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Reshoring by Decree? The Effects of Decoupling Europe from Global Value Chains

Reshoring by Decree? The Effects of Decoupling Europe from Global Value Chains DOI: 10.1007/s10272-022-1087-9 Forum Intereconomics, 2022, 57(6), 359-362 JEL: F11, F13, F17 Alexander Sandkamp Reshoring by Decree? The Eff ects of Decoupling Europe from Global Value Chains Political opposition to ever-increasing globalisation up to to the domestic economy. It is argued that this would not the point of calls for deglobalisation seem to be spreading only increase resilience, but also reduce dependence on like wildfi re. Be it the presidency of Donald Trump, Brexit or systemic rivals such as China. Based on fi ndings by Fel- China’s dual circulation strategy, the past few years have bermayr et al. (2021a, 2022), this article investigates the witnessed a politically induced shift towards reduced eco- impact of decoupling the EU from global value chains on nomic cooperation across countries. Most recently, the trade and welfare (i.e. real income). In particular, four spe- two major challenges to globalisation are without a doubt cifi c scenarios are presented. the COVID-19 pandemic and the war in Ukraine. Both have demonstrated the vulnerability of the global economy, thus The fi rst scenario investigates a unilateral decoupling by inducing governments to openly question the benefi ts of the EU from the rest of the world with the aim of reduc- supply chains that span the entire planet. ing imports and shifting production back to EU countries. The second scenario investigates a mutual decoupling, Three consequences should be noted. First, the pandemic meaning the explicit restriction not only of EU imports but and the war have indeed severely disrupted global pro- also exports. Against the backdrop of increased depend- duction networks. In 2020, medical products such as face ence on China, the third scenario simulates the impact of masks, protective gloves and ventilators were in short sup- a mutual decoupling of the EU from China only. Finally, the ply. In 2021, many other products including wood, contain- fourth scenario models a mutual decoupling of the EU, ers and microchips experienced shortages. Now the focus the US and their allies from Russia. is on energy products, in particular oil and gas. Second, this imbalance between demand and supply has led to a gen- Dependencies on non-European suppliers eral increase in prices. In the European Union (EU), infl ation was already at 2.9% in 2021, i.e. before the war in Ukraine Before investigating the potential impact of decoupling the (Eurostat, 2022a). In September 2022, prices increased by EU from global value chains, it is worth taking a look at an 10.9% year-on-year. Third, the disruptions have led com- example that illustrates the current dependence of the EU panies and governments to question the reliability of global on global value chains. Germany, Europe’s largest economy, supply chains. This scepticism is partly unjustifi ed, since sourced 92% of its intermediate products from Europe in shortages were also driven by the strong increase in de- 2018 (OECD, 2021). Relocating the remaining 8% may thus mand for medical products in 2020 as well as the general seem feasible. In 2018, only 1.3% of total direct intermediate resurgence in demand that accompanied the global recov- products (6% of imported intermediates) came from China. ery in 2021. EU imports actually increased by 29% in 2021 However, these aggregates mask signifi cant heterogeneity (Eurostat, 2022b), surpassing the pre-pandemic level. Nev- across products. For example, 80% of laptops and 70% of ertheless, the impression remains that global supply chains mobile phones imported into Germany originated from Chi- are not as resilient as previously thought. na in 2021. In a recent survey among German companies, 46% of respondents said that they were currently sourc- Overview of decoupling scenarios ing important intermediate products from China (Baur and Flach, 2022). Decoupling from China, let alone the world, One way to seemingly increase resilience to such bottle- may therefore be diffi cult – at least in the short run. necks in global value chains is to shift production back Methodology © The Author(s) 2022. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License The four scenarios are simulated using the Kiel Institute Trade (https://creativecommons.org/licenses/by/4.0/). Policy Evaluation (KITE) model. It is a general equilibrium Open Access funding provided by ZBW – Leibniz Information Centre trade model that simulates trade fl ows between 141 countries for Economics. 