Originally published on by Bruegel Institute. Link to original report( 10 mins)
Germany’s foreign economic policy has barely got a mention in the 2021 federal election campaign. Yet, the issues arising are all central for Germany’s prosperity: the potential impact on Germany of rising tensions between the United States and China; international climate diplomacy; climate action; the declining effectiveness of international and multilateral rules in a geopolitical environment in which a multitude of power poles pursue different interests; and European integration.
Openness implies vulnerability
The experience of recent years shows how the US and China use economic pressure points to assert their geopolitical interests against Germany. This raises the central questions of how Germany should deal with international pressure on its own economy, and to what extent Germany and Europe can work with their trading partners to pursue their interests globally. One approach, often suggested in the US, is to reduce economic interdependence in particular with China in order to become less vulnerable. It is in particular the systemic rivalry with China that should raise concerns in Europe. Germany needs to be at the forefront of defining an economic policy strategy to defend its interests while avoiding decoupling.
This discussion is of great importance for Germany because of the openness of its economy. Exports represent more than 30% of gross domestic product. Half of Germany’s trade in goods is with the EU, 10% with China, 7% with the United States and 4% with the United Kingdom. This openness with the EU as its central trading partner is the foundation of German prosperity. The EU, in turn, has contractually secured the opportunities for German and European companies to trade worldwide by concluding trade agreements.
But openness also means vulnerability. To safeguard its own interests, Germany must therefore actively shape globalisation. A strategy of decoupling or dismantling international interdependencies is not recommended. However, instruments must be sharpened within the European framework to defend and enforce interests and to make Europe less susceptible to economic policy pressure.
Weaknesses in the domestic economy
Germany’s economic development has been positive overall since 1999. Per-capita GDP growth compares favourably with the US. France and the UK lag behind Germany and the US; Italy has been stagnant for decades.
But closer analysis reveals clear structural weaknesses to which German economic and foreign policy must respond in the next decade:
- Germany and the EU have a relatively old corporate structure with few young and growing companies. Among the top 50 Fortune 500 Global Companies, 22 are from the US, 12 from China and only seven from the EU (three from Germany: Volkswagen, Daimler, Allianz). Among the top 500, China now has more companies than the US for the first time.
- The lack of qualified personnel, for example in the digital sector and especially in artificial intelligence, is making it difficult to introduce cutting-edge technologies. Germany risks losing its leadership position in key sectors where data-driven and AI-based solutions are becoming the industry standard.
- Germany’s energy transition is incomplete. Comparatively high energy prices combine with insufficient decarbonisation. The share of renewable energies is increasing, but is below the EU average and far behind the frontrunners, the Nordic countries.
- There are also clear weaknesses in the efficiency of public administration. In the OECD Digital Government Index, which measures the openness, usefulness and reusability of government data, Germany is below average.
These weaknesses are the backdrop against which German foreign economic policy will be shaped in the coming years. Clearly, the new federal government must remedy the internal weaknesses to improve the competitiveness of the economy. This will also increase the foreign policy strength of the Federal Republic.
Recommendations for German foreign economic policy
- Increase the resilience of the EU and the euro area
The EU has made substantial progress in reinforcing the structure of the euro area but weaknesses remain. The next German government should develop a proactive strategy to reduce these by, for example, completing the banking union and deepening and integrating capital markets while increasing the supply of safe assets. It is also in Germany’s interest to further strengthen the EU’s internal market.
- Managing technological and geopolitical confrontation
Technology policy has become one of the central fields of action in foreign economic policy, because of the central role those digital technologies play for all economic sectors, and because competitors can exploit digital interdependencies for their geopolitical goals. The EU has focused more on this in recent years but does not have all the necessary instruments to respond effectively. While it can enforce standards through regulation, the EU lacks financial instruments to promote new technologies. Decisions on foreign investment in European companies that produce key technologies also remain largely at the member-state level.
A fundamental problem is the lack of investment in new technologies, networks and human capital. In AI, for example, there are far too few graduates in the EU. A training push, the strengthening of the digital single market, more investment and the improvement of venture capital funding are indispensable prerequisites to ensure Europe does not fall further behind in digital technology. This, in turn, is of central importance to better manage interdependencies and thus be less vulnerable.
When making decisions about the use of technologies, Europe’s resilience must be taken into account. Overall, a defensive strategy will not be enough. Europe must invest more in digital technologies, not only to better manage geostrategic dependencies, but above all to be future-proof in these key technologies. In recent years, Germany has rightly started to invest more in digital technologies. However, current investments remain insufficient and should be stepped up.
