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CHAPTER 4
Looking Outward: Western Disarray,
China Rising
4.1 INTRODUCTION Russia presents a menacing face. On the one hand
it has significant trade links with the European Union,
While the European Union is struggling internally with and is an important source of natural gas to Germany
growing divergence among member states regard- partly using pipelines through the Ukraine, and partly
ing both their economic performance and their sup- using the controversial Nord Stream pipelines via the
port of common governance structures, the interna- Baltic. On the other hand, there are growing fears of
tional environment is changing rapidly creating new military intervention in the Baltic States following
challenges. The two most important developments Russia’s activities in eastern Ukraine, the annexation
in the international environment are the shift in US of the Crimea, its persistent military provocations in
economic policy towards protectionism and against the Baltic, and interference in democratic elections
NATO, and the rise of China. The changes in the inter- in the United States and elsewhere. Russia has sup-
national environment are linked to the internal chal- ported Assad’s position in Syria, and is ready to help
lenges faced by the European Union because these Iran as US sanctions create pressure. It has welcomed
changes affect different EU member states differently; the authoritarian drift of Victor Orban’s Hungary, has
and may potentially exacerbate existing divergences been ready to exploit Greece’s difficulties under the
and tensions. bailouts of the Troika, and will now offer support to
The United States has become an unreliable tra- Turkey, which is on the receiving end of US sanctions,
ding partner and strategic ally, with Donald Trump has suffered a substantial fall in the value of its cur-
undermining NATO, unilaterally pulling the United rency and is still facing the possibility of a financial
States out of the 2015 nuclear treaty with Iran, pres- crisis.
suring the European Union on its military spending, Japan meanwhile, continues to sustain the multi-
trade, and tariffs, imposing tariffs on steel, aluminium lateral trading system. The United States pulled out of
and automobiles, and making overtures to Russia’s the Trans Pacific Partnership in January 2017, a move
Vladimir Putin and North Korea’s Kim Jong Un. that was widely thought to have killed off the whole
The growth in the Chinese economy has genera- agreement at the time. Nevertheless, Japan and the
ted new markets for European exports and sources other ten participants continued negotiations, and
of imports. China is presenting itself as a defender of signed a new agreement – the Comprehensive and
multilateralism and a rules-based international order, Progressive Agreement for Trans-Pacific Partnership
while the United States is retreating into mercanti- (the CPTPP) – in March 2018. Japan and the European
lism, bilateral deals, and tariff wars. At the same time, Union signed an agreement on trade in July 2018.
Europe has got caught in the crossfire of the escalating In this chapter we will discuss the implications of
US-China tariff war. China’s growing economic and changes in the global environment for the European
political prominence and international assertiveness Union. We will focus on the rise of China. While econo-
follows on from its ‘Belt and Road’ initiative and for- mic and political relations with the United States are
mation of the AIIB (the Asia Infrastructure and Inves- called into question by the administration, the critical
tment Bank) at the end of 2015. The ‘Belt and Road’ issues are clearly defined – conflicts are mostly about
project provides lavish funding for infrastructure defence efforts and trade. The implications of the rise
investments in European, Asian, and African coun- of China for Europe and the European Union are less
tries, but the conditions attached to their financing, clear. The presence of China as a foreign investor, as
ownership, and control raised questions and prob- a leading actor in science and technology, and as a
lems. Chinese efforts to establish control over most of geopolitical power is growing rapidly; and the debate
the South China Sea, contested by other countries in about the implications for Europe is evolving fast.
the region and world powers, raise tensions and pose The setup of this chapter is as follows: Sec-
the risk of military confrontations in the area. tion 4.2 discusses the changing role of the United Sta-
Next to the United States and China, there are tes under President Donald Trump and the impact of
other countries that require the attention of the Euro- Brexit. Section 4.3 turns to the rise of China as a glo-
pean Union. The United Kingdom will soon be an bal economic factor. Section 4.4 discusses the impact
external country. The extent to which it will be a con- of China’s rise on Europe. Section 4.5 discusses policy
structive partner and ally will depend on how Brexit implications of changes in the international environ-
is managed and whether there will be a cooperative ment for Europe and the European Union, while Sec-
agreement. tion 4.6 offers some conclusions.
EEAG (2019), “Looking Outward: Western Disarray, China Rising”,
EEAG Report on the European Economy, CESifo, Munich, pp. 77–94. EEAG Report 2019 77CHAPTER 4
4.2 DESTABILISING FORCES: PRESSURES FROM Trump’s initial tariffs, on washing machines and
THE UNITED STATES AND BREXIT solar panels imported from China, have incited reta-
liatory Chinese tariffs on American exports of soya
4.2.1 US Destabilisation beans. Another round of tit-for-tat tariffs has followed
and there is a threat of an all-out tariff war breaking
Donald Trump has been fixated on US trade balances out. While the tariffs actually imposed to date are
with individual countries. Moreover, he has focused limited in size and scope, a full-scale tariff war could
on the balance of trade in goods, ignoring services involve a substantial increase on a wide range of
and primary incomes, where the United States tends goods and services. Trump has threatened to impose
to have bigger surpluses; and indeed in some cases he tariffs on 500 billion US dollars of US imports from
has focused on the balance of trade in particular goods, China, and China has responded with similar thre-
such as the US balance in automobiles with Germany.1 ats. A dispute on this scale would have a substantial
It seems that, in his mind, trade is a zero-sum game: effect on trade flows and a significant impact on real
one side gains, the other loses. This argument appeals per capita incomes. One estimate is that the effect
to his supporters in the United States who share this will be as great as that of the 2008/9 global financial
view. Imports represent foreign countries taking jobs crisis (Jean et al., 2018). An analysis from the Banque
away from the United States. Surpluses are good, defi- de France (Berthou et al., 2018) pegs the effects of a
cits bad. (This is diametrically opposed to Valéry Gis- general increase in tariff rates by 10 percentage points
card d’Estaing’s complaint in the 1960s that America’s at between 1 percent and 3 percent of global GDP after
trade deficits, financed by printing dollars, which the two years.