1 It does not matter whether the EU imposes barriers on exports to third Alexander Sandkamp, Kiel University (CAU); and countries or whether these countries impose barriers on their imports Kiel Institute for the World Economy (IfW), Germany. from the EU. Within the model, both actions have the same eff ect on trade and real income. ZBW – Leibniz Information Centre for Economics 359 Forum Table 1 Table 2 Trade eff ects following EU decoupling Change in real income following EU decoupling Change in real Change in real Change in real Income change EU imports (in %) exports (in %) EU income (in %) (in bn euro) Scenario I (Unilateral decoupling) -62.5 -54.2 Scenario I (Unilateral decouping) -3.5 -584.4 Scenario II (Trade war) -84.1 -87.0 Scenario II (Trade war) -5.3 -873.1 Note: Without China (eff ects similar). Excluding oil and gas. Note: Change in income based on GDP in 2019. EU28 including the UK. Excluding oil and gas. Source: Felbermayr et al. (2021a). Source: Felbermayr et al. (2021a). in 65 sectors and covers 98% of global economic activity. The lateral imposition of trade barriers on EU imports would model is calibrated using the latest version of the Global Trade reduce real income by 3.5% (Scenario I). This is a perma- Analysis Project (GTAP; Aguiar et al., 2019) database. Within nent eff ect and implies that income in the EU would be the model, a shift in production back to the domestic econ- permanently 3.5% lower than in a world without additional omy is modelled by a doubling of non-tariff barriers (NTBs). barriers. In terms of 2019 GDP, this amounts to foregone These incorporate a plethora of diff erent instruments includ- income of €584.4 billion every year. A mutual decoupling ing import controls, state aid, public procurement and trade (Scenario II) would increase this loss to 5.3%. defence instruments that have been shown to signifi cantly re- duce trade fl ows (Bratt, 2017; Kinzius et al., 2019). NTBs are The aggregate eff ects presented in the table mask signif- doubled because this strongly reduces bilateral trade fl ows icant heterogeneity across EU member states. For exam- without completely eliminating them (no full shift to autarky). ple, Germany as a very open economy loses more from Crucially, the model allows investigating the impact of such a a trade war (-6.9% or €236.7 billion). Small open econo- change in trade barriers on trade and real income. mies such as Belgium, Malta and Ireland are hit hardest by a trade war between the EU and its trading partners. Simulation results Welfare in the EU’s trading partners declines, too (on av- erage by 1.5% in Scenario II). Shifting a large part of pro- In a fi rst step, Table 1 shows how a doubling of EU trade duction back to the EU is thus possible in principle, but barriers vis-à-vis non-EU countries impacts EU imports and would involve considerable costs for both the EU as well exports in the model. Doubling import barriers reduces EU as its partners. imports from third countries by 62.5% (Scenario I). Raising import barriers shifts production back to Europe. However, Decoupling the EU from China and Russia this means that EU producers have to forego the benefi ts from the international division of labour and specialisation In view of recent geopolitical developments, a strategic as the production of intermediate products is relocated decoupling of the EU from specifi c countries may be more to Europe. Instead of being imported from the cheapest plausible than a general move back towards autarky. Fol- source country, intermediates are now being produced at lowing the Russian invasion of Ukraine on 24 February home at higher cost. Prices of remaining imports also in- 2022, EU trade with Russia has declined signifi cantly. In crease due to the imposed trade barriers. In addition, the August 2022, EU exports to (imports from) Russia were euro experiences a real appreciation as EU demand for 46% (27%) lower than in February (Eurostat, 2022b). A non-EU products falls (in the model, this appreciation is decoupling from Russia is thus already in progress (Euro- achieved through price adjustments). All this weakens pean Commission, 2022a, 2022b). In addition, decoupling the competitiveness of European exporters, resulting in a from China may also seem increasingly likely as the EU 54.2% fall in exports, almost as large as the decline in im- worries about a one-sided dependence on a country that ports. In a trade war scenario (explicit barriers on imports is on “a mission to establish its dominance in East Asia and as well as exports), trade would fall even more strongly. its infl uence globally” (European Commission, 2022c) and also keeps close diplomatic and economic ties with Rus- Shifting production back to Europe sia. Scenarios III and IV therefore analyse the impact of a decoupling of the EU from China and Russia, respectively. The eff ects of such general reshoring of European pro- duction on real income are illustrated in Table 2. A uni- 3 Compared to August 2021, EU imports from Russia actually increased 2 For a detailed description of the model, please see Felbermayr et al. by 6% in August 2022. This is driven by the strong increase in the (2022). price of energy products. Intereconomics 2022 | 6 360 Forum Table 3 trade war than China. Finally, given that the EU alone ac- Change in exports and real income following decoupling counted for 37% of Russian trade in 2020 compared to a Russian share of 5.8% in EU trade in 2021 (European Com- Change in bilat- Change in real income mission, 2022d), it is clear that Russia loses more from a eral exports (in %) (in %) trade war than the EU, the US and their allies. This result Ger- has important policy implications, as it implies that sanc- EU China EU many China tions will be more eff ective, the more countries implement Scenario III (Decoupling EU – China) -97.7 -96.2 -0.8 -1.0 -0.9 them (a fi nding also put forward by Chowdhry et al., 2022). EU, US, EU, US, Ger- allies Russia allies many Russia The relatively small welfare losses for the EU, the US and Scenario IV their allies may seem surprising at fi rst glance. However, (Decoupling EU, US, all simulated eff ects are long-run eff ects that occur once a allies – Russia) -97.7 -96.4 -0.2 -0.4 -9.7 new equilibrium has been reached. Specifi cally, in the case Notes: EU27 