Keywords

A Global Tempest

Russia’s war of aggression against Ukraine, in conjunction with the global COVID-19 pandemic, has shaken the foundations governing the international economic and political order. It has also raised questions about the future of globalisation. While the COVID-19 pandemic did indeed inflict significant health, social, economic and political costs across the world, Russia’s ongoing war against Ukraine has not only dampened the prospects of post-pandemic recovery but also brought significant instability to global governance. With the world economy facing downward pressures, the geopolitical environment has become more contested, challenging global institutions and the framework in which globalisation has taken place in recent decades.

A Watershed Moment in European History

Europe’s response to these changes in globalisation and international economic governance will be shaped by the triple challenge Europe faces: the watershed moment of Russia’s invasion of Ukraine, fundamental structural transformations, and the ongoing challenge of the permacrisis.

The invasion of Ukraine launched by President Putin represents a watershed moment in European history (Zuleeg, 2022a). Russia has threatened European stability and security by violating the territorial integrity of an independent country. In both its foreign and domestic policy, the EU has always emphasised the importance of multilateral cooperation and respect for international law. Economic and political interdependence has been seen as a way of reducing the possibility of war while at the same time promoting prosperity, peace and security, as well as the respect of fundamental rights and freedoms. Regrettably, in the case of actors like Russia, which do not share Europe’s values and are willing to disregard international law, this assumption has been proven wrong; Russia’s second invasion of Ukraine in less than a decade on the 24th of February 2022 demonstrated that Putin does not feel constrained by the human and economic costs he is inflicting on Ukraine, Russia and the rest of the world. The policies and strategies of all countries will have to adapt to this realisation, which is a moment of truth for Europe (Zuleeg and Emmanouilidis, 2022).

This watershed moment not only increases uncertainty and volatility in the EU’s political, economic and financial system, it also provides an important test for European democracy and the future of liberal democracies on the continent and beyond. The EU has been able to react swiftly in conjunction with international partners, specifically the US. In a matter of days following the invasion, the EU has welcomed Ukrainian refugees and provided military and financial support to Ukraine. It has also imposed ten sanction packages on Russia and adapted its security and energy policies at the national and European level. However, Russia’s invasion of Ukraine is not only a regional war as it marks a defining moment in the reshaping of the geopolitical order, with repercussions for both Europe and the world.

The global economic environment remains challenging for the coming period. The rate hikes around the world to tame inflation, tightening financial conditions and China’s slowdown have weighed on global growth in 2022 (OECD, 2022). Investment and consumption rose in the third quarter of 2022, but economic activity (in China especially) slowed down in the fourth quarter. However, recent events could lead to some improvements for this year thanks to China’s full reopening and the easing of supply bottlenecks. Further crunch points might emerge throughout the year. For instance, some emerging markets face debt distress (despite the recent US dollar depreciation and a general easing of global financing conditions) (International Monetary Fund, 2023). In addition, financial markets are currently representing a source of vulnerability, in the context of monetary tightening. The collapse of the Silicon Valley Bank on 10 March prompted concerns worldwide of widespread contagion. Stock markets fell in recent days and in Europe Credit Suisse, the second largest bank in Switzerland, avoided bankruptcy thanks to the buyout from the UBS group.

The knock-on effects of Russian aggression on the EU economy are considerable, given its historical reliance on Russian gas. The invasion has triggered a cost-of-living crisis in Europe, with many households struggling to pay for food, heating and transport. In the Euro Area, inflation has been at a record high fuelled by high energy and commodities prices. Energy prices have been declining since the peak of August 2022 (Trading Economics), bringing down headline inflation which was (on a yearly basis) 8.6% in February 2023 down from 8.5% in January (Eurostat, 2023). The ECB will keep raising interest rates as core inflation increases, potentially posing financial stability concerns for overindebted countries. The outlook looks less gloomy than a few months ago, but relatively low growth and inflation will remain (European Commission, 2023a).

These immediate challenges arising from this watershed moment coincide with fundamental transformations the EU is already facing: mitigating and adapting to climate change, dealing with a global technological revolution and population ageing. These are, to a large extent, global phenomena, but they have particular salience for the EU. In addition to these transformations, which will all require structural reform and enormous investments, the EU now also needs to transform its economy in order to achieve greater economic security. Russia’s war of aggression has disrupted the global supply chain ecosystem and demonstrated that dependence on commodities and energy from unreliable partners can be costly indeed. But the concerns go beyond these sectors and it has become even more obvious that unsustainable dependency in key enabling technologies will have to be addressed.

