When Europe's friends around the world are asked what they think of the old continent's prospects, they often respond with two sentiments. One is admiration. In the struggle to help Ukraine and counter Russian aggression, Europe has shown unity, determination and an exemplary willingness to bear the enormous costs. However, the second is the alarm. A brutal economic contraction will test Europe's resilience in 2023 and beyond. There are growing fears that the restructuring of the global energy system, US economic populism and geopolitical rifts threaten the long-term competitiveness of the European Union and non-member countries, including Britain. Not only is the prosperity of the continent in jeopardy, but also the health of the transatlantic alliance.
Don't be fooled by the spate of good news coming out of Europe in recent weeks. Energy prices are down from summer and a spell of good weather means gas installations are almost maxed out. However, the energy crisis continues to pose dangers. Gas prices are six times higher than their long-term average. On November 22, Russia threatened to reduce the flow of the last operating gas pipeline to Europe, while missile strikes caused emergency power outages throughout Ukraine. European gas storage facilities will have to be refilled in 2023, and this time without any piped Russian gas.
Vladimir Putin's energy weapon will have costs beyond Ukraine. According to our models, in a typical winter, a 10% increase in real energy prices is associated with a 0.6% increase in deaths. Therefore, this year's energy crisis could cause in Europe more than 100,000 additional deaths of older people. If so, Putin's energy weapon would claim more lives outside Ukraine than his artillery, missiles and drones directly claim in that country. It is another reason why Ukraine's resistance to Russia is also Europe's struggle.
On the other hand, the war is creating financial vulnerabilities. Energy inflation spreads to the rest of the European economy and creates a serious dilemma for the European Central Bank (ECB). The ECB has to raise interest rates to control prices. However, if it goes too far, it risks destabilizing the weaker members of the eurozone; among them, the indebted Italy.
As the energy crisis rages, the war has exposed the vulnerability of the European business model. Too many European (mostly German) industrial companies have been dependent on abundant Russian energy inputs. Many companies have also become more dependent on China, another autocracy, as an end market. The prospect of a break in relations with Russia, structurally higher costs, and a disengagement from the West and China has caused many boardrooms to jitter.
Those fears have been amplified by economic nationalism in the United States, which threatens to drive business across the Atlantic in a whirlwind of subsidies and protectionism. President Joe Biden's Reduced Inflation Act includes $400 billion in aid to energy, industry and transportation, and also includes provisions about manufacturing in the United States. In many respects, the plan resembles the industrial policies followed by China for decades. As the other two pillars of the world economy become more interventionist and protectionist, Europe, with its peculiar insistence on upholding World Trade Organization rules on free trade, seems too naive.
Businesses are already reacting to the subsidies. Northvolt, a valued Swedish battery company, has said it wants to expand its production in the United States. The Spanish energy company Iberdrola is investing in the United States twice as much as in the European Union. Many employers warn that the combination of expensive energy and US subsidies puts Europe at risk of massive deindustrialisation. German chemical giant BASF recently made public plans to "permanently" scale back its European operations. It also doesn't help that Europe is aging faster than the United States.
The loss of investment impoverishes Europe and feeds a sense of declining economic vigour. If we refer to the trajectory of GDP before the covid, Europe has fared worse than any other economic bloc. Of the 100 most valuable companies in the world, only 14 are European. Politicians will be tempted to abandon the rule book and respond with their own subsidies in an escalation of corporate giveaways. The German economy minister has accused the United States of "hoarding investments." French President Emmanuel Macron has called for "a European awakening".
Thus, the dispute over subsidies also fuels tensions between the United States and Europe. US financial and military support for Ukraine far exceeds that of Europe; And as it turns to Asia to meet the challenge from China, the United States is upset that the European Union is not paying for its own security. The majority of NATO members have missed the goal of devoting 2% of GDP to defense. The European Union showed astonishing ingenuity in the face of Russian aggression. While the war has brought the United States and Europe closer after the rifts of the Trump years, the danger is that prolonged conflict and economic tensions will slowly drive them apart again. Nothing would please Putin and Chinese President Xi Jinping more.
To avoid a dangerous break, the United States must not lose sight of the big picture. Biden's protectionism threatens to drain Europe of vitality, even as the United States props up the Ukrainian military and fleets of gas carriers cross the Atlantic to supply Europe with energy. The main objective of "bidenomics" is to prevent China from dominating key sectors: the United States has no strategic interest in seizing European investment. It must make it possible for European companies to benefit from its energy subsidies and more deeply integrate transatlantic energy markets.
Europe, for its part, needs to protect the economy against energy crunch. Schemes that correctly seek to subsidize consumers and businesses to meet basic energy needs should limit demand by charging higher prices on the margin, as in Germany. To reduce energy prices in the long term, Europe must accelerate the renewable energy revolution, while continuing to keep energy markets open to competition. You must also adapt to a new security reality. That means spending more on defense so that it can pick up the load when the United States turns its sights to Asia.
In addition to admiration and alarm, the other sentiment that governs transatlantic relations is frustration. The United States chafes at Europe's economic torpor and its inability to defend itself; Europe is outraged by the economic populism of the United States. However, just as Europe must not be divided by war, it is also vital that the most powerful democratic alliance in history adapt and resist.
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Translation: Juan Gabriel López Guix
