The EU, US and China are all getting more assertive. Can UK compete?

We have had 40 years of broad consensus among “western” democracies on open economies, largely unfettered globalisation and limited state intervention in the economy.

That period is over.

Because of three closely linked imperatives:

Tackling climate change;

Boosting economic autonomy;

Defending our democracies against outside threats.

Climate cash

First, major state intervention is a prerequisite for successful climate policies. Transforming industry towards greener production and helping consumers to afford electric cars and heat pumps require government investment, incentives and subsidies.

Keeping control

The second reason for increased intervention in the economy is to reduce dependence on authoritarian and/or unpredictable states. As French MEP Raphael Glucksmann recently said: "We have become consumers. Consumers of American security, (ex) consumers of Russian energy, consumers of Chinese products. We need to be producers again”.

The EU and others are using various policy instruments to wean themselves off Russian gas, with some success.

But China currently has a near monopoly on many of the rare earths and intermediate technologies needed to produce chips and semi-conductors, batteries (crucial for electric cars) and solar panels. Free markets and free trade alone will not cut reliance on Chinese components any more than they were sufficient to diversify from Russian gas.

The looming ‘cold war’ between the US and China could – along with other alarming implications - lead to trade conflicts and supply chain disruption. This will no doubt reinforce the EU’s will to seek greater economic autonomy, though it will remain a US ally.

Staying free

The third driver for renewed state intervention is the need for effective defence and security. Some of the technologies on which the modern military depends are precisely those where supply chains could be blocked by unreliable partners. Equally, it is hard to deploy effective economic sanctions against rogue states if we depend on components from the very states we are seeking to sanction.

The IRA – America first?

So the US’s momentous Inflation Reduction Act (IRA) is not only about controlling inflation. It is also about environmental ambition, economic control and national security. It is in part a belated response to China’s own radical “Made in China 2025 Plan”, whose implementation began in 2015.

The IRA is also highly protectionist. It is skewing global investment in the US’s favour. Other jurisdictions need to respond.

But how? There is no level playing field in geopolitics.  Only jurisdictions with huge markets and big financial firepower can compete with the US on subsidies and other incentives to invest. China can. The UK cannot. The EU might be able to, if it gets key strategic decisions right.

Insufficient, excessive or ineffective intervention in the economy could mean a catastrophic triple whammy for the EU: losing the battle to limit climate change, surrendering leadership of the West to the US and failing to cope with China (a challenge set out clearly by European Commission President Ursula Von der Leyen).

The EU response

So what has the EU done so far? On 18 April, the European Parliament agreed a deal with Member States on core elements of the Green Deal package proposed by the Commission in 2021.

This includes a carbon border tax on certain imports to the EU from countries with less stringent emissions rules. This will mean additional costs and red tape for UK exporters. The UK could also become a dumping ground for high-carbon goods. To prevent much of the damage, the UK may align its approach with the EU’s. Probably a good move. But hardly “taking back control”.

Negotiations between EU institutions are also advanced on the EU “Chips Act”, aiming to double the EU’s global market share in semiconductors.

Meanwhile, discussions on the Commission’s proposals for a specific response to IRA – the Green Deal Industrial Plan, Net Zero Industry Act and Critical Raw Materials Act – are getting under way.

And now 19 Member States are calling for a Critical Medicines Act to boost investment in sourcing pharmaceutical ingredients and producing drugs within the EU, reducing reliance on China and India…and making it harder for the UK to compete in this key industry.  

No more frugals?

One thing is clear. Even EU governments traditionally allergic to ‘meddling’ in markets now accept a need to expand the role of the state. For example, at a recent summit with President Macron, Dutch Prime Minister Mark Rutte – famous as a fiscal ‘frugal’ - signed up to declarations on industrial policy that he once would not have countenanced.  

Green imperatives, economic self-determination and security considerations are trumping national economic traditions and left-right divisions.

UK at sea?

In this world of green, interventionist and protectionist blocs, Brexit puts the UK at a triple disadvantage, creating a real risk that investment will be sucked out of its economy.

First, the UK acting alone cannot mobilise as much money to incentivise sustainable investment as bigger blocs can. Especially now that public finances have been hit by pandemic payouts, the Brexit hit to tax revenue and Liz Truss’s fiscal disaster. Neither can the UK coordinate economic intervention over such a wide area, bringing synergies and economies of scale to bear.  

Second, those resources that the UK can mobilise will not be as effective. The UK is less attractive to investors now that it has erected significant barriers to trade with the EU single market.

Third, the UK no longer benefits from the EU’s geopolitical clout. China, the US and others need to listen to the EU more than to the UK. 

Europe on the money?

The EU itself faces constraints that the US and China do not. Its central budget is minimal, about 1% of EU GDP or 2% of the combined 27 national budgets. Net contributor Member States will not vote for a big permanent increase. Agreement on major EU-level policy action is never easy.

But in recent years the EU has, in three ways, boosted its economic firepower. First, it has massively increased direct support, through European Commission grants and European Investment Bank loans, for strategic research and innovation and for cross-border infrastructure.

Second, the EU has begun to borrow jointly, with Germany and other former ‘frugals’ accepting for the first time a (limited) form of mutualised debt to finance the trillion euro Covid Recovery Plan.

Third, Member States are coordinating their use of national funds to get better results and better value. The EU’s collective purchase of Covid vaccines was a stand-out example. We are also seeing this coordinated approach with defence procurement (including for Ukraine) and green procurement.

Furthermore, relaxation of EU fiscal and state aids rules may make national level intervention easier.

Treasury mantras

We have an increasingly tripolar world. Those three poles are all getting more interventionist, more assertive and putting more money where their mouth is. The Made in China 2025 Plan, the US Inflation Reduction Act and the EU Green Deal are only the start.

The UK government has so far seemed isolated intellectually as well as economically and politically, trapped by outdated free market doctrines. As Times commentator Juliet Samuel puts it: “They sink comfortably into Treasury mantras: let others subsidise; we’ll deindustrialise.”

There is clear blue water with the Labour opposition, which is proposing to use state intervention to generate £28 billion a year in green investment. However, no government can make up the gap with the US, China and the EU. Because you cannot get the advantages of a vast single market without being in one.

Untenable isolation

UK isolation from the EU is likely to become ever more untenable as the EU becomes greener, more economically interventionist and more geopolitically strategic, in response to daunting global challenges.

The UK alone cannot meet those challenges. The EU might succeed. It would stand a better chance with the UK’s still considerable economic and political weight inside, provided Britain behaved as a constructive partner.

From reality check to real change

So stark macro-economic and geopolitical reality is likely, over time, to push a changed UK towards a closer relationship with a changed EU.

Micro-economic factors will push in the same direction: for how long can every company in, say, Liverpool operate behind barriers not faced by its counterparts in Lille, Leipzig or Ljubljana?

But the speed and extent of change will depend also on public opinion, effective campaigning and political leadership. That’s where European Movement UK comes in…..

by Mark English, policy adviser to EM UK