Coronavirus won’t kill globalization, but will clip its wings
EU will not seek an all-out break with China, but will seek to reshore some key industries.
Coronavirus has touched a raw nerve. Fearing they have undermined their security through overreliance on China, European politicians are stressing that manufacturing must return to the EU.
As the crisis deepened, the EU's Internal Market Commissioner Thierry Breton conceded that Europe may have gone "too far in globalization" and become too reliant on "one country, one continent." German Chancellor Angela Merkel argued that the pandemic reveals the need for a "certain sovereignty here" obtained through a "pillar of domestic production."
For the self-sufficiency hard-liners, that means rolling back globalization. Armed with new technologies like 3D printers, they see a prime opportunity to rein in supply chains for machinery that stretch out to East Asia.
Current and former EU economy ministers, diplomats, business people and economists contacted for this article stressed such a wholesale revolution is unlikely, but predicted a reshoring of selected critical industries, particularly medical supplies.
For many EU leaders, the most disarming shock of the crisis has been Europe's fumbling inability to make face masks or the basic chemicals required for pharmaceuticals. Nurses in wealthy countries like Italy, Spain and even the U.S. donning trash bags for lack of gowns showed the fragility of international supply chains.
The buzzword, though, is likely to be diversification rather than all-out reshoring.
"We must learn lessons from the crisis," German Economy Minister Peter Altmaier told POLITICO. "For example, when it comes to the question of dependency on just one supplier or just one region."
Face masks and pharma
Reshoring had been steadily climbing the political agenda, even before the virus forced countries into lockdown. Late last year French Economy Minister Bruno Le Maire criticized the carmakers Peugeot and Renault for making vehicles in Morocco, Slovenia and Turkey.
The EU's own industrial strategy, launched last month, also identified the need "to make the most of localization as an opportunity to bring more manufacturing back to the EU in some sectors.”
The hapless response over medical supplies, however, has propelled the debate to a more practical level. Both France and Germany were quick to identify the pharmaceutical sector as a key area where reshoring made sense.
Industry ministers and business leaders who loved talking about the sharing economy, artificial intelligence and 5G, were suddenly asking anyone with a sewing machine to help make face masks.
The lack of coordination in Europe stood in stark contrast with the Asian Tigers, whose factories within days pumped out masks by the millions, along with large-scale testing kits that allowed them to contain the virus where the alleged rich world — Europe and the U.S. — conspicuously failed.
Indeed, the Europeans were playing catch up. The carmaker Seat in Spain said it had started making ventilators at one of its plants. French President Emmanuel Macron announced last week that a group of French companies will ramp up production of masks and ventilators.
Back to the drawing board
The shambles over medical equipment dealt a painful blow to advocates of the theory of comparative advantage, which underpins globalization. The theory says that countries should specialize in what they make best. Free trade will make sure that every country gets what it needs at a better price on the world market than if it tried to make everything itself.
But the pandemic showed that in times of crisis, the world market collapsed. Companies remained loyal to their governments or bound by local export bans.
This came on top of research from economists working with César Hidalgo at the Massachusetts Institute of Technology, which in the past years has shown that countries that export a wide variety of more complex products, such as Japan or Switzerland, fare much better in terms of future growth and income inequality than countries that rely on just one industry, such as oil or soybean exporters.
Even staunch advocates of free trade started questioning whether countries had pushed the global division of labor too far.
French economist Philippe Aghion criticized what he said was excessive "deindustrialization, offshoring, extended value chains," in his country, in an op-ed for Les Echos last week. "Quietly, France has deindustrialized, it has pushed the offshoring of its value chains to the limit."
"It is difficult, even in a war economy, to mobilize non-existent capacity and evaporated know-how."
In what is maybe the strongest sign of a shift in European thinking yet, Merkel on Monday joined her French counterpart Macron in calling for economic "sovereignty" for Europe. The traditionally liberal leader argued that the crisis had made it clear that EU countries need to define a set of Europe-based "strategic capabilities."
In her remarks, Merkel made a distinction between production capacity that her government would build up immediately to tackle the health crisis — notably masks — and a wider set of systemically critical sectors, which EU governments would identify after the crisis.
“We will have a discussion on the question of what strategic capabilities we must and want to have in Europe. We will then have to develop these in a very targeted manner,” she said. “These will be the decisions to be taken once we have overcome the most serious parts of this crisis in the health sector.”
Diplomats and ministry officials said EU governments are likely to define such a set of "critical" industries that they want to reshore, but it is unclear whether this would happen at a national or an EU-wide level. The obvious risk would be wasteful overlaps across Europe as each country scrambles to build very similar plants for medical supplies.
With this in mind, French Economy Minister Le Maire, as well as Internal Market Commissioner Breton, have called for Brussels to play a role in the reshoring of those yet-to-be-defined industries.
The difficulty with identifying such sectors is obvious: Where to stop? The next crisis to hit may not be a virus but the eruption of a supervolcano — which could cripple air transport and freight and bring about a volcanic winter, turning trains, greenhouses and fossil fuels into the strategic industries.
Alicia García-Herrero, chief economist for Natixis bank, pointed out the reshoring list could indeed be lengthy.
"This could be for a lot of sectors. If the next crisis was a collapse of the electricity system, you would need to reshore production of turbines."
"If you push that argument it's the end of globalization and the single market," she added. "It would be autarky."
Instead, García-Herrero said companies would diversify their supply chains to become less reliant on China. Within the EU, she said, Brussels should step up to enforce the single market and prevent countries like France and Germany from restricting their exports to neighboring Italy and Spain.
No end to globalization
EU trade chief Phil Hogan this week pointed out that total independence from imports was an "unattainable goal" for the EU.
“Self-sufficiency is not an option,” Hogan told the European Parliament's trade committee on Tuesday. However, he acknowledged that “we should reduce our trade dependencies that make us vulnerable.”
Even Paris recognizes that reshoring only makes sense in narrowly defined sectors. “A violent and massive decline in globalization is unlikely,” said an internal memorandum prepared for the French government and quoted by Le Monde, “because companies have no reason to give up the advantages of international production chains in terms of costs, competitiveness and profitability.”
Instead, the report recommended diversification away from China.
Similarly, former Italian trade minister Carlo Calenda said reshoring makes sense only for a very small number of sectors. “In general this approach risks triggering commercial wars and protectionism. After a crisis of demand and supply, the last thing we need is a subsequent export crisis,” he told POLITICO.
García-Herrero said EU companies had woken up to this need to diversify when China shut its factories in February. "The lesson of COVID-19 is that it is better to pay a little bit more to have security," she said. "Part of the production will move much closer to Europe, to countries where companies feel they know the political risks," she predicted.
German Economy Minister Altmaier warned that "the consequence of the crisis must not be increased protectionism and renationalization.
"Our prosperity is based on the principle of an economy based on the division of labor," he told POLITICO."But of course companies will have to focus on further diversification in the future, reducing dependencies and making our economy more resilient."