The Case for an EU-US Economic Security Alliance (2024)

Despite much goodwill on both sides, trade and economic relations between the United States and Europe have remained strained. Working together to collectively improve transatlantic geoeconomic security would offer a way forward.

It might appear fanciful to propose the creation of a transatlantic economic security alliance to deter geoeconomic coercion. Transatlantic trade cooperation remains troubled. Although trade relations initially improved under the Biden administration, the passage of the Inflation Reduction Act in the United States and its protectionist provisions have caused significant consternation in the Europe Union, adding to strained trade relations. 

The US-EU Trade and Technology Cooperation Council, which focuses on non-market-access trade issues, such as technology and security, met for the fifth time on January 30. Judging by the press release, the TTC continues to make only slow progress after more than two years of talks. A revival of the Transatlantic Trade and Investment Partnership (TTIP), a project launched, then aborted during the presidency of Barack Obama, is out of the question for domestic political reasons. And, finally, there is the real risk that a future Republican administration may again shift toward an aggressive unilateralism on international trade issues, treating Europe more like a foe than a friend.

A Formidable Alliance

And yet it makes sense to explore the viability of a transatlantic economic security alliance. The increasing “securitization” (defensive) and weaponization (offensive) of international economic relations makes a common approach to economic alliance worth exploring. To the extent that such an arrangement delivers mutual benefits and at low costs, it may even be sellable to future US administrations with inherently unilateral instincts and a distinctive disregard for multilateralism. 

An EU-US economic defense alliance would be formidable. According to the WTO, the EU and the US accounted for a combined 23 percent of global merchandise exports and 31 percent global merchandise imports in 2022. The respective shares for commercial services exports and imports were 40% and 36% of the world total. According to the International Monetary Fund (IMF), the euro and the dollar account for an even more impressive 80 percent of central banks’ foreign-exchange holdings, a proxy of the two currencies’ importance in international trade and finance. The two economies are also leading providers of advanced technologies and offer foreigners relatively unfettered access in terms of investment. The threat of (partial) exclusion from two of the world’s three largest markets would serve as a powerful deterrent to geoeconomic coercion, provided it can be made credible.

Globalization has given rise to extensive economic interdependence. Interdependence is often asymmetrical interdependence, giving one country the ability to impose or threaten to impose asymmetric economic costs on another by, for example, restricting customary trade and financial relations in an attempt to deter, compel, punish, or degrade. This is often referred to as the weaponization of international economic interdependence. As geopolitics and relative gains are increasingly trumping economics and absolute gains in the context of intensifying great power rivalry, countries must prepare for the greater politicization of international economic relations. 

Designing a Credible Deterrence Strategy

A US-EU geoeconomic defense alliance is not meant to be coercive in the sense of forcing third parties to change their behavior or reverse specific actions they have taken. The empirical literature on economic sanctions as a form geoeconomic coercion shows that they more often than not fail in terms of getting the targeted country to change their political behavior—particularly so, if the targeted country is a geopolitical antagonist. Instead, a geoeconomic defense alliance is meant to deter unfriendly economic measures by third parties targeting alliance members. In addition, it can and should foster intra-alliance cooperation to mitigate individual and collective economic vulnerabilities vis-à-vis third parties.

Like in a defensive military alliance, the members would commit to come to the support of any member that becomes the target of geoeconomic coercion, meaning the imposition of discriminatory economic policies for political reasons. Support involves policies to lessen the negative impact of third geoeconomic measures as well as retaliating collectively against the coercer. If the commitment is credible, the alliance may not ever have to make good on its promises, thus providing a cost-effective way of preventing cost-imposing third-party economic measures. If deterrence fails, the combined weight of the US and the EU stands a good chance of imposing significant costs on the geoeconomic aggressor, which should help deter further aggressive action due to the alliance’s escalation dominance.

Managing Alliance Politics

For an alliance to be successful, it needs to address what International Relations literature refers to as abandonment and entrapment. Alliance members confront the risk of both being let down by their alliance partners and being entrapped and pulled into other alliance members’ conflicts. To address the risk of abandonment, an EU-US economic alliance would therefore need to define as precisely as possible what constitutes third-party geoeconomic aggression and thus obligates the alliance to provide support. To minimize the risk of entrapment, the alliance would also need to agree on what “offensive” national security-related economic measures taken by an alliance member vis-à-vis third parties qualify for alliance support. 