excluding UK. The country group allies includes Albania, of decoupling from Russia, this means that new gas pipe- Australia, Canada, Iceland, Japan, New Zealand, Norway, the Philip- lines and liquefi ed natural gas terminals have been built pines, South Korea, Taiwan, Turkey and the United Kingdom. Including and the energy transition has been completed. In the short oil and gas. run, the negative eff ects are likely to be much stronger Source: Felbermayr et al. (2022). (0.5% to 3% for Germany; Bachmann et al., 2022). Simulation results are reported in Table 3. Doubling im- Implications for resilience port and export barriers between the EU and China almost completely eliminates bilateral trade (Scenario III). EU ex- The model results provided by Felbermayr et al. (2021a, 2022) ports to China decline by 97.7%, while Chinese exports to have demonstrated that shifting production back to the EU the EU fall by 96.2%. Intuitively, it is easier for the EU to comes at the cost of lower living standards. Besides po- decouple from one country – even one as large as China – litical considerations, decoupling may still be worthwhile if it than from many countries. Consequently, the fall in bilateral increases the resilience of the European economy. Surely, a trade is stronger than in Scenario II as some trade is now return to autarky would insulate the EU from shocks in third diverted to other countries. Real income declines by 0.8% countries, such as pandemic lockdowns in China or Russian in the EU and by 0.9% in China in this scenario. gas export bans. However, it would make the EU more vulner- able to shocks within Europe. These might be less likely, but Decoupling from Russia is modelled in Scenario IV. In line nevertheless remain possible, as recent fl oods in Germany with recent developments, this scenario assumes joint ac- and the forced shutdown of nuclear power plants in France tion by the EU, the US and their allies. The impact on bilat- have painfully demonstrated. In such cases, international eral trade between the EU, the US and their allies on one trade traditionally serves as a type of insurance, as urgently side and Russia on the other is comparable to that between needed products can be imported in the event of a crisis. A re- the EU and China in Scenario III. However, the eff ect on in- turn to autarky would deprive the EU of such possibilities. The come is very diff erent. The EU, the US and their allies lose same is true if global shocks occur at slightly diff erent times in 0.2% on average. Once again, there is signifi cant heteroge- diff erent countries. For example, at the time most European neity within the EU, with Eastern European economies suf- countries entered into lockdown in 2022, China was already fering most from a decoupling from Russia. Germany, Eu- starting to emerge from its lockdown (albeit only temporarily). rope’s largest economy, loses 0.4% when decoupling from Russia, compared to 1% when decoupling from China. On Alternatives to full decoupling the other hand, Russia loses much more from decoupling (9.7% in Scenario IV) than China (0.9% in Scenario III). Bilateral decoupling – as in the case of Russia – may some- times be politically unavoidable. However, instead of a gen- These varying eff ects can be explained by diff erences in eral reshoring of production, a superior strategy to reduce relative economic size. To give an example, 22% of EU dependence is diversifi cation. Sourcing intermediate prod- imports came from China in 2021, while Russia was only ucts from diff erent regions would strengthen the resilience responsible for 7% of EU imports (UN, 2022). It is thus not of the EU economy while at the same time preserve the ad- surprising that the EU loses less from a trade war with Rus- vantages of the gains from trade. This diversifi cation can be sia than from one with China. On the other hand, the EU, explicitly facilitated by the European Commission through the US and their allies are more important for Russia than increasing international cooperation. Specifi cally, trade just the EU is for China, which is in itself a larger economy agreements can lower trade barriers, for example by mutual than Russia. Consequently, Russia suff ers more from a recognition of standards, and thus make it easier for Euro- ZBW – Leibniz Information Centre for Economics 361 Forum pean companies to increase the number of source coun- Europe would be accompanied by signifi cant losses in real tries. Similarly, investment agreements can reduce risks and income. In addition, while reducing dependence from third thus encourage investment in new production sites abroad. countries, it would make the EU more vulnerable to local Moreover, the funds earmarked for international investment shocks. Instead of decoupling, the EU should therefore pur- projects in the context of the EU’s Global Gateway initiative sue an active policy of increased international cooperation in (European Commission, 2022e) can be used to invest in en- order to diversify its suppliers and thus increase resilience of ergy or raw material production projects. This would benefi t its economy. This should be accompanied by initiatives that people in the countries concerned while at the same time en- encourage fi rms to fi nd technical solutions to supply chain suring supply of critical raw materials and energy for Europe. disruptions such as improved recycling techniques and 3D printing. If done correctly, Europe can emerge from the cur- In addition