Hello from Brussels. By now there seems to be a reasonable degree of confidence here that there will actually be a Joe Biden administration to deal with at the end of January rather than an alt-right paramilitary junta. Attention has turned away from the aftermath of the Capitol Hill insurrection and towards what the forthcoming policymakers are actually saying.
As we noted in Trade Secrets yesterday, the maiden speech of Katherine Tai, the US trade representative-elect, was interesting if not breathtakingly radical. (Not radical is fine, as far as the EU is concerned.) In fact, it echoed a lot of the thinking over here, that enforcement of existing trade rules will be the big thing rather than racking up shiny new agreements. Whether the EU and US can collaborate on said enforcement is the open question.
Today’s main piece looks at an EU initiative that might either be a source of tension or co-operation with the US: its plans for a carbon border tax. Tall Tales continues to mine the rich vein of told-you-sos arising during the implementation of Brexit. Our chart of the day covers the boom in Chinese goods exports.
An incremental way to save the planet
On Monday we looked at the digital services tax, a prominent document in the “Potential trade battles with the US” folder on the EU’s computer desktop. A similar item in the “Potential trade battles with everyone” file is the proposed carbon border adjustment mechanism, or CBAM.
A CBAM, which the EU hopes to introduce in the next couple of years, would mean that the carbon emissions of imports are charged the same cost as their EU equivalents. Such a system would be economically efficient and intuitively fair: it prevents carbon leakage by internalising the cost of carbon emissions to the EU’s trading partners, as well as to its own producers. Unfortunately, its economic and ethical attractiveness is in inverse proportion to the ease of designing a mechanism that could both achieve these desired ends and stay within World Trade Organization rules.
The European Commission’s finest have beavered away since 2019 to produce a proposal by this year. There are two particular reasons why it’s a lot harder than it sounds to come up with an effective CBAM. For one, a blanket tariff on all imports from a particular country erases the difference between relatively carbon-light and carbon-heavy producers. Second, assessing a product arriving at the EU border depending on its last export destination glosses over carbon emitted earlier in the supply chain. Detail matters in the design of a CBAM. Ignoring technicalities is both inefficient and potentially opens the measure to legal challenge at the WTO.
An obvious way to do a carbon border measure, as we’ve described before, is in effect to incorporate foreign producers into the EU’s emissions trading system, its carbon market and also the most important tool Brussels has right now for reducing greenhouse gas emissions. This would require them to buy the permits that European producers must now use to be able to compete with them in the EU market.
Implemented properly, this ought to be OK under WTO law, if necessary by invoking the right to impose tariffs to conserve “exhaustible natural resources”. A paper commissioned by the European Parliament offers a very clear analysis of the WTO legality of carbon border measures. The policymaking connections of its authors, David Kleimann and Joost Pauwelyn, are worth noting. Kleimann is former adviser to the chair of the European Parliament’s trade committee and now a fellow at Georgetown University in Washington: Pauwelyn is Brussels’ nominee to sit on the EU-designed stopgap WTO appeals mechanism, and probably a future appellate body member, if it ever gets revived. He also helped to design border measures in a carbon pricing proposal presented to the US Congress more than a decade ago.
However, using the emissions trading system limits the measure’s scope. The scheme covers only some industries, and to start with the CBAM will similarly be limited to a small range of basic energy-intensive commodities — perhaps cement and steel. For finished goods rather than raw materials, the question remains whether the costs of inputs can be calculated. To assess emissions by product and by producer will require a complex emissions certification, granted by external inspectors working to an EU benchmark.
Finally, there’s the issue about what to do with those EU industries (including steel and cement manufacture) at present given free allocations for emissions under the emissions trading system. It would make sense to abolish those allocations simultaneously with introducing the CBAM. The US already regards 100 per cent-free allocations as trade-distorting subsidies that can be met with anti-subsidy duties. But industries that receive free allocations are resisting.
If and when the EU launches a CBAM, it will start it off narrow in coverage and address as many of the technical and legal complexities as possible while being prepared to adjust it as it goes along. It’s quite likely that there will be WTO litigation: indeed, you might well conclude that if China hasn’t brought a case within a few months, then the scheme wasn’t ambitious enough. Through a process of trial and error, in the same way that the Airbus-Boeing litigation has gradually pointed the way to an enduring aviation subsidies regime, perhaps the EU’s carbon border mechanism will bed down enough that it can at least start to make a measurable difference to relative carbon prices worldwide, which at the moment offer far too little incentive to reduce emissions.
