China’s troubles and Europe’s response
China’s economic challenges have exposed Europe’s vulnerabilities, especially as options for responding are limited.
In a nutshell
- The Chinese economy is unlikely to improve in the short to medium term
- Trade matters will become more relevant for China’s future
- The EU has neglected crises by prioritizing regulation over household needs
The Chinese economy is in trouble, and there is little hope for a recovery. Although its annual gross domestic product (GDP) growth has remained just under 5 percent over the past three years, doubts about the meaning of that figure are growing. Growth in fixed investments (machinery and equipment) has slowed considerably, from 9.9 percent in 2021 to just 3.2 percent in 2023. At the same time, productivity is declining, and in 2024, foreign direct investments (FDI) sharply fell by about 30 percent. Last year, FDI into China had slumped to a 30-year low.
The current geopolitical tensions and uncertainties surrounding the Chinese government’s response to its economic weaknesses weigh heavily on future developments. The worsening public debt does not help either, nor does the recent government response – a mix of increasing centralization and financial laxity.
In the past, the authorities often turned to real estate and exports as the go-to solutions for China’s growth challenges. Today, however, the construction industry is in shambles, marked by many empty buildings and bankruptcies. On a brighter note, export growth is still satisfactory, driven by trade flows with Russia, the Association of Southeast Asian Nations (ASEAN) and Europe. Indeed, trade matters will become more and more relevant for Beijing’s future.
Europe’s trade policy directions
Europe has usually tried to balance its various, sometimes vaguely defined, trade policy priorities. These priorities have become generic lines of action, sometimes in conflict with each other and largely dependent on the pressure groups operating in Brussels.
Europe’s trade policy comprises three key components. First, it strives to maintain the existing trade barriers against countries with limited retaliatory power and in industries where trade liberalization would yield modest short-run benefits for European Union producers. This applies to agriculture and the food industry, particularly in developing countries.
Second, Europe avoids sharp confrontation with the United States. Instead, it accepts and takes advantage of the U.S.’s technological leadership and follows its guidance when discussing trade relations with third countries. This strategy seems to have paid off: Today, the EU enjoys a large trade surplus in goods with the U.S., which keeps many manufacturing companies in the EU afloat.
Unfortunately, the recent performance of the Chinese economy has exposed all European weaknesses while limiting the possibilities for developing adequate responses.
Third, the European approach to trade reflects the evolution of the economic bloc over the past two decades. Due to high taxation and heavy regulation – as well as a general hostility toward large corporations, foreign companies and entrepreneurial risk-taking – productivity growth has slowed. As a result, producers have increasingly shifted their focus to non-tradable goods such as construction and tourism, as well as market segments characterized by low costs, including low-tech manufactured products or well-established brands in the fashion and luxury industries.
Despite some exceptions, this led to sluggish growth in the old continent and partial relocation of the production process to low-cost countries, with financial capital being redirected to high-tech economies. In turn, global, interdependent production structures have added new dimensions to the expression “retaliatory power.” Producers and investors in the EU can suffer from punitive legislation in the target countries and be affected by unexpected developments, such as low growth, rising input costs and trade wars.
Unfortunately, the recent performance of the Chinese economy has exposed all European weaknesses while limiting the possibilities for developing adequate responses. In the past, the European Commission as well as individual EU member countries frequently resorted to non-tariff barriers and subsidies to soften European producers’ gradual loss of competitiveness.
Not surprisingly, it is now apparent that trade barriers have further reduced the incentives to compete using higher productivity. At the same time, taxpayers are less tolerant of tax-financed grand strategies to promote the EU’s ailing industries. Their concerns over the burdens from clean-energy initiatives and the future financial load of larger military expenditures compound this frustration.
The Chinese economy could deteriorate further
As mentioned, it is highly likely that the Chinese economy will not improve in the short to medium term. It could deteriorate further, and the overall picture could suffer from rising tensions with Taiwan, the Philippines and Japan. In this light, Europe could encounter new prospects, some of which will be shaped by how Beijing reacts to its present and forthcoming difficulties. Despite its large domestic market, China’s economy still relies heavily on foreign trade – in 2023, its export-to-GDP ratio was close to 20 percent (15 years ago, it was above 30 percent), and Beijing will likely try to increase the current ratio.
So far, China’s efforts to develop privileged trade relations with the African continent have produced questionable results. Interest in the Asian and Latin American markets has therefore intensified. Success is not guaranteed, though. Currently, the ASEAN bloc is China’s largest trading partner. In 2023, it accounted for almost 16 percent of China’s foreign trade and presented a large surplus in China’s favor. The ASEAN economies are growing relatively fast, with average annual GDP growth rates above 4 percent. They present good economic fundamentals and could absorb larger quantities of goods and services from China.
Latin America looks less promising. While China is a major trading partner for some countries – it invests heavily in Brazil, for instance – the overall economic growth in Latin America is low. The strongest economies in the region may fear becoming overly reliant on China.
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In brief, if ASEAN does not solve China’s export problems, Beijing will have to strengthen its ties with Europe. Although economic growth in the EU is weak, China’s exports are still competitive due to their relatively low prices and continually improving production quality. These efforts will lead to three possible scenarios depending on how Europe responds.
Scenarios
Less likely: Europe keeps the door open for Chinese imports
One possible scenario involves a lack of decisive EU initiative. In this case, European buyers would take advantage of cheap, good-quality products from China, possibly from production chains that include European manufacturers. Meanwhile, EU policymakers would avoid imposing higher trade barriers against Chinese imports, as globalized EU companies would oppose them. Beijing might offer to buy EU bonds and make European public debt sustainable.
This would not do much to revive growth in Europe, but it could keep the door open for ongoing exports to China and avoid deep recession and continental public finance crises.
Less likely: The U.S. grants Europe preferential trade treatment
In a second scenario, Brussels might consciously exploit international tensions by asking the U.S. to grant Europe preferential trade treatment. This could serve as a reward for complying with a possibly aggressive American trade policy toward China and the subsequent lower trade volumes. Such a scenario would include the possibility for European exporters to replace Chinese exports to the U.S. and a more significant role in the new bilateral and multilateral trade agreements that might follow, like those with the ASEAN bloc.
Most likely: Europe faces the effects of a Chinese slowdown
The above scenarios are quite unlikely. The first relies on a “business-as-usual” global framework, leading to closer integration with the Chinese economy. Trade wars are around the corner, and the U.S. would probably ask the EU to reduce its dependence on China as a supplier and a market for exports. The second scenario requires a clear policy view in Brussels and transparent, reactive, well-functioning coordination among the EU member countries. Unfortunately, this is not the case now and is hardly in sight.
The most likely scenario involves Europe facing the effects of China’s slowdown, grappling with increasing trade barriers and working to contain the additional damage that can come from the policies adopted in Washington.
Regrettably, this does not bode well from three different angles. First, protectionism always affects the entire global economy, and it hits hardest in countries that struggle to adjust and react by fostering entrepreneurship. Several European economies present these non-enviable features.
Second, European producers will probably accelerate their flight to better entrepreneurial environments, primarily in the U.S. and possibly Southeast Asia. This phenomenon will further weaken Europe’s productive capabilities.
Third, the traditional responses of the EU to crises have always followed a pattern of neglect, leading to regulation and grand ideas at the expense of households in the member countries. There is no sign that this time will be any different. The commission’s predictions for GDP growth in 2025 and 2026 of even 1.5 percent and 1.8 percent, respectively, are unlikely to be met.
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