to actively encouraging diversifi cation, the EU rent crises stronger and more open, thus securing prosper- should carefully evaluate potential confl icts of interest with ity for both its own citizens as well as its partners. other policy objectives. For example, the European Com- mission’s proposed EU due diligence legislation would re- quire European companies to ensure compliance with cer- References tain human and environmental rights standards along the Aguiar, A., M. Chepeliev, E. L. Corong, R. McDougall and D. Van Der Mens- brugghe (2019), The GTAP data base: version 10, Journal of Global Eco- entire supply chain (European Commission, 2022f). As ar- nomic Analysis, 4(1), 1-27. gued by Felbermayr and Sandkamp (2022), such legislation Bachmann, R., D. Baqaee, C. Bayer, M. Kugbm, A. Löschel, B. Moll, A. Pei- would increase fi rms’ cost per supplier relationship, as EU chl, K. Pittel and M. Schularick (2022), What if? The Economic Eff ects for Germany of a Stop of Energy Imports from Russia, ECONtribute companies need to control each supplier (as well as each Policy Brief, 028. supplier’s suppliers) with respect to compliance. These ex- Baur, A. and L. Flach (2022), Deutsch-chinesische Handelsbeziehungen: plicit costs, as well as the implicit costs of the risk of being Wie abhängig ist Deutschland vom Reich der Mitte?, ifo Schnelldienst, 75(4), 56-65. fi ned for failing to uncover violations of human and environ- Bratt, M. (2017), Estimating the Bilateral Impact of Non-Tariff Measures on mental rights, incentivise fi rms to consolidate their supply Trade, Review of International Economics, 25(5), 1105-1129. chains by reducing the number of suppliers (even those that Chowdhry, S., J. Hinz, K. Kamin and J. Wanner (2022), Brothers in arms: The value of coalitions in sanctions regimes, Kiel Working Paper, 2234. do not violate human rights). The result would be a concen- European Commission (2022a), Joint Statement between the European tration rather than a diversifi cation of suppliers and thus re- Commission and the United States on European Energy Security. duced resilience. This does not mean, of course, that human European Commission (2022b), Statement by President von der Leyen on energy. rights should rank behind supply chain security. However, all European Commission (2022c), Opening remarks by President von der legislation has to be carefully evaluated with respect to its Leyen at the joint press conference with President Michel following the potential to hinder increased resilience of supply chains and meeting of the European Council of 21 October 2022. European Commission (2022d), Russia: EU trade relations with Russia. adjusted where necessary. Facts, fi gures and latest developments. European Commission (2022e), Global Gateway, https://ec.europa.eu/info/ Beyond diversifi cation, additional ways to increase resilience strategy/priorities-2019-2024/stronger-europe-world/global-gateway_ en (18 November 2022). include improved warehousing and strategic reserves at the European Commission (2022f), Proposal for a Directive on corporate sus- EU level (Felbermayr et al., 2020). Improved recycling sys- tainability due diligence, COM(2022) 71 fi nal, 2022/0051 (COD). tems are particularly important, as the production of certain Eurostat (2022a), HICP – infl ation rate. Eurostat (2022b), EU27 (from 2020) trade by SITC product group. raw materials can never be shifted to the EU, because they Felbermayr, G., A. Sandkamp, H. Mahlkow and S. Gans (2020), Supply simply do not exist on European soil. At the same time, recy- chains in the post-Corona era, IfW study for the Mechanical Engineer- cling can contribute to more sustainability and reduced car- ing Industry Association. Felbermayr, G., A. Sandkamp, H. Mahlkow and S. Gans (2021a), Decou- bon emissions. Finally, new technologies such as 3D printing pling Europe, Kiel Policy Brief, 153. might actually make certain comprehensive manufacturing Felbermayr, G., R. Langhammer, A. Sandkamp, C. Herrmann and P. Trapp processes obsolete and would thus contribute to shortening (2021b), Economic Evaluation of a Due Diligence Law, IfW study com- missioned by Gesamtmetall e.V. supply chains and therefore increasing their resilience. Felbermayr, G., H. Mahlkow and A. Sandkamp (2022), Cutting through the Value Chain: The Long-Run Eff ects of Decoupling the East from the Conclusion West, Kiel Working Paper, 2210. Felbermayr, G. and A. Sandkamp (2022), Can the government really do it better? Neo-interventionism as illustrated by the Supply Chain Due Dil- Overall, decoupling from certain countries may be both igence Act, in Stiftung Familienunternehmen (ed.), Free Enterprise and politically necessary and economically feasible, at least in state control – Annual Bulletin of the Advisory Board of the Foundation for Family Businesses. the long run. However, a general shift of production back to Kinzius, L., A. Sandkamp and E. Yalcin (2019), Trade Protection and the Role of Non-Tariff Barriers, Review of World Economics (Weltwirtschaftli- ches Archiv), 155(4), 603-643. 4 For alternatives to the proposed EU due diligence legislation that OECD (2021), OECD Inter-Country Input-Output (ICIO) Tables. would not incentivise fi rms to consolidate supply chains, see Felber- UN (2022), UN Comtrade Database. mayr et al. (2021b). Intereconomics 2022 | 6 http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Intereconomics Springer Journals

Reshoring by Decree? The Effects of Decoupling Europe from Global Value Chains

