think that this is something that can happen. So we shouldn’t be too pessimistic, yet we should also be aware of the challenges we are facing.
We are facing challenges that Germany wouldn’t have expected after the Cold War. So this is really a watershed moment and we need to find a striving force to bring us to more positive horizons. I think solutions can only be found on the European level given the extent of the challenges we are facing.