This gradualist approach is no doubt the sensible one, but it does raise the question of whether such an incremental measure is worth the hassle. An independent study commissioned by the Finnish government concluded that a CBAM might well end up being more symbolic than substantive, and indeed counterproductive if it provokes retaliation from the likes of China.
The real prize would be for the mechanism to have an impact on international political economy. If the US enacts its own form of domestic carbon pricing and adopts a similar border measure, the global balance of power could change. It would no longer be Green Europe against the world but that fabled transatlantic alliance we keep hearing about holding China to its promises to cut carbon emissions to net zero by 2060. That’s a project for the medium term, to say the least. But at least a working EU CBAM, even a limited one, might nudge the world gently in the right direction.
Trade tensions? What trade tensions? China’s trade surplus hit its highest ever monthly level in December, as the country’s exports continued to boom during the pandemic, Thomas Hale writes. Exports grew 18.1 per cent in dollar terms last month, while imports rose 6.5 per cent, pushing the trade surplus to a record $78bn. Here’s what has happened to goods exports since the pandemic went global in March last year:
Exporters have benefited from higher demand for medical products and lockdown-related goods at a time when global trade has come under intense pressure and other big economies have struggled to cope. China is the only one of the world’s major economies that is expected to have grown in 2020.
Tall tales of trade
We can see that the implementation of Brexit is going to keep us in Tall Tales, which we might temporarily rename Told You Sos, for months to come.
This week’s involves the comic sight of Dutch customs officials gently relieving a British lorry driver of his ham sandwich at the border under EU food hygiene rules. Cue spluttering from Brexiters that the UK hasn’t diverged from EU regulations in this area, or not yet, so there’s no need to treat them differently. Forgive us while we do a few eye-rolling exercises.
The point, as some of us have explained only about a billion times, is that as soon as you leave the single market and its enforcement mechanisms, including the European Court of Justice, the EU no longer has oversight of your inspection and regulatory processes and so will not take them on trust. It’s not about having the same regs: it’s about having different legal regimes to enforce them.
Bad news for the UK economy, to be sure, but at least the Dutch catering industry can see brighter days ahead, assuming of course there will be any British lorry drivers left to sell sandwiches to.
Michel Barnier has warned that many of the new regulatory frictions hampering cross-Channel trade will be impossible to smooth over, as the inevitable consequences of Brexit begin to manifest themselves for businesses across Europe.
On the topic of frictions, German logistics group DB Schenker on Wednesday became the latest major parcels operator to suspend cross-border delivery services because of new red tape and customs paperwork imposed by Brexit. In a note issued to customers, the company said it was suspending shipments from the EU to the UK blaming the “enormous bureaucratic regulations” created by the post-Brexit trading arrangements that had left recipients in the UK unable to handle shipments in a “legally compliant manner”.
Amsterdam is already showing potential to eat into London’s pre-eminence as a European capital markets centre. Trading in EU shares fled London for EU centres, including the Dutch city on the first day outside the single market at the start of 2021, while Polish ecommerce group InPost picked the city for its stock listing on Wednesday. The announcement by the parcel locker business suggests that initial public offerings may also gravitate towards where trading in European stocks is more lively.
The best trade stories from Nikkei Asia
The US company behind The North Face and Vans will relocate its Asia-Pacific headquarters to Shanghai and Singapore, the latest high-profile corporate exit from Hong Kong.
Even business travel bubbles with 11 neighbouring countries will be closed as Japan restricts entry once again to curb the spread of coronavirus.
Indian government data show imports from China fell 19.5 per cent in the first 10 months of 2020, as a border dispute stoked bilateral tensions and spurred a build-up of domestic industries.
European Commission upgrades economic forecasts
The European Commission has sharply raised its economic forecasts for the coming two years, as an accelerating vaccination campaign helps the eurozone recover from the historic blow delivered by the pandemic.
The euro area will expand by 4.3 per cent this year and 4.4 per cent in 2022, Brussels said on Wednesday, compared with previous forecasts for 3.8 per cent growth in both years. As a result, all member states are now expected to regain their pre-crisis output levels by the end of next year, following a historic 6.6 per cent slump in 2020.
The stronger outlook was driven by the rising vaccination rates and the prospect of lockdowns easing across the region, as well as improving export demand driven by a global rebound. Brussels for the first time fully factored in the impact of the €800bn Next Generation EU economic relaunch package, which is expected to begin paying out in the second half of the year.
