Germany's China Dilemma

In line with the objectives of the European Union, the German government approved a China strategy on July 13, 2023. This strategy aims to provide structure and direction to Germany's complex relationship with China as a partner, competitor, and systemic rival. The focus is on building additional balanced partnerships in Asia to enhance economic resilience and reduce risks for Germany by decreasing dependencies and diversifying economic relations.

One year later in 2024, what is the current situation? Despite these efforts to achieve greater independence, Germany’s direct investments in China are increasing. According to the Bundesbank, in the first half of this year, German direct investments in the Chinese economy amounted to €7.28 billion, representing a 13% increase compared to the entire year of 2023. This trend suggests a potential doubling of investments.

The freedom of choice

Whether countries or companies, participants in Europe’s self-organizing economic system can largely choose their relationships. This freedom of choice is a key driver of Western prosperity. Digitalization is expected to enhance this effect bringing new opportunities to companies and countries.

Some countries are loosening ties with China while others are deepening their relationships. Some companies continue to invest, while others are withdrawing from China. Diversification helps spread risk. The perspectives and approaches at both economic and political levels are by no means uniform.

A coordinated withdrawal of Europe from the People’s Republic of China would have various consequences for the Economic Bloc, including lower growth, higher prices, and a departure from Europe’s strategic autonomy. Decoupling would effectively align Europe with U.S. rivalry against China, drawing Europe into a vortex of tensions and complications.

Embracing realities

China remains the world’s factory. Although it is no longer a low-wage country, no other market offers comparable industrial ecosystems and scalable capacities. Chinese companies learn quickly and are productive as well as innovative. By combining capacity, skilled labor, productivity, supply networks, logistics, legislation, and infrastructure, China has created the conditions for a highly efficient economic super system. Well-equipped large factories and access to a flexible workforce allow Chinese producers to quickly respond to changing demand and trade situations on the world's markets.

Europe depends on China for green technologies (like solar panels and lithium batteries), antibiotics, and rare earth elements. Thus, decoupling from China would not only drive up prices but could also delay the green transition.

Additionally, as China is an important market for Europe distancing from it would negatively impact European economic growth. Companies like Volkswagen, Siemens, and BASF still consider China a crucial growth market. For example, the German automotive industry sells about one-third of its new cars in the Chinese market each year. Alternative markets are Vietnam, Thailand, and India. However, these countries lack qualified labor and infrastructure, which can lead to quality and operational issues. Furthermore, the supplier base in these markets is hardly comparable to that of China.

What companies can do

European companies must weigh the pros and cons carefully. Certainly, European and German companies must align their risk management with geopolitical realities. Digital systems and service providers that generate indicators for early detection of crises and shocks should be part of their set of measures to be implemented. Contingency plans must be dynamically adjusted to the developments. International trade will most likely face some bumps in the coming years. Preparation is crucial—history has shown that situations can change abruptly.

Investment planning will also be adapted to changing circumstances. Those heavily involved in the Chinese market will either divest to reduce the exposure or invest in defending and expanding their market position. Moments of change are moments of opportunity. Partnerships with local companies are an alternative to direct investments. Maintaining relationships with business partners is essential as this partner network forms part of an early warning and backup system.

However, Europe must work on its competitiveness. Targeted investments in Europe are critical for success. Technological and other advantages must be preserved, and innovation promoted.

Opportunities for logistics

Diversification through establishing operations in alternative markets requires robust logistics capabilities. While China possesses these capabilities, many alternative markets do not.

Logistics is indispensable; thus, the logistics sector can make significant contributions through investments in networks and new services—from visibility into inventories and the movement of goods, as well as early warning systems—to support shippers and partners in developing alternative and contingency plans.

Volatility and dynamism in trade offer great opportunities for those not directly hit by such developments.

Closing remarks

Companies are on their toes, and rightly so. Measures to navigate current realities include risk analysis, early warning systems, diversification, preparations for shocks, investments in market positions, and ensuring good business relationships. The dynamic situation will create winners and losers. But trade is also not a zero-sum game.

It is a mixed bag and the situation remains intriguing. According to a survey by the German Chamber of Commerce in China, the number of German companies planning to leave China has doubled since 2020. But, more than half of those surveyed stated their intent to increase their investments in China to remain competitive. They also observe that innovation is rising in China and German companies want to ensure their edge.

This article was originally published in German on the BVL Blog.