“Europe’s New Role in the Global Economic Economy”
Géopolitique
Since coming to office for the second time Donald Trump has instituted a paradigm shift in US international economic policy. In several key areas he has effectively withdrawn the US from its global leadership role of the past eighty years. Some commentators have focused on China as providing the main alternative to US economic leadership. But it is only Europe, broadly defined, that has the combination of characteristics required to form an alternative economic “pole” in the global economy to the US.
The EU would need to be at the core of this European-led economic pole. It has the economic weight (18 per cent of global GDP by market value vs 26 per cent for the US), a fully convertible currency accounting for 20% of central bank foreign exchange reserves at end 2024 (versus 57% for the US dollar), industrial skills and scientific capabilities, regulatory competence, a law-based system of governance, and a wide suite of international economic alliances. Many of these features are strengthened and amplified by close economic cooperation with Europe’s other major economies.
Trump’s paradigm shift
It is still unclear where the end point for Trump’s policies will be in many areas. But after five months of his second Presidency one can begin to identify five broad economic policy themes.
First, the President appears set to deliver a substantial permanent increase in the US average tariff rate from 2.5% in 2024 to perhaps 10-20%, or even higher, going forward. This is combined with a withdrawal from all WTO disciplines and procedures for setting and changing tariffs. The President has also ignored some 20 existing bilateral free trade agreements, and it is unclear what value may be placed on new agreements signed following the current negotiations.
Second, the Trump administration has taken a much more ambivalent view of the US dollar’s status as the leading global reserve asset. Trump advisers have questioned the benefit of the dollar’s status to the US economy Trump has threatened to replace the current chairman of the Federal Reserve with a more compliant figure when Powell stands down in May 2026. Meanwhile the Trump-backed tax bill going through Congress is expected to lead to a further sharp increase in the US public debt burden of some $2.4 tn over ten years. These factors have combined with continuing concerns among foreign holders of convertible currencies caused by the G7 decision to freeze up to $300bn in Russian foreign exchange reserves in February 2022. But these now focus more acutely on the dollar given the range of circumstances in which President Trump might choose to take such action on his own.
A third major theme has been the Trump Administration’s withdrawal from collective international efforts to tackle climate change, disease and poverty. This includes withdrawing the US for a second time from the Paris climate change agreement, US withdrawal from the WHO and making dramatic cuts in US aid (eliminating 90% of current USAID projects worth some $60bn pa and withdrawing funding for the GAVI Vaccine Alliance). The Administration is also attempting to use its shareholdings and board seats in the International Financial Institutions to try and shift their focus away from climate action. It remains to be seen what the substantive effect of this will be, but it clearly threatens the COP29 projection that the multilateral development banks (MDBs) would collectively provide $120bn a year in climate finance to low- and middle- income countries by 2030.
Fourthly, the Trump Administration is ending US support for global efforts to fight corruption and strengthen governance. The Department of Justice has said that it will no longer enforce the Foreign Corrupt Practices Act (the cornerstone of the OECD Anti-Bribery Convention). Nor will the US Treasury enforce beneficial ownership transparency laws. These international moves are re-enforced by the President’s own disregard for ethics principles and the weakening in domestic US governance brought about the Administration cuts to public research, denial of scientific evidence on climate change and the efficacy of vaccines, and constant challenges to the authority of US courts.
A fifth aspect of the international economic paradigm shift which has yet to play out fully is the Administration’s new agenda on financial deregulation. So far this has focused mainly on removing domestic constraints on the development of crypto currencies, but there is also the prospect that the authorities will substantially weaken the regime put in place to prevent a recurrence of the global financial crisis.
Just these steps alone would constitute and extraordinary shift in the US’s international economic role. But they have been combined by an equally sharp change in the US’s approach towards its closest military and security allies. Trump has threatened the sovereign integrity of both Canada and Denmark/EU (through his threat to take over Greenland). He has undermined the collective security of NATO members by qualifying the application of Article 5. He has also made no distinction between close allies and strategic competitors in his application of tariffs and other damaging economic policy measures. Very strong security ties between the US and its allies have historically re-enforced economic ties bringing considerable economic benefits to both parties. This is now at risk.
How has Europe responded?
To date the EU – and indeed most of the US’s major trading partners – have prioritised bilateral responses to Trump’s tariff hikes.
While China has enacted substantial retaliatory tariffs against the US, the EU has suspended its planned retaliation while negotiations continue. The UK did not retaliate against Trump’s reciprocal or sectoral tariffs and so far it is the only major country to reach a political settlement with the US. Under this, the UK has accepted an asymmetric 10% tariff rate on most exports to the US in return for relief from even higher tariffs on export of cars and steel.
The EU has a great deal more leverage than the UK, particularly if it is willing to extend retaliation into the digital services sector where the US has a substantial trade surplus with the Union. EU authorities have ruled out concessions in some areas which go to the heart of how the EU economy operates, such as VAT. The Commission has also continued with anti-monopoly enforcement against major US tech companies. But debate continues among member states on how far the Union should use its considerable leverage to attempt to negotiate a balanced long-term trade agreement with the US versus seeking a quick settlement which limits the short-term economic costs.