Sandkamp, Alexander
Intereconomics , Volume 57 (6) – Nov 1, 2022
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10.1007/s10272-022-1087-9
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Abstract

DOI: 10.1007/s10272-022-1087-9 Forum Intereconomics, 2022, 57(6), 359-362 JEL: F11, F13, F17 Alexander Sandkamp Reshoring by Decree? The Eff ects of Decoupling Europe from Global Value Chains Political opposition to ever-increasing globalisation up to to the domestic economy. It is argued that this would not the point of calls for deglobalisation seem to be spreading only increase resilience, but also reduce dependence on like wildfi re. Be it the presidency of Donald Trump, Brexit or systemic rivals such as China. Based on fi ndings by Fel- China’s dual circulation strategy, the past few years have bermayr et al. (2021a, 2022), this article investigates the witnessed a politically induced shift towards reduced eco- impact of decoupling the EU from global value chains on nomic cooperation across countries. Most recently, the trade and welfare (i.e. real income). In particular, four spe- two major challenges to globalisation are without a doubt cifi c scenarios are presented. the COVID-19 pandemic and the war in Ukraine. Both have demonstrated the vulnerability of the global economy, thus The fi rst scenario investigates a unilateral decoupling by inducing governments to openly question the benefi ts of the EU from the rest of the world with the aim of reduc- supply chains that span the entire planet. ing imports and shifting production back to EU countries. The second scenario investigates a mutual decoupling, Three consequences should be noted. First, the pandemic meaning the explicit restriction not only of EU imports but and the war have indeed severely disrupted global pro- also exports. Against the backdrop of increased depend- duction networks. In 2020, medical products such as face ence on China, the third scenario simulates the impact of masks, protective gloves and ventilators were in short sup- a mutual decoupling of the EU from China only. Finally, the ply. In 2021, many other products including wood, contain- fourth scenario models a mutual decoupling of the EU, ers and microchips experienced shortages. Now the focus the US and their allies from Russia. is on energy products, in particular oil and gas. Second, this imbalance between demand and supply has led to a gen- Dependencies on non-European suppliers eral increase in prices. In the European Union (EU), infl ation was already at 2.9% in 2021, i.e. before the war in Ukraine Before investigating the potential impact of decoupling the (Eurostat, 2022a). In September 2022, prices increased by EU from global value chains, it is worth taking a look at an 10.9% year-on-year. Third, the disruptions have led com- example that illustrates the current dependence of the EU panies and governments to question the reliability of global on global value chains. Germany, Europe’s largest economy, supply chains. This scepticism is partly unjustifi ed, since sourced 92% of its intermediate products from Europe in shortages were also driven by the strong increase in de- 2018 (OECD, 2021). Relocating the remaining 8% may thus mand for medical products in 2020 as well as the general seem feasible. In 2018, only 1.3% of total direct intermediate resurgence in demand that accompanied the global recov- products (6% of imported intermediates) came from China. ery in 2021. EU imports actually increased by 29% in 2021 However, these aggregates mask signifi cant heterogeneity (Eurostat, 2022b), surpassing the pre-pandemic level. Nev- across products. For example, 80% of laptops and 70% of ertheless, the impression remains that global supply chains mobile phones imported into Germany originated from Chi- are not as resilient as previously thought. na in 2021. In a recent survey among German companies, 46% of respondents said that they were currently sourc- Overview of decoupling scenarios ing important intermediate products from China (Baur and Flach, 2022). Decoupling from China, let alone the world, One way to seemingly increase resilience to such bottle- may therefore be diffi cult – at least in the short run. necks in global value chains is to shift production back Methodology © The Author(s) 2022. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License The four scenarios are simulated using the Kiel Institute Trade (https://creativecommons.org/licenses/by/4.0/). Policy Evaluation (KITE) model. It is a general equilibrium Open Access funding provided by ZBW – Leibniz Information Centre trade model that simulates trade fl ows between 141 countries for Economics. 