A transatlantic economic defense alliance must not provide members with incentives to behave more aggressively, economically or politically vis-à-vis third parties. An alliance will only be viable, however, if its individual members do not feel overly constrained in terms of their foreign and foreign economic policies, particularly as it pertains to national security. But the goal needs to be to deter third-party geoeconomic measures targeting alliance members, not to provoke them. 

Last but not least, deterrence policies need to be credible, proportional, and effective. Given the combined geoeconomic power of the EU and the US, designing credible and effective cost-imposing deterrence policies should not be difficult, either. Credibility may present a greater challenge. It is politically impossible to enshrine an agreement on economic defense in an international treaty. Good luck finding a two-thirds majority in the US Senate. While an executive-level agreement would be much weaker and might prove less durable, it does not mean that it could not be reasonably credible. Adversaries would surely think twice before launching unfriendly policies against a member of the alliance if there is only a small risk of significant retaliation. 

Coordinating Defense and Extending Deterrence

Deterrence seeks to prevent third parties from resorting to geoeconomic measures for fear of retaliation. It does not require much imagination to see how national economic defense policies could be adapted in an alliance context in terms of broader policy coordination, even if some of the required coordination may require domestic legislative support. Defense policies essentially aim to limit the opportunity of third parties to impose economic costs on alliance members. Here Brussels and Washington could seek to coordinate their diversification policies and “innovative substitution” policies to limit their dependence on critical imports in the short- and longer-term as well as coordinate policies aimed at the purchasing and stockpiling of critical goods. The main geoeconomic vulnerabilities of the US and the EU are related to their dependence on critical imports of goods, not their exports or foreign financial dealings.

Finally, the US and the EU could opt for extended deterrence. This would widen the economic security umbrella to selected associate members. US treaty allies could be included to afford them similar or even equal protections than its alliance members. This may increase the risk of entrapment. But it is worth considering in terms of deterring geoeconomic coercion more widely and preventing the weaponization of international economic relations—making the extended “Western world” a safer place.

See also: 

The Case for an EU-US Economic Security Alliance

A Transatlantic Economic Security Alliance to Deter Geo-Economic Coercion      

US Partisan Politics Risks Leading America to Make an Unforced Strategic Error (2024)

Europe and Germany cannot take timely and sufficient American support for Ukraine for granted. Partisan-political divisions and the prospect of a second Trump administration are creating heightened uncertainty. Brussels and Berlin should make it clear to both American policymakers and legislators that Europe has thus far provided far more total aid than Ukraine than America. They should also emphasize that US support is highly cost-effective in terms of America’s broader, China-focused national security strategy.

The Biden administration’s request for an additional $60 billion of Ukraine aid remains tied up in a hyper-partisan Congress. Worse, a second Trump administration may threaten to reduce or even withhold further Ukraine aid altogether, possibly in an attempt to force Europe to increase its support. To the extent that transatlantic disagreement over cost sharing is amenable to rational argument, Europe should emphasize two important points in its negotiations with America: Europe has already committed to providing much more aid to Ukraine than America; and American aid generates significant economic and strategic benefits to the United States at a comparatively small cost, while a reduction, let a alone complete withdrawal in aid would jeopardize Washington’s broader strategy goals. 

Europe has committed far greater resources to Ukraine than America 

As of October 2023, EU countries, directly and indirectly, have committed about twice as much military, financial and humanitarian aid to Ukraine than America. According to the Kiel Institute for the World Economy, total commitments by EU countries and EU institutions have amounted to $133 billion, compared to $72 billion since the beginning of the war in February 2022. The United States is the largest single provider of total aid ($71 billion) as well as military aid and assistance ($44 billion), followed by Germany (total aid: $21 billion/ military aid: $17 billion) and the UK (total aid: $13 billion/ military aid: $7 billion). As a share of GDP, however, Lithuania and Estonia have been the most generous providers of aid worth 1.8%. By comparison, Germany has provided aid worth 0.9% of GDP (including through EU institutions) and the United States 0.3% of GDP. 