rest of the world stored as foreign exchange reserves, While China’s retaliation has been measured, and
represented exploitation of its ‘exorbitant privilege’ the European response has been to propose a general
as the supplier of the international means of payment. lowering, or indeed a removal of tariffs between the
The world produced goods using labour and capital, United States and the European Union; it is unclear
for which the United States paid by printing dollars at how long this tariff war will last, or how far it will go.
zero cost.) The Trumpian analysis of trade ignores the Donald Trump appears to believe that tariff wars are
fact that the US unemployment rate is currently at its easy to win for a country that is running a deficit. But
lowest for many years; discouraged workers are com- his policies are unlikely to reduce the deficits, and per-
ing back into the labour force, and the participation sistent failure may induce him to retain tariffs longer
rate is increasing. (Irwin, 2018). The tax cuts passed by the US govern-
Trump has launched a tariff war on China. At the ment in 2017 have stimulated consumer spending and
same time, he has complained loudly about the EU’s will tend to increase the balance of payments deficit,
trade surplus with the United States, highlighting Ger- not reduce it. The deficit equals the excess of total
many’s trade surpluses, and particularly Germany’s spending over production in the country. Unless spen-
trade surplus in automobiles. ding falls relative to the amount of production, that is,
US tariffs on steel (at 25 percent) and aluminium unless there is an increase in saving, there will be no
(10 percent) were imposed at the end of May 2018 using reduction in the deficit.
a section of US trade laws dating from the cold war era, Donald Trump’s policy also overlooks the fact that
namely Section 232 of the Trade Expansion Act 1962 the United States has a trade deficit with the European
that was intended to prevent dependence for strate- Union, but a surplus in services and primary incomes.
gic supplies on Communist enemies. These tariffs have At least according to US foreign commerce statistics,
hit imports from Canada, Mexico, Japan, and Euro- the United States runs a small current account surplus
pean countries, who are US allies, rather than Russia with the European Union, not a deficit.2 This implies
or China, from whom the United States buys relati- that US companies are actually earning more in the
vely little steel, as anti-dumping duties have already European Union than vice versa. This questions his
reduced imports from these countries (Irwin, 2018). view that the United States can ‘win’ a trade war with
The European Union has threatened to retaliate by Europe.
imposing tariffs on particular goods such as US Bour- The US administration is using tariffs more widely
bon Whiskey and Harley-Davidson motorcycles. The as a tool of foreign policy. They have been imposed on
Mexican government intends to retaliate by putting Turkey (tariffs on exports of steel to the United States
tariffs on pork bellies, apples, cranberries, grapes, cer- doubled to 50 percent and aluminium to 20 percent in
tain cheeses, and various types of steel. Canada has August 2018) in response to Turkey’s holding of Ame-
imposed further taxes on imports of American steel, rican citizens. These citizens included Andrew Brun-
aluminium, coffee, candy, pizza, and quiche, represen- son (now released), a pastor from North Carolina,
ting imports worth around 12.8 billion US dollars. working in Izmir, who was accused of aiding the July
1
As a recent study by Felbermayr and Braml (2018) shows, accord-
2
ing to US data the United States had a bilateral current account sur- See Felbermayr and Braml (2018). Eurostat surprisingly reports a
plus with the European Union in 2017, mainly due to a large surplus in current account deficit for the US, but as Felbermayr and Braml ex-
primary incomes and a smaller surplus in services, overcompensating plain, the US figures are probably closer to reality than the Eurostat
the deficit in goods trade. numbers.
78 EEAG Report 2019CHAPTER 4
2016 attempted coup d’état, and was placed under to come to the aid of other NATO members. There has
house arrest. Tariffs have the advantage for the Trump been concern among European leaders and diplomats
administration that they can be imposed by an edict that Trump might withdraw the United States from
from the President without the bothersome need for military exercises in Eastern Europe and may scale
approval by the US congress. back the US military presence in Europe, weakening
Trump’s repeated complaint that the United Sta- the US security umbrella.
tes has been suckered into bad deals has prompted
the United States to pull out of the 2015 nuclear deal 4.2.2 Brexit
with Iran (the ‘Joint Comprehensive Plan of Action’),
re-impose sanctions on Iran, and threaten sanctions From the perspective of the European Union as
on any firms that do business with the latter. The a whole, the prospect of Brexit is a manageable
other signatories to the deal (the United Kingdom, economic irritant, although it will have significant
France, Russia, China, Germany, and the European effects on some members and particularly on Ireland.
Union) want to preserve it. The ability of the European Brexit will also impact some industries, particularly
countries to resist the effects of the US withdrawal those with long supply chains that go in and out of
and sanctions are restricted because European firms the United Kingdom, such as the motor industry.
are likely to be sanctioned by the United States if they The scale of the effects depends on what form Brexit
do business with Iran. As their US business is more eventually takes, whether the United Kingdom goes
important than their actual and potential Iranian for a Norway-style arrangement, with continued
links, they are likely to withdraw from Iran, undermi- participation in the customs union and single market,
ning the beneficial effects on the Iranian economy. with minimal disruption to trade, a Canada-style free
European banks, in particular, are very susceptible to trade agreement, or a hard or disorderly departure,
US pressure. The European Union has attempted to with trade conducted under WTO rules. The costs and
impose blocking sanctions to protect firms that con- disruptive effects of Brexit to the United Kingdom
tinue to trade with Iran, but it is not clear that they become clearer as time passes, and voices in favour of
will be effective. As the United States confronts Iran, abandoning the entire enterprise grow louder. There
and Europe is unable to sustain economic ties, Iran is growing support for a second referendum, with
is likely to drift further into the sphere of influence of staying in the European Union as one of the options
Russia and China, who are more likely to continue to on the ballot paper, the others being a ‘soft’ and a
buy its oil, undeterred by US sanctions. Most Iranian ‘hard’ (WTO) departure. There is the possibility that
oil, which accounts for a significant fraction of global no proposal put forward by the UK government will
supply at around 4 percent, is sold to China, India, get a majority in parliament, the government will lose
Japan, and South Korea. a vote of confidence, and a general election will ensue.