1 It does not matter whether the EU imposes barriers on exports to third Alexander Sandkamp, Kiel University (CAU); and countries or whether these countries impose barriers on their imports Kiel Institute for the World Economy (IfW), Germany. from the EU. Within the model, both actions have the same eff ect on trade and real income. ZBW – Leibniz Information Centre for Economics 359 Forum Table 1 Table 2 Trade eff ects following EU decoupling Change in real income following EU decoupling Change in real Change in real Change in real Income change EU imports (in %) exports (in %) EU income (in %) (in bn euro) Scenario I (Unilateral decoupling) -62.5 -54.2 Scenario I (Unilateral decouping) -3.5 -584.4 Scenario II (Trade war) -84.1 -87.0 Scenario II (Trade war) -5.3 -873.1 Note: Without China (eff ects similar). Excluding oil and gas. Note: Change in income based on GDP in 2019. EU28 including the UK. Excluding oil and gas. Source: Felbermayr et al. (2021a). Source: Felbermayr et al. (2021a). in 65 sectors and covers 98% of global economic activity. The lateral imposition of trade barriers on EU imports would model is calibrated using the latest version of the Global Trade reduce real income by 3.5% (Scenario I). This is a perma- Analysis Project (GTAP; Aguiar et al., 2019) database. Within nent eff ect and implies that income in the EU would be the model, a shift in production back to the domestic econ- permanently 3.5% lower than in a world without additional omy is modelled by a doubling of non-tariff barriers (NTBs). barriers. In terms of 2019 GDP, this amounts to foregone These incorporate a plethora of diff erent instruments includ- income of €584.4 billion every year. A mutual decoupling ing import controls, state aid, public procurement and trade (Scenario II) would increase this loss to 5.3%. defence instruments that have been shown to signifi cantly re- duce trade fl ows (Bratt, 2017; Kinzius et al., 2019). NTBs are The aggregate eff ects presented in the table mask signif- doubled because this strongly reduces bilateral trade fl ows icant heterogeneity across EU member states. For exam- without completely eliminating them (no full shift to autarky). ple, Germany as a very open economy loses more from Crucially, the model allows investigating the impact of such a a trade war (-6.9% or €236.7 billion). Small open econo- change in trade barriers on trade and real income. mies such as Belgium, Malta and Ireland are hit hardest by a trade war between the EU and its trading partners. Simulation results Welfare in the EU’s trading partners declines, too (on av- erage by 1.5% in Scenario II). Shifting a large part of pro- In a fi rst step, Table 1 shows how a doubling of EU trade duction back to the EU is thus possible in principle, but barriers vis-à-vis non-EU countries impacts EU imports and would involve considerable costs for both the EU as well exports in the model. Doubling import barriers reduces EU as its partners. imports from third countries by 62.5% (Scenario I). Raising import barriers shifts production back to Europe. However, Decoupling the EU from China and Russia this means that EU producers have to forego the benefi ts from the international division of labour and specialisation In view of recent geopolitical developments, a strategic as the production of intermediate products is relocated decoupling of the EU from specifi c countries may be more to Europe. Instead of being imported from the cheapest plausible than a general move back towards autarky. Fol- source country, intermediates are now being produced at lowing the Russian invasion of Ukraine on 24 February home at higher cost. Prices of remaining imports also in- 2022, EU trade with Russia has declined signifi cantly. In crease due to the imposed trade barriers. In addition, the August 2022, EU exports to (imports from) Russia were euro experiences a real appreciation as EU demand for 46% (27%) lower than in February (Eurostat, 2022b). A non-EU products falls (in the model, this appreciation is decoupling from Russia is thus already in progress (Euro- achieved through price adjustments). All this weakens pean Commission, 2022a, 2022b). In addition, decoupling the competitiveness of European exporters, resulting in a from China may also seem increasingly likely as the EU 54.2% fall in exports, almost as large as the decline in im- worries about a one-sided dependence on a country that ports. In a trade war scenario (explicit barriers on imports is on “a mission to establish its dominance in East Asia and as well as exports), trade would fall even more strongly. its infl uence globally” (European Commission, 2022c) and also keeps close diplomatic and economic ties with Rus- Shifting production back to Europe sia. Scenarios III and IV therefore analyse the impact of a decoupling of the EU from China and Russia, respectively. The eff ects of such general reshoring of European pro- duction on real income are illustrated in Table 2. A uni- 3 Compared to August 2021, EU imports from Russia actually increased 2 For a detailed description of the model, please see Felbermayr et al. by 6% in August 2022. This is driven by the strong increase in the (2022). price of energy products. Intereconomics 2022 | 6 360 Forum Table 3 trade war than China. Finally, given that the EU alone ac- Change in exports and real income following decoupling counted for 37% of Russian trade in 2020 compared to a Russian share of 5.8% in EU trade in 2021 (European Com- Change in bilat- Change in real income mission, 2022d), it is clear that Russia loses more from a eral exports (in %) (in %) trade war than the EU, the US and their allies. This result Ger- has important policy implications, as it implies that sanc- EU China EU many China tions will be more eff ective, the more countries implement Scenario III (Decoupling EU – China) -97.7 -96.2 -0.8 -1.0 -0.9 them (a fi nding also put forward by Chowdhry et al., 2022). EU, US, EU, US, Ger- allies Russia allies many Russia The relatively small welfare losses for the EU, the US and Scenario IV their allies may seem surprising at fi rst glance. However, (Decoupling EU, US, all simulated eff ects are long-run eff ects that occur once a allies – Russia) -97.7 -96.4 -0.2 -0.4 -9.7 new equilibrium has been reached. Specifi cally, in the case Notes: