Trade as a weapon: Europe between the US and China

America is now blocking the export of sophisticated semiconductors to China. This shows how its attitude to trade has fundamentally changed. A decade ago, American politicians still argued that trade would transform the world. Open markets would bring freedom in their wake, transforming countries like China. Now, America sees trade with adversaries as both a weakness and a weapon.

The Biden administration worries that some kinds of trade can weaken America by creating strategic vulnerabilities. In particular, American officials fear that if they become too dependent on China, then China will take advantage. They point to China’s dominance of solar panel manufacturing, batteries, and rare earth processing as evidence that China might one day hold America to ransom, by threatening to withhold the technologies needed for the transition to green energy.

Taiwan presents other vulnerabilities. If China invaded Taiwan, or blockaded it, then the US would no longer have access to the advanced semiconductors made by TSMC, the Taiwan Semiconductor Manufacturing Corporation, which has an effective monopoly on manufacturing the smallest and most powerful semiconductors.

The EU needs to think about its own industrial policy and whether its restrictions on state aid still make sense

All this explains why the US has turned away from free trade to industrial policy. The US has recently passed two major laws that are intended to encourage production of key technology on American soil. The CHIPS Act subsidizes semiconductor manufacturers to build production facilities on US soil, on the condition that they do not build facilities in China. The more recent Inflation Reduction Act subsidizes clean energy manufacturing in batteries, electric vehicles and other key technologies.

These new laws carry costs for Europe and South Korea, whose car manufacturers currently aren’t eligible for these subsidies. The EU is currently considering whether to take action against the US at the World Trade Organization. The problem is that the World Trade Organization’s legal appeals process is effectively dead, because the US refuses to appoint officials to it.

All this is more complicated, because the US is itself turning trade ties into a weapon. The Biden administration’s most recent action on semiconductors is deliberately and explicitly intended to undermine China’s grasp on high technology. As Biden’s National Security Adviser, Jake Sullivan describes it, advanced semiconductors are a “foundational” part of America’s advantage over China. The US government used to think that it was enough to keep China a couple of generations behind the most advanced technology. Now, instead, Sullivan says that “it must maintain as large of a lead as possible,” doing everything it can to make sure that China can never catch up.

Again, this has implications for Europe and for America’s allies in Asia. The new rules don’t just block American companies from exporting advanced semiconductors to China. They block any company that uses a significant amount of US intellectual property to make semiconductors, or even US intellectual property for the equipment that is used to build them. Since US know-how is key to the semiconductor and advanced technology supply chain, European companies like ASML (which makes the equipment to build super-advanced chips), and Taiwanese companies like TSMC, have to obey American laws. Otherwise, they will lose access to the technology and know-how that they need.

This is remaking international trade. The US used to underpin the global trade system, even if it often twisted the rules to its own advantage. Now, its attitude to trade is more complicated.

In a recent speech, the US Trade Representative, Katherine Tai, promised that the US wouldn’t let the world trade system devolve into a “state of nature where might makes right.” But she also emphasized that free trade would sometimes have to make way for industrial policy. As she put it, “market opening, liberalization, and efficiency … cannot come at the cost of further weakening our supply chains, exacerbating high-risk reliances, decimating our manufacturing communities, and destroying our planet.”

This presents some awkward problems for Europe. The foundations of the EU are the “four freedoms,” allowing movement of goods, services, money and people throughout the European Union. The EU could live very happily in a world of free and open trade that seemed to reflect its own internal make-up, and learned over decades how to nudge global trade rules so that they reflected European interests.

Now, it has to remake itself in a colder and harsher world. And things may get much worse. Even if Europe doesn’t like some of Biden’s policies, his administration is willing to work together with its allies. If Trump, or someone like him, is elected in 2024, then America might start weaponizing trade relations against Europe too.

The old world of open trade is gone. America and China both believe, with good reason, that it endangers their security. So too does Europe, even if it hasn’t quite worked through the consequences. Germany’s decades of reliance on Russian gas turns out to have been a fundamental political mistake. In the world after open trade, politicians will have to move beyond talk about a “geopolitical” European Union, to the specific and difficult political and institutional changes that it needs to defend its interests.

The EU needs to think about its own industrial policy and whether its restrictions on state aid still make sense. It will face new fights between Northern and Southern Europe over how to centralize power while making sure that it isn’t just Germany and France that make the key decisions. Finally, it will have to think more systematically about its own tools and approach to trade. In a world where China and the US are willing to weaponize trade against their adversaries, what weapons does the EU need to protect itself? The challenges and problems are more obvious than the answers.