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The Troubling Rise of Economic Nationalism in the European Union

Summary:
German and French politicians have been arguing for a more muscular response from the European Union (EU) to competitive threats from China and the United States. Some of the concerns motivating these calls are valid. But the proposed response—weakening intra-EU competition rules to push European champions (likely involving large French and German companies), adopting Chinese-style industrial policies, perhaps even restricting international trade—is far more likely to undercut than to boost innovation and growth in the EU. It will also make it harder for the EU to credibly advocate an open, multilateral international economic order. The economic success of the EU has both internal and external dimensions. Within the EU, economic integration and strong common institutions create growth and

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German and French politicians have been arguing for a more muscular response from the European Union (EU) to competitive threats from China and the United States. Some of the concerns motivating these calls are valid. But the proposed response—weakening intra-EU competition rules to push European champions (likely involving large French and German companies), adopting Chinese-style industrial policies, perhaps even restricting international trade—is far more likely to undercut than to boost innovation and growth in the EU. It will also make it harder for the EU to credibly advocate an open, multilateral international economic order.

The economic success of the EU has both internal and external dimensions. Within the EU, economic integration and strong common institutions create growth and prosperity by giving firms and consumers access to a large internal market, increasing competition, regulating and supervising at arm’s length from domestic constituencies, and creating opportunities for private and public risk sharing. At the same time, a prosperous and united Europe stands a greater chance of asserting its values and interests on the global stage than any individual member country. This involves pushing for a multilateral framework that embodies EU values—rules-based competition and international integration—to the maximum extent possible. But it also requires defending EU interests when they come under attack: for example, when trading partners fail to enforce intellectual property rights, impose tariffs, or create de facto barriers to entry.

The EU has long pursued these various dimensions of economic policy in parallel, with occasional tensions. Recently, however, these tensions have become more acute. The reason for this is a growing sense among EU politicians that the EU must do more to counter external threats. This development is partly a reaction to the political and economic nationalism of President Donald Trump and partly a response to the growing economic and technological power of China and the Chinese brand of economic nationalism. The latter includes mergers to create national champions, extensive state participation in or support of specific firms and industries, closing “strategic” sectors to foreign competition, and forced technology transfers. EU politicians are right that these challenges require a response that goes beyond business as usual. US protectionism must be deterred, the Chinese must be forced to play by the rules, and Europe must avoid becoming dependent on technologies controlled by companies that are themselves controlled by an authoritarian government.

The problem is that in their eagerness to push back against economic nationalism in China and the United States, EU politicians have begun to advocate their own brand of economic nationalism. While stopping short of calling for tariffs—except in retaliation to potential US tariffs—EU economic nationalism checks some of the same boxes as economic nationalism in China. Germany’s new National Industrial Strategy 2030, for example, proposes promoting national and European champions, even when it hurts competition within the EU; providing extensive state support to sectors believed to be “of great economic significance”; and “maintaining closed value chains” within the EU. A joint Franco-German manifesto argues for changes in EU rules that would allow the EU Council, which represents the member states, to overrule merger prohibitions by the European Commission.  

These are terrible ideas. In the name of more external assertiveness, they would undermine the internal dimension of the EU’s economic success, which is based on strong competition enforcement and governance structures that support markets while minimizing the risk of capture by private interests. They would also weaken the EU’s credibility in defending the rules-based international order.

It is well established that a decline in competition not only hurts consumers but also reduces investment and innovation. It is also well established that political backing for national champions creates risks for consumers and taxpayers, through implicit guarantees and by raising the risk of regulatory capture. The VW emissions scandal and, most recently, the Boeing case, are examples. At the same time, the main argument for mega-mergers—that effective competition in global markets requires extremely large companies—is unconvincing. As Germany’s and Italy’s “hidden champions” demonstrate, companies of all sizes can be globally successful. And if a global project were to turn out too large or complex for existing EU companies, “a champion could very well be a temporary collaboration, or a consortium of companies that complement each other’s services,” as the European Commission puts it in an excellent recent paper.

With respect to industrial policy, Germany’s National Industrial Strategy seems to operate on the assumption that state-led industrial policies are the reason why China is doing well (the document describes China as “a particularly successful country in terms of industrial policy”). However, it is unclear that these policies are working even in China. In a new book, Nicholas Lardy attributes the recent decline in Chinese productivity growth to declining competition and channeling of ever more resources to unproductive state firms. China’s former finance minister, Lou Jiwei, has been quoted as saying that “Made in China 2025” (the initiative that inspired Germany’s National Industrial Strategy) is “a waste of taxpayers’ money.”

I am not arguing that industrial policy is bad per se. Rather, my point is that industrial policy motivated by economic nationalism is much less likely to be successful than industrial policy that seeks to correct broadly defined market failures. Industrial policy should support new activities with the greatest potential of providing spillovers and demonstration effects (for example, through competitive R&D grants, which already exist in Germany). Financial incentives should stimulate, rather than reduce, competition. And importantly, what determines success in industrial policy is not so much “the ability to pick winners, but the capacity to let the losers go.” These objectives are much harder to achieve when politicians decide that a sector or firm must receive support to help it compete in international markets.

As I argue in a recent PIIE Policy Brief, the EU should take a different approach. It should start by ensuring that economic policies—including, but not limited to, industrial policies—are as supportive of business dynamism and productivity growth as possible. This should happen regardless of competitive threats from China or other any countries. In addition, there is a role for policies that penalize forced technology transfers and state aid by non-EU governments, along with improved and better enforced World Trade Organization (WTO) rules. There may even be a role for an EU-level R&D program that specifically targets technologies in which Western democracies risk becoming dependent on China. Apart from adequate funding, such a program would require a governance structure that avoids capture by large companies or sectors and maintains or increases competition.

EU leaders are right to worry about China. They are also right to challenge orthodoxy and look for additional or better ways in which the state can promote economic growth. But in doing so, they should look to best practices in industrial policy, not Chinese practices. They should also remember that there are tried-and-tested ways in which the state can support economic growth—such as providing proper infrastructure and creating a genuine EU single market—which currently fall woefully short in many EU countries and in the EU as a whole. Most importantly, they should not engage in policies that, for the sake of a muscular reaction to China or the United States, threaten the very underpinnings of prosperity in the EU.

Economist and Senior Fellow

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