Germany Can Afford to Spurn China

The economic case for Germany cozying up to China is surprisingly weak.

By , a senior researcher at the Danish Institute for International Studies and the author of How China Loses: The Pushback Against Chinese Global Ambitions.
Volkswagen CEO Martin Winterkorn and Xu Jianyi, President of China FAW Group Corporation, shake hands after signing an agreement as German Chancellor Angela Merkel and Chinese Premier Wen Jiabao look on at the Volkswagen factory on April 23, 2012 in Wolfsburg, Germany.
Volkswagen CEO Martin Winterkorn and Xu Jianyi, President of China FAW Group Corporation, shake hands after signing an agreement as German Chancellor Angela Merkel and Chinese Premier Wen Jiabao look on at the Volkswagen factory on April 23, 2012 in Wolfsburg, Germany.
Volkswagen CEO Martin Winterkorn and Xu Jianyi, President of China FAW Group Corporation, shake hands after signing an agreement as German Chancellor Angela Merkel and Chinese Premier Wen Jiabao look on at the Volkswagen factory on April 23, 2012 in Wolfsburg, Germany. Sean Gallup/Getty Images

German Chancellor Olaf Scholz’s visit to Beijing this week has sparked fierce debate over whether Germany is a reliable partner in the West’s strategic competition with China.

On both sides of the Atlantic, many see Germany’s export-driven economy as simply too dependent on the Chinese market to strongly confront Beijing on its unfair trade practices, industrial espionage, and human rights abuses. Even hawkish voices in the German parliament view this reliance as rendering Berlin “helpless” in joining any sanctions deployed by the United States and its allies in response to a possible Chinese invasion of Taiwan.

There is no refuting China’s importance to the German economy. In recent years, China has become Germany’s largest trading partner. But Germany is not dependent on China. Be it in trade or foreign investment, there is no single market outside of Europe on which Germany is critically reliant. Rather than national economic interest, it is the special interests of select German multinationals and industries that drive a China-dependency narrative that limits strategic action from Berlin.

German Chancellor Olaf Scholz’s visit to Beijing this week has sparked fierce debate over whether Germany is a reliable partner in the West’s strategic competition with China.

On both sides of the Atlantic, many see Germany’s export-driven economy as simply too dependent on the Chinese market to strongly confront Beijing on its unfair trade practices, industrial espionage, and human rights abuses. Even hawkish voices in the German parliament view this reliance as rendering Berlin “helpless” in joining any sanctions deployed by the United States and its allies in response to a possible Chinese invasion of Taiwan.

There is no refuting China’s importance to the German economy. In recent years, China has become Germany’s largest trading partner. But Germany is not dependent on China. Be it in trade or foreign investment, there is no single market outside of Europe on which Germany is critically reliant. Rather than national economic interest, it is the special interests of select German multinationals and industries that drive a China-dependency narrative that limits strategic action from Berlin.

Let’s begin with trade. In 2021, China topped the rankings of Germany’s trading partners in representing 9.5 percent of its total exports and imports in goods. But focusing on which partner is number one distorts the larger picture of Germany’s trade relations.

Diversity, not dependency, characterizes Germany’s trade relationship with the world. Following closely behind China at the top, the United States, France, Poland, and other European countries each represent between 5 percent and 8 percent of Germany’s total trade in goods. Including trade in services, which makes up roughly one-fifth of total global trade of late, narrows the gap between China and Germany’s Western trading partners further.

Unlike South Korea, Japan, and Australia, which have trade dependencies on China of between 20 percent and 30 percent, Germany has far more space for geopolitical maneuvering.

Neither is China strongly propelling trade growth for Germany. The research of German economist Jürgen Matthes reveals how China only made up about one-tenth of Germany’s export growth between 1991 and 2018. This is a noteworthy contribution, but it hardly fits the picture of Chinese demand as the engine of Germany’s export-driven economy.

If there is a single market Germany depends on, it is the European Union common market. This is where Germany’s world-leading automotive and mechanical engineering industries are deeply integrated. For example, Germany trades 40 percent more with its Visegrád countries—Poland, Hungary, the Czech Republic, and Slovakia—than it does with China. This despite its four neighbors representing 7 percent of China’s economic size.

These internal European trade linkages are not overly dependent on China. In complex global supply chains in which Chinese inputs are first processed in a third country before final export production in Germany, the Munich-based Ifo Institute for Economic Research finds that China accounts for 7 percent of all foreign value added, whereas the EU represents 44 percent and the United States, 10 percent.

Contrary to conventional thinking, China does not make everything. In Europe, as elsewhere in the world, economic regionalization still trumps globalization.

