Europe and China

The US-China trade talks look like they may very well continue through most of the second quarter, despite how much progress is being claimed.  Meanwhile, the tariffs remain in effect, but the market's sensitivity to developments has slackened since it was clear the Trump and Xi were not going to meet at the end of this month.  

Europe's relationship with China will eclipse the US-China trade talks that resume with Mnuchin and Lighthizer in Beijing this week.   Xi is spending a second week in Europe, culminating in a summit later this week.  Nearly regardless of the outcome of the summit, Xi will go home with an important success.  Italy signed a memorandum of understanding (MOU) with China regarding the Belt-Road Initiative (BRI).  

There is both more and less than meets the eye.  Italy is not the first EU country to sign MOUs.  Portugal was the latest, at the end of last year, but thirteen have MOUs with China.  Italy is the largest country, and now a full half of the EU (with the UK still a member) has signed up.  Of course, China can score some PR points by highlighting that Italy is the first G7 country to agree. 

Some of Italy's critics seem to suggest that being a member of the club comes with certain responsibilities and leaves unarticulated what those responsibilities are. The G7 has become a little more than a caucus within the G20, and even when the G7 was at its peak, it did not prevent Italy (and Canada) from sometimes being excluded (G5).  Nor did membership in the exclusive group stop Germany, for example, of being the only G7 country that will receive gas directly from Russia without going through Ukraine. 

The US did not want Italy to sign an MOU with China.   It is concerned about deeper economic ties.  However, Germany, France, and the UK have greater trade and investment ties to China than Italy.    Italy is in dire straits.  The economy contracted H2 18.  Its ability to provide fiscal stimulus is limited by the EC and the Stability and Growth Pact.   Most of the debt overhang, which international observers harp on, is a legacy from past excesses, but Italy, unlike many other countries, has not been able to grow out of it because its growth is so poor.  

Despite appeals by liberal and neoliberal economists for Germany to use the fiscal space it has to boost investment, and through it, offset the fiscal restraint elsewhere, but there is little appetite in Berlin. The roughly one percent expansion seen this year in structural terms is a drop in the bucket of what the critics claim is needed.   Some argue that a large stimulus would help the periphery, including Italy, though it often seems exaggerated. Trade would be the main transmission channel.  Stronger German stimulus would ostensibly boost its imports.  Italy exported about 58.5 bln euros of goods and services to German last year.  One needs to dig deeper and see the elasticity of demand relative to growth for those goods.

The trade deals signed alongside the MOU are expected to boost Italy's exports to China by 2.5 bln euros, with the potential to rise to 20 bln euros. The MOU does not conflict with existing policy, and the chief goal seems to be to boost exports to China, and perhaps to demonstrate its will to Brussels.  The MOU is not a binding agreement.  Different sectors for potential cooperation were specified, including construction and ports.

Europe's relationship with China is more complicated than American-Sino relationship.   Leaving aside Jeffrey Sachs recent interview of CNBC,  there is a broad consensus in the United States that is one of the few issues of agreement in the current discourse:  China has the power and intent to frustrate America.  It is cruel to its people and steals the fruit of others' labor.  In fact, given the political cycle, an anti-China campaign could be a unifying message and a differentiator.  

Last week. EU formally recognized China as a "strategic player" not an economic partner.  It recognizes China promote an alternative model of governance. It knows that China uses its economic power to project strategic influences.  Yet, EU several countries, led by the UK,  previously joined the Chinese-founded Asian Infrastructure Investment Bank, over US objections.  While the, US, Japan, and Australia have barred Huawei, Europe has not.  

In the Cold War II hypothesis (sketched here), suggests Europe is the main theater as it was in the first Cold War.  Europe does not have the national or regional champions in most industries that can compete with American, Chinese, and soon Indian companies that will dominate the "commanding heights" of the 21st-century economy.  Yet it is fairly wealthy, even if slow growing.   It is not that China can dominate Europe in a pre-modern sense.  Rather by making inroads through trade and investment, which naturally builds special interest groups defending their prosperity, China simple has to neutralize Europe to weaken the US.   It is noteworthy that the yuan-euro is allowed by Chinese officials to trade in a range more than twice as wide as the yuan-dollar exchange rate is allowed to move (on a daily basis from the reference rate) 

Through investment and trade ties, China's influence in Asia is growing. NATO and the threat of the Soviet Union (and then Russia), and the economic prosperity kept the US and Europe close.  There has always been a low level of tensions and frustrations that occasionally flare up. At best the relationship is simply at a low ebb, at worst, the ties are weakening and may not be restored.  It has been recognized for nearly two decades that the US and "new Europe"-eastern and central Europe-had more in common in terms of defense than the west.   

The trend has extended under the Trump Administration.  Tariffs have been levied on Europe's steel and aluminum exports to the US on national security grounds.  The US is threatening a 25% tariff on auto imports from Europe.  It is asking that countries that house US bases cover their full costs plus 50%.    

Europe is carving its own course with China.  There is one observation from the Brexit experience that may be particularly useful.  The EU has demonstrated a remarkable degree of unity in terms of the UK leaving the EU.  The UK, in contrast, is the opposite.  The referendum that was to unite the party is tearing the country apart.  It will not have the advantage in China of an adversary shooting themselves in the foot, which makes European unity all the more important.  Castigating Italy, when German and French ties are so much greater, may not be particularly helpful in building that unity. 

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