Addressing these issues is especially challenging, particularly in an era that the European Policy Centre, in 2021, dubbed the “age of permacrisis” (Zuleeg et al., 2021). For the last 15 years or so, the EU has experienced a number of crises related to the global financial system, the Euro and sovereign debt, migration and asylum, internal and external security, COVID-19, Brexit, populism and the rule of law, and so on. One challenge has been seamlessly followed by the next, straining the ability of the EU to address the subsequent crisis. However, despite some gloomy predictions, the EU has been able to overcome these crises, and at times even making significant forward steps in terms of European integration. This has been true in the case of the Recovery and Resilience Facility, which temporarily allowed common EU borrowing to finance investment in response to the economic repercussions of the COVID-19 pandemic. But the permacrisis also has created lasting damage, not least reducing Europe’s ability to deal with future challenges.

From the perspective of the EU, in this moment of uncertainty and risk as it faces three major challenges, effective global governance is needed now more than ever. However, there is a mounting consensus that the global system has to change. A “new multilateralism” is needed that reflects ongoing shifts in the world economy, demography, and political power distribution. However, current global trends are moving in a different direction, towards a more contested environment where state power is becoming predominant and multilateralism is in decline.

Global Economic Governance in Decline

At least in part, the global economic system and the associated international rules as we know them now are an US invention put in place in the wake of World War II. This shaped the rise of global economic interdependence which, in turn, has generated economic benefits for many across the globe. The hope of the architects of the system was that this could help to spread prosperity, peace and democracy across the world, within a rules-based multilateral system.

However, in recent years, this belief has been increasingly questioned. First, the rise of inequality, especially in advanced countries, can be partly explained by international trade and the formation of global value chains (Roberts, 2017), suggesting that economic globalisation does not benefit all, and certainly not equally. Second, the 2008 global financial crisis was perceived by many as a by-product of globalisation and an unhealthy focus on excessive economic profit. Third, the rise of new global actors has put the global system into question, in particular with respect to China, which has engaged successfully in geo-economic competition with the West. China has now become a key hub in international value chains (Buysse and Essers, 2022) and a crucial player in the technological race (especially in micro and nanoelectronics, robotics, as well as in Artificial Intelligence) (Heimberger and Karaulova, 2021). While the world has benefitted from China’s economic progress, increasingly there have also been concerns, mainly due to its state-driven form of capitalism and the perceived nature and practice of Chinese competition.

As a result of the longer-term global trends and recent challenges, we are seeing a change in how economic globalisation is perceived. International trade and investment are no longer perceived a positive-sum game by many, and even more common are concerns regarding the distributional consequences of global economic exchanges. Global interdependence has also become a geopolitical concern, given its potential to be weaponised (Drezner et al., 2021) for political purposes if over-reliance on critical goods and technology from foreign partners results in systemic vulnerabilities. The Trump presidency, with its counterproductive antagonistic stance vis-a-vis all international partners, was a stark expression of these new trends, resulting in the US withdrawing its support from the multilateral system it had founded and shaped. While the Biden administration is very different, when it comes to the support of the multilateral system many of the challenges of the Trump era persist.

The international economic order is currently facing significant challenges: unprecedented technological innovation, “my country first” and “take back control” movements, the rise of new regional players and non-state actors, as well as new societal challenges, which are fuelling growing complexity and are accelerating the fragmentation of the multilateral world order, which can be seen clearly when it comes to the ability of the World Trade Organisation to adjudicate trade disputes. COVID-19 and the war against Ukraine, with all the supply and value chain disruptions these issues have caused, reinforced the current global paradigm shift. In sharp contrast with the age of the free market, we are witnessing resurgent public interventionism in economic, industrial and trade policy, and economic security has become one of the predominant objectives of public policy. Policymakers in Europe and elsewhere are mapping strategic dependencies, supporting businesses to boost the production of critical goods and to accelerate climate action, reorienting supply chains and deploying trade instruments more aggressively.

Paradoxically, this deterioration in global cooperation comes at a time when all countries face the common and existential challenge of climate change that can only be addressed if countries work together. Addressing climate challenge requires a dramatic shift in economic structures, which necessitates further public investments and decisive industrial policies. China made the domestic manufacturing of clean technologies (fuelled by public funding) a national priority and now the country is a powerhouse in solar photovoltaics, wind turbines and batteries for electric vehicles (International Energy Agency, 2022).