- Not limiting climate policy to Germany and the EU alone
In the area of climate policy, two priority areas are relevant to foreign economic policy. First, the European Green Deal has direct and indirect effects on global trading partners. Second, it must be a goal of German and European policy to accelerate decarbonisation worldwide.
The European Green Deal has direct consequences for trade. The goals of full decarbonisation by 2050 and significant emissions reductions by 2030 mean the EU will import less fossil fuel. Energy suppliers in the European neighbourhood will be affected with direct impacts on their economic models and implications for political stability. Managing this political change will be a major challenge.
The energy transition also means the EU will need significant raw material imports for green technologies. Supply chains must be resilient to avoid new dependencies on raw material suppliers. Finally, falling demand for fossil fuels – of which the EU is one of the largest importers – will have a global impact in that, in principle, the price will fall. European foreign policy cannot ignore the Green Deal; on the contrary, it will have to manage its global impact. Europe needs a programme of aid and technical assistance to manage the transformation of economic systems to promote the development of green-energy production in the neighbourhood. Green hydrogen, for example, could become a new export commodity for countries suffering losses in fossil-fuel exports to Europe.
Meanwhile, global emissions continue to rise. The EU now contributes only about 8% of global emissions, far less than China (26%) and the US (13%). The European Green Deal alone can only make a small contribution to combating climate change. An agreement with the US on a carbon tariff or border adjustment mechanism would provide China with an incentive to step up its climate efforts, and could also spill over to other countries.
Technology cooperation with third countries, especially poor third countries, could help globalise the green deal by reducing the cost of green technologies. Flanked by financial support, this could reduce global emissions in a cost-effective manner.
- Leverage health policy for ethical and economic leadership
Health policy and pandemic control should also become one of the central pillars of German foreign policy, not only because of their economic relevance. To be sure, there has been significant progress in pandemic control. But the global economy remains vulnerable and worldwide the number of COVID-19 infections remains high, while new pandemics and other health risks could appear.
This presents a major economic opportunity for Germany and Europe because of their strong healthcare sectors. The EU could expand its role as a key global producer of essential medical goods. From a foreign policy perspective, most important is the global reputation that a leading role in pandemic response would bring to the EU and Germany. It is a moral imperative to deal with the health crisis as quickly as possible. The financial and technological capacity exists, and the EU should play a major part. The world cannot be safe as long as high levels of infection continue and new variants of the virus can emerge.
Towards a strategy
In times of major geopolitical tension and severe economic crisis, there is a political tendency to try to solve problems through protectionism. This is rarely successful. In Germany in particular, it would entail considerable risks for the export-oriented middle class and workers. Historical evidence even suggests that it is precisely severe economic crisis that could usher in a new golden age of globalisation. Germany and the EU can and should remain open, even if Germany’s current account surplus is closing.
Germany should therefore focus on managing globalisation and economic interdependencies rather than aiming for decoupling. Economic interdependence, however, also means vulnerability to political pressure from abroad. Three guidelines are therefore of central importance:
- In order to credibly enforce its positions, the EU needs stronger instruments, such as a strengthened investment review process and a subsidy review process. These can increase the stability and openness of globalisation because they can act as a deterrent to other trading powers and push them to comply with global trade rules. The multilateral system will be strengthened if Germany and the EU are maintained as a strong pillar alongside the US and China.
- The appropriate framework for action is the EU. Germany has neither the economic nor the political power to resist pressure from China or the US by itself. It is a significant inconsistency that in an integrated single market, the instruments of external protection, for example against hostile takeovers in key technologies, reside mainly at national level, while investments, once made, allow access to the entire single market. Germany should support EU initiatives that provide for greater centralisation of such decisions. In the area of foreign policy, it would be advisable to reconsider the unanimity principle.
- In economic areas of outstanding strategic importance, it is necessary to increase the resilience of value chains. This means that dependencies on individual producers, for example of modern digital technologies, must be reduced through a diversification strategy. Mention should be made here of key technologies including computer chips and essential raw materials for the production of green technologies.
Implementing the proposals in the four specific fields of action discussed above – resilience, technology, climate and health – would bring clear benefits to Germany and the EU. Strengthening the European economy and European decision-making structures will benefit the economy while creating room for manoeuvre relative to international partners and competitors. Support for, and reinforcement of, global public goods is a strength of the EU and Germany.
The new German government cannot be a neutral bystander. While the transatlantic relationship is of central importance, the EU cannot rely on the US to defend its international economic interests. Instead, Germany and the EU need to develop a strong and proactive agenda to manage foreign economic relations, which are essential for German and European prosperity.
Wolff, G. (2021) ‘Germany’s foreign economic policy: four essential steps’, Bruegel Blog, 23 September