These actions against countries who are not allies Both major political parties are divided amongst
of the United States are paralleled by similarly aggres- themselves over Brexit. The Conservative party is
sive behaviour towards allies. Using the argument that openly split into camps of increasing mutual hostility.
Europe contributes too little to the costs of NATO and The extreme pro-Brexit faction wants a clean break
the United States too much, Trump has sustained a from the European Union, are prepared for no deal,
verbal assault on Europe, limbering up at the G7 mee- and are pressuring the government not to make
ting in Taormina in May 2017, and more recently erupt- concessions on migration in return for access to the
ing at a NATO summit in July 2018, where he deman- Single Market. Theresa May’s government, surviving
ded that members increased their military spending with a small majority and reliant on the support of the
to 2 percent of GDP by January 2019, in comments that Democratic Unionist Party (DUP) in Northern Ireland,
some commentators interpreted as a threat to with- has been trying to keep a majority of Members of
draw from the organisation, notwithstanding Trump’s Parliament (MPs) onside, making some concessions
later assurance that he fully supported it.3 The Ger- to satisfy the Brexit extremists, while simultaneously
man Chancellor Angel Merkel commented after Taor- trying to limit economic disruption.
mina that: “We Europeans truly have to take our fate The Labour Party has maintained an equivocal
into our own hands ...”.4 Trump’s words have raised position on Brexit. The party’s membership includes
questions about whether NATO will survive, and have many younger people who support staying in the
undermined any deterrence effect it may have by thro- European Union and older people in former indus-
wing into doubt the commitment of the United States trial areas who strongly support Brexit. Some MPs
represent constituencies that voted to remain, while
3
Washington Post, 12 July 2018, “At NATO, Trump claims allies
make new defense spending commitments after he upends summit”,
others represent Brexit strongholds. A cross-party
https://www.washingtonpost.com/world/europe/trump-upends-na- group of pro-European MPs are arguing against Brexit
to-summit-demanding-immediate-spending-increases-or-he-willdo-
his-own-thing/2018/07/12/a3818cc6-7f0a-11e8-a63f-7b5d2aba7ac5_
and campaigning for a second referendum. There has
story.html?utm_term=.982cd9a3c944. been talk of a new party being created to coordinate
4
Politico, 28th May 2018, “Angela and Jacques get frank with
Christoph”, https://www.politico.eu/article/angela-merkel-europe-
pro-European politicians and increase the influence
cdu-must-take-its-fate-into-its-own-hands-elections-2017/. of this large, but currently disparate group.
EEAG Report 2019 79CHAPTER 4
While most of the analyses of the effects of Brexit were bedevilled from the start by the unrealistic and
have dealt with the effects on the United Kingdom, conflicting aims of the UK negotiators, the ‘red lines’
some have examined its effects on the European imposed by the UK government, the weak position
Union. The IMF (2018) finds that, in the event of ‘hard’ of the government operating as a minority and sur-
Brexit, long-term output and employment in the viving with the support of the DUP, and the problem
European Union may fall by around 1.5 percent and created by Northern Ireland. They eventually con-
0.7 percent respectively, relative to what they would cluded in November 2018, with the publication of a
have been otherwise; and to a much lesser degree in draft agreement5 and a brief political statement on
the event of a ‘soft’ Brexit. These estimates are on the future relationship between the United Kingdom
roughly the same scale as those of other studies. Of and the European Union. But these agreements were
course, the effects differ from member to member. only put to a vote in the UK parliament in mid-Janu-
Ireland may suffer a 4.0 percent fall in output under ary 2019. A scheduled vote on 11 December 2018 was
a WTO scenario in the long term, while the Nether- withdrawn by the government, anticipating that it
lands, Denmark, and Belgium would see a roughly would be comprehensively defeated by a combination
1.0 percent fall. Other members’ costs would be of extreme Brexiteers, arguing for a clean break with
smaller. Losses under a free-trade-area scenario are the European Union, pro-Europe MPs aiming for closer
somewhat smaller. integration, or indeed, the idea of abandoning Brexit
While the economic effects of Brexit on the Euro- altogether, and Democratic Unionist Party (DUP) MPs
pean Union are small, the political effects may be gre- dissatisfied with the possible appearance of any diffe-
ater. Whether these effects will be positive or negative rences in treatment of Northern Ireland and the rest
remains an open question. Early on, Brexit may have of the United Kingdom. The suspicion of any kind of
been feared as an existential threat to the European border in the Irish Sea between Northern Ireland and
Union. Had the United Kingdom shown that leaving Great Britain is anathema to the DUP.
was beneficial – if the United Kingdom had been able The European Union insisted from the start that
to have its cake and eat it, as in the Brexiters’ fantasy – changes to the relations between the Union and the
it may have led to a rush for the door and a disinteg- United Kingdom should proceed in stages; that first
ration of the European Union. Indeed, this prospect the terms of the UK’s withdrawal should be agreed,
may have stiffened the EU’s resolve to take a firm line and only after that should the longer-term future
in negotiations and prevent any mass exodus from relations be negotiated. Accordingly, the withdra-
happening, insisting on the inseparability of the four wal agreement provides for a transition period from
freedoms (of movement of labour, capital, goods, and 30 March 2019 until 31 December 2020 (with the possi-
people) in the Single Market. bility of an extension of up to two years) in which little
In the event, the accumulating evidence that will change, in terms of trade and other relations. The
the United Kingdom is shooting itself in the foot by United Kingdom continues effectively to be a part of
leaving may strengthen rather than weaken the re the European Union, except that it loses its ability
maining 27-member union. Simon Kuper in the Finan- to take part in any EU decision-making. Freedom
cial Times notes that populists across Europe have of movement between the United Kingdom and the
dropped the idea of leaving the European Union: Marine European Union is preserved through the end of the
le Pen, Geert Wilders, Matteo Salvini in Italy, Syriza in transition period, and most of the rights of EU citizens
Greece (Kuper, 2018). The United Kingdom has long in the United Kingdom and UK citizens in the European
been seen in some quarters as a difficult member, Union are preserved. The United Kingdom continues
seeking successive opt-outs, Margaret Thatcher’s to be a member of the Single Market, and to maintain
rebate, and special arrangements, resisting further EU social and environmental protection, and abide by
inte
gration, advocating widening membership as EU limits on state aid. The United Kingdom can begin
a force against deepening. As the prime minister of to negotiate trade deals with other countries during
Luxemburg, Xavier Bettel, remarked, “Before, they the transition period, though these should not come
were in and they had many opt-outs; now they want into effect until after a new long-term relationship
to be out with many opt-ins.” The United Kingdom with the European Union has been agreed.