“The shadow of Covid-19 is beginning to lift from Europe’s economy,” said Paolo Gentiloni, the EU’s economics commissioner. “After a weak start to the year, we project strong growth in both 2021 and 2022. Unprecedented fiscal support has been — and remains — essential in helping Europe’s workers and companies to weather the storm.”
Europe slid into a double-dip recession early this year amid renewed lockdowns and a shaky start to the vaccination effort. However, evidence has been mounting more recently that the economy has “moved up a gear”, according to the commission, which cited improved business and consumer sentiment surveys.
Further easing of containment measures combined with the early payouts from the recovery fund should mean economies would accelerate in the third quarter — including those with big tourism sectors, which should benefit from the return to “quasi-normality of social activities over the summer”, according to the commission.
Stronger global growth, driven in part by the US stimulus packages and improved growth in China, will also help lift the EU’s export sector and contribute to the recovery. The broader EU economy will grow 4.2 per cent in 2021 and 4.4 per cent in 2022, according to the forecast, also an upgrade from the February outlook. The bloc’s unemployment rate will hit 7.6 per cent this year before heading back down to 7 per cent in 2021.
Spain, which was the hardest-hit EU economy last year, losing more than a tenth of its output, will grow 5.9 per cent in 2021 and 6.8 per cent in 2022, according to the new outlook. Italy is set to expand by 4.2 per cent this year and 4.4 per cent next.
Germany, which suffered a much smaller 2020 contraction, could grow 3.4 per cent in 2021 and 4.1 per cent in 2022. France is tipped to expand by 5.7 per cent this year and 4.2 per cent next.
The outlook next year will be supported by the highest public investment levels as a share of gross domestic product in more than a decade. That will be driven in part by the Next Generation EU package, which is meant to start paying out in the summer once member states get their recovery plans signed off by the commission.
In total, the six-year programme should pay out about €140bn of grants over the two years covered by the commission’s forecasts. That should deliver a 1.2 per cent of GDP uplift, according to the outlook.
The crisis will still continue to exert a massive strain on public finances, however, with the overall eurozone deficit set to rise to 8 per cent of GDP this year. That is predicted to halve next year to 4 per cent, but the legacy of the vast government spending programmes will still loom large. The overall euro area public debt-to-GDP ratio will remain above 100 per cent this year and next, the commission said.
EU member states face a tense debate later this year over how to rapidly pare back their stimulus programmes and whether to reform the bloc’s fiscal rules, which are set to remain suspended until 2023.
Among the risks to the outlook, the commission said, was the possibility that governments would decide to start paring back their economic support packages too soon, undermining the recovery. The continued effectiveness of vaccines and the evolution of the pandemic will also play a critical role in determining whether the EU’s upgraded forecast proves justified.
No, ‘hyperinflation’ is not here
There’s a lot of concern out there about inflation right now. Including, unsurprisingly, here in Germany. And where not just talking about the Bund yield. This is this morning’s hot take from state broadcaster ZDF:
For non-German speakers, the headline reads ‘Fear of hyperinflation’.
The article is not entirely unreasonable, focusing on the pressures we’ve seen build up in producer prices over the course of the pandemic. As markets this morning are all too aware ahead of an important US print Wednesday, we are likely to see broader consumer price inflation surge in the coming months.
We’re betting that it’ll be a temporary blip. Round about this time last year, the West Texas Intermediate oil contract went sub zero. Twelve months on, we were always likely to see some dramatic CPI readings simply as a result of the slump in price pressures that happened when the pandemic first struck.
To boot, take away stimulus cheques and furlough schemes, and the labour market on either side of the Atlantic is nowhere near strong enough to trigger the sort of wage-price spiral that saw inflation surge into the double digits in the US and UK in the 1970s. Even in Germany, where manufacturing unions are still relatively strong, companies like Volkswagen say they don’t need to pay their workers more. Those are workers who did not get a pay rise in 2020, nor will they get one this year either — though they will see a 2.8 per cent bump from 2019 levels in 2022.
But our main point is this: Even if the price pressures seen in supply chains do spread more widely, and even if higher CPI readings do endure, raising the spectre of hyperinflation — which conjures up the cash-in-wheelbarrows images witnessed in the 1920s to many here — is completely overblown.
The article itself notes that hyperinflation is a phenomenon where prices shoot up by more than 50 per cent. We’re nowhere near that sort of situation — even over the next few months inflation readings are likely to remain in the single digits. To suggest otherwise is nothing short of scaremongering.
