of
Europe

How Economic Dependence Could Undermine Europe’s Foreign Policy Coherence

January 26, 2016
by
Hans Kundnani
22 min read
  • For nearly all EU member states, trade with other member states is decreasing as a share of total trade. Intra-EU exports have declined as a share of the EU’s overall exports from 68 percent in 2000 to 63 percent in 2014. This shift away from intra-EU trade raises difficult questions about the future of European integration.
  • EU member states are becoming more dependent on trade with, and investment from, non-Western powers for growth – a development that is being strengthened by the response to the eurozone crisis. The Eurozone “core” will increasingly rely on non-Western powers as export markets, while the eurozone “periphery” will likely increasingly rely on them as sources of investment.
  • This increasing dependence gives non-Western powers – especially China – leverage that can be used to prevent EU member states from taking tough positions or agreeing common positions with each other or with the United States.
  • In order to prevent Europe’s economic dependence on non-Western powers from undermining its incremental progress in developing institutions and “strategies,” Europeans need to go further in making linkages between economic and foreign policy. In particular, they must find ways better to deal with situations like the one created by Greek Prime Minister Alexis Tsipras’s threat to undermine EU sanctions against Russia last year.

Introduction

During the last year, Europe’s internal crisis triggered by the euro crisis five years ago and its external crisis triggered by the Russian annexation of Crimea in 2014 have become dramatically linked. Immediately after becoming Greek prime minister in January 2015, Alexis Tsipras received the Russian ambassador and declared that he opposed EU sanctions against Russia. The overture to Moscow was widely seen as a way for Greece to increase its leverage in negotiations with its eurozone partners and the International Monetary Fund, which were reaching a critical stage. As speculation about a Greek default increased in April, Tsipras visited Russian President Vladimir Putin in Moscow. They subsequently signed a preliminary agreement to cooperate on a gas pipeline under which, according to news reports, Greece would receive an advance payment of €5 billion.

In the end, a deal was reached between Greece and its eurozone partners that prevented a default and allowed Greece to remain in the single currency, though it is unlikely to do much to solve Greece’s deeper economic problems. Thus Greece may remain supportive of European policy toward Russia, as it did when the EU agreed to extend sanctions for another six months in February — despite the initial rhetoric by Tsipras and other ministers. But although fears about Greece undermining EU Russia policy have not (yet) materialized, the threat illustrates that European policymakers need to think in more joined-up terms. In particular, unless they take into account the foreign policy consequences of economic policy decisions, Europe will continue to find its coherence undermined by non-Western powers.

Since the euro crisis began in Greece in 2010, policymakers and experts have tended to see economic policy and foreign policy as two quite separate and disconnected areas of policy. Policymakers and experts seem to have been split into two communities: on one hand those who have focused on the euro crisis and the economic and institutional questions it raised, and other the other those who have focused on Europe’s external challenges. Most eurozone economists have tended to ignore the consequences of measures to save the single currency for Europe’s external relations. Meanwhile foreign policymakers and experts have tended to engage with the euro crisis only in terms of the way it has diverted attention away from external problems, squeezed defense and development aid budgets, and undermined European soft power.

This brief argues that the EU increasingly needs to go further in connecting economic and foreign policy because Tsipras’s flirtation with Russia was not a one-off. It will instead argue that the situation of an EU member state seeking external help — or coming under external pressure to undermine an European policy — is likely to recur in the future. EU member states are becoming more dependent on trade with, and investment from, non-Western powers for growth, a long-term development that is being exacerbated by the eurozone’s response to the crisis. In the future, non-Western powers are likely to have increasing leverage over EU member states, and this has the potential to undermine whatever slow, incremental progress Europeans are making in developing common foreign policy institutions and “strategies.”