EU27 excluding UK. The country group allies includes Albania, of decoupling from Russia, this means that new gas pipe- Australia, Canada, Iceland, Japan, New Zealand, Norway, the Philip- lines and liquefi ed natural gas terminals have been built pines, South Korea, Taiwan, Turkey and the United Kingdom. Including and the energy transition has been completed. In the short oil and gas. run, the negative eff ects are likely to be much stronger Source: Felbermayr et al. (2022). (0.5% to 3% for Germany; Bachmann et al., 2022). Simulation results are reported in Table 3. Doubling im- Implications for resilience port and export barriers between the EU and China almost completely eliminates bilateral trade (Scenario III). EU ex- The model results provided by Felbermayr et al. (2021a, 2022) ports to China decline by 97.7%, while Chinese exports to have demonstrated that shifting production back to the EU the EU fall by 96.2%. Intuitively, it is easier for the EU to comes at the cost of lower living standards. Besides po- decouple from one country – even one as large as China – litical considerations, decoupling may still be worthwhile if it than from many countries. Consequently, the fall in bilateral increases the resilience of the European economy. Surely, a trade is stronger than in Scenario II as some trade is now return to autarky would insulate the EU from shocks in third diverted to other countries. Real income declines by 0.8% countries, such as pandemic lockdowns in China or Russian in the EU and by 0.9% in China in this scenario. gas export bans. However, it would make the EU more vulner- able to shocks within Europe. These might be less likely, but Decoupling from Russia is modelled in Scenario IV. In line nevertheless remain possible, as recent fl oods in Germany with recent developments, this scenario assumes joint ac- and the forced shutdown of nuclear power plants in France tion by the EU, the US and their allies. The impact on bilat- have painfully demonstrated. In such cases, international eral trade between the EU, the US and their allies on one trade traditionally serves as a type of insurance, as urgently side and Russia on the other is comparable to that between needed products can be imported in the event of a crisis. A re- the EU and China in Scenario III. However, the eff ect on in- turn to autarky would deprive the EU of such possibilities. The come is very diff erent. The EU, the US and their allies lose same is true if global shocks occur at slightly diff erent times in 0.2% on average. Once again, there is signifi cant heteroge- diff erent countries. For example, at the time most European neity within the EU, with Eastern European economies suf- countries entered into lockdown in 2022, China was already fering most from a decoupling from Russia. Germany, Eu- starting to emerge from its lockdown (albeit only temporarily). rope’s largest economy, loses 0.4% when decoupling from Russia, compared to 1% when decoupling from China. On Alternatives to full decoupling the other hand, Russia loses much more from decoupling (9.7% in Scenario IV) than China (0.9% in Scenario III). Bilateral decoupling – as in the case of Russia – may some- times be politically unavoidable. However, instead of a gen- These varying eff ects can be explained by diff erences in eral reshoring of production, a superior strategy to reduce relative economic size. To give an example, 22% of EU dependence is diversifi cation. Sourcing intermediate prod- imports came from China in 2021, while Russia was only ucts from diff erent regions would strengthen the resilience responsible for 7% of EU imports (UN, 2022). It is thus not of the EU economy while at the same time preserve the ad- surprising that the EU loses less from a trade war with Rus- vantages of the gains from trade. This diversifi cation can be sia than from one with China. On the other hand, the EU, explicitly facilitated by the European Commission through the US and their allies are more important for Russia than increasing international cooperation. Specifi cally, trade just the EU is for China, which is in itself a larger economy agreements can lower trade barriers, for example by mutual than Russia. Consequently, Russia suff ers more from a recognition of standards, and thus make it easier for Euro- ZBW – Leibniz Information Centre for Economics 361 Forum pean companies to increase the number of source coun- Europe would be accompanied by signifi cant losses in real tries. Similarly, investment agreements can reduce risks and income. In addition, while reducing dependence from third thus encourage investment in new production sites abroad. countries, it would make the EU more vulnerable to local Moreover, the funds earmarked for international investment shocks. Instead of decoupling, the EU should therefore pur- projects in the context of the EU’s Global Gateway initiative sue an active policy of increased international cooperation in (European Commission, 2022e) can be used to invest in en- order to diversify its suppliers and thus increase resilience of ergy or raw material production projects. This would benefi t its economy. This should be accompanied by initiatives that people in the countries concerned while at the same time en- encourage fi rms to fi nd technical solutions to supply chain suring supply of critical raw materials and energy for Europe. disruptions such as improved recycling techniques and 3D printing. If done correctly, Europe can emerge from the cur- In