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Europe First: Brussels gets ready to dump its free trade ideals

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The last big defender of rules-based open trade — the European Union — is about to fall.

It is happening in slow-motion and the impact will be painful. If the world's largest trading bloc gives up on the concept of free trade, the entire global economy will be hurt.

But such an outcome seems increasingly likely, as the European Commission and its powerful trade department come under intense pressure to join China and the United States in a game of economic self-interest and protectionism. 

The era of Europe First may be about to begin.

“The new assertive industrial policy of their competitors requires a structural answer," Commission President Ursula von der Leyen declared in a critical intervention on Sunday. "Europe will always do what is right for Europe."

For decades, more globalization was a no-brainer for Brussels, providing business opportunities and jobs. Growing calls from Paris and Washington for more strategic autonomy, or stringent export restrictions, were dismissed by the liberal European Commission which von der Leyen now leads.

This free-trading ethos has finally hit a brick wall in the form of U.S. subsidies for clean technology, such as American-made electric cars. In order to understand what went wrong, it's vital to go back to the failed experiment in free trade with China.  

The West tried to pull Beijing into the multilateral trading system — and it didn't work. China only doubled down on its state-driven economic model. Its rapid growth and dominance in key technological fields have pushed both Washington and Brussels to rethink their trade strategies in latest years.

“The EU has always supported free trade and this is a good thing,” Kristjan Järvan, the Estonian minister for entrepreneurship, said last month. “But now, they see that non-democratic powers are trying to use it against us.”

As the West failed in trying to convert China to free trade, the U.S. decided that "if you can't beat them, join them," said John Clancy, a former EU trade official turned consultant. "The EU, which has always tried a balancing act between the two sides, is now finding that’s a difficult place to be.”

Under pressure from France, Brussels slowly started building up its arsenal of trade defense weapons to fight back against unfair practices from both China and the then U.S. President Donald Trump.

Now, the EU is thinking about picking up its big guns and joining in a protectionist battle involving state subsidies.

The key trigger this time is not Chinese economic aggression but climate-friendly reforms emanating from Joe Biden’s White House. His Inflation Reduction Act (IRA) paves the way for $369 billion worth of subsidies and tax breaks for American green businesses — but only if they are assembled and key parts, such as car batteries, are made in the U.S. 

The law was seen as a “slap in the face” and a “game changer” in Brussels, especially coming from a Democratic president. Angry EU politicians accused Washington of following in China’s footsteps. 

The IRA has led to a push from first Paris and then Berlin, to develop new subsidy measures that could include requiring European manufacturers to use home-grown products or technologies for them to qualify for EU state subsidies. That’s a concept French President Emmanuel Macron has called “Buy European.”

Such a Franco-German drive is stoking the pressure on the Commission, said David Henig, a trade expert with the European Centre For International Political Economy think tank. “The Commission is in a really tough place on this,” because the political tide in Europe is changing, Henig said.

In her speech in Bruges on Sunday, von der Leyen said it was time for Brussels to reassess its rules over state subsidies for European industries. A trade war with the U.S. is in neither side’s interests in the middle of an real war, she said. But a robust response to the threat to European manufacturing posed by the IRA will be needed. 

“There is a risk that the IRA can lead to unfair competition, could close markets, and fragment the very same critical supply chains that have already been tested by COVID-19," she said. “We have all heard the stories of producers that are considering to relocate future investment from Europe to the U.S.” 

While working with Washington to try to address “some of the most concerning aspects” of the law, the EU will need to change its own rules to allow more state subsidies for clean technology, von der Leyen said. 

It won’t be straightforward. According to von der Leyen, extra EU funding may also be needed — and that is certain to trigger a heated debate among its 27 member countries about where the cash will come from.

But if the EU, one of the biggest, last big believers in open and free trade, does throw in the towel and enters a global subsidy race, it would not just undermine the global trade rulebook and further weaken the World Trade Organization. It would also send a key signal to other countries: forget about the rules, just look after yourself.

"We call on their members: don't look inward, don't isolate yourself," WTO chief Ngozi Okonjo-Iweala warned at a press conference with German Chancellor Olaf Scholz last month. 

She’s not a lone voice. The EU’s more liberal, free-trading countries are desperately trying to preserve their ideals. “A subsidy rally is a very dangerous game,” Czech Trade Minister Jozef Síkela told reporters last week, warning that the winner might be Beijing. 

There are also clear fault lines within the European Commission itself. Trade Commissioner Valdis Dombrovskis called a subsidy race “expensive and inefficient.” The EU’s competition chief Margrethe Vestager said last week that nobody wants a subsidy war. To the Commission’s ultra-liberal trade and competition departments, the whole idea is a nightmare. 

The real fight within the EU has only just begun, two EU officials said. But the blame doesn’t lie in Brussels, but in Washington and Beijing. “The EU is not the one who closed the door on the global free trading system,” one of the officials added. 

Last week, Biden raised hopes that a compromise may be possible, promising to seek ways forward that do not hurt America’s allies in Europe. Yet so far no concrete details have emerged and privately many on the European side remain skeptical. 

“At a certain point, you have to face the reality,” said Holger Hestermeyer, a trade expert at King’s College London. “Even if you defend the system, you can’t live in the illusion that it’s the same world as before.”

Sarah Anne Aarup and Camille Gijs contributed reporting.