The EU is trailing China’s trade distortions all round the world
This article is an on-site version of our Trade Secrets newsletter. Sign up here to get the complete newsletter sent straight to your inbox every Monday to Thursday.
Hello from Brussels, and welcome to the first edition of the new and improved Trade Secrets.
We’re still feeling the reverberations from the US’s announcement last week supporting, in principle, a patent waiver for Covid-19 vaccines at the World Trade Organization. The EU’s incredibly indignant that it’s been outspun and made to look like the bad guy, and is letting everyone know about it. The problem is that, being the EU, it’s unable to convey a quite simple and entirely reasonable message — it’s fine to talk about patents, but tech transfer and exports are the main thing — without a bit of a cacophony and strange references to Anglo-Saxons.
The babble managed to overshadow some quite big news at the EU-India summit over the weekend. As the Financial Times predicted last week, Brussels and Delhi launched (or technically renewed) talks on a trade deal, plus ambitious notions about co-operating on digital connectivity, geopolitics and so on, plus an investment treaty of the kind that’s gone down so well since the EU signed it with China. Speaking of which, today’s main piece is on the EU’s determined campaign to create legal tools to take on Chinese trade distortions, complicated by the fact that the problem keeps changing shape.
Charted Waters takes a look at trade flows over the past decade.
New answers to the ever-changing China question
There’s been a finely tuned humming heard around Brussels over the past few years, like a high-performance engine being run at speed. It’s the legal brains of the European Commission designing new “autonomous” (unilateral) tools to counter what the EU regards as the unfair trade and investment distortions produced by Chinese state capitalism. (They don’t say China, but that’s what they mean.)
Whether you support the campaign’s underlying philosophy — free-traders are sceptical about it — the process is impressive to watch. Frankly, we wouldn’t want the lawyers of the trade and competition directorates after us. The latest contrivance was wheeled out of the hangar last week, in the form of a subsidies instrument to be used against state-supported foreign companies operating in the EU.
Assuming it gets adopted, and depending on how it’s used, it’s a big deal, bringing competition tools to bear on international trade. Essentially, it extends the reach of the EU’s state aid regime abroad where foreign handouts distort the European market. It can be applied to market competition, mergers and acquisitions, and public procurement.
The anti-subsidy tool is the latest in the following list of China-unfriendly initiatives implemented or proposed by the EU over the past five or so years. If you’re taking notes: sharpening up trade defence instruments (anti-dumping and anti-subsidy duties); allowing those duties to be used against companies subsidised by the Chinese government but exporting from another country; tightening up screening of inward foreign direct investment (FDI) for national security reasons; developing an anti-coercion tool (aimed more at Donald Trump’s administration, to be fair) to use against foreign governments acting illegally; producing a toolbox for member states to manage risky entities (Huawei) from 5G networks; banning imports made with forced labour; and requiring European companies to exercise “due diligence” in eliminating labour and environmental abuses from their supply chains. Quite a list.
You have to admire the commission’s stamina and ingenuity, finding ways to tackle one alleged distortion after the other. You’d also think that, what with China and the EU becoming ever closer trading partners, Brussels’ stance would somewhat rattle Beijing. But it’s hard to conclude that the EU’s tools, along with a bunch of similar actions by the US and other countries, have pushed the Chinese growth model towards a market economy. In fact, President Xi Jinping’s going the other way, with a “dual circulation” growth strategy, one of the aims of which is to use heavy government intervention to build up high-tech capacity in China in an insulated domestic market.
Why? Well, some of the explanations are political. These tools are housed in the commission, but some require EU member state acquiescence to create and/or use. Powers over national security FDI and 5G screening, for example, reside at national level: China can pick off individual countries with carrots and sticks.
Some explanations are institutional. The ability to use anti-dumping and anti-subsidy duties against Chinese companies based in third countries has been tried just a few times (glass fibre fabric and reinforcements from Egypt and steel from Indonesia and India) and only partially succeeded. Antidumping lawyers grumble that the commission makes it too hard to bring new cases.
Some are practical. The subsidy instrument will involve complex investigations, trying to apply existing EU state aid disciplines to the myriad opaque ways that China hands out money to its companies. The thresholds for action also have to be set high enough not to deter benign investments, especially since a foreign business attempting to acquire a company in the EU may also have to file separate national FDI notifications.
