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Aug 14, 2017 | 13:47 GMT

13 mins read

Trade Profile: The European Union Tries to Reconcile Its Differences

Notwithstanding their differences, the European countries as a bloc have achieved outsize clout in the global trade sphere.
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Editor's Note

Global trade is changing. The kinds of multilateral agreements that characterized the postwar years have stalled out over the past two decades, prompting countries and economic blocs to try to negotiate smaller deals with fewer partners. Nations and blocs have more leeway under this new model to negotiate the trade agreements that best suit their interests and to avoid those that don't. Now, more than ever, the future of international trade depends on a country or bloc's defensive interests, offensive interests and underlying factors of production. Our fortnightly Trade Profiles aim to break down these factors to facilitate an understanding of where global trade stands today and where it's headed.
 
In the seventh installment, we focus on the European Union.

A Snapshot of the European Union
Offensive and Defensive Interests

Economic Background

Over the past seven decades, the European Union has grown from a group of six Western European countries to a bloc of 28 member states spanning the Continent. And in the process, it has become a formidable force in global trade. The bloc, home to roughly 7 percent of the world's population, accounts for around 20 percent of global exports and imports today. The European Union is the largest exporter of manufactured goods and services in the world, the biggest export market for around 80 countries, and the global leader in both inbound and outbound international investment. But when crafting its trade strategy, the bloc must take into account the diverging priorities of individual member states, each of which has a distinct history, identity and economic profile.

When it comes to trade policy, EU members are split along regional lines. Rugged terrain and limited natural resources have made countries in Southern Europe such as Spain and Italy less competitive than their northern peers and more prone to adopt protectionist measures as a result. In the northern part of the Continent, by contrast, a more forgiving landscape and access to navigable waterways have encouraged states such as Germany and the Netherlands to focus on commerce, and today, they prioritize exports above all.

Similarly, different industries are important to different regions in the bloc. While many countries in Northern Europe built their wealth on trade, giving rise to large manufacturing bases and, later, business and financial services sectors, much of Southern Europe has kept true to its agrarian roots. Each region's industrial evolution, in turn, ties into national identity and goes on to influence the trade priorities of constituent states. France, for instance, shelters its agricultural sector and has pushed the European Union since the bloc's inception to adopt trade barriers and subsidies to protect the countryside and rural way of life it prizes. Along the way, the countries of Southern Europe have managed to turn their agricultural goods into lucrative exports: Greek feta, Italian Parma ham and French Champagne are sought after all over the world.

Notwithstanding their differences, the European countries as a bloc have achieved outsize influence in the global trade sphere. The gradually expanding European Union (and the European Economic Community before it), along with the United States, has been largely responsible for setting global trade standards throughout most of the post-war period. The two agreed to lower tariff barriers on manufactured goods, before moving on to tackle non-tariff barriers around the services sectors. The strategy suited the Northern European countries and their strong manufacturing and services industries. And since agriculture was a low priority in multilateral agreements, the Southern European states were able to keep their agricultural sectors largely protected.

The situation changed in the late 1990s, however, when rapidly developing countries such as China, India and Brazil emerged on the global trade stage with different objectives in mind. The capital-rich European Union, home to many multinational corporations, pursued competition, investment and government procurement opportunities in these up-and-coming nations, ensuring access to whatever their markets had to offer. The developing countries, meanwhile, worried that by conceding to Brussels, they could jeopardize their sovereignty. Instead, they pushed to discuss liberalizing agricultural trade, an area of interest for the emerging markets, most of which (with the exception of India) were agricultural exporters. The European Union took some steps to ease the way for increased agricultural trade — partly to accommodate the accession of new members, which would have made the existing system of agricultural subsidies unsustainable. Still, the differences between the developed and developing countries proved insurmountable. The World Trade Organization's Doha Round of negotiations collapsed in 2008 after seven years of stagnation, bringing the multilateral model of engagement down with it.

Bilateral and plurilateral trade deals soon became the standard. By then a seasoned veteran of bilateral negotiations, the European Union had a head start on the new trend. The trade bloc had spent decades brokering trade deals with single countries as a precursor to accession or as a way to gain regional influence. Mutualizing trade standards across its current and prospective members, moreover, was part and parcel of operating as a trade bloc and, later, a single market.

