Caught in the Crossfire: How the EU can navigate the US-China trade dispute

In this post, Edward Knudsen argues that the trade – and now currency – dispute between the United States and China leaves the European Union with only one good option: take the economic measures necessary to insulate itself from these two clashing great powers.

An unresolved dispute

On 11 October, US President Donald Trump and Chinese Vice Premier Liu He announced that they had concluded a ‘handshake agreement’ on trade, offering a respite from the eighteen-month trade conflict between the two countries. The White House advertised the deal – which delays US tariff increases in exchange for Chinese purchases of $40-50 billion worth of US agricultural goods – as ‘phase one’ in pursuit of a larger agreement.

Although global markets initially greeted the news with enthusiasm, critics were quick to note the deal was unofficial and left many issues unresolved. Earlier news of an impending agreement had similarly boosted markets, only for the deals to fall away. Additionally, this deal did not settle many outstanding areas of disagreement. Scott Kennedy, an expert in US-China relations at the Center for Strategic and International Studies (CSIS), remarked, “I’m skeptical that there is anything that could be objectively called a deal”. Substantial issues, such as the currency dispute and the US’ treatment of Huawei, were not dealt with.

Furthermore, regardless of the outcome of the 11 October declaration, the unpredictability of White House trade policy hardly precludes a further escalation of trade tensions. Following the agreement, US Treasury Secretary Stephen Mnuchin was clear in stating that further tariff increases in December were still under consideration.

While the prospect of a deal between the US and China may have calmed some nerves in Brussels, the ongoing uncertainty leaves Europe with a clear choice. To protect itself from the spillovers of the US-China trade conflict, as well the lingering threat of US tariffs on European auto imports, Europe must ensure it has sufficient domestic demand to weather the uncertainty of the increasingly turbulent global economy. Only a strong European economy and sufficient investment can truly insulate the EU from the capricious trade policy emanating from Washington.

Europe gets drawn in

From the United States Trade Representative’s (USTR) imposition of tariffs worth $50 billion in April 2018, the US-China trade war has intensified steadily. As Mark Hallerberg and Diego Salazar Morales argue in a recent Dahrendorf Working Paper, “President Donald Trump has led US trade policy to a novel, unilateral stance, and taken a harsh line with China.” This aggressive policy now has resulted in US tariffs on $550 billion worth of Chinese products, Chinese tariffs of $185 billion worth of US goods, and the US’ decision to label China a ‘currency manipulator.’

In a narrow sense, increased tariffs on trade between the US and China should actually benefit Europe. As it becomes costlier to trade between the two superpowers, the diversion of trade should result in increased demand for European products. The United Nations estimates that EU companies could export an additional $70 billion due to the trade conflict – $50 billion in exports to China and $20 billion exports to the US.

Europe’s worries, however, go well beyond the the immediate economic effects of tariffs. A key concern is that the overall negative effect that the trade clash has on the world economy could drag Europe down with it. The International Monetary Fund (IMF) recently estimated that the US-China trade war may cost the world economy $700 billion by 2020. As growth slows overall, the EU’s export-led economy is almost sure to suffer.

Furthermore, the European Union, a strong proponent of the ‘rules-based’ multilateral trading system, had been deeply alarmed about the consequences of tit-for-tat tariffs that have been handled outside of the World Trade Organisation (WTO). Europe is fearful that the rise of unilateral protectionism will undermine this system. In an interview with Der Spiegel, European Trade Commissioner Cecilia Malmström stated that “with regard to China, we see many things in the same way as the US does” but that Europeans “expressly do not share” Washington’s strategy.

In addition to the fraying of the international trade order, the recent devaluation of the yuan – a direct result of the US-China trade dispute – threatens Europe’s competitiveness. As Shahim Vallee of the German Council on Foreign Relations (DGAP) argues, “the effective devaluation of the Yuan…would provoke a realignment of global exchange rates, with substantial appreciation of the Euro”. Such a rise in the value of the euro would harm the competitiveness of European products on the world market, harming already-low Eurozone growth.

How the EU can respond

Although Europe has attempted to mediate the trade conflict, its efforts to talk down Trump from disruptive policy decisions have fared poorly. A protectionist and confrontational United States may be the new normal, and Europe must prepare for it.

As things now stand, Europe is in a weak position on multiple fronts. Its trade surplus leaves it vulnerable to economic and political changes outside its borders. The signs of an impending recession in Germany is evidence of its vulnerability. While the world-leading German trade surplus may be seen as a sign of national strength among business and governmental leaders in Frankfurt and Berlin, in reality it is a dire economic and political liability.

Low demand and investment across the Eurozone have continued to plague economic growth. Economic expansion has hovered at just above one percent, despite ongoing efforts from the European Central Bank to stimulate growth. The European Commission has urged national finance ministers to boost spending, arguing that “the slowing growth and the downside risks inherent to the current situation may call for a pre-emptive, rather than reactive, approach to fiscal policy”.

Greater spending also protects the EU from opportunistic powers seeking to gain influence on its periphery. Following years of punishing austerity imposed from Frankfurt and Berlin, Greece accepted substantial Chinese investment, notably in the port of Piraeus. Unsurprisingly, this earned China a degree of leverage of the Aegean country. In a recent vote, Greece blocked an EU declaration condemning human rights violations in China. Hungary, another large recipient of Chinese investment, has done the same on several other occasions.

These examples serve as reminders that European foreign policy can only be as strong as its weakest members. According to Jennifer Lind of Chatham House, “Beijing seeks to prevent the EU from speaking with a unified voice on and with China” by using ‘wedge strategies’. It must ensure that peripheral countries are not left behind—and that they are protected from foreign opportunism.

Considering the degree of unpredictability in the international trading system, the slowing global economy, and an increasingly competitive geopolitical space, it is clear that Europe desperately needs improved fiscal coordination to boost investment and economic growth. While the EU should surely take the necessary diplomatic and foreign economic measures to mitigate the effects of the trade and currency wars, its best solution lies within its own borders.

The opinions expressed in this blog contribution are entirely those of the author and do not represent the positions of the Dahrendorf Forum or its hosts Hertie School and London School of Economics or its funder Stiftung Mercator.