A new European mercantilism?

Bulletin article
01 August 2008

Europe’s economic liberals have had a successful ten years. There have been protectionist pressures throughout this period, of course. But there has been a pretty broad consensus that Europe benefits from open markets, and that it has little option but to become more open or else risk stagnation and accelerated relative decline. But protectionist instincts run deep across the EU. And there are signs that Europe could be about to turn inwards again.

Why is this happening? One factor is the immediate economic backdrop. The economic outlook is darkening rapidly, as EU countries suffer from higher prices and, in some places, collapsing housing markets. Declining eurozone exports suggest that the strength of the euro is starting to price European goods out of foreign markets. And the shift in the balance of global economic power towards Asia is accelerating. These trends are exacerbating already widespread economic insecurity.

There are underlying reasons too, however. The political elites in a number of big member-states have never really bought into the idea of free markets. For example, the classical arguments in favour of free trade – that an economy benefits from opening its markets even if others maintain restrictions – have few advocates in France, Italy and Germany. Underlying this scepticism is the idea that trade is a zero-sum game: that a country can only profit at someone else’s expense. Accordingly, the fact that the EU has a rising trade deficit with China must mean that trade with China is bad for Europe.

The belief that Europe’s openness is somehow to blame for its waning economic significance and for growing economic insecurity is now increasingly widespread across the continent. Leading European politicians such as the French president, Nicolas Sarkozy, and the Italian prime minister, Silvio Berlusconi, argue that Europe is at a disadvantage because it fails to defend its economic interests in the way other countries do. They present free trade as a threat to European industry and to the EU’s ability to maintain high health, environmental and safety standards.

Sarkozy may be pushing through various economic reforms at home. But he has criticised the EU’s trade policy as overly liberal and demanded a ‘Europe that protects’, to help insulate European citizens from globalisation. He has also criticised EU competition policy for putting European firms at a competitive disadvantage relative to companies in the US and Asia.

Italy’s economic problems are almost entirely home-grown. Nevertheless, Berlusconi prefers to criticise the Commission for doing too little to protect Europeans from the impact of globalisation, and for preventing EU governments from supporting national champions. His finance minister, Giulio Tremonti, has openly called for Europe to protect itself against ‘unfair’ competition from low-cost countries in East Asia and elsewhere.

But it is not just the usual suspects who are demanding action. Protectionist pressures are rising in countries that are usually seen as liberal. As the world’s biggest exporter of manufactured goods, Germany has gained hugely from globalisation, but the average German remains sceptical and increasingly hostile to foreign capital. Public opinion is turning leftwards, symbolised by a surge in support for the hard-left Linkspartei. The next German government could consist of a coalition between the SPD, the Linkspartei and the Greens. But whatever its composition, it is likely to oppose free trade in services inside the EU, and to be willing to intervene to maintain national ownership of German firms.

Spain became a leading European advocate of free markets under the previous government of José María Aznar, but the severe economic downturn now confronting the country will test the depth of its commitment to economic liberalism. The socialist government of José Luis Zapatero has already been found guilty of breaking EU competition law by attempting to prevent energy firm Endesa being bought by a German competitor, E.ON. It is not inconceivable that Zapatero will attempt to attribute mounting unemployment to globalisation and the EU’s ‘excessive openness’.

Britain alone among the big member-states has a broad national consensus in favour of free trade and competition. Past experience strongly suggests that this consensus will not be undermined by the present economic downturn. But Britain under Gordon Brown appears unwilling to set the agenda or lead in Europe. A disengaged Britain would be poorly placed to resist a broad-based reaction against open markets.

All of this spells trouble for Europe’s economic prospects. The evidence that Europe benefits from open markets is clear. After all, the European countries that are most open and liberal are also the wealthiest: the Scandinavians and the Dutch. Italy is not mired in economic stagnation because of China, but because of a lack of domestic competition and a sclerotic labour market. Workforces in Scandinavia and Holland are less fearful of globalisation than those in France and Italy because they are confident that they have the skills to benefit from economic change.

A backlash against liberalism could certainly strike a cord with European electorates, by tapping into their insecurity and anger at growing inequality. But protectionism would do very little to make Europeans more secure or to improve their economic prospects. The principal reason for rising inequality is the pace of technological change, which is reducing demand for low-skilled workers in developed economies. Open markets actually benefit European workers by making available cheap foreign-made goods and by boosting the competitiveness of their employers, who gain improved access to low-cost suppliers. Instead of erecting new barriers, European governments should redouble their efforts to ensure their workforces have the skills required by employers and they should launch a renewed drive to deepen the single market.

Less competition, combined with barriers to foreign capital and trade protection, would undermine the dynamism of Europe’s economy by slowing the pace of economic restructuring, cushioning inefficient firms and increasing costs. Far from being threatened by globalisation, Europe has a huge amount to gain from freer trade in goods and services, as well as open capital markets. But it will be poorly placed to argue the case for more openness if it turns in on itself. Indeed, an inward-looking Europe will have much less weight in the world.

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