If contributions were adjusted to take into account America’s slightly larger economy compared to the EU-27 (15.2% vs 14.3% of global GDP on a purchasing power parity basis) and its significantly higher per capita income ($80,000 vs $57,000 in PPP terms), Europe’s relative “adjusted” share would be even greater than what is implied by dollar contributions alone. Any transatlantic discussion of how to share the cost of support in future should start from an acknowledgment that Europe is committing far greater resources to support Ukraine than America. Far from free-riding, Europe is pulling its weight.

America’s Support for Ukraine is Highly Cost-Effective in Terms of its Broader Strategic Goals

A second issue European should emphasize is that America derives significant economic and strategic benefits from supporting Ukraine, and it does so at a relatively low cost. Financially, American aid is small, amounting to a little more little more than $70 billion since the start of the, or less than 0.15% of GDP on an annual basis. The $60 billion of additional aid requested by the Biden administration would amount to another 0.2% of GDP in 2024. To put this into perspective, a sustained 100 basis point increase in US interest rates costs the US taxpayer $260 billion, annually. 

Economically, Ukraine aid is not simply “money out of the door”. American aid, unlike EU aid, consists primarily of military aid and assistance. To the extent that military aid comes out of new production rather than existing stockpiles, the money flows directly to the US defense industry and US workers. According to the American Enterprise Institute, 90% of the funds spent stay in the United States. To the extent, however, that aid is financed by debt issuance, the American taxpayer is ultimately accountable for servicing it. But 0.15-0.2% of GDP worth of additional annual spending is as close to a rounding error in GDP terms as it gets.

Strategically, US military aid helps maintain the balance of conventional military power in Eastern Europe, and thus stability and security in Europe. From Washington’s point of view, it does more than that: it weakens Russia strategically. Leaving aside Russian losses in equipment and personnel as well as the impact of sanctions, the continued flow of Western aid to Ukraine is forcing Russia to increase “unproductive” military expenditure, thereby reducing the ability to invest to support long-term economic development. Russia’s trend growth has already decelerated to less than 1% over the past decade, and it is set to decline further, thereby weakening the country’s strategic position.

Keeping Russia at bay militarily in Ukraine is consistent with, and conducive to America’s primary strategic goal, as articulated in the National Security Strategies of both the Trump and Biden administrations: countering China. The war in Ukraine has led Moscow and Beijing to form a closer relationship. Preventing Russian from making gains in Eastern Europe is therefore in America’s best interest in terms of its broader national security strategy. From Washington’s point of view, spending less than 0.2% of GDP a year to prevent Russia, China’s major international partner, from making gains in Ukraine is simply efficient and effective strategy.

Reducing US Support for Ukraine Would Be Nothing Short of an Unforced Strategic Error

A second Trump administration may wager that a reduction of American aid will force the Europeans to increase their support and such a move would not fundamentally change the prospect of Russian gains in Ukraine. After all, Europeans feel more immediately threatened by the war in Ukraine than America. But this is a risky approach to take. A substantial reduction in aid would benefit Russia and might allow it to make military gains. And even if American aid does come through in the end, uncertainty about the availability and timing of future funding might undermine morale in Kyiv and embolden Moscow. Withholding Ukraine is also risky because Europeans, who have delivered more financial than military aid, are not well-placed to replace shipments of US military equipment necessary to support Ukraine effectively.

Washington might insist that Europeans purchase the necessary defense goods from America. But this would lead America to incur significant reputational costs in the eyes of its European and Asian allies. Uncertainty over America’s commitments to its security alliances would increase and weaken America’s geo-strategic position in East Asia. So even if the Europeans manage to increase their financial support to the level required to preserve the military balance in the Ukraine – and it is far from clear that this will happen – withholding or substantially scaling back American support for Ukraine looks like an unforced strategic error in the making. 

Should serious transatlantic disagreement over Ukraine funding emerge, then Europe would do well to point to the significant support it has provided thus far. It should also remind America of the significant strategic and reputational costs it would incur and of the very limited financial savings a reduction of US support would generate if it were to sharply reduce or withhold support altogether. These argument may not sway ideologues among policymakers, nor congresswomen (sic!) under electoral pressure. But they are squarely aimed at the Downsian median “voter” in Congress and pragmatic policymakers. Europeans must hope that America’s strategic interests prevail over populist, partisan domestic politics as well as some of its latest or not-so-latent unilateral-isolationist instincts.

