Economic growth and European foreign policy

In the last edition of the European Foreign Policy Scorecard, I and my colleagues at ECFR argued that the crisis had damaged European power in 2011 in four ways: first, it had led to a loss of soft power (as German Chancellor Angela Merkel put it in a speech to the European Parliament last month, the crisis “dominates people’s perception of the European Union” around the world); second, it had limited Europe’s ability to respond effectively to the Arab Awakening; third, it had led member states to cut defence and development budget cuts; and fourthly, it had led to a “renationalisation” of European foreign policy. Although, a year later, the crisis is no longer quite so acute, the EU continues to be preoccupied by it (and there is now serious discussion about whether the UK might leave the EU altogether). 

Clearly, therefore, the most important thing that Europe can do to increase its power in the world is solve the crisis and restore economic growth in Europe. Unless and until it does so, European hard and soft power – that is, the power to coerce and the power to persuade – is bound to be limited further. European leaders will continue to have to respond as well as they can to foreign-policy crises such as in Libya in 2011 and Syria in 2012 and to do more with less by pooling and sharing. But as long as the euro crisis drags on, they will inevitably have little time for foreign policy and cuts in defence and development budgets will continue. In that sense, European leaders are right to focus on solving the crisis and restoring growth – and now on institutional issues around economic and political union – even at the expense of foreign policy. 

However, what type of economic growth Europe tries to create as it deals with the euro crisis may have a huge impact on European power in the world. In particular, there are two possible growth models between which Europe must choose. One is a model in which Europe is able to generate sufficient internal demand to grow, as it had before the crisis began. The other is a model in which Europe will depend to a large extent on external demand – in particular from the emerging economies of Asia – to produce growth. The effect of European policy on this balance between internal and external demand will massively affect its relationship with the rest of the world. In a sense, this may be the most fundamental foreign-policy decision facing the EU: how to grow.

In this respect, Germany is the key EU member state. “The core problem in Europe is that it has no strong internal source of aggregate demand at all”, argues Martin Wolf. “Its most competitive – that is, its least financially stressed – economy is Germany. But Germany has chronically deficient aggregate demand. It imports demand from its trading partners, and none of its trading partners in Europe is now in a position to export demand to it. So Germany must get this demand from the rest of the world – not from the US, but from Asia.” Low German demand means deficit countries in Europe cannot export. Conversely, the co-ordinated and prolonged austerity advocated by Germany is depressing demand in deficit countries.

Because, in the last decade, Germany has been so successful in exporting beyond Europe  Jim O'Neill said at a talk at ECFR this week that he projects that, on current trends, Germany will export twice as much to China as to France by 2020  it now argues that others in Europe should copy its export-driven economic miracle. The implication is that everyone should become an Exportweltmeister. But whether or not this is realistic (I don’t think it is), it is far from clear it would be a good thing: it would mean that Europe as a whole – the world’s largest trading bloc – would become a bigger version of Germany. Taken as a whole, Europe is currently one of the few parts of the world that has a balanced current account, though its current-account surplus is increasing, in part because of low internal demand for imports from beyond Europe. But the current-account surplus of the Europe of Germany’s dreams would be much bigger. (Germany’s current account surplus is currently 6.3 percent of GDP.)

There are two ways of looking at the foreign-policy consequences of this for Europe. There is a mercantilist view that surpluses create power – though to the same extent they create conflict. But being an exporter that is excessively dependent on external demand for growth, as Germany is, can also make you vulnerable. Hillary Clinton famously asked how you talk tough with your banker. But in fact the United States is now pursuing a tougher approach to China based on a mixture of cooperation and balancing. (Some such as Aaron Friedberg argue it should pursue an even tougher approach.) As Germany, on the other hand, has become more dependent on exports to China for growth and they have developed a "special relationship", it seems to have become more reluctant to confront China (see for example Merkel’s reluctance to support an anti-dumping case against China this year). In future the question for Europe in may be: how do you talk tough with your customer?

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