has attempted to limit the European Union to a trad The most contentious element of the withdrawal
ing agreement, rather than a political union. The agreement has been the Northern Ireland backstop.
remaining members may be able to pursue further The Good Friday Agreement of 1988, which ended
integration without the United Kingdom holding them decades of sectarian violence in Northern Ireland,
back. The UK’s departure may weaken arguments provided for the removal of a hard border between
for open markets and competition and increase the the Republic of Ireland and Northern Ireland, as both
relative strength of the more corporatist tendencies, were part of the EU customs union and, in due course,
represented by France, Italy, and southern European the Single Market. Border posts were much resented
members. and had been the object of attacks by the IRA and uni-
Negotiations between the United Kingdom and 5
Available at: https://ec.europa.eu/commission/sites/beta-politi-
the European Union on a withdrawal agreement cal/files/draft_withdrawal_agreement_0.pdf.
80 EEAG Report 2019CHAPTER 4
onist forces in the preceding decades. The Republic of abundantly clear that a no-deal Brexit would be much
Ireland, which may be very badly affected by Brexit, worse than withdrawal under the agreement, except
campaigned successfully for the European Union to in the view of a small number of extreme Brexiteers
insist that Brexit would not involve the re-instatem- and members of the DUP.
ent of any such physical border on the island of Ire- The United Kingdom finds itself in a position in
land. This presents obvious problems should the Uni- which the negotiated withdrawal agreement is likely
ted Kingdom leave the EU customs union and Single to be voted down in the UK House of Commons when
Market. Consequently, the backstop provides that put to a vote in the middle of January 2019, as is now
until the United Kingdom and European Union have scheduled. The European Union has ruled out making
concluded a long-term relationship that would avoid any further changes to it, although the UK Prime
any need for a physical border, Northern Ireland will Minister, Theresa May, has stated that she is seeking
remain in the customs union and in the single mar- stronger reassurances on the Irish backstop. Signi-
ket, as far as most goods are concerned. However, to ficant changes to the agreement seem unlikely. The
avoid creating a need for customs checks on goods alternatives are that the United Kingdom could leave
moving between Northern Ireland and the rest of the the European Union without an agreement, or that
United Kingdom (Great Britain), under the backstop, Brexit might be abandoned altogether.
the whole of the United Kingdom will remain in the The UK government has recently stepped up
customs union. Some checks on goods moving bet- preparations for a no-deal Brexit, setting aside GBP
ween Northern Ireland and the United Kingdom will 4.2 billion to cover the costs of these preparations,
be needed, but they can be carried out at other ports which include putting 3,500 troops on standby in case
and manufacturing plants. of disturbances. Businesses in the United Kingdom
Despite the ingenious compromises involved in are aghast, and many people are incredulous. The
the proposed backstop, the various constraints on European Union is also doing some planning for the
which have left little room for manoeuvre in negoti- contingency of a no-deal Brexit. While a substantial
ations (which have been an exercise in squaring the majority of members of the UK parliament appears
circle), it has generated furious opposition; from the to be firmly opposed to a no-deal Brexit, and a subs-
DUP on account of the remaining modest checks on tantial number in favour of no Brexit, they are distri-
the flow of goods across the Irish sea, and the possibi- buted across the political parties, and seem unable
lity of slightly different treatment of Northern Ireland to coordinate their actions. The equivocal position of
from the rest of the United Kingdom; and from hard the main opposition party, Labour, regarding Brexit
Brexiteers in the United Kingdom, on account of the is a major obstacle to ensuring a soft Brexit or no Bre-
possibility that, if the United Kingdom and European xit at all. There is a widely-held view that a ‘no-Bre-
Union fail to conclude a longer-term arrangement xit’ could only be achieved if legitimised by a second
obviating the need for border checks between the referendum; but holding one in itself introduces risks.
Republic and Northern Ireland, the United Kingdom There is the unsettled question as to what options
may be locked into the EU customs union indefinitely. should be on the ballot paper, which may be compli-
The European Union as a whole, and the Republic of cated if a three-way choice is offered; a referendum
Ireland in particular, have refused to allow the Uni- is likely to take some time to set up, necessitating a
ted Kingdom to exit from the backstop unilaterally postponement at the very least; and its outcome is far
and insist on its being by mutual agreement. They from certain. While there have been shifts in opinion
have also refused to include an end-date. Despite among the UK electorate, it is not clear that support
assurances that the European Union does not wish for either a soft or no Brexit would clearly win.
to see the backstop implemented and that it wishes On balance, it appears that a UK withdrawal along
to keep any period of its implementation as short as the lines of the negotiated agreement is the most
possible, proponents of hard Brexit have not been likely outcome, although a ‘no-deal’ or a ‘no-Brexit’
satisfied and threaten to vote against the withdrawal outcome is still possible. In the case of a negotiated
agreement. agreement, there will be few immediate effects on
One of the many problems is that the draft With- trade flows, or migration, and an interval of 21 months
drawal Agreement (WA) makes it very clear that mem- (possibly extended by another 24) in which the United
bership of the European Union is better for the United Kingdom can negotiate its longer-term relationship
Kingdom than withdrawal from it. The only possible with the European Union.
advantage from the UK’s point of view is that Brexit
may eventually, after the end of the transition period 4.3 THE RISE OF CHINA
and exit from the Northern Ireland backstop, permit
greater limits on migration into the United Kingdom In the debate over the economic and political future
from the European Union. Any such benefits are, of of Europe, the fact that the global balance of power is
course, hotly contested, and in any case it is clear that shifting towards Asia, and especially towards China,
reintroducing such controls would come at consider- is a key factor. In recent decades various countries
able economic cost. At the same time, it has become in East Asia have achieved spectacular growth rates.