But one of the hardest issues is that the creation of the instruments generally lags behind the evolution of the Chinese trade and growth model by a few years. While Europe’s trade defence tools were being strengthened against exports from China, Beijing was instead building industrial capacity abroad through the Belt and Road Initiative. Then, just as the EU started to apply those duties against Chinese companies outside China, Beijing was rethinking the Belt and Road Initiative and reducing its foreign exposure. The subsidy tool arrives several years after Chinese FDI into the EU started falling and many European governments became disenchanted with China. You can very plausibly argue the EU now needs more rather than less Chinese FDI.
As the EU-China Comprehensive Agreement on Investment shows, China is less interested in getting market access in the EU than securing European inward investment in intellectual property-intensive sectors such as electric vehicles, and we can guess what for. The agreement has provisions to prevent forced technology transfer, and the EU has brought cases on the issue at the WTO, but winning dispute settlement cases rather than wielding a unilateral tool is a slow and uncertain business.
This isn’t a counsel of despair: there are still plenty of Chinese exports and investment in the EU that can be regulated, assuming that’s a good idea. But the EU’s critiques of the latest phase of Chinese development — dominating advanced markets through huge government support and weaponising trade for geopolitical ends — will be even harder to address than the previous ones. And that’s before we get to the question of human rights.
We’ll take a deeper look at the EU’s anti-subsidy initiative in future newsletters: there’s a lot to examine. For now, we’ll just say that there’s been a lot of painstaking legal engineering going on, but the devices that result are already looking a little dated.
This is about as big a picture on global trade as you can get. The data, from the CPB Netherlands Bureau for Economic Policy Analysis, track trade flows over the past ten years and show two things.
First, the good news (for those of you who are fans of globalisation at least). The recovery from the early months of the pandemic has been remarkable, with flows now at their pre-Covid mark.
This is a point that we don’t think is made often enough. While semiconductor chip shortages and high shipping costs often make headlines (including, we confess, in Trade Secrets), global manufacturing and logistics should be given an awful lot of credit for ensuring that the rebound seen over the past three quarters has been so strong.
The bad news is that broader geopolitical tensions were clearly affecting flows in the run-up to the pandemic. We don’t see those tensions dissipating soon, so expect growth to stutter even if we manage to get Covid under control. Claire Jones
Welcome to our new Trade Links section, a round-up of the best content we’ve come across over the past few days.
Today’s must-read comes from the European Centre for International Political Economy and covers the trade implications of the radical shift in technology turning manufacturing giants, such as Volkswagen, into software developers. It’s well written and has some great charts that help support the case that, when it comes to trade and technology, the future is now.
We’d highly recommend this FT piece, which takes an in-depth look at why the Serum Institute of India, the world’s top vaccine maker, is struggling. One of the reasons being that it’s at the sharp end of the vaccine trade wars. Also worth a look is this Big Read from Andrew Hill, explaining why the UK’s services sector is taking a big hit from Brexit. This is a massive deal. And — as Lionel Barber, formerly of this parish, notes — it is a story too few are talking about given that services makes up a whopping 80 per cent of UK output. Expect this to change, and the services sector’s woes to rise in prominence, as economies on both sides of the Channel begin to reopen.
This morning’s edition of the FT’s excellent Europe Express newsletter focuses on the transatlantic spat over the vaccine waiver, which Mehreen Khan concludes will do little to help poorer countries in desperate need of more jabs. For those of you interested in European policy and politics beyond trade, sign up here for a daily guide to what’s driving the European agenda, available for premium subscribers Monday to Friday at 7am CET. Nikkei Asian Review looks at ($ — subscription needed) why bureaucratic timidity led to the withering of Japan’s pharmaceuticals industry, leaving it reliant on foreign countries for vaccine supplies. For fans of the chip story (who isn’t?), Nikkei has dug into how Korean electronics group Samsung lost its lead to Taiwanese chipmaker TSMC.
Elsewhere, the International Economic Law and Policy Blog asks what if the US can’t create consensus around a vaccine waiver. (There are some interesting recommendations for further reading in the comments too.) This week’s Economist delves into the topic ($) of vaccine donations. While Covax has made almost 50m vaccination donations, this is well short of its target. One of the reasons for that being the tragedy unfolding in India. China, meanwhile, has doled out 13.4m doses to 45 different countries, and India more than 10m vaccines. Alan Beattie and Claire Jones
Any recommendations on articles to include in Trade Links? Send your tips here.
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