The economic loss of a sharp decoupling in trade from China would indeed be damaging at an estimated 48 billion euros in Germany’s real income. But compare this possible outcome with Germany’s present reality in losing 55 billion euros per year from industrial espionage coming largely from China.

Then there is Germany’s investment relationship with China. After a decade of gradually falling growth, German foreign investment in China shot up to a record high in the first half of 2022. But the 10 billion euros invested in the Chinese market by German companies so far this year still only represent roughly 10 percent of Germany’s total foreign investment activity. Even at new heights, German investment in China is over five times lower than what German companies invested in the 19 countries of the Eurozone.

Driving a European-wide trend, the value of Germany’s foreign investment in China has also become highly concentrated among a small number of large multinationals. German carmakers Volkswagen, Mercedes-Benz, and BMW lead the way. Unlike the mechanical engineering, electrical equipment, and chemical industries, the German automotive industry has significantly expanded its foreign investment in China, which represented 29 percent of its total foreign investment in 2019.

In recent years, Germany’s auto sector has typically accounted for more than 70 percent of German investment and over a third of European investment in China. It is now spending billions to acquire larger stakes in longstanding joint ventures and establish new tech partnerships in hopes of competing against rising domestic players in China’s electric vehicle market.

But other German companies appear eager to develop higher dependencies of their own. Undeterred by Beijing’s stated aims to become self-reliant from international markets and the geopolitical risks emitting from a possible future Chinese invasion of Taiwan, BASF started the first stages of a $10 billion investment in new petrochemical plants, and Siemens plans for a major expansion in digital industries in China.

Just like many of their U.S., Japanese, and Korean counterparts, German business leaders continue to anticipate future growth in revenues and profits in China and see success in the Chinese market as driving forward their global competitiveness. Although the sales of China-based subsidiaries of all German companies fell from 9 percent of overseas revenues in 2016 to 8.4 percent in 2019, the corporate revenues generated by the largest 40 German blue-chip companies on the DAX stock market have edged upward to 16 percent on average in 2021.

It is no surprise that some of Germany’s leading companies are strongly lobbying to put a stop to efforts within the German government to limit high corporate dependencies from growing further. In a point of growing contention between Germany’s Foreign Affairs and Economic Affairs ministries, Scholz and his advisors appear to have sided with German business leaders keen on ensuring measures, such as outbound investment screening, are not a part of Berlin’s forthcoming China strategy.

Scholz and his advisors must keep in mind that the growth of German multinationals in China does not necessarily bring many benefits back home to the average German. Exports to China underpin some 1 million jobs in Germany, but there are nearly 46 million in its workforce. According to a recent survey by the German Chamber of Commerce in China, the core of the German economy, the so-called Mittelstand of small and medium-sized manufacturing companies, is less optimistic about prospects in the Chinese marketplace compared to its larger counterparts. At the same time, Beijing has demonstrated its willingness to exploit economic connections to coerce and control German and European foreign- and security-policy decision-making.

Despite the German chancellor saying he wishes to “dismantle one-sided dependencies” with China, his actions, such as bringing a dozen business executives to Beijing, are reenforcing those risks that do exist. Even shareholders and institutional investors in leading German multinationals will need to increasingly consider the geopolitical risk of investing deeply in China into their valuations.

China is not Germany’s ticket to economic prosperity. A fixation on building competitiveness through what is ultimately a slowing, and increasingly risky, Chinese economy undermines attention needed to overcome Germany’s innovation and productivity challenges, from poor digital infrastructure to labor shortages. Germany can incentivize trade and investment in India and Southeast Asia, but at the end of the day its political and industry decision-makers must also keep German and European domestic competitiveness in mind.

Broad trade and investment interdependencies between China and Germany are still not overwhelming for either side. But Germany must move quickly to reverse the few but deeply embedded supply vulnerabilities it holds with China. For instance, the EU sources 98 percent of processed rare earth elements from China, and Chinese industries produce many of the essential components for the solar and wind industries. Germany must also diversify imports in some chemical goods and electrical and transportation equipment from China.

As the world’s fourth-largest economy, Germany is far from helpless. It could act with strategic urgency and lead the EU in working closely with countries—such as Japan, Australia, and the United States—actively taking on the immense challenge of building alternative supply chains in critical sectors. But for the time being, Berlin has elected to upset its close allies instead.

Scholz is right to keep lines of communication open with Beijing. Germany does not need to pursue a broad-scale decoupling strategy. But as the German chancellor travels back to Berlin from Asia, he needs to start separating special interests from national interests in Germany’s approach to China.

Luke Patey is a senior researcher at the Danish Institute for International Studies and the author of How China Loses: The Pushback Against Chinese Global Ambitions.

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