EEAG Report 2019 81CHAPTER 4
But the rise of China is the Figure 4.1
most important development, GDP of China, the European Union, India, and the United States since 1980
not only because of the size China India
of the country, but also due United States European Union
Billion int'l dollar, PPP adjusted
40 000
to its particular political and
economic system.
Figure 4.1 compares the
30 000
development of GDP over
time in the United States, the
European Union, India, and 20 000
China, measured in purcha-
sing power parity. According to
this metric China overtook the 10 000
European Union as the world’s
largest economy in 2015. India
0
is also catching up but at a
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
much lower pace, although its
Source: IMF, World Economic Outlook (October 2018). © CESifo
growth is expected to pick up
in the years to come. Figure 4.2
shows the size of GDP in current Figure 4.2
US dollars. Here, the econo- GDP of China, the European Union, India, and the United States since 1980
mies of the United States and China India
the European Union are still United States European Union
Billion US dollar
30 000
larger but China is catching up
quickly.
The rapid growth of China,
and to a lesser extent India too, 20 000
is leading to a massive shift of
weight in the world economy
towards Asia. Figure 4.3 shows
how the relative shares of glo- 10 000
bal GDP have changed over
time, again measured in terms
of purchasing power parity.
0
In 1980 the European Union
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
represented almost a third of
Source: IMF, World Economic Outlook (October 2018). © CESifo
the world economy. Together
with the United States, it pro-
duced over half of global GDP, Figure 4.3
while China’s share was negli- Share of World GDP of China, the European Union, India, and the United States
gible. In 2000, the EU’s share since 1980
was still almost a quarter and China India
United States European Union
that of the United States was 35
%, PPP adjusted
20 percent. China’s share was
just over 7 percent. By 2023 30
the share of the European 25
Union and the United States
will have fallen to 15 percent 20
respectively, while China will 15
account for over 20 percent of
world output. China and India 10
together will represent one 5
third of the world economy,
0
according to an IMF forecast.
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
How is China’s growth
Source: International Monetary Fund, World Economic Outlook (October 2018). © CESifo
reflected in living standards?
Figure 4.4 shows the catch-up
process in per capita income. In 1980 per capita In 2003 it reached the 10 percent threshold and in
income in China was just 2.5 percent of the US level. 2023 it will reach almost a third. The discrepancy is
82 EEAG Report 2019CHAPTER 4
Figure 4.4 expected to continue, there
GDP per Capita of China, the European Union, India, and the United States since 1980 are also more sceptical assess-
China India ments. For instance, in his
Int'l dollar, PPP adjusted
United States European Union paper ‘Growing and slowing
80 000 down like China’, Zilibotti
70 000 (2017) argues that China faces
a number of challenges that
60 000
might slow down its growth.
50 000 He emphasises that China has
40 000 arrived at a critical point in its
economic development, where
30 000
the catching up process needs
20 000 to change from ‘investment
10 000
led growth’ to ‘innovation
led growth’. The concept of
0 investment led growth refers
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
to a situation whereby capital
Source: IMF, World Economic Outlook (October 2018). © CESifo
accumulation and the adapta-
tion of existing technologies
still large, but shrinking. It should also be taken into and knowledge is enough for a country to catch up
account that there are huge differences in econo- economically. But beyond a certain level of economic
mic development within China. The most highly-de- development, this is no longer enough. “At this junc-
veloped provinces have per capita incomes not far off ture, the focus on physical capital accumulation gives
those of advanced countries, while living standards way to human capital and innovation” (Zilibotti, 2017,
in the less developed provinces are closer to those in p. 948). In addition, the state of China’s economic
developing countries. Of course, this heterogeneity is per capita income – roughly one third of the leading
a feature of most developing and emerging economies industrialised countries, is sometimes referred to as
and not just China. the ‘middle income trap’ (Eichengreen et al., 2014).
Clearly, a key question is whether the economic The Chinese government is well aware of these
development of China can continue at the same pace challenges. In its 2015 work report, the government
in the future. In recent years, China has experienced explicitly mentions that the country faces consider-
a slowdown in growth rates, which is widely expected able challenges and needs to: “avoid falling into the
to continue, but the economy is still growing at rates ‘middle income trap’, and achieve modernisation …”.6
of around 6 to 7 percent (Figure 4.5). Given the size of As a result of this insight, the Chinese government has
Chinese GDP, this is still a very dynamic development. decided to invest heavily in research and science and
While there is a consensus that Chinese growth to pursue an industrial policy strategy called ‘Made in
rates will be smaller in the future, the open question China 2025’, aimed at developing China’s manufactu-
is whether the country will continue to catch up in ring sector. We will describe and discuss this strategy
terms of per capita incomes, and how fast this pro- further below.
cess will be? While the catching up process is widely
4.4 WHAT IS THE ECONOMIC
Figure 4.5 IMPACT OF THE RISE OF
Real GDP Growth Rates in China and India since 1980 CHINA ON EUROPE?
China India
% The rise of China affects
16
Europe in many ways – it
14 affects not just the European
12 Union, but also the rest of the
world and its relations with
10
Europe. The rise of China has a
8 profound impact on the world
economy and on the global
6
balance of political power. The
4 opening up of China has led to
the integration of hundreds
2
of millions of people into the
0 world economy. This has led to
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
6
Report on the Work of the Govern-
Source: International Monetary Fund, World Economic Outlook (October 2018). © CESifo ment (2015), p. 9.
