China better economic choice than US for EU

The United Kingdom and the European Union face a critical choice about the direction of future trade policies with the rest of the world. Should the EU deepen its already heavy exposure to the United States even as the country turns inward, or should it begin to diversify its trade relations toward a less familiar albeit increasingly prosperous China?

From an economic perspective, the EU should begin diversifying its outlook, and China should certainly be on its radar. The Donald Trump administration is moving away from long-standing commitments to sound fiscal policy and free trade, which supported the US’ economic growth for the past few decades. Inflation and currency risks due to US trade deficits are rising over the near-term in addition to the potential adverse consequences for the EU’s trade with the US over the longer term.

Emerging market investors are familiar with late-cycle economic populism of the kind currently on display in the US. In clear parallel with the current US situation, the Nestor Kirchner administration in Argentina failed to transition from demand stimulus to supply-side reform as the country’s economy approached full employment after the 2001 crisis. By the mid-2000s, Argentina was already beginning to overheat and trade deficits were widening. Interventions in the free operation of markets followed, including imposing tariffs and restrictions on the free movement of labor and capital, which raised costs and disrupted supply chains. Protectionism then led to greater public spending as the government sought to shore up the ailing economy, which only increased indebtedness. This weighed on private investment and eventually pushed up unemployment.

The prudent path for the EU is to begin to dilute its heavy exposure to the US in favor of more business with China, ideally before it really starts to hurt.