The Shift Away from Intra-EU Trade

Long-term changes in the structure of global trade are transforming the economic basis of the EU’s external relations. In particular, for nearly all EU member states, trade with other member states is decreasing as a share of total trade. As Figure 1 shows, intra-EU exports have declined as a share of the EU’s overall exports from 68 percent in 2000 to 63 percent in 2014. Some Western and Central European economies, particularly those clustered around Germany, continue to trade overwhelmingly with other EU member states (though the exports of Germany itself to the rest of the EU now make up only 58 percent of its total exports). But for three member states — Greece, Malta, and the United Kingdom — intra-EU exports are now less than 50 percent of overall exports. The drop in intra-EU exports was particularly precipitous in the case of the U.K.: it fell from 59 percent in 2000 to 48 percent in 2014.

Figure 1: Intra-EU exports as a share of EU member states’ total exports, 2000-2014 

Source: Eurostat. EU27 excludes Croatia due to trade data unavailability.

This shift away from intra-EU trade raises difficult questions about the future of European integration. Although it does not mean that further integration will not take place, it will mean that, for the first time, it must go against the flow of developments in global trade rather than with it. From the creation of the European Coal and Steel Community in the 1950s, steps in political integration took place against the background of a growth in trade between European countries. This is particularly clear in the case of the United Kingdom, which originally remained aloof from European integration but became more receptive to it from the 1960s onwards, when trade with the Commonwealth declined as a proportion of total trade and trade with European countries increased.[1] (Conversely, Euroskeptics point to the decline in intra-EU trade as a share of total trade as an argument against British membership of the EU.)

This shift away from intra-EU trade raises difficult questions about the future of European integration. 

Above all, the long-term reduction in the share of intra-EU trade as a share of total trade could be a problem for the countries that are members of the European single currency, whose creation now appears to have coincided with the beginning of a period of trade diversion to the rest of the world. The crisis has put the eurozone under more pressure than ever before to integrate further and “complete” Economic and Monetary Union (EMU).[2] But this integration must for the first time in the EU’s history take place at a time at which trade flows are putting pressure in the opposite direction, toward disintegration rather than integration. Jim O’Neill and Alessio Terzi argue that these “gargantuan changing patterns of wealth creation” mean that the economic benefits of EMU are becoming less clear-cut and decreasing over time.[3]

It is often pointed out that the founders of the single currency did not initially see what became the eurozone as an optimal currency area (OCA) of the kind outlined by the economist Robert Mundell in the 1960s.[4] Rather, the founders of the single currency hoped and believed it would become more like an OCA over time — in particular, by producing convergence between eurozone economies and forcing further political steps to “optimize” the single currency area. Capital has become more mobile since the creation of the single currency, though this did not produce the desired convergence between eurozone economies. But as intra-EU trade decreases as a share of the EU’s total trade, eurozone countries are now being pulled away from each other in a way the creators of the single currency did not anticipate. “When EMU was created, it was highly unlikely that 21 years later, many would have envisaged a world in which China, not France, would be Germany’s number one trade partner,” write O’Neill and Terzi.[5]

The Strategic Consequences of the Eurocrisis

Prolonged and coordinated austerity and the constitutional limits on public debt...leave no alternative to externally fueled growth.

The data in Figure 1 on intra-EU trade as a proportion of overall trade since 2000 suggest that, even before the euro crisis revealed that the single currency had produced divergence rather than convergence, a structural shift may have already been putting long-term disintegrative pressure on the EU, in particular on the eurozone. But the way the eurozone countries decided to respond to the crisis is also exacerbating this trend of increasing economic dependence on non-Western powers. In particular, prolonged and coordinated austerity and the constitutional limits on public debt to which eurozone countries have agreed limit the potential for Europe to generate growth internally and thus leave no alternative to externally fueled growth. This has already transformed the relations of individual EU member states with non-Western powers, in particular China.