EEAG Report 2019 83CHAPTER 4
a huge increase in the supply Figure 4.7
of labour, but the Chinese Exports of Goods and Services of the European Union and the United States to China,
population also has a growing 2000‒2017
weight as a consumer. In the European Union United States
rest of the world the impact of Billion US dollar
250
the opening up of China was an
initial increase in trade. Later, 200
capital movements moved
to the focus of the debate.
150
European and US companies
have been active as investors
100
in China for a long time. More
recently Chinese outbound
50
foreign investment started
growing. A more recent impact
0
is through China’s role as an
2000 2002 2004 2006 2008 2010 2012 2014 2016
emerging power in science
Source: UN Comtrade. © CESifo
and technology. We will briefly
discuss each of these factors
below. The availability of cheap products from China has
increased worldwide consumer welfare enormously.
4.4.1 Trade with China But many companies competing with Chinese pro-
ducts have been put under intense competitive pres-
Within a relatively short period of time, China has sure, forcing them to restructure or even to shut down.
become the world’s largest exporter of goods and This has led to job losses and falling wages, especially
services, overtaking big exporters like the United for low-skilled workers in advanced economies.7
States, Japan, and Germany. Figure 4.6 illustrates the At the same time, China’s imports have created
growth of imports from China for the United States opportunities for companies in other countries. In
and the European Union. Europe, for instance, producers of luxury goods,
At the same time, China has become the world’s sophisticated machinery and premium cars found
second largest importer of goods and services, after new sales markets in China. This protected existing
the United States. Exports of the United States and the jobs in Europe or led to the creation of new ones. For
European Union to China are illustrated by Figure 4.7. many companies, the opening up of China also cre-
The integration of China into global trade has had ated opportunities by providing cheap intermediate
a profound impact on Europe, as well as the rest of the goods.
world. It is one of the fundamental insights of interna- The gains and losses due to increasing global
tional economics that trade integration will increase trade differ considerably not just across individuals
global welfare. But the gains may be distributed une- and firms, but also across sectors, regions, and coun-
venly and there may be groups in the economy who tries. There is a growing body of literature investi-
lose out as a result of trade liberalisation. gating how large changes in international trade, like
the opening up of China or the
Figure 4.6
transition of the formerly com-
Imports of Goods and Services of the European Union and the United States from munist countries of Eastern
China, 2000‒2017 Europe, have affected different
workers, sectors, and regions.
European Union United States
Billion US dollar Various studies on the United
600
States have shown that indus-
500 tries competing with Chinese
imports have suffered, as have
400 regions where these industries
were concentrated (Autor et
300 al., 2013). Trade liberalisation
is also widely considered to
200
7
Clearly, trade is not the only – and
100 may not even be the most important –
factor leading to the decline of manu-
facturing jobs and falling wages for low
0 skilled labour. Technological change
2000 2002 2004 2006 2008 2010 2012 2014 2016 plays a key role as well. Of course, trade
and technological change are interde-
Source: UN Comtrade. © CESifo pendent.
84 EEAG Report 2019CHAPTER 4
be a key factor driving the decline in manufacturing industries in the United States was stronger and more
employment in the United States.8 Autor et al. (2013) negative than in Europe. But in both regions the ‘China
refer to these effects as the ‘China syndrome’. In a shock’ underlines the fact that trade integration crea-
recent study Caliendo et al. (2018) find that the China tes winners and losers, and these two groups tend to
trade shock led to a reduction of 550,000 US manu- cluster regionally, which means that entire regions or
facturing jobs. This is equal to about 16 percent of the even countries may be winners or losers. It is import-
observed decline in US manufacturing employment ant to note that the overall impact of increasing trade
between 2000 and 2007. Pierce and Schott (2016) find also depends on the ability of economies to adjust
a link between trade policy changes reducing the like- and create new jobs. Different European countries
lihood of tariff increases on Chinese imports and the have had very different experiences in this regard (see
decline in US manufacturing. Chapter 2).
Empirical studies for Europe show a slightly dif-
ferent pattern. Dauth et al. (2014) investigate how 4.4.2 Investment Flows
trade liberalisation with Eastern Europe and China
has affected firms and workers in import competing Trade in goods and services is linked to investment
industries in Germany. Their key finding is that the flows, particularly in cases where trade imbalances
impact of competition from Eastern Europe was stron- arise. In general, irrespective of trade balances, capital
ger than that of import competition from China. The mobility is another potential source of global welfare
reason is that the pattern of specialisation in German gains. Again, the potential for welfare gains through
industry was such that imports from China were less capital movements does not imply that everybody will
of a threat than in other countries. For instance, the benefit.
textile industry had largely vanished in Germany even For a long time China was a net capital expor-
before the integration of China into global trade. The ter. That is surprising in so far as one could expect a
other interesting finding is that many German firms developing country like China in the 1980s and 1990s,
were able to benefit from export opportunities crea- with abundance of labour rather than capital, to
ted by the liberalisation of trade with Eastern Europe import capital from the industrialised world. But the
and China. Overall, Dauth et al. (2014) find that trade more common empirical pattern is that successful
liberalisation led to a net increase in employment in economic development often goes along with a strong
Germany amounting to 442,000 jobs, suggesting that focus on exports and regulated capital markets,
German workers have been winners of globalisation in which limit foreign capital inflows, leading to current
recent decades. However, most of this effect is due to account surpluses. This development strategy requi-
trade with Eastern Europe, not China. res that domestic savings are large enough to finance
Badinger and Reuter (2017) investigate the impact domestic investment, as well as the current account
of trade with China and Eastern Europe for regions in surplus.