The European Union extended this practice to trade partners outside the bloc, as well, forcing countries from North Africa to the Caribbean to conform to its standards to sell their goods on the massive EU market. The European Union's standards are some of the strictest in the world. According to its so-called "precautionary principle," for example, the European Union errs on the side of safety when considering products that may prove harmful, even if scientists have not yet found them deleterious to human or environmental health. The bloc, unsure of the products' long-term effects, has banned imports of agricultural goods such as genetically modified produce and hormone-treated beef. The policy and others like it at times have been hard for comparatively laissez-faire trade partners such as the United States to swallow. Nevertheless, by pushing its standards as a precondition for entering its market, the European Union has managed to spread its trade influence well beyond the Continent.

To advance the strategy, the bloc began courting more developed countries outside its immediate surroundings for bilateral trade deals in the wake of the Doha Round's breakdown. It opened negotiations with South Korea, India, the Association of Southeast Asian Nations, Canada, the United States and Japan between 2007 and 2013. At the same time, it reignited talks with the Gulf Cooperation Council and Mercosur. Brussels has made headway in these negotiations over the years; the bloc's free trade agreement with South Korea reached its fifth anniversary in July 2016, and a year later, EU and Japanese leaders reached a tentative agreement on their pact. 

In pursuing these deals, though, policymakers in the European Union and its constituent nations have had to work against a growing popular distrust of globalization. Europe's economic crisis breathed new life into nationalist and anti-establishment movements in many EU member states, and a significant number of voters see globalization as the cause of, rather than the solution to, the Continent's timid economic growth. In countries such as France and Italy, political parties that want to reduce immigration and introduce protectionist measures have gained considerable ground with the electorate. Protests against free trade agreements are common and often influence government decisions. The disparity between the interests of EU leaders and the demands of much of the public will only continue to cause political strife in the bloc.

As it does, the European Union won't have the luxury of time on its side. The bloc is in a race against economic and demographic factors that are conspiring to reduce its share of global trade. Facing a shrinking, aging population and growth rates far below those in emerging nations, Europe stands to lose some of its influence over the world's political and trade policy in the not-so-distant future. But it still has a glimmer of hope: The European Union's advanced economy could help it become a trailblazer in technological innovation and, in turn, sustain its competitiveness despite its demographic decline.

Trade Implications

Defensive Interests

Agriculture is still a sensitive sector for many member states, though recent reforms in the Common Agricultural Policy, a system that helps subsidize the industry, have made the European Union less defensive (if only slightly). Agricultural subsidies have fallen in the past decade and a half but still represent the biggest portion of the EU budget, resulting in inefficient and often wasteful practices in the industry. Member countries with large agricultural sectors, such as France, Italy and Spain, are protective of their farmers, who still play important social and political roles. Newer additions to the bloc, including Poland and Romania, meanwhile, receive more in EU agricultural funding than they contribute, and staunchly defend the need to continue the subsidies. In light of these considerations, the bloc keeps its World Trade Organization tariffs on agricultural goods at an average 18 percent — a rate four times higher than its tariffs on other products.

Member States' Agricultural Output in 2015 as Percent of EU Total

Besides agriculture, the European Union maintains restrictive regulations prohibiting the flow of private data to countries outside Europe that do not guarantee equal privacy protection. The European Union's interest in protecting private data derives from its members' experience with the totalitarian governments of Nazi Germany and of the Eastern Bloc, systems that regularly exploited and manipulated personal information for political reasons. Germany, which lived under fascist and communist rule at different points in the 20th century, is particularly invested in protecting private data, but countries such as Luxembourg, Austria, Denmark and the Netherlands also have strict data protection laws in place.

Despite their connection to the past, Europe's data protection policies are just as relevant to the present and future. Digital data has become an increasingly important economic resource. The more control a country (or bloc) has over the asset, the greater its influence and power in the sector will be. From the European Union's perspective, guarding its digital industry offers a way not only to create jobs in the sector but also to limit interference from abroad. And its people largely support its stance on the issue; polls show that most Europeans do not trust internet companies to protect their personal information.

In countries such as Germany, France and Italy, automobile manufacturing is an essential part of the economy. The bloc offers the sector moderate protection with a 10 percent WTO tariff on imported cars imported. The rate — lower than EU tariffs on agricultural products but higher than those on energy imports, for example — is intended mostly to protect the interests of France and Italy, where vehicle production provides an important source of jobs but can't keep up with the competition abroad. Brussels' stance on the issue has proved to be more flexible than its position on agriculture and data protection, though. After months of negotiation with Japan, the bloc finally agreed to eliminate tariffs on Japanese cars so long as Tokyo would do the same for European agricultural products.