Led by Germany, the eurozone sought to solve the crisis through asymmetric adjustment in pursuit of a “competitive” Europe. In order to do this, it used tough conditionality to impose austerity and structural reform on deficit countries. The eurozone also introduced new fiscal rules based on German preferences: in 2011, eurozone countries (and some other EU member states) also agreed to incorporate into their constitutions a version of the Schuldenbremse, or debt brake, that Germany introduced in 2009. Meanwhile countries with a surplus came under little pressure, for example through the European Commission’s Macroeconomic Imbalance Procedure, to rebalance. In particular, Germany has refused to significantly stimulate domestic demand, despite being urged to do so by the International Monetary Fund. Meanwhile the European Central Bank has kept inflation well below its 2 percent target.

This approach has made EU member states more dependent on economies outside the EU in different ways. The surplus countries are increasingly dependent on external sources of demand. Over the last decade, for example, the German economy has become much more export-dependent: the contribution of exports to GDP went from 33 percent in 2000 to 48 percent in 2010.[6] Even before the crisis began, German exporters were already focusing increasingly on markets beyond Europe: between 2000 and 2010, exports to other EU member states as a proportion of total exports declined from 65 percent to 60 percent.[7] But the collapse in demand from within Europe since then seems to be exacerbating this trend toward demand from beyond Europe.[8] By 2020, O’Neill and Terzi argue, China will probably be Germany’s number one export market — though, of course, a crash in the Chinese economy could affect this.[9]

The deficit countries, meanwhile, have been starved of investment by the eurozone’s approach to the crisis. The single currency had already deprived the countries that joined it of the possibility of devaluing their currencies, one of the most important tools of economic statecraft. As a result, the post-crisis adjustment needed to be done through internal devaluation — that is, reduced domestic wages and prices, compared to the eurozone average, on the back of lower domestic demand. The eurozone’s fiscal rules also reduced their ability to borrow to invest. Finally, the creditor countries have sought to keep the size of bailouts to a minimum. This has put the debtor countries under enormous pressure to seek alternative sources of investment from outside the EU. Thus Tsipras’s flirtation with Russia is an unsurprising outcome of the eurozone’s policies since the crisis began.

In the last five years, Greece has sought investment from China as well as Russia. Before it came to power, Syriza said it would reverse the privatization of the Piraeus Port Authority, which the previous Greek government had agreed upon with the troika. Since then, however, it has reversed its position and said it would go ahead with the sale. The Chinese state-owned enterprise China Overseas Shipping Group Co., which acquired the port’s container terminal in 2009, is one of the five shortlisted buyers. Acquisitions of such critical infrastructure by Chinese state-owned enterprises could make Greece even more dependent on China for investment than it currently is on Russia. In the last five years, other EU member states such as the United Kingdom have also increasingly sought Chinese investment — whether in their sovereign debt or in infrastructure.[10] China will also be a major contributor to the European Commission’s €315 billion Investment Plan for Europe.

EU member states could become more and more reliant on non-Western powers for economic growth.

Thus as a consequence of shifts in the structure of global trade and of eurozone’s response to the crisis, EU member states could become more and more reliant on non-Western powers for economic growth. This reliance will likely take different forms based on the different economic structures of EU member states. Current developments suggest that the eurozone “core” — in particular the group of countries whose economies are now deeply integrated into the German manufacturing supply chain — will increasingly rely on non-Western powers as export markets. Meanwhile the eurozone “periphery” will likely increasingly rely on them as sources of investment. Other EU member states such as the U.K. may increasingly rely on non-Western powers both as export markets and sources of investment.

Leverage and Coherence

This increasing dependence could undermine the coherence of European foreign policy. This is because it gives non-Western powers leverage that can be used to prevent EU member states from taking tough positions or agreeing common positions with each other or with the United States. While economic interdependence produces gains, it also creates vulnerability. To the extent that states get an economic “bump” from trade with, or investment from, other states, they also become vulnerable to a cut off. As Dale Copeland puts it, “If state Y is getting a large relative gain from trading with state X, then it is also giving X more bargaining leverage in the future, considering that Y has a greater relative need for the continuation of trade and will be more hurt than X by any severing of economic relations.”[11]

China could offer EU member states much more — and could also punish them more severely.