Geo-Commercial and Geo-Financial Vulnerabilities in View of Fragmentation and Coercion Risks (2024)

An economically highly integrated country like Germany is at greater risk of sustaining significant losses in the event of economic fragmentation. All other things equal, it is also more vulnerable to geo-economic coercion. An analysis of Germany’s foreign trade and financial relationships allows high-level evaluation of bilateral economic and geo-economic vulnerabilities. 

Economic decoupling is obviously a bad idea. But this does not meant Germany should not prepare for such a possibility. After all, a war in East Asia may lead to involuntary decoupling. De-risking is therefore the right approach in the sense of re-calibrating policies so as to achieve the desired risk-reward trade-off.

Geo-commercial vulnerabilities are broadly manageable, but dependence on critical intermediate inputs needs to be addressed

Germany is G7 country that is most open to international trade. According to the World Bank, exports and imports of goods and services are equivalent to almost 90% of GDP. For Japan, the respective figure is less than 40% of GDP, for the United States 25% of GDP. Admittedly, the bulk of Germany’s trade is with EU partners and geopolitical allies. This limits geo-commercial risks.

In 2022, China was Germany’s single-largest trading partner with combined exports and imports equivalent to EUR 300 billion. The United States is Germany’s second most important partner with EUR 250 billion worth of bilateral trade. China was Germany’s fourth-largest export market and its largest import market (see charts). German exports to China accounted for 6.7% of total exports, and imports from China for 12.8% of total imports. As a share of GDP, exports accounted for 2.8% and imports for 5% of GDP. 

By comparison, Russia is relatively insignificant in terms of the value of goods traded. In 2022, it was Germany’s 23rd largest export and its 14th largest import market, accounting for a mere EUR 15 billion of exports and EUR 36 billion in imports. As a share of German GDP, exports to and imports from Russia amounted to a quantitatively negligible 0.4% and 0.9%. Qualitatively, however, Germany’s reliance on critical energy imports from Russia proved a significant vulnerability following the beginning of the Ukraine war and led to significant economic output losses and higher inflation.

The IFO Institute[1] estimates that 2.7% of total German value-added depends on demand from China, while Chinese imports account for 2.2% of total value added. This is significant, but not catastrophically large from an output and employment perspective.

While Germany is much more dependent on China in terms of trade, the EU as a whole is less so. EU exports to and imports from China account for 3.1% and 1.6% of EU GDP, respectively. Chinese exports to and imports from the EU account for 1.4% and 3.9% of Chinese GDP, respectively. This establishes a broad mutual dependence between the EU and China, which in the event of broad-based decoupling would lead to losses on both side. Hence the mutual interest in avoiding a broader trade conflict. In the context of Brussel’s trade defense policy, the more balanced EU-China trade relationship affords Germany protection from geo-commercial coercion. 

The most significant vulnerability, and the vulnerability most easily and efficiently exploited is to do with German imports. China accounts for 7% of all imported intermediate inputs , which in turn presents 1% of German final output (see chart). An IFO Institute survey also showed that almost half of all German industrial firms that rely on intermediate inputs from China. To the extent that these inputs are critical in the sense of low substitutability, restricting them has significant potential to cause significant economic losses. 

Again, China is unlikely to restrict European and German imports on a large scale. Similarly, it is highly unlikely to restrict exports. However, selective export restrictions targeting critical and difficult-to-substitute goods is a much more cost-effective way to exercise geo-economic leverage. Export restrictions are efficient in that they limit the costs to the coercer and have the potential to cause substantial economic disruption in the target economy. German and the EU would be well-advised to mitigate their systemically most important import-related vulnerabilities through a combination of stockpiling, diversification, innovative substitution and reshoring. [2]

Geo-financial vulnerabilities are also manageable, at least at the macro-financial level

Germany is not just the most trade-dependent country among the G7, but it is also the greatest net creditor in terms of GDP. German net claims amount to nearly EUR 3 trillion (or 70% of GDP), while gross foreign claims stand at a significant EUR 12.6 trillion (or 300% of GDP). Similar to trade disruption, a breakdown of international and especially financial relations can lead to significant losses, as the recent partial severing of financial ties with Russia demonstrates.

