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Smart diversification: Economic security through diplomacy

Economic governance / COMMENTARY
Ricardo Borges de Castro , Raúl Villegas Barrera

Date: 21/09/2023
COVID-19 and Russia’s invasion of Ukraine woke Europe up to the risks of strategic and economic dependency. But, if overplayed, calls for ‘de-risking’ could backfire, alarming key economic partners. Now is the time for the Commission to adopt a ‘smart diversification’ approach to expand its partnerships while maintaining its security priorities.

China in the room

President von der Leyen proposed and outlined the European Commission’s first economic security strategy in June. Internally, the strategy would strengthen the European Single Market. Externally, it would keep tabs on dual-use exports and investment outflows, reduce overreliance on vulnerable supply chains, and diversify economic dependencies.

Albeit ‘country-agnostic’ and not explicitly mentioning China, the proposal aims to steer the EU through its ambivalent relations with Beijing. Trade volume between the two blocs has soared, and European leaders have recently visited Beijing with large business delegations. Yet, scepticism over Xi Jinping’s illiberal reforms and fears of strategic dependency on Chinese exports, such as rare earth materials, compel Brussels to 'de-risk' the relationship as laid out in President von der Leyen’s March EPC-MERICS speech.

The timing of the proposal was all but accidental. After years of improvised adaptation to economic security threats, the EU needs to adopt a preventive, anticipatory approach. And, while the 27 member states might not yet agree on what economic security and de-risking entail, they endorsed von der Leyen’s rhetoric in their June China consensus. But the hard part starts now.

With an increasingly fraught Sino-American rivalry and a slowing Chinese economy turning inward, de-risking must tread a fine line. If too hawkish, it could trigger outright decoupling - something the European economy can’t afford. If too dovish, it could deepen existing vulnerabilities and dependencies while also straining transatlantic relations. Taking notes from its overreliance on Russian energy, the EU should know that the political and economic toll of complacency is too high in a world where interdependence can be weaponised.

Thus, economic security is not a one-directional solution and should involve forethought and diplomacy. As President von der Leyen’s term concludes, the European Commission should follow a new approach: smart diversification.

Securitisation and its discontents

The June strategy is a welcome sign of maturity and shows a resolve uncommon in European foreign economic policy. Matching each economic risk area to concrete policies, it complements the 2019 triptych labelling of China as a “partner, competitor, and systemic rival” with at least a broader action plan.

But it has also raised the stakes for the member states to act cohesively in the long-term. Without a sustained China and economic security consensus, the strategy, rather than projecting resolve, could become a hallmark of European disunity and geopolitical weakness.

Yet, the greater challenge that the strategy crystallises is diplomatic. Binding economic policy to the foreign policy goals of autonomy and security, the language of the strategy could dampen relations with the partners that the EU needs to de-risk from China.

The dilemma between 'securitisation’ and ‘openness’ is likely to continue occupying the EU27 in the coming months. Still, an abrupt bet on economic security policies, regardless of intent, could be interpreted as protectionism and erode the EU’s reputation for open and fair trade.

Walking the diversification trade-offs tightrope

Successful diplomacy is a prerequisite not only to building partnerships but also to reducing the trade-offs and collateral effects of diversification. If the necessary agreements are not in place, reconfiguring global supply chains away from China can result in fierce competition even between long-standing partners, as demonstrated by the recent US-EU subsidy race.

For instance, the ongoing negotiations for a free trade agreement (FTA) with India are undercut by the imposition of European carbon tariffs on Indian industrial exports. Experiencing a green transition at different speeds, Indian policymakers perceive foul play in what their European counterparts understand as a necessary cap on carbonisation. Nothing short of a compromise can solve the stalemate, but Europe's negotiating power will significantly depend on its understanding of the rising power's geopolitical vision. To mitigate the trade-offs of diversification, the EU will need all the diplomatic leverage it can get.

