The EU must choose between protectionism and industrial policy

The recent European mini-tour of Chinese leader Xi Jinping exposed the internal contradictions of the EU’s economic strategy. While in Paris Xi was treated to a litany of complaints about unfair competition from Chinese exports, in Hungary and Serbia he saw Chinese investments being welcomed with open arms. Despite talk of pursuing economic ‘sovereignty’ and ‘strategic autonomy’ in the EU’s economic relations with other powers, Xi’s visit showed just how little Europeans still agree on the meaning of these terms.

 

Generally speaking, ideas in the EU about a more muscular and strategically minded economic policy in recent years run along two tracks: the deployment of protectionist measures against competitive exports from rivals like China in new strategic economic sectors like electric vehicles and green tech; and the use of public subsidies at the EU level to create so-called ‘European champions’ to compete with mega-corporations from the US and China in these areas.

 

Protectionism and industrial policy are often lumped together as the two sides of a more strategic mindset in economic policy. But in reality, they are quite distinct in their logic and implications, and the European debate has long failed to untangle them. It often appears as if the EU must adopt both at the same time if it wants to compete with its rivals. This is a fallacy that keeps Europe from having a more nuanced but vital conversation about its economic future.

 

Standard economic theory as well as experiences from the 20th century show that protectionism combined with subsidies for domestic industry inevitably leads to sub-optimal results. Instead, positive examples of economic statism in previous decades, especially in East Asia, were those that combined openness to international trade with an activist industrial policy. Conceivably, this virtuous combination could be applied by the EU by welcoming competitive exports from China or the US while supporting its ‘champions’ in their early steps against international competition.

 

This strategy however is clearly not welcome by everyone. First, it clashes with a growing perspective that views areas like green technologies, EVs and AI through the lens of geopolitical and security competition, and therefore sees Chinese tech in Europe as a grave security threat. Second, unfettered competition with foreign imports will undoubtedly undermine the interests of established economic actors who will mobilize their governments to protect them. Finally, EU subsidies are seen very suspiciously by smaller member-states who rightfully fear a concentration of power in the hands of larger countries like Germany and France.

 

What about the opposite mix: protectionism against the outside world together with maintaining the level-playing field of the single market internally? This has been the preferred course of action of the Commission, mainly as a holding pattern in the absence of a clear strategic consensus about the future course of the EU. Investment and subsidy screening tools adopted in recent years aim to protect the integrity of the single market by keeping out actors who do not play by the rules e.g., foreign corporations (again, mainly Chinese) who enjoy subsidies from their governments.

 

While this is the comfort zone for free-trading and subsidy-fearing northern member-states, it is also seen by many others as too timid and defensive for the kind of global strategic challenges the EU faces. It condemns European companies to irrelevance against big competitors from China and the US, and could make the EU a laggard in the global race for innovation. It also hurts poorer member-states in the South and East who already struggle to compete in the single market and would stand to lose from Chinese investments being screened and shut out from the EU.

 

In the real world of course, things will be more complex than a clearcut choice between two neatly delineated models. But the point remains that the EU must both resist the temptation of crude all-out statism – protectionism plus subsidies – and stop postponing the debate about what kind of mixes of openness and closure it wants deploy in specific economic sectors.

 

This is bound to be a difficult, even divisive debate given the multitude of crosscutting purposes such economic strategy must satisfy, from national security and international competitiveness concerns to market fairness and consumer choice. These dilemmas also entail uneven distribution of adjustment costs across Europe. But the EU cannot afford to remain stuck in the current mindset, dominated by knee-jerk reactions to economic moral panics, from Biden’s IRA subsidies to Chinese over-capacity, and the short-term priorities of powerful national or industrial actors.

 

Ultimately, the EU’s future economic strategy cannot be designed behind closed doors, highjacked by well-connected economic actors and the governments of the biggest member-states. Giving teeth to the EU’s ‘strategic autonomy’ – the right balance between free markets and judicious use of protectionism and industrial policy in selected areas – must happen on the basis of open democratic deliberation. Above all, it must respect the principle of equity, ensuring that the benefits and costs of the new strategy will be distributed fairly among its member-states.