German gross foreign assets consist of EUR 3 trillion of foreign direct investment, EUR 3.7 trillion of portfolio investment, EUR 1.9 trillion in derivative-related claims, EUR 3.8 trillion of loans and deposits and 0.3 trillion of central bank reserve assets (see chart for foreign assets as a share of GDP).

As in case of trade, the geographic breakdown of the financial claims matters in terms of their potential to incur losses due to economic fragmentation or geo-economic coercion. In terms of German companies’ loans and trade credit claims and liabilities vis-à-vis non-residents,[3] which amount to EUR 1.4 trillion of claims and EUR 1.75 trillion of liabilities as of November 2023, EU members, EFTA members, the UK and the USA account for the largest share of both assets and liabilities.

By comparison, claims on China are vanishing small at EUR 31 billion. This compares to EUR 24 billion in German liabilities vis-à-vis China, which translates into a net exposure of just EUR 7 billion. Moreover, of the EUR 31 billion in claims, EUR 27 billion are lower-risk, often short-term trade credits, which have a lower loss potential. Similarly, claims on Hong Kong are small accounting for EUR 6.8 billion, compared to EUR 10.6 billion in liabilities. And claims on Russia are even smaller, amounting to a mere EUR 4.5 billion, compared to liabilities of EUR 7.5 billion. 

In short, Germany companies’ credit-related financial claims vis-à-vis China and Russia amount to less than 1% of German GDP. On a net basis, they amount to almost zero. Total claims on China and Russia are insignificant from a macro-financial perspective, even if they may represent more significant risks to individual German companies.

German companies’ foreign direct investment amounts t EUR 1.4 trillion, or a sizeable 60% of GDP. Once again, overseas FDI is strongly concentrated in other EU countries, the UK and the USA. However, German FDI in China is significant at more than EUR 100 billion, even if it pales in comparison with the EUR 400 billion worth of German foreign direct investment in the United States. Moreover, China also accounts for 10% of German foreign investment enterprises’ annual turnover.

German FDI in Russia is comparatively small. In 2021, it was EUR 23.2 billion (on a “gross” basis). And a significant share of this amount may already have been written down since 2022.

Finally, Germany’s “net” FDI exposure vis-à-vis China and Russia is less favorable than in the case of credit claims, for Chinese FDI in Germany amounts to less than USD 5 trillion and Russian FDI to less than USD 3 billion.

German financial exposure to China is significant, but it also happens to be highly concentrated in the sense that ten German companies account for ¾ of German FDI in China. The credit exposure of German companies is pretty insignificant at the macro-financial level. 

Overall, Germany’s trade and financial vulnerabilities vis-à-vis China and Russia are manageable, particularly on a “net” basis. On the trade side, the dependence in terms cost-effective alternatives and China dominant or monopoly supplier represents a more serious risk. 

Ultimately trade matters more than finance to the extent that the loss of access to critical intermediate inputs has the potential to cause far greater economic harm than a trade-related reduction in GDP, or financial losses. 

German government and the EU should therefore address the most critical trade-related vulnerabilities to limit their geo-economic exploitability and the economic costs that would be incurred in case of disruption of trade relations. The government can help support risk mitigation by providing the private sector with economic and financial incentives in terms of diversification of supply chains, stockpiling of critical goods, re-shoring of production and innovative substitution, all aimed at limiting economic losses in the event the import of critical inputs is disrupted for economic or geo-economic reasons.

[1] IFO Institute, German-Chinese Trade Relations, 38 (6), 2022
[2] Markus Jaeger, Economic Security Strategy Should Focus on Import-Related Vulnerabilities, Memo, 2024
[3] Loans and trade credits do not include participating interests in foreign companies, non-residents’ participating interests in the equity capital of domestic companies or securitized claims and liabilities vis-à-vis non-residents.