In the medium term, China could be an even bigger challenge for Europe than Russia. Precisely because EU member states have so much to gain from trade with, and investment from, China, it is likely to have increasing leverage over them. The sheer size of the Chinese economy means that trade with China is in the future likely to make up a much greater proportion of each EU member state’s total trade than vice versa — even if the Chinese economy slows. In addition, whereas Russia is a declining power with decreasing resources, China is a rising power with increasing resources. Russia was limited in what it could offer Tspiras in order to tempt it to undermine EU sanctions. But in the future, China could offer EU member states much more — and could also punish them more severely. In short, China’s potential to divide Europeans is much greater than that of Russia.

Europeans have tended to focus on the gains from economic interdependence with China and ignore the implications for the power relations between themselves and China. However, it is going to become increasingly too difficult to ignore these implications as the economic interdependence between China and Europe is likely to become more asymmetric over time. As the Chinese economy continues to develop, it is likely to become less dependent on technology from EU member states. As it seeks to shift its economy from exports toward greater domestic consumption, it is also likely to become less dependent on exports to Europe for economic growth. Meanwhile, as EU member states become more dependent on China as an export market and as a source of investment, interdependence will increasingly become dependence, which could translate into both direct and indirect forms of leverage.

The way that direct leverage works can already be seen from China’s repeated attempts in the last few years to use coercive diplomacy with countries in its own neighborhood with whom it has territorial disputes, such as Japan and the Philippines, but also with European countries such as Norway. For example, after the Chinese dissident Liu Xiaobo was awarded the Nobel Prize in 2010, China imposed restrictions on the import of Norwegian salmon. (Norway subsequently complained to the WTO.) It also froze talks on a bilateral free trade agreement and imposed visa restrictions for tourists from Norway. China has also retaliated against other EU member states such as the United Kingdom when their heads of government met with the Dalai Lama. As a consequence, European heads of government have now all but given up on meeting the Dalai Lama.

China could also use more indirect forms of leverage. Increased trade with and investment from China means that Chinese business people now have access to the highest levels of government in Europe. As economic interdependence increases, the lobby of European business people who profit from trade with and investment from China is likely to become more powerful and to put pressure on the governments of EU member states to align their policies with Chinese interests — much as the “Russia lobby” in Germany did in the past. China has also begun to even more subtly influence European foreign policy debates through its support of journals, think tanks, and universities, in particular through Confucius Institutes. Thus increasing economic dependence can also constrain European foreign policy by “osmosis,” as one European policymaker puts it.[12]

Europe’s economic dependence could not just divide it internally but also cause tensions with the United States.

The increasing economic dependence of EU member states has already constrained the ability of Europeans to take tough common positions toward China. European officials say it has become almost impossible to agree upon positions in the European Council that are critical of Chinese human rights abuses. Member states such as Cyprus and Greece — or whichever country is about to host the next “16+1” summit between the Central and Eastern European countries and China — invariably prevent such issues from being discussed in meetings of the European Council. As one official puts it, China has “bought a blocking minority” in the European Council.[13] In future, such a blocking minority could prevent the European Council taking a stand on other issues such as Asian security. Thus Europe’s economic dependence could not just divide it internally but also cause tensions with the United States.

Joined-Up Policy

In recent years, Europeans have made slow, incremental progress developing foreign policy institutions and “strategies.” The Lisbon Treaty created a European foreign minister in the form of the high representative for foreign and security policy and a European diplomatic service in the form of the European External Action Service, which in turn created the institutional basis for a more coherent European foreign policy. In the last few years, the EU has also sought to go further in the development of a global “strategy.” In particular, at the European Council in December 2013 — a decade after the first European Security Strategy was published — the high representative was empowered to undertake a review of European foreign policy. This has prompted much discussion among policymakers and think tanks about how the EU can become a more “strategic” actor.