The EU has successfully re-energised some of its long-standing bilateral free trade negotiations with non-US counterparties and was able to sign an outline agreement with Mercosur at the end of 2024. However, it has not to date led an overt collective effort to manage the threat of trade diversion from the US and preserve a low tariff rules-based trading system “around” the US, despite a number of calls to do so.
Trump’s actions have re-enforced the case made in Draghi and Letta reports for faster more comprehensive internal economic reform in the EU. This has been reflected in a renewed efforts by the Commission to progress the Savings and Investments Union. At the same time ECB President, Christine Lagarde, has called for a renewed focus on strengthening the Euro’s international role, which could bring a range of economic benefits, including lower borrowing costs, a reduction in currency risk and transaction costs for European firms and higher seigniorage earnings for the ECB.
But it remains to be seen how far this will be carried through in such practical areas as pan-European debt issuance and implementation of the euro system plans for a central bank digital currency. The EU’s new euro 150bn SAFE (Security Action for Europe) financial instrument designed to support development of European defence industries through joint procurement and production could also make a broader contribution to the EU’s financial markets (its will be funded through EU-level debt issuance) and technology capabilities.
Both the EU and UK have taken a nuanced towards continuing economic engagement with China. While the US has effectively shut Chinese EVs out of the US market, the EU has adopted a tariff strategy designed to encourage Chinese EV makers and suppliers to establish in the EU. The UK has the same objective and has not to date imposed specific tariffs on Chinese EVs. However, as part of its trade deal with the US, it has agreed to take unspecified measures to protect the US supply chain. It is unclear how broad the impact of this will and whether it will restrict the UK’s trade and investment relationship with China beyond what the UK might wish to do justified on genuine national security risks.
Europe’s response to Trump’s paradigm shift in international organisations and multilateral fora has been much less active than its bilateral response. However, on such issues as the climate focus of the IFIs and implementation of the 2015 OECD global tax agreement, both the EU and the UK appear to be trying to compromise with the US’s positions and maintain consensus. This was also visible in the EU and UK’s support for Canada’s approach to the recent G7 Summit. Underlying this seems to be a desire to keep the US engaged in international organisations and groupings, at least while the Trump review of US membership of international inter-governmental organisations is continuing. However, there are major risks in this approach, not least that ground will be conceded by the large majority on issues of principle which will prove impossible to recover.
What should Europe do?
The international economic system is very unlikely to return to the way it was before President Trump’s second term. Trump could easily be succeeded by a politician with similar views, but even if the Democrats win back the House of Representatives in the mid-term elections, or the White House in 2028, the world will have moved on. The structure of national economies will have changed, new bilateral relationships will have formed and international institutions will have adapted. Trust between the US and its traditional allies will be particularly hard to repair.
It is also increasingly clear that, while Europe will not be able to avoid being hurt economically by Trump’s actions in the short-term, it could well benefit in the long term, simply because it will look more attractive in relative terms to investors and human talent as a result of predictable regulation, science-based policy making in government, competent non-political bureaucracy and respect for freedom of opinion and speech. This relative improvement depends critically on populist parties staying out of power in the EU’s major economies. It could be further strengthened and built on by the right kind of policies framed in a long-term strategy.
Three principles will help in shaping such policies.
First, European policy makers must avoid being co-opted into following the direction of US economic policy simply because it reflects a new fashion, is the price of consensus with the US or is backed by heavy private sector lobbying. This is especially true in relation to policies to deliver the net zero transition (which are just as critical as ever) or to prevent a recurrence of the global financial crisis. But even in such areas as AI regulation, where the EU may want to adapt its approach, underlying principles on such issues as privacy, preventing on line harms and protecting the integrity of democratic processes should continue to be respected.
Second, Europe should invest more to develop a new Europe-centred economic pole for the global economy situated between the US and China. This should encompass the EU, UK and any other advanced countries which wish to maintain a stable rules-based approach to international trade and investment, continue with low average tariffs, limit distorting subsidies and as far as possible respect the WTO’s MFN[1] and non-discrimination principles. Reaching out to the democratic large emerging economies (such as Brazil, South Africa and Indonesia) and showing greater readiness to consult rather than take unilateral actions, however justified (as with the CBAMs[2]), could also help Europe establishing an influential grouping.
Third, European policy makers should avoid hubris and focus on pragmatic incremental steps to strengthen Europe’s role in the global economy over the long term. It is unlikely that the euro will take over from the dollar as the world’s leading reserve currency in the foreseeable future.[3] However, a number of steps could be taken to strengthen the euro’s international standing including addressing the remaining weaknesses in the euro financial safety net post-GFC and consolidating EU or euro area representation in the IMF. Europe also urgently needs greater pragmatism in starting to address the demographic time bomb arising from low fertility rates through an effective system of managed migration. In the absence of migration, the EU population is projected to fall by some 125mn by the end of the century which would have a devastating impact on prosperity and growth.
Conclusion
While Europe certainly has to manage its short-term response to Trump’s paradigm shift, it is increasingly urgent that time is also devoted to a longer-term strategy. This should reflect the indefinite nature of the Trump shock and recognise that capitalising on the longer-term opportunities for Europe may require incurring greater short-term costs.
[1] Most Favoured Nation
[2] Carbon Border Adjustment Mechanisms
[3] Indeed, according to a recent report from the ECB gold now accounts for a larger share of world central bank foreign exchange reserves than the euro.