Conflict and Competitiveness in Europe

Returning from their summer recess, European Union leaders have a packed agenda. At the top of the list are strengthening the bloc’s readiness for conflict and bolstering its economic competitiveness.

For decades, the EU relied on economic influence as a substitute for hard power. But in an era of renewed geopolitical tensions, soft power is not sufficient. The evidence of this comes in many forms. If Europe’s shrinking industrial base and scramble to adjust to the reality of deglobalization are not convincing enough, the Ukraine war surely must be.

That conflict has not only upended the long-held belief that full-scale wars in Europe belonged to the past; it has also demonstrated the limits of economic ties and levers to shape countries’ behavior. Despite facing one of the most expansive sanctions regimes in history, Russia’s economy grew by 5.4% in the first quarter of this year, and 4% in the second – well above the global average.

A key reason for this resilience is that Russia has found ways to circumvent sanctions and acquire restricted goods, including defense and high-tech products. More than half of the battlefield equipment that Russia obtained between February and August of 2022 contained components made in Europe or the United States. And the majority of the semiconductors being exported from China and Hong Kong to Russia – a trade that has surged tenfold since the war started – originated with US manufacturers.

The Western firms producing those goods, however, are not reaping the full profits of this trade, which is happening largely through complex networks involving third countries. It is no coincidence that Armenia, Azerbaijan, Georgia, Turkey, and several Central Asian countries have drastically increased their trade with both Russia and Europe since the 2022 invasion. Kazakhstan has a relatively small tech industry, yet its tech exports to Russia surged from $40 million in 2021 to $298 million in 2023.

Russia’s success at circumventing sanctions – often at high cost to Western businesses – has forced European policymakers to scramble to adapt. While 14 rounds of sanctions have been introduced in two and a half years, Europe’s leaders have so far failed to devise effective solutions. The new trade with Russia is simply too lucrative for intermediary countries to pass up. While the EU could step up its pressure on these countries, using either carrots (like aid packages) or sticks (secondary sanctions), coercion would create its own challenges, and it could undermine Europe’s economic and security interests.

Intermediaries are also handling goods headed in the opposite direction: as the EU has sought to reduce its energy dependence on Russia, it has often ended up importing refined Russian fuel at inflated prices via third countries, such as India. Even in terms of direct energy imports, many EU countries continue to rely on Russia. Austria now gets a staggering 98% of its natural gas from Russia’s state energy company, Gazprom, with the share having risen since the start of the Ukraine war. Moreover, the EU’s imports of liquefied natural gas from Russia surged by 37.7% between 2021 and 2023. Given that LNG is particularly expensive, this has further exacerbated energy costs – and internal discord.

The EU’s failure to update its fragmented and reactive energy framework has left it unable to balance geopolitical considerations with economic realities. This has not only eroded the bloc’s soft power – including its international credibility and its economic competitiveness – but also has undermined its ability to invest in strengthening its hard power.

This situation calls for a fundamental rethink of Europe’s priorities and policies, argues Mario Draghi, a former head of the European Central Bank and prime minister of Italy, in a just-released report. For example, he suggests that the EU should break its habit of blocking mergers over competition concerns – a practice that has often kept European firms too small to compete globally – and instead introduce a new regime for monitoring potentially problematic mergers after they happen.

More broadly, Draghi argues that the EU must urgently strengthen its industrial base, simplify its regulatory framework, and increase investment in defense and innovation. Without these reforms – designed carefully and implemented quickly – the EU risks falling even further behind at a time when it can ill afford to. The stakes will grow only higher if Donald Trump returns for a second term in the White House, which would surely lead to the US becoming a far less reliable partner, leaving Europe’s security and economy even more vulnerable than they already are.

Copyright: Project Syndicate, 2024. www.project-syndicate.org

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