European External Economic Policy in the Age of Zeitenwende

Klaus Günter Deutsch

Federation of German Industries (BDI)

Dr. Klaus Deutsch is Head of Department of Research, Industrial, and Economic Policy at the BDI e.V. (Federation of German Industries).

Previously, he was Senior Economist with Deutsche Bank Research. Dr. Deutsch received his education in political science and economics from the Free University of Berlin (diplomas in 1990 and 1992, doctorate in 1995) and spent a year as a Fulbright exchange student at George Washington University, Washington, DC, in 1988/89.

Paul Maeser

Federation of German Industries (BDI)

Paul P. Maeser is Senior Manager at the BDI (Federation of German Industries), covering European general affairs.

Previously, Paul was Senior Consultant with EY's Financial Services Organization and capital markets expert with Deutsche Bank in Berlin, Frankfurt, and Amsterdam. In 2011-12, he served as an APSA German Marshall Fund Congressional Fellow in the U.S. House Committee on Financial Services. He holds a B.A. in Business Administration from the Berlin School of Economics and Law and an M.A. in International Trade in Investment Policy from The George Washington University.

For the past thirty years, the global economy has operated on the premise of political alignment. The promise of democratization and the rule of law around the world allowed unprecedented diversification in value chains. Offshoring production and sourcing inputs globally, however, was mostly driven by the paradigm of cost competitiveness. Almost all political risks had (seemingly) vanished.

Businesses in Europe and other world regions must acknowledge that political risks are still prevalent factors in today’s world, even beyond the war in Ukraine. With the Zeitenwende, political risks must be reflected in business decisions as well as in economic policy. Not just the current energy crises, but also potential future disruptions in all autocratic regimes should come back on business leaders’ radar screens. A new external economic policy, both in Brussels and Berlin, should support them by favoring new options. But what should such a new policy entail?

At least since the 1990s, classic trade policy has embraced the principle of welfare maximization as its main goal. Specialization of economies through the division of labor allowed for unprecedented efficiency gains. In the absence of larger security risks, liberal trade and investment rules governed the flow of goods, capital, and to some extent labor. While there is per se nothing wrong with optimizing gains from trade, policymakers must now enhance their external economic policy with additional components. A cutting-edge European economic policy certainly includes new ways of risk management. But just to clarify, such policy must not be mixed up with isolation or autarky. Much more the opposite is true: The ongoing energy crisis is a case in point that diversification is imperative for Europe’s well-being and further dependencies exist.

Economic actors must choose their partners wisely. The reversal of domestic democratic progress in many countries and the hardening of autocratic regimes shake the very foundation of the [multilateral] trade order. Increasing security strains in Asia, for instance, must be a wake-up call for all democracies. They must scrutinize their economic policies with respect to security considerations. Therefore, a new economic policy should encourage businesses to establish risk-reducing relations. This implies, by nature, that emphasis lies on deepening economic partnerships with like-minded countries such as the United States and other democracies.

Sourcing from only one country is less dangerous as long as there is a robust “Plan B” in place for all critical inputs along the value chain.

At the same time, a realistic point of view must include the fact that interaction with less-democratic countries oftentimes remains unavoidable. This is because certain elements, such as specific raw materials, are not always available at home or in befriended countries. From a strategic sovereignty perspective, dealing with such countries is less concerning if European businesses can swiftly pivot to other suppliers or substitute materials. In other words, sourcing from only one country is less dangerous as long as there is a robust “Plan B” in place for all critical inputs along the value chain. This leads us to two open questions: What is a “critical input” and who defines it?

For European businesses and policymakers, four criteria should apply to qualify an input as strategically relevant: its absence can destabilize supply chains; it helps secure and expand crucial technological capabilities; it is a critical skill to have also from a national security perspective, or it can assert international competitiveness. Defining these inputs, therefore, is a political decision which requires an ongoing stakeholder dialogue.

Strengthening Europe across all four dimensions requires a broad set of measures. But there are simply too many to-dos to launch them all at the same time. Ergo, priority setting is indispensable. From today’s business point of view, a focus should lie on expanding capacities in the field of semiconductors, a coordinated expansion of a sustainable energy infrastructure, a diversification of procurement in raw materials, reliable structures in cloud and edge computing, and a strengthening of European efforts in international standardization bodies and projects.

In the short run, pursuing these projects adds to the costs for both governments and businesses. However, they might prevent significant expenditures in crises further down the road. Thus, the question arises of who will foot the bill. In some cases, initial public support will be needed, both in terms of trade and raw material policies and in the promotion of technologies.

Stopping autocracies from weaponizing economic goods starts with investment in flexibility, mostly through diversification.

Interestingly, demand patterns have already changed in some markets. For example, with respect to medical devices or in the automotive sector, there is at least a consideration among producers to pay more for safe supplies than taking the risk of halting production. The latter comes oftentimes with a lot of unforeseen and incalculable expenses, e.g., for labor, rent, and financing. In the aftermath of the current Chinese COVID policy, there is a broad tendency in global business to reduce dependencies on Chinese inputs, e.g., by diversifying supplies to neighboring Asian countries. Such a strategy leads to additional medium-term costs. Consumers and taxpayers will therefore absorb some charges, while businesses will face lower margins, at least in the interim.

It is critical to understand, however, that all stocktaking today can only form a snapshot of the current state of play. Risks—in business and politics alike—are dynamic. Without constant revision and adjustment, strategic sovereignty might not be sustainable or even achieved at all. In other words, the homework will not be done by simply setting up a few strategic projects. Strengthening economic sovereignty is a long-term objective and must be seen as a governance process rather than a stand-alone undertaking.

A holistic approach to such dependencies is imperative.

The European Commission, for example, has coined the term “ecosystems” for diverse fields of action. These ecosystems include, for instance, the production of hydrogen, active pharmaceutical ingredients, batteries, or semiconductors. The ecosystem approach implies that achieving goals in each field requires the interaction of policies from several divisions. This philosophy clearly heads in the right direction. But for the idea to succeed, all affected directorates general must pursue it, and so must member states and private actors. Thus, economic policy must evolve much more along horizontal avenues rather than through sector-focused approaches.

Finally, a simple expansion of major value chains will not bring us into the promised land. Strengthening capabilities in one field inevitably creates new dependencies as other inputs likely need to be imported, such as raw materials or semifinished goods. But a smart economic policy focuses on tampering with the toughest choking points. Stopping autocracies from weaponizing economic goods starts with investment in flexibility, mostly through diversification. Reflecting the Zeitenwende in international economics requires cooperation—within the business community worldwide and among democratic governments.