Similarly, the US Inflation Reduction Act (IRA) will direct $400 billion to reduce carbon emissions through a system of tax incentives targeting both corporations and consumers (Badlam et al., 2022). A key feature of the IRA is a subsidy scheme for electric vehicles, which includes local content and assembly requirements, putting producers on the other side of the Atlantic at a disadvantage. In response to this, the EU has adopted the “Green Deal Industrial Plan”, which includes several initiatives to boost the EU net-zero industrial transformation (European Commission, 2023b). In line with the new industrial plan, the Commission tabled the “Net-Zero Industry Act”. This proposed regulation sets a 40% target for green tech manufacturing capacity in the European Union.Footnote 1 (European Commission, 2023c). In order to reach these ambitious objectives and react to the global industrial competition, the European Union is stepping up access to finance for business. The Commission already eased state aid rules and president Von der Leyen announced in September 2022 her willingness to propose the establishment of a new Sovereignty Fund (also for green projects, see section below “policy response across the globe”). In the short term, however, the green deal industrial plan is focussed more on streamlining and simplifying existing tools (such as InvestEU and RepowerEU). These developments highlight the difficulties in addressing climate change in the current economic governance system, given that competitiveness, level playing field, technological progress, state intervention and climate change action are all intertwined.

Policy Response Across the Globe

The ongoing fragmentation of the geopolitical order started long before Russia’s war of aggression against Ukraine. In recent years, many governments have increasingly turned to bilateral or regional deals, and issue-based cooperation rather than multilateral agreements, leading to a decline in the effectiveness of international institutions. This, together with a general public distrust towards international economic governance, and a lack of global confidence in its ability to find common sustainable solutions, have mutually reinforced a vicious circle where countries no longer gravitate towards the mechanisms set up by international treaties and organisations.

Unilateral actions in the economic and political environment have shown how global governance is increasingly shaped by power politics, with a multipolar world order taking shape. Meanwhile, international organisations—which have not been able to adapt fully to the changing environment and challenges—face legitimacy problems with public opinion increasingly questioning the effectiveness and integrity of established institutions, citing conflicts of interest, poor leadership and a gap between expectations and reality.

Whether or not one supports a multipolar or multilateral world order, a battle for influence is unfolding. Future transformations in global governance will most likely reflect the expanding geopolitical role that some of the most developed Asian countries are playing. At the same time, global powers such as the US and China have competing visions on how global economic governance should be structured.

What are the consequences for economic interdependencies and globalisation? Globalisation will not disappear and rules, national policies and interests will continue to shape economic dynamics. While trade has never been completely unrestrained, these new tendencies will reshape globalisation. Like-minded partners will presumably engage in “friend-shoring activities” in critical sectors and try to align trade, industrial and technology policies to face the challenges of geo-economic and political competition. The transatlantic coordination on export controls in the aftermath of the Russian Invasion, the EU–US Trade and Technology Council and the “Chip 4” initiative on semiconductors (Gargeyas, 2022) are cases in point (Buysse and Essers, 2022).

The EU is currently adapting to the above-mentioned trends, and the current watershed moment will lead to further consequences, in particular with regard to the pursuit of economic security. Only a few years ago, the EU had already adopted a long-term strategy to achieve ‘open strategic autonomy’ (European Commission, 2021). With this strategy, the EU aims to become an economic powerhouse of critical goods and technologies, thus reducing critical dependencies. While remaining open to international trade, this strategy will allow it to react to unfair practices and act more autonomously in defence and security. Broadly speaking, strategic autonomy means shaping global dynamics and defending European interests.

In a range of areas, from industrial, trade and economic policies, to security and foreign policies, the EU is already equipping itself with a set of new instruments and others will follow. The “Enforcement Regulation” enables the EU to adopt countermeasures if the block receives a favourable ruling from a WTO dispute settlement panel, and the other party drops the dispute into a void by appealing the panel report (given the current gridlock of the Appellate Body) (European Parliament and European Council, 2021). Other measures include a mechanism to screen foreign direct investment (European Commission, 2022a), foreign subsidy instrument (European Commission, 2022b) and a proposed anti-coercion tool (Szczepanski, 2022). More recently, as mentioned above, sanctions have been imposed on Russia in conjunction with Western allies (European Council, 2022a).

Furthermore, in pursuit of sustainability, EU institutions have agreed on establishing a Carbon Border Adjustment Mechanism (CBAM), which will impose a carbon price on imported goods equivalent to the one applied to the same goods manufactured in the EU. If an EU trading partner prices the carbon content similarly to the EU, it will be exempted from the CBAM. This new mechanism should also prevent European industries from relocating to countries whose climate objectives are less ambitious than the EU’s.

COVID-19 and recent watershed events have reinforced the need for the EU to retain its ability to act independently. The EU is looking for autonomy in strategic goods such as chips (European Commission, 2022c) and raw materials (European Commission, 2023d) where the block relies on just a few suppliers and is thus potentially vulnerable (Noyan, 2022). In addition, given that Russian aggression has brought the threat of large-scale war back to the European continent, the EU will need to be united and improve its military industrial base. The EU has already provided important military aid to Ukraine through the European Peace facility and proposed a procurement system which would enable member states to jointly procure defence technologies (European Commission, 2022d). The European Parliament is discussing the proposal, however delayed negotiations and concerns over its proper legal basis risk to undermine the whole project (Pugnet, A., 2023).

