The European Union’s economy faces two big strategic challenges: the break-up of a rules-based approach to trade and the threat posed by growing Chinese domination of trade in manufactured goods such as cars. In the face of these twin challenges, the EU is currently acting like a rabbit caught in the headlights, with no appropriate strategic response.
While the US has torn up the trade rule book and unleashed tariff mayhem, the EU’s hands are tied by the need to retain US support for Ukraine.
As I’ve argued, the best way for the EU to counter an unreliable US trade partner is to double down on free trade by concluding deals with Mercosur, Canada, India, Australia and southeast Asia. If the US wants to isolate itself from the world trade system, it is their choice. If the EU succeeds in establishing an alternative free trading world, at some future date a different US administration may choose to rejoin.
China’s superior technology and lower production costs currently pose a huge threat to key sectors of EU manufacturing. In the late 1980s, the EU (and US) faced a very similar challenge from Japanese industrial expansion, with major fears that Japan would come to dominate much of manufacturing, putting EU and US factories out of business.
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These concerns turned out to be exaggerated, partly because Japanese export success saw their currency double in value between 1985 and 1992. That dramatically raised the price of Japanese cars and computer memory chips for the rest of the world.
In the end, Japan took its place as a major global exporter of high quality manufactured goods, and the rising value of the Japanese yen resulted in a big improvement in Japanese standards of living. However, the outcome did not wipe out the related industries in the US and the EU.
If a similar mechanism were to operate today, it could dampen Chinese progress towards domination of world manufacturing. If the Chinese currency appreciated, Chinese cars and other goods would become more expensive in their export markets, which would leave space for competitive EU production.
China would continue to be a major force, but would not completely wipe out manufacturing elsewhere.
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However, for geopolitical reasons, China is not allowing such economic forces to play out. By keeping their exchange rate low, China can put serious pressure on the rest of the developed world.
China also holds a near monopoly in refined rare earths needed by modern industry elsewhere, enabling it to undermine production in competitors such as the EU’s electric vehicle industry.
The artificially low exchange rate results in a lower standard of living for Chinese consumers, but that’s a price their government is willing to pay to establish a dominant economic position.
While Ireland’s car assembly industry has long since vanished, the automotive sector is of major importance in EU countries such as Germany and France. Because EU companies were exceptionally slow to develop electric vehicle manufacturing at scale, these companies are now at a huge disadvantage on the world market. They are rapidly losing market share on international markets because they are not competitive in price.
The EU response to this threat shows signs of panic.
Earlier this month, the EU proposed a buy-EU policy, restricting imports of goods and services. Because of the very high level of integration of EU supply chains into the rest of the world economy, this would make no sense, and has been withdrawn.
With their complex supply chains, firms in the German car industry were strong objectors to this policy.
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The EU is also seeking to protect the EU car industry through tariffs on Chinese imports. If the yuan is undervalued, this may be appropriate in the short term. However, it is not a permanent solution.
The latest EU proposal is to ease the ban on sales of fossil fuel cars after 2035. This is a potentially disastrous policy for EU car manufacturing. It suggests that continuing to concentrate on producing out-of-date products is the solution.
If EU car manufacturers are to continue selling to the outside world, they need to reach the forefront of the technology frontier by 2035, making and selling electric vehicles. To survive, European car manufacturers need to dramatically shift gear to catch up on superior Chinese technology and production methods.
As it was with China, greatly expanded investment in research by the EU will be key to developing new technologies, new methods of production and new manufacturing sectors. Europe needs a strategy to innovate at scale to remain successful in today’s challenging economic environment.