Brazil's Economic Performance Mean-Reverts (2024)

After years of economic stagnation and heightened political uncertainty, Brazil finds itself on a more stable and predictable economic path; however, the country’s medium-term economic growth will remain modest despite government efforts to accelerate it, including by developing the country’s abundant offshore oil reserves. Over the past decade, Brazil’s economy has largely stagnated. A decade ago, a major corruption scandal coincided with the end of a more than decades-long commodity boom, which weighed on investment and economic growth. This was followed by the COVID-19 pandemic, which caused a sharp recession. In economic terms, the past decade thus differed sharply from the Lula years (2003-10), which were characterized by solid economic growth and increased macroeconomic stability in the context of increasing commodity prices and stability-oriented macroeconomic policies. Absent renewed exogenous shocks and barring a major change in savings and investment, which is unlikely, Brazil’s economic growth rate will return to its long-term average and potential of 2.0% in the next few years. 

Real GDP growth in Brazil averaged 2.5% over the past four decades, but only 0.6% in the past decade. The ten-year average is inconsistent with Brazil’s medium-term growth potential of 1.5-2.5% on account of its investment levels. In 2023, real GDP growth is forecast to have increased nearly 3%, though this level of growth will be unsustainable due to continued low investment. Brazil ‘s savings ratio is a mere 14% of GDP and its investment ratio 16% of GDP. This is low by international standards and helps explain Brazil’s modest economic growth compared to many of its emerging economy peers. Historically, such a low investment rate is consistent with real GDP growth rate of around 2%.

Brazil’s economic outlook is stable, but its growth potential will remain modest. The risk of serious macroeconomic instability is low. Although Brazil’s has a high level of government debt and large public sector deficits, the bulk of government debt is denominated in local currency and the public sector is net foreign currency creditor, which sharply limits the economy’s vulnerability to external shocks. Moreover, Brazil continues to run trade surpluses and modest current account deficits, which are easily financed by non-debt foreign direct investment inflows. A flexible exchange rate, combined with an independent central bank, allows Brazil to absorb even severe external shocks. In the medium term, Brazil’s greatest economic challenge are a high level of government debt and limited economic growth. But the government has committed to eliminate the primary deficit, which has helped maintain investor confidence in the short term. Medium- to long-term, however, the government needs to make a greater effort if the debt-to-GDP ratio is to be stabilized. As long as the real interest rate exceeds the real growth rate of the economy, the government will need to run primary surpluses, sooner or later. Although the Lula government has loosed some of the restrictions that were meant to curtail real public sector expenditure, the risk of a fiscal crisis will remain manageable in the near-term, as public debt will increase only gradually over the medium term. Five-year sovereign credit default spreads, an important measure of sovereign default risk, are trading at less than 150 basis points, pointing to a very low level of sovereign default risk.

Institutionally, the Brazilian state has proven resilient in the face of political polarization, but resilience and stability also mean inertia in terms of economic reform, particularly in the context of an improving economic outlook through productivity-improving structural reform. An independent judiciary and a strong, or at least obstructive congress limit the Brazil’s ability to generate radical policy change. But the relative stability of the institutional framework is also responsible for the relative policy and reform inertia. While large-scale reform is difficult in all political systems, it is particularly difficult in Brazil due to the high number of veto players. Congress is highly fragmented and party discipline is low. Ideology barely matters, and presidents need to carefully build diverse and heterogenous presidential majorities, which limits the president’s ability to implement wide-ranging reform due to the need to reconcile politically divergent interests. The constitution is very detailed and many important economic reforms require super-majorities in both houses of congress, which are difficult to construct. The judiciary is very independent and both willing and able to constrain government action. In addition to institutional constraints, the relatively stable economic outlook also militates against growth-enhancing structural reform. Significant economic reform typically occurs during times of significant economic stability or after devastating economic crises. Relative economic stability limits the incentives of the government to pursue wide-ranging economic reform, often leading it prioritize smaller, less significant reform. Instead, the Lula government relies on fiscal spending to accelerate economic growth. But this will sooner or later run into the budget constraint and will do little to increase productivity, judging by the success of similar growth programs under the previous Lula and Dilma governments.