However, in these discussions, the growing economic dependence of EU member states on non-Western powers is rarely discussed. For example in June, as part of her review of European strategy, High Representative Federica Mogherini published an analysis of the changing global environment in which the EU must operate.[14] But the document hardly mentions the effects of changes in global trade and investment on EU member states and includes only a superficial discussion of the strategic consequences euro crisis (the crisis “temporarily tarnished the EU’s international reputation and took a toll on its self-confidence and openness to the outside world,” but although Europeans now have “less of an appetite for expensive endeavors abroad,…steps forward in economic governance are putting the crisis behind us”).

More research is now needed on the trends in the global economy described above — and how they and the eurozone’s response to the crisis are affecting the EU’s external relations. There has been much discussion among academics and analysts about the EU as an international “actor.” But this discussion has focused predominantly on what type of power the EU should aspire to be (“civilian,” “normative,” etc.) and how the EU can more effectively convert its huge resources into outcomes. In other words, it has focused on the EU as a subject in international politics. The assumption is that Europe can shape the world. However, as the center of the global economy shifts to Asia, the EU is also likely to be an object of international politics. In other words, the world could shape Europe. If non-Western powers have leverage over EU member states, the EU will need a “defensive” strategy as well as an “offensive” one.

In order to prevent Europe’s economic dependence on non-Western powers from undermining its incremental progress in developing institutions and “strategies,” Europeans need to go further in making linkages between economic and foreign policy. In particular, they must find ways better to deal with situations like the one created by Tsipras’s threat to undermine EU sanctions against Russia. Whereas discussions about Greece’s debt took place in the Eurogroup (and therefore did not include key EU member states such as the U.K.), discussions about Russia took place in the European Council. But the deeper problem was that some of the EU member states that were the most hawkish on Russia were also the toughest on Greece. The danger is that their lack of flexibility on the latter could undermine their interests on the former.

What the EU needs is a way to take into account the negative strategic costs of internal policy, in particular economic policy, and to adjust the former where necessary.[15] Member states are able to reconcile their own economic and strategic interests on an individual basis, though the eurozone’s response to the crisis has increasingly constrained member states’ foreign policies. But there is no mechanism for EU member states to collectively reconcile their internal and external interests. For example, after Tsipras threatened to undermine sanctions, the EU had no way to discuss how to balance the need to resolve the euro crisis with the need to uphold the European security order and to reconcile member states’ interests in each. In short, the EU needs a mechanism through which it can prioritize between internal and external objectives.

Conversely, the EU should also find ways to encourage good strategic behavior by member states. For example, after the annexation of Crimea in 2014, France faced a difficult decision about whether to go ahead with planned €1.2 billion sale of two Mistral-class helicopter landing ships to Russia, on which thousands of French jobs depended. In the end, France took the right decision in strategic terms by suspending the sale of the ships. But it received little support from its eurozone partners — just as they provided little assistance in its military interventions in Africa in recent years. The case of France illustrates the need to find a way to compensate member states that make a disproportionate contribution to European security. In 2013, President François Hollande called for a permanent EU fund to support military interventions led by member states, but unsurprisingly, the idea went nowhere.[16] Following the terrorist attacks in Paris in November 2015, he declared: “the security pact is more important than the stability pact.”[17]

In practice...member states do not have identical interests on either internal or external policy.

The only place where such a joined-up policy can be developed is the European Council. If the EU member states had identical interests, they could have agreed, say, to make concessions to Greece on its debt repayment in order to maintain unity in relation to Russia. In practice, however, member states do not have identical interests on either internal or external policy. The EU has long made trade-offs between the different interests of member states on both internal and external policy — indeed, such trade-offs are the basis of European integration. But the changing relationship of EU member states with the rest of the world —in particular the increasing leverage that non-Western states will have over them — mean that it is now necessary to go further in connecting internal and external policy and to make even more complex trade-offs between member states’ interests.