The COVID-19 crisis necessitated deeper fiscal integration through the establishment of the Recovery and Resilience Facility and recently President Von der Leyen, in her State of the Union speech, announced the creation of a Sovereignty Fund to direct resources towards industrial projects (Von der Leyen, 2022), potentially providing a route for the EU to invest in the future technologies (Zuleeg, 2022b). Calls for speeding up the establishment of the new fund have recently increased in the light of the US IRA. The Commission intends to table a proposal in summer. However, so far, there is no consensus among member states, as some are reluctant to introduce a new fiscal mechanism, especially if financed through common debt. In parallel, as mentioned above, the Commission loosened state aid rules to incentivise green investments (European Commission, 2023e), which is also not uncontroversial, given that it might distort the EU’s Single Market.

Russia’s invasion has also resulted in Europe rethinking its reliance on Russian energy. Through RepowerEU, the block is aiming to end its dependency on Russian energy, by saving energy, diversifying supply sources, and boosting renewable energy. Funding will come from the sale of Emission Trading System allowances, from cohesion policy and unused Recovery and Resilience Facility funding. Member states will add an energy chapter to their respective national recovery plans. New projects will fund sustainable transport, energy efficiency measures in buildings, investments in renewable energy and energy security (including oil and gas infrastructure, but only to meet immediate security supply needs) (European Council, 2022b). In addition, the EU has made the first steps towards joint purchases of gas (European Council, 2022c).

Time to Act Together

The ability of the EU to act together in facing this triple challenge and the associated energy, economic and security crises, will determine its global position and its power to shape global dynamics. Within the block, member states need to establish a consensus and act in a united way on the above-mentioned economic and industrial policies. If the block is fragmented along national lines, EU credibility would be undermined and its ability to act on the international stage would be compromised.

However, this should not be seen as an intention to dismantle the global economic governance system. The first preference for the EU is still the multilateral rules-based order. However, it is also clear that the global system needs to be reformed to take into account not only global developments, but also the legitimate pursuit of societal objectives such as climate change mitigation, recognising that this will inevitably affect free trade and globalisation. In the absence of effective global systems, the EU will maintain its commitment to principles of multilateralism, but in its day-to-day activities it will increasingly become ‘normalised’, i.e. acting in a manner similar to other economic and political actors across the globe.

Yet, international economic coordination remains necessary as no country or regional block can face existing global challenges on its own.

First, countries have to agree on a path that leads to a sustainable planet. Those areas concern, among others, shared indicators to measure emissions in the production process and along value chains, coordination on national carbon border adjustment mechanisms (Bernasconi-Osterwalder and Cosbey, 2021), and involving developing countries by also providing them key technologies to decarbonise their economies.

Second, the use of industrial policy instruments, including subsidies (in the legitimate pursuit to green transition and economic security), must be framed under new common rules, leveraging existing discussion fora to promote communication among like-minded partners, namely the US-EU-Japan trilateral negotiations and the Trade and Technology Council. Those discussions must be complemented with additional exchanges with relevant actors, including China, which must be at the negotiating table.

Third, COVID-19 showed us that supply shortages can paralyse the global economy and threaten not only economic progress but human health and well-being. Building resilience within supply chains is important, but interdependence will not disappear and nations will always rely on third partners for specific goods. Against this background, avoiding unilateral and disproportionate restrictions in the name of “my country first” should represent a key objective of global economic cooperation. More broadly, uncoordinated fiscal, monetary and trade responses to global crises may exacerbate the downside risks. This implies that countries should not abandon macroeconomic policy cooperation. A successful example was the work of the G-20 in the aftermath of the financial crisis. Back then, countries set out a shared approach for the macroeconomic response and rejected raising new barriers and protectionist measures (Dadush and Suominen, 2011).

Europe must work with partners to rebuild an effective system of global economic governance while bearing in mind that the global environment existing before the aggression against Ukraine, COVID-19 or even the Trump presidency will not return. Frictions will be as common as cooperation, but in order to negotiate from a position of strength and be ready to act, EU countries will have to integrate further on economic, security and foreign policies. Moreover, it is in the EU’s interest to draw clear red lines: there can be no tolerance of the disregard for international law and practice that Russia has shown. Trust and cooperation are the basis of the rules-based multilateral order. While Europe remains committed to the multilateral order, this should not be misunderstood as naivety, given the era we have entered. Europe stands ready to defend its values and interests in this more contested global environment.