The government’s plan to develop its energy exports is welcome, which would boost export revenues, but it will not fundamentally alter the economy’s medium-term growth outlook. Even if the government succeeds in implanting its energy plan, the boost to medium-term economic growth will be limited, if welcome. First of all, the government would need to convert higher export revenues into savings and investment. But political-electoral pressures makes it likely that at least part of the windfall will be consumed. Second, not the entire increase in domestic oil and energy production will translate into increased net exports. Third, even though Brazil may become the fifth-largest oil exporter a decade from now, oil exports as a share of GDP will remain small compared to other major oil exporters, which will limit the impact of expanding production, exports and higher prices on Brazil’s medium-term economic outlook. In addition, increased government investment focused on other sectors, which often revives projects abandoned more than a decade ago under a similar growth program, will only boost aggregate investment marginally. Therefore, Brazil’s long-term economic growth will be highly unlikely to exceed 3% over the medium term, and this assumes that the underlying growth potential will not deteriorate in the next few years. But higher economic growth will help keep a lid on public debt, provided the government manages to eliminate the primary fiscal deficit. But it will be insufficient to raise aggregate investment to a level where it would make a significant difference to the medium-term economic growth outlook.

(Conditional) Economic Convergence? Not in the Americas (2024)

Argentina, Brazil and Mexico should have grown much faster than the United States in the past few decades. They didn't. Admittedly, per capita growth or per capita income as a share of US income would be better measures to capture income convergence. Yet, it is remarkable that the United States whose per capita income is 3-4 times higher than in Argentina, Brazil and Mexico managed to generate faster growth than in the three largest Latin American economies. That's why they call it "conditional (!) income convergence."

Argentina, Brazil and Mexico have very different economic characteristics and they differ widely in terms of their financial strength as well as their approaches to economic policy and international trade integration. Remarkably, their long-term growth performance has not differed much. In the past four decades, real GDP growth has averaged 2.0%, 2.5% and 2.1% in Argentina, Brazil and Mexico, respectively. Ten-year average growth differs a little more, but not dramatically so. It was zero, 0.6% and 1.5%, respectively. This is quite remarkable given the vastly different economic trajectories and different approaches to economic policy and international economic integration taken in the three countries.

 

The composition of GDP in the three countries is very comparable in terms of primary, secondary and tertiary sectors. The service center represents 50-60% of GDP in all three countries. Mexico’s agricultural sector is slightly smaller than in in Argentina and Brazil, but not considerably so. Manufacturing exports account for 14%, 25% and 77% of total exports in Argentina, Brazil and Mexico, respectively. Not surprisingly, Mexico’s terms-of-trade have been far less volatile than Argentina’s or Brazil’s. Yet, the three countries’ economic performance has been very similar.

Mexico’s economy is also far more open than Argentina’s and Brazil’s. Exports account for 40% of GDP, compared to 20% in Brazil and less than 20% in Argentina. Mexico’s exports are far more geographically concentrated. Around 4/5 of Mexican exports go to the United States. Only 2% of Mexican exports to go to China. By contrast, a full 25% of Brazilian exports go to China, which is Brazil’s largest trade partner. Less than 10% of Argentinian exports go to China, which is Argentina’s third-largest trading partner after Brazil and the EU.

Last but certainly not least, all three countries differ in terms of their overall financial stability. Mexico is rated investment, Brazil sub-investment grade, and Argentina teeters on the verge of yet another default. Remarkably, the three countries’ long-term economic performance is almost impossible to distinguish, even though Mexico has by and large pursued Washington Consensus types policies, while Argentina’s economic policy has swing form orthodox to heterodox, to put it politely. And yet, their long-term economic performance has been virtually identical. Possible explanation? Similar investment ratio. Implication? Economic policies should be geared toward raising investment as well as productivity.

Seizure of Russian Government Assets Will Lead to Confiscation of American and European companies' assets in Russia (2024)

Faced with increasing domestic opposition to the provision of large-scale financial support to Ukraine, Washington and Brussels are exploring the seizure of Russian government owned financial assets; if the U.S. and the EU manage to overcome domestic legal constraints around the seizure of Russian assets, Russia will retaliate by seizing the assets of Western companies in Russia. In the context of increasing domestic opposition to lending financial support to Ukraine, the EU and its members have warmed to the idea of exploring the seizure of Russian government owned financial assets. Brussels and especially Washington have been more forceful in pushing the proposal, while skepticism in several EU member states remains considerable, but is softening at the margin. A decision to seize, not just freeze, Russian government owned assets, whatever its legal and political merits, would lead Moscow to retaliate by seizing the assets of Western-owned assets in Russia, not just make it difficult and unprofitable to sell these assets, forcing them to write down the value of their assets even further.