An Economic Policy that Strengthens Foreign Policy Coherence

The situation of Greece illustrates this necessity most clearly. It is the eurozone’s most intractable problem but its location on the south-eastern edge of Europe means it is “too strategically important to fail.” Although the immediate danger that Greece might undermine EU sanctions against Russia has passed, it remains under pressure to seek investment from beyond the EU and could again turn to Russia, or China, for help. The migration crisis has illustrated another way in which the effects of austerity in Greece have undermined European security. Instead of making policy in the eurozone without regard to the strategic consequences, the EU must make an even more complex deal with Greece. That means giving Greece positive incentives to remain in the eurozone rather than just relying on fear of the devastating consequences of an “exit” to keep it in line.

However, the problem is not limited to Greece. Shifts in the global economy and the consequences of the euro crisis mean that all EU member states will in the future become more dependent on trade with and investment from non-Western powers. The possibilities for such powers using their leverage against individual EU member states could undermine the slowly developing coherence of European foreign policy. In addition to a more joined-up policy, therefore, Europeans ultimately need to develop an economic policy that strengthens coherence in foreign policy. This means finding a way to create economic growth that does not further increase the dependence of member states on non-Western powers as export markets or sources of investment — in other words, creating internal demand. How it goes about creating growth may be the most important strategic decision Europe makes.

Acknowledgements

The author would like to thank Philipp Niesenhoff for his assistance with research. Rosa Balfour, Sebastian Dullien, John Springford, and Sir Michael Leigh all made extremely helpful comments on an earlier draft. He would also like to thank Rachel Tausendfreund for her help in shaping the argument and sharpening the language.

 


[1] See Stephen Wall, A Stranger in Europe. Britain and the EU from Thatcher to Blair (Oxford: Oxford University Press, 2008), pp. 1-2.

[2] See European Commission, “Completing Europe’s Economic Monetary Union,” June 22, 2015, http://ec.europa.eu/priorities/economic-monetary-union/docs/5-presidents....

[3] Jim O‘Neill and Alessio Terzi, “Changing trade patterns, unchanging European and global governance,” Bruegel, February 25, 2014, p. 29, http://www.bruegel.org/publications/publication-detail/publication/817-c....

[4] See Robert A. Mundell, “A Theory of Optimum Currency Areas,” American Economic Review 51 (4), 1961, pp. 657—665.

[5] O’Neill and Terzi, “Changing trade patterns, unchanging European and global governance,” p. 24.

[6] World Bank figures, available at http://data.worldbank.org/indicator/NE.EXP. GNFS.ZS?page=2

[7] German Federal Statistical Office, “Share of intra-EU trade in Germany’s total foreign trade,” https://www.destatis.de/EN/FactsFigures/NationalEconomyEnvironment/Forei...

[8] Ibid.

[9] Jim O’Neill and Alessio Terzi, “The World in 2020,” Bruegel, March 19, 2014, http://bruegel.org/2014/03/the-world-in-2020/

[10] See François Godement and Jonas Parello-Plesner with Alice Richard, “The Scramble for Europe,” European Council on Foreign Relations, July 2011, http://www.ecfr.eu/page/-/ECFR37_Scramble_For_Europe_AW_v4.pdf

[11] Dale C. Copeland, Economic Interdependence and War (Princeton: Princeton University Press, 2015), p. 29.

[12] Author interview, September 2015.

[13] Author interview, September 2015.

[14] “The European Union in a changing global environment. A more connected, contested and complex world,” June 2015, http://eeas.europa.eu/docs/strategic_review/eu-strategic-review_strategi...

[15] Here and in what follows, the terms “internal” and “external” are relative to the EU. In other words, “internal” policy refers to relations between the member states; “external” policy refers to relations between the EU and the rest of the world.

[16] Hugh Carnegy, “French seek permanent EU defence fund,” Financial Times, December 17, 2013, http://www.ft.com/cms/s/0/230c8198-671a-11e3-a5f9-00144feabdc0.html#axzz...

[17] Mark Deen and Helene Fouquet, “Hollande Signals French Security Measures Will Swell Deficit” Bloomberg, November 16, 2015, http://www.bloomberg.com/news/articles/2015-11-16/hollande-signals-frenc...