Outside the realm of goods, the European Union's attitudes toward various aspects of international trade can also act as a barrier to foreign trade. Private arbitration, for example, is a controversial topic in Europe. Surveys conducted by the EU Commission indicate that the public is wary of entrusting private courts with the task of settling disputes between states and companies. Furthermore, many EU members see the issue as a matter of their individual sovereignty and oppose bypassing national courts through private abitration. Considering the resistance among center-left and left wing politicians at the state and supranational levels, the bloc has proposed creating a permanent multilateral investment court to resolve potential disputes instead.

The European Union likewise is skeptical of trade agreements that involve granting visas or temporary work permits to foreign workers. Member states such as France, Germany, Austria and the Netherlands oppose including provisions in trade deals to make it easier for non-EU citizens to work in the bloc, fearing that the measures would encourage increased migration to the Continent. Given the current strength of nationalism in Europe, these countries are unlikely to change their minds anytime soon.  

Offensive Interests

Though high wages make much of Europe's agricultural output uncompetitive on the global market, a select few of the sector's products are in high demand beyond the bloc. The Continent's enduring cultural traditions and imperial history have lent unmatched cache to products such as Iberian ham or Scotch whisky. Because consumers around the world buy these products in part for their geographic origin, the goods represent the intersection of agriculture and intellectual property. The European Union has an interest in ensuring that products sold overseas aren't falsely labeled as French Morbier, for example, since an imposter cheese could tarnish France's brand and reduce its income. The countries most concerned with protecting official regional denominations are clustered around the Mediterranean — France, Spain, Portugal, Italy and Greece. The issue dates back to at least 1919, when France passed a law over regional names after a massive wine-selling fraud. Over the past few decades, however, it has figured more prominently in the European Union's trade negotiations, including those with Japan and South Korea.

The European Union's interest in defending its intellectual property doesn't stop at agricultural goods, either. The bloc is a powerhouse in research and development (R&D). In 2015, its members combined spent around 300 billion euros on the sector — a nearly 50 percent increase from 2005; the bloc's R&D expenditure in 2014 exceeded that of China by 80 percent, according to Eurostat. Of the European Union's members, Sweden, Austria, Denmark, Finland and Germany devote the most money to R&D each year, spending nearly as large a proportion of their gross domestic product on the sector as the United States does. To reap the most from its labors, the European Union takes an assertive approach to patenting. The strategy pays off especially in the pharmaceutical industry, where lapsed patents open producers up to competition from generics manufacturers. The European Union pushes for longer patents to keep generics at bay.

Gross Domestic Expenditure on R&D in 2015, as Percent of GDP

Manufacturing exports, such as vehicles and machinery, are among the European Union's most competitive goods today. Northern Europe has long been a manufacturing hub, but since the bloc adopted a common currency — and expanded to Eastern Europe — Germany has benefited from a weaker currency and cheap labor to give its industry an extra boost. As a result, the bloc is motivated to break down trade barriers to its manufactured goods wherever possible.

Investment, procurement and competition, the issues that drove the European Union away from the negotiating table during the Doha Round, are still important to the bloc more than 15 years later. Multinational companies based on the Continent are striving to reduce barriers to market entry around competition and procurement. In addition, EU countries are some of the world's most litigious when it comes to investment protection. (Germany has launched 55 investment protection cases, while France has brought 41 and Italy 30.) Recently, however, Europe's efforts to liberalize global investment policy has started to cut both ways; China is pouring more and more money into the bloc, much to Brussels' consternation. In response, the European Union has started taking a more defensive stance on investment, once a purely offensive interest for the bloc. 

Investor-State Settlement Cases by EU Member

Services, long an important offensive interest for the European Union, may take a back seat to other sectors in the future. For decades, the bloc's strength in the industry was its financial and business services sector, thanks in large part to the United Kingdom's prowess in that area. Now that negotiations for the Brexit are underway, the European Union looks set to lose its upper hand in services, something it will try to recoup in trade discussions with London.

Selected EU Trade Pacts
EU Members' Human Capital Index Ranking in 2016

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