· The U.S. has until recently taken a more assertive stance than the EU and especially several EU members, like France, Germany and Italy. But in the context of the G7, the have all agreed to study the possibility and implications of seizing Russian assets.

· Western governments have frozen, but not seized, about $300 billion worth of assets owned by the Russian government. Sanctioned Russian individuals and companies have also seen their asset frozen. But Western governments have thus far refrained from confiscating Russian government owned assets.

· Moscow has introduced a variety of measures that make it very unattractive for Western companies to sell their local assets. The Russian government has also seized the assets of Danone and Carlsberg after they announced their decision to leave the Russian market.

Faced with waning domestic political support and increasing opposition from member states, the EU has warmed to a US proposal to seize the holdings of Russian government owned assets to help finance Ukraine aid or, at least, the country’s post-conflict reconstruction. While the domestic legal obstacles should not be discounted, seizing Russian government owned Western financial assets to provide support to Ukraine has gained political traction in recent months. The U.S. and the EU are more keen to seize Russian assets than individual EU members. France, German and Italy are concerned about the risk of financial instability and the possibility of Russian retaliation in the shape of Moscow confiscating Western assets in case Russian assets are seized. They are also worried about the precedent the seizure of government owned assets might set, including the weakening of protections of their own foreign-held, government-owned assets under international law. Berlin, in particular, is concerned that the expropriation of Russian government owned assets may pave the way for World War II related expropriation of German-owned assets. 

· In the EU, Hungary’s opposition to a new Ukraine aid package has forced Brussels and other member countries to find ways to provide support by circumventing unanimity. Meanwhile, U.S. financial support is being held up by a divided congress and disputes over border security.

· The U.S. has been substantially more hawkish on seizing Russian held assets than the EU. Russia is estimated to hold $200 billion worth of European assets, but less than $5 billion in U.S. assets. European countries as well as the European Central Bank are concerned about the reputational damage the euro would sustain and the possible implications for financial stability.

· Under international law, government-owned foreign financial assets are largely immune from seizure. Countries, including the United States, have domestic legislation in place that largely protects foreign governments from seeing their assets seized. If the G7 reaches a compromise on some form of assets seizure, governments in many instances will need to change their domestic legislation and possibly contend with opposition from constitutional courts.

If the anti-Russian alliance decides to seize Russian-owned assets, it is highly likely that Russia will retaliate by expropriating the foreign assets of Western companies in Russia without compensation. This would lead to a further severing of economic and financial ties. More importantly, it would force financial losses on Western companies. The financial claims of Western companies are already much diminished, not least because of the various restrictions Moscow has placed on the disposal of assets by Western companies. But the loss of ownership would nevertheless force them to write down the remaining value of their assets held in Russia. The seizure and sale of assets would go some way toward the domestic financing of Russia’s war effort. Seizing Russian assets would help Western countries help support Ukraine. The Russian seizure of privately-held Western assets would help Moscow finance its war effort.

· In July 2023, Moscow established an “unfriendly countries list” requiring foreign companies selling their local assets to Russian buyers at a 50% discount and make a 10% “donation” of the total asset value. In addition, the ability to convert ruble-denominated sales proceeds into dollars and transfer them abroad was also curtailed in an attempt to alleviate undue balance-of-payments pressure.

· In November, the Russian government issued a decree that allows foreign companies that hold frozen assets in Russia to use them to buy blocked assets owned by Russian companies abroad, effectively establishing a mechanism for swapping frozen assets. This suggests that Moscow is aware of the leverage foreign-held Russian assets provide.

· On December 20, Russia passed a decree that allows the government to seize and sell off the Russian assets held by foreign energy companies deemed “unfriendly”.

· Western countries may be stepping up sanctions enforcement through the seizure of Russian assets. This month, a German prosecutor has filed a motion to seize more than $700 million worth of assets held by a Russian financial institution, the National Settlement Depository, a subsidiary of the Moscow Stock Exchange, which has been under sanctions since mid-2022, on account of sanctions violation. Even if the G7 fails to agree on seizing Russian government assets, the financial tit-for-tat is likely to intensify.