17 Western European countries for the period 1991- Figure 4.8 shows the development of savings
2011. Their findings confirm that jobs were lost in and investment in China since the 1980s. Since the
import competing regions, while regions with indus- early 1990s, savings have consistently exceeded
tries benefitting from export opportunities experien- domestic investment. In recent years the difference,
ced growth in manufacturing jobs. Overall, job gains which is equivalent to the current account balance,
and losses balanced out. There is, however, consider- has declined. However, the many years of surpluses
able heterogeneity across countries. France and the imply that China has accumulated a significant stock
United Kingdom are identified as the countries with of investment in foreign assets.
the largest losses. Germany, in contrast, also lost jobs Of course, the current account surplus only
due to trade with China, but that was overcompen- reflects the change in net foreign assets. From an
sated for by job growth in firms exporting to Eastern economic perspective, the gross capital flows are at
Europe. Of course, the effect of trade on manufactu- least as important. Since there is considerable foreign
ring employment is only one aspect of the consequen- investment in China, gross foreign assets held by Chi-
ces of trade shocks. A key issue is the ability of the eco- nese investors have also grown.
nomy to generate other job and growth opportunities, It is well known that China holds a significant
particularly in the service sector. Clearly, new jobs in share of its foreign assets in US government bonds.9
the service sector may be less well paid or require dif- However, it has been part of the explicit economic
ferent qualifications and greater flexibility than those policy strategy of China for several years to diversify
lost in the manufacturing sector. In particular, older the country’s foreign asset holdings. In recent years
employees may find it difficult to adapt. Some may Chinese companies have become increasingly active
also prefer early retirement to moving or retraining. as international investors. Figure 4.9 illustrates the
Overall, the literature on the impact of trade with 9
In August 2018 the stock of US government bonds held by foreign
China suggests that the shock for import competing investors was 6.2 trillion US dollar, or roughly 30 percent of the overall
outstanding debt of the US federal government. 1.16 trillion US dollar
8
Between 1944 and 2015 the share of manufacturing in US employ- were held by Chinese investors, primarily by the Chinese central bank,
ment declined from 39 percent to 8.6 percent (Autor et al., 2016). available at: http://ticdata.treasury.gov/Publish/mfh.txt.
EEAG Report 2019 85CHAPTER 4
development of China’s outbound and inbound For- ted for 2.8 percent of China’s GDP. By 2017 this figure
eign Direct Investment (FDI). Until the mid-2000s Chi- reached 12.8 percent. Although the volume of FDI in
nese outbound FDI was negligible. In 2005 it accoun- China is larger, it is growing more slowly. In 2005 it
totalled 20.6 percent of China’s
Figure 4.8 economic output and in 2017 it
Savings and Investment in China since 1980 amounted to 24.3 percent. Its
Total investment Gross national savings share in Chinese GDP has been
% of GDP
55 roughly constant since 2009.
Foreign investment is still
50
growing, but not more quickly
than Chinese GDP.
Figure 4.10 illustrates the
45
geographical distribution of
Chinese outbound foreign
40 direct investment. Almost
three quarters is located in
35
other Asian countries. Only
7.6 percent goes to Europe.
While the volume of Chi-
30
nese foreign direct invest
1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
ment in Europe is still low, it
Source: IMF, World Economic Outlook (October 2018). © CESifo
is expanding rapidly. A large
share of this investment takes
Figure 4.9 the form of mergers and acqui-
Inward and Outward FDI Stocks in China since 2005 sitions. Figure 4.11 shows that
Inward Outward takeovers of European com-
% of GDP
30 panies by Chinese investors
have increased considerably
25 in recent years.
Some of these acquisi-
20 tions have attracted consider-
able attention in the public
15 debate. A recent Bloomberg
story entitled “How China is
10 buying its way into Europe”10
reports that Chinese inves-
5
tors have taken over approxi-
mately 360 companies since
0
2008, ranging “from Italian
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
tire maker Pirelli & C. SpA to
Source: OECD, Foreign Direct Investment Stocks Data. © CESifo
Irish aircraft leasing company
Figure 4.10 Avolon Holdings Ltd., while
Chinese Outward Foreign Direct Investment Stock in 2017 Chinese entities also parti-
ally or wholly own at least
Asia
four airports, six seaports,
3%
5% South America
wind farms in at least nine
3% countries and 13 professional
Europe
7% Oceania soccer teams.”11 In Germany
North America the Chinese takeover of the
Africa industrial robot producer
12%
Kuka attracted a lot of atten-
tion. Chinese investors have
also acquired significant sta-
kes in car companies, inclu-
70% ding Daimler in Germany and
Peugeot-Citroen in France.
10
Available at: https://www.bloomb-
erg.com/graphics/2018-china-busi-
ness-in-europe/.
Source: OECD, Foreign Direct Investment Stocks Data. © CESifo 11
Ibid.
86 EEAG Report 2019CHAPTER 4
Figure 4.11 private companies, have made
Merger and Acquisition Activities of China in Europe, 2006‒2017 considerable efforts to invest
Number of Deals (left) Volume (right) in research and development.
Million US Dollar
Figure 4.12 shows that the
350 90 000 share of spending on research
300
80 000 and development is still higher
70 000 in countries like Japan, the
250 United States, Germany, and
60 000
even in the EU-28, but China
200 50 000
is catching up. Gaining ground
150 40 000 in science and technology and
30 000 eventually taking over a lead
100
20 000 ing role is a key objective of
50 Chinese economic policy.
10 000
In 2015 the Chinese State
0 0
Council launched its ‘Made in
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
China 2025’ initiative, which it
Source: Ernst & Young (2018). © CESifo
defines as “the country’s first
ten-year action plan focusing
13
A further important characteristic of Chinese on promoting manufacturing.” In his report on the
foreign investment is a growing interest in infrastruc- work of the government in 2015, Chinese Prime Minis-
ture investments. For instance, Chinese state owned ter Li Keqiang summarised the objective of Made in
companies like the China Ocean Shipping Company China 2025 as follows: “We will … upgrade China from
(COSCO) and China Merchants Port Holdings have a manufacturer of quantity to one of quality” (Report
acquired cargo terminals and other facilities or on the Work of the Government, 2015, p. 26).