addition to actively encouraging diversifi cation, the EU rent crises stronger and more open, thus securing prosper- should carefully evaluate potential confl icts of interest with ity for both its own citizens as well as its partners. other policy objectives. For example, the European Com- mission’s proposed EU due diligence legislation would re- quire European companies to ensure compliance with cer- References tain human and environmental rights standards along the Aguiar, A., M. Chepeliev, E. L. Corong, R. McDougall and D. Van Der Mens- brugghe (2019), The GTAP data base: version 10, Journal of Global Eco- entire supply chain (European Commission, 2022f). As ar- nomic Analysis, 4(1), 1-27. gued by Felbermayr and Sandkamp (2022), such legislation Bachmann, R., D. Baqaee, C. Bayer, M. Kugbm, A. Löschel, B. Moll, A. Pei- would increase fi rms’ cost per supplier relationship, as EU chl, K. Pittel and M. Schularick (2022), What if? The Economic Eff ects for Germany of a Stop of Energy Imports from Russia, ECONtribute companies need to control each supplier (as well as each Policy Brief, 028. supplier’s suppliers) with respect to compliance. These ex- Baur, A. and L. Flach (2022), Deutsch-chinesische Handelsbeziehungen: plicit costs, as well as the implicit costs of the risk of being Wie abhängig ist Deutschland vom Reich der Mitte?, ifo Schnelldienst, 75(4), 56-65. fi ned for failing to uncover violations of human and environ- Bratt, M. (2017), Estimating the Bilateral Impact of Non-Tariff Measures on mental rights, incentivise fi rms to consolidate their supply Trade, Review of International Economics, 25(5), 1105-1129. chains by reducing the number of suppliers (even those that Chowdhry, S., J. Hinz, K. Kamin and J. Wanner (2022), Brothers in arms: The value of coalitions in sanctions regimes, Kiel Working Paper, 2234. do not violate human rights). The result would be a concen- European Commission (2022a), Joint Statement between the European tration rather than a diversifi cation of suppliers and thus re- Commission and the United States on European Energy Security. duced resilience. This does not mean, of course, that human European Commission (2022b), Statement by President von der Leyen on energy. rights should rank behind supply chain security. However, all European Commission (2022c), Opening remarks by President von der legislation has to be carefully evaluated with respect to its Leyen at the joint press conference with President Michel following the potential to hinder increased resilience of supply chains and meeting of the European Council of 21 October 2022. European Commission (2022d), Russia: EU trade relations with Russia. adjusted where necessary. Facts, fi gures and latest developments. European Commission (2022e), Global Gateway, https://ec.europa.eu/info/ Beyond diversifi cation, additional ways to increase resilience strategy/priorities-2019-2024/stronger-europe-world/global-gateway_ en (18 November 2022). include improved warehousing and strategic reserves at the European Commission (2022f), Proposal for a Directive on corporate sus- EU level (Felbermayr et al., 2020). Improved recycling sys- tainability due diligence, COM(2022) 71 fi nal, 2022/0051 (COD). tems are particularly important, as the production of certain Eurostat (2022a), HICP – infl ation rate. Eurostat (2022b), EU27 (from 2020) trade by SITC product group. raw materials can never be shifted to the EU, because they Felbermayr, G., A. Sandkamp, H. Mahlkow and S. Gans (2020), Supply simply do not exist on European soil. At the same time, recy- chains in the post-Corona era, IfW study for the Mechanical Engineer- cling can contribute to more sustainability and reduced car- ing Industry Association. Felbermayr, G., A. Sandkamp, H. Mahlkow and S. Gans (2021a), Decou- bon emissions. Finally, new technologies such as 3D printing pling Europe, Kiel Policy Brief, 153. might actually make certain comprehensive manufacturing Felbermayr, G., R. Langhammer, A. Sandkamp, C. Herrmann and P. Trapp processes obsolete and would thus contribute to shortening (2021b), Economic Evaluation of a Due Diligence Law, IfW study com- missioned by Gesamtmetall e.V. supply chains and therefore increasing their resilience. Felbermayr, G., H. Mahlkow and A. Sandkamp (2022), Cutting through the Value Chain: The Long-Run Eff ects of Decoupling the East from the Conclusion West, Kiel Working Paper, 2210. Felbermayr, G. and A. Sandkamp (2022), Can the government really do it better? Neo-interventionism as illustrated by the Supply Chain Due Dil- Overall, decoupling from certain countries may be both igence Act, in Stiftung Familienunternehmen (ed.), Free Enterprise and politically necessary and economically feasible, at least in state control – Annual Bulletin of the Advisory Board of the Foundation for Family Businesses. the long run. However, a general shift of production back to Kinzius, L., A. Sandkamp and E. Yalcin (2019), Trade Protection and the Role of Non-Tariff Barriers, Review of World Economics (Weltwirtschaftli- ches Archiv), 155(4), 603-643. 4 For alternatives to the proposed EU due diligence legislation that OECD (2021), OECD Inter-Country Input-Output (ICIO) Tables. would not incentivise fi rms to consolidate supply chains, see Felber- UN (2022), UN Comtrade Database. mayr et al. (2021b). Intereconomics 2022 | 6

Journal

Intereconomics – Springer Journals

Published: Nov 1, 2022

Keywords: F11; F13; F17

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