Moreover, European policymakers should update diplomacy and values to a new reality in forming partnerships. Latin America holds untapped markets and key energy and mineral supply chains for Europe's diversification - yet negotiations for an FTA with Mercosur remain stalled even after July's CELAC Summit. Disagreements between Mercosur members are partly to blame, but years of paltry European investment and lacklustre external action have made the EU’s sudden interest in the region appear opportunistic and half-hearted.

Although ad-hoc de-risking might seem efficient, it will rarely charm the plurality of actors across the negotiation table. And, by inadvertently alienating credible alternatives, it might even re-risk relations with China. Indeed, the EU’s capacity to de-risk and build a more resilient domestic economy is intimately linked to its capacity to diversify. Without successful diversification, key European industries will continue to hang by single, precarious threads, regardless of the industrial policy that guides them.

Towards a smart diversification approach

If the EU wants to become a 'nimbler actor' in an emerging geopolitical landscape shaped by geoeconomic and geo-technological competition, it should learn to walk before it tries to run and master the diplomatic game it’s set itself up for. To do so, it must achieve three balancing acts.

It must deter economic coercion while affirming itself as a non-protectionist actor. It must anticipate challenges and work towards 'strategic autonomy' rather than announce it on the diplomatic stage, where such declarations could be seen as arrogant and self-serving. And it must also use its multilateral influence to persuade its partners (especially those in electorally uncertain Washington) to pursue economic security without renouncing openness.

Smart diversification can succeed on all fronts by following clear, coherent principles:

1. Moving from reaction to forethought

Any policy is defined by the immediate issue it tries to address. The economic security strategy, dominated by the rise of China, is—despite the declared country agnosticism—no different. Nonetheless, the strategy should be pursued with a long-term scope and transcend the parameters of European resource and economic dependence as they stand today. Without anticipation and forethought, diversification may push the EU into new unknowns and erode its capacity to find alternative solutions as risks emerge. Beyond developing diversification scenarios, the EU should design actionable policy responses accordingly. 

2. Deterring instead of threatening

An effective economic security strategy should deter economic coercion without having to explicitly warn against it. The Commission has begun building such a deterrent by developing an anti-coercion instrument and putting industrial policy at the top of the agenda. But more can be done. Rather than expanding its retaliatory capacity, the EU should focus on making itself less vulnerable to economic coercion. And this is an economic issue as much as a foreign policy one. Incentivising companies to shorten supply chains and make their linkages more flexible and transparent, optimising resource allocation and utilisation, investing in industrial R&D, and onshoring overly dependent sectors can all make Europe less coercible without overplaying the 'de-risking' mantra. Show, don’t tell.

3. Redoubling multilateralism and interdependence

In adapting to the realities of economic security, the EU should not reverse course on its greatest strengths: interdependence and multilateralism. Therefore, it must be careful not to lean heavily on bilateral agreements. They might be the best vehicle for good or industry-specific diversification, but their proliferation would undermine the principles of non-discrimination and predictability that sustain the multilateral trading system. Multilateral principles can be overwritten by expedient unilateralism, or they can be updated to allow partners to de-risk collectively. Brussels should lead multilateral efforts to detect and punish economic weaponisation and coercion through multilateral action where possible and unilaterally when needed.

As the EU adapts to the age of permacrisis and continues to learn the language of power, it should avoid undermining its global influence by taking a one-way protectionist path. Smart diversification should be the EU’s external economic approach to navigate a contested pluripolar world.

Ricardo Borges de Castro is an Associate Director and Head of the Europe in the World programme at the European Policy Centre.

Raúl Villegas Barrera is a Programme Assistant in the Europe in the World programme at the European Policy Centre.

The support the European Policy Centre receives for its ongoing operations, or specifically for its publications, does not constitute an endorsement of their contents, which reflect the views of the authors only. Supporters and partners cannot be held responsible for any use that may be made of the information contained therein.

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