taken over management functions in various ports in
Europe including in Malta, Antwerpen, Zeebrugge, and The key elements of the plan are as follows:
Pireaus. Chinese infrastructure investment in Europe
and other parts of the world is often linked to China’s “Nine tasks have been identified as priorities:
‘Belt and Road’ initiative, which aims to revolutionise improving manufacturing innovation, integrating
economic exchanges between Asia and Europe by technology and industry, strengthening the indust-
expanding road networks, rail links, ports, and com- rial base, fostering Chinese brands, enforcing green
munication and energy networks. China Merchants manufacturing, promoting breakthroughs in ten key
Port Holdings explicitly points out that its subsidiary sectors, advancing restructuring of the manufactu-
Terminal Links “operates a network of terminals with ring sector, promoting service-oriented manufactu-
a global reach including Far East, North Europe, Medi- ring and manufacturing-related service industries,
terranean, West Africa and North America, among and internationalising manufacturing.
them, Terminals including Malta Freeport Terminal
are important hubs along the ‘One Belt and Road’ 13 Available at: http://english.gov.cn/policies/latest_releas-
layout.”12 es/2015/05/19/content_281475110703534.htm.
4.4.3 China’s Growing Role Figure 4.12
in Science and Technology Spending on Research and Development for Selected Countries, 1995‒2016
Germany Japan South Korea
Together with its growing role United States EU-28 OECD
in international trade and % of GDP
China
5
border crossing investment,
China has also gained
importance as a global player 4
in science and technology.
Just two decades ago, China 3
was primarily a producer of
low tech goods in the lower 2
quality segment. But this has
changed. The government, 1
as well as state-owned and
12
0
Available at: http://www.cmport.
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
co m . h k / E N / b u s i n e s s / D eta i l . a s px-
?id=10000819. Source: OECD Science, Technology and R&D Statistics. © CESifo
EEAG Report 2019 87CHAPTER 4
The above ten key sectors are: tive democratic control, that it will fail to do justice to
the diversity of Europe and that it would only under-
1. New information technology mine political support for the European Union.
2. High-end numerically controlled machine tools Clearly, different EU member countries will have
and robots rather different perspectives on the pros and cons
3. Aerospace equipment of deeper economic and political integration. Those
4. Ocean engineering equipment and high-end member states who have done well economically
vessels may be more likely to favour intensified economic
5. High-end rail transportation equipment integration. Those doing less well may ask for more
6. Energy-saving cars and new energy cars political integration, in the hope that this will lead to
7. Electrical equipment greater redistribution. Yet others may expect little
8. Farming machines from “more Europe” and reject both.
9. New materials, such as polymers There is a large body of literature in economics
10. Bio-medicine and high-end medical equipment. that discusses the advantages and disadvantages of
decentralised versus centralised decision making in
The country should also further open up its market federations and confederations like the European
and attract foreign investors to invest in key areas, Union. The advantages are primarily economies of
such as the development of new information scale in the provision of public goods and the inter-
technology and bio-medicine, and foreign companies nalisation of spill-overs. The advantages of decen
and institutions should be encouraged to set up R&D tralised policy making are that the political process is
centers in China.”14 closer to the citizens; that decentralisation allows for
China’s efforts to invest in research and develop- learning from policy experimentation; and that diffe-
ment and to upgrade its large manufacturing sector rences in preferences across regions or countries are
have given rise to a number of concerns in other coun- more likely to be taken into account.
tries. Foreign companies have pointed to the risk that In addition, whether centralised or decentrali-
‘Made in China’ may lead to more protectionism and sed policy making is preferable also depends on the
import substitution. At a more fundamental level, quality of economic policy making. Those who think
there are growing fears, particularly in the United that governments tend to tax and regulate too much
States, that China may overtake others and become largely favour decentralisation, because mobility
the leading country in science and technology, with across borders leads to inter-jurisdictional competi-
far reaching economic and geopolitical implications. tion and limits the powers of governments. Of course,
In Europe the debate is generally more positive and mobility across borders itself depends on joint poli-
recognises that the rise of China generates not only cies. Those who think that governments primarily do
risks, but also significant opportunities. desirable things and correct market failures tend to
reject intergovernmental competition caused by the
4.5 POLICY IMPLICATIONS FOR EUROPE mobility of resources. Clearly, the perception of the
quality of government both at the national and the
How should the European Union react to and adapt European level is likely to differ across EU member
to the changing external economic and political states.
conditions described in the preceding sections? We How does the optimal degree of centralisation
have discussed three important developments. The and decentralisation change as a result of changes
first is the shift in US policy towards protectionism in the external environment? Does the rise of China,
and away from rule-based international trade as Brexit or the decline of US leadership in security
represented by the WTO as well as the growing US policy require the European Union to centralise or
critique of Europe’s inadequate contribution to decentralise?
common defence efforts, and particularly to NATO. For some policy areas the answer seems stra-
The second is the necessity of dealing with the United ightforward. International security and military pro-
Kingdom as an external partner after Brexit. The third tection can be seen as an international public good.
is the rise of China. If the US supplies less of this good and Europe can do
Those who advocate “more Europe” argue that nothing about this, the rational answer for the Euro-
individual EU member states are too small to play a pean Union is to supply more. Since there are massive
role at the global level. Here the idea is that Europe economies of scale in this policy area, the conclusion
can only be successful if it is united and speaks with is that “more Europe” in defence and foreign policy
one voice. This suggests that member states should is needed. This would, of course, come at the price of
shift responsibilities to the European level. reducing scope for individual member states to pur-
Critics point out that greater centralisation of sue their own foreign and security policy. But if it is
political decision making is incompatible with effec- correct that even countries like France do not have
14
Available at: http://english.gov.cn/policies/latest_releas-
enough weight to be effective as a geopolitical, or
es/2015/05/19/content_281475110703534.htm. even a regional power, this price is small.
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