Europe is facing an ongoing crisis of energy and geopolitics

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mef you ask Europe friends around the world what do they think of the old continent in mind they often respond with two feelings. One of them is honor. In the struggle to help Ukraine and resist Russian aggression, Europe has shown unity, grit and principled willingness to bear great costs. But the second is a warning. A brutal economic downturn will be the test of Europe’s resilience in 2023 and beyond. Fears are growing that the reshaping of the global energy system, America’s economic republic and geopolitical conflicts threaten the long-term competitiveness of the European Union and non-members, including Britain. It is not only the prosperity of the continent that is at risk, the health of the alliance across the Atlantic is also.

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Don’t be fooled by the good news from Europe in the last few weeks. Energy prices are down since the summer and good weather means gas storage is almost full. But the energy crisis remains a threat. Gas prices are six times higher than their long-term average. On November 22 Russia threatened to shut down the last operational pipeline to Europe, even as missile attacks caused emergency power cuts across Ukraine. Europe’s gas storage will need to be replenished again in 2023, this time without any Russian pipeline gas.

Vladimir Putin’s energy arsenal will surely tax Ukraine beyond. Our modeling suggests that, in a typical winter, a 10% increase in real energy prices is associated with a 0.6% increase in deaths. So the energy crisis this year could cause more than 100,000 more deaths for elderly people across Europe. If so, Mr. Putin’s energy weapons could do more life outside of Ukraine than his artillery, missiles and drones do directly inside. That’s one more reason why Europe’s struggle against Ukraine is also against Russia.

The war also creates financial vulnerability. Energy inflation is spilling over into the rest of the European economy, creating a real dilemma for the European Central Bank. It has to raise interest rates to control prices. But if it goes too far it could destabilize the weakest members of the euro zone, especially debt-ridden Italy.

Even as the energy crisis worsens, the war has exposed the vulnerability of the European business model. Too many industrial companies in Europe, especially German ones, have been dependent on abundant energy imports from Russia. Many companies have also relied on another autocracy, China, as an end market. The prospect of fractured relations with Russia, higher structural costs and the disengagement of the West and China has meant reckoning in many boardrooms.

That fear is heightened by American economic nationalism that threatens to pull operations across the Atlantic in a wave of subsidies and protectionism. President Joe Biden’s Inflation Reduction Act includes $400bn in handouts for energy, manufacturing and transportation and includes made-in-America provisions. In many ways the scheme is similar to the industrial policies that China has been pursuing for decades. As the other two pillars of the world economy become more interventionist and protectionist, Europe, with its strong adherence to World Trade Organization rules on free trade, looks like to flirt

Already, companies are dealing with the subsidies. Northvolt, a valuable Swedish battery startup, has said it wants to expand production in America. Iberdrola, a Spanish energy company, invests twice as much in America as in the European Union. Many leaders are warning that the combination of expensive energy and American subsidies is leaving Europe at risk of massive unemployment. BASF, a German chemicals giant, recently announced plans to “permanently” scale back its European operations. It doesn’t help that Europe is getting older than America, too.

Loss of investment is leaving Europe poorer and contributing to declining economic dynamism. Compared to his pre-covid gdp way, Europe has done worse than any other economic bloc. Of the 100 most valuable companies in the world, only 14 are European. Politicians will be tempted to throw out the rule book and respond with subsidies of their own in an increasingly corporate arms race. Germany’s economy minister has been accusing America of “raising investments”. French President Emmanuel Macron has called for a “European awakening”.

So the subsidy row is also causing tension between America and Europe. America’s financial and military aid to Ukraine far exceeds that of Europe, and as it moves to Asia to meet the challenge from China, America rejects the theys failure to pay for his own security. Most members of nato failed to meet the target of spending 2% of gdp on defense. The them he was terribly naive about Russian aggression. Although the war brought America and Europe together after the break of the Trump years, the risk is that prolonged conflict and economic tension will gradually pull them apart again. Mr Putin and China’s president, Xi Jinping, would like that.

To avoid a dangerous impasse, America must see the bigger picture. Mr. Biden’s protectionism threatens to energize Europe even as America maintains the Ukrainian army, and armadas of tankers cross the Atlantic to supply Europe with energy. The main goal of Bidenomics is to stop China from dominating key industries: America has no strategic interest in siphoning off European investment. It should make European companies eligible for their energy subsidies, and integrate overseas energy markets more deeply.

Europe, at the same time, must protect its economy from an energy recession. Schemes that are properly aimed at subsidizing consumers and companies for their basic energy needs should curb demand by charging higher prices at the margin, as is the case in Germany. To lower long-term energy prices, Europe should accelerate the renewable transition, while keeping energy markets open to competition. It also needs to adapt to the new security reality. That means spending more on defense so it can shoulder the burden as America moves toward Asia.

Apart from admiration and fear, the other emotion that governs transatlantic relations is frustration. America is humiliated by Europe’s economic turmoil and its failure to protect itself; Europe is oppressed by American economic republicanism. But just as Europe must not be divided by war, so it is imperative that the most powerful democratic alliance in history changes – and survives.

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