Where are China-Germany relations headed?
As the Western mood on China sours, Germany’s booming business ties with Beijing are under the spotlight.
In a nutshell
- Germany has grown increasingly reliant on the Chinese market
- Russia’s war in Ukraine is raising concerns about overdependence on Beijing
- Berlin is not able to immediately help diversify German investments abroad
German Chancellor Olaf Scholz travels to Beijing this week, making him the first Western leader to visit the People’s Republic of China during Xi Jinping’s third term. This year also marks the 50th anniversary of diplomatic ties between China and Germany, which have seen tremendous changes over that span. Berlin’s China policy has evolved, bearing consequences for the German economy.
Immediately following American President Richard Nixon’s visit to China, on the morning of October 11, 1972, Chinese Foreign Minister Ji Pengfei and then-Federal German Foreign Minister Walter Scheel signed a communique in Beijing establishing bilateral relations. At the time, no one knew where these ties would lead. Germany has since experienced the fall of the Berlin Wall and the reunification of East and West Germany, while China, under the leadership of Deng Xiaoping, emerged from poverty to become a manufacturing powerhouse, shaping the development of the world economy.
Opening up
From the time of China’s reform and opening, the Chinese Communist Party (CCP) developed an extraordinary enthusiasm for capital, especially foreign capital. Foreign investors brought not only funds but also technology and management methods that were desperately needed. The Party’s hunger for capital is reflected in its preferential treatment of foreign investors in terms of taxation, land and factory rent. Of course, the CCP never forgets to acquire key technologies from investors – the so-called “market-for-technology” approach that has driven its decades-long efforts to obtain Western technology.
Volkswagen was the first major enterprise to benefit from the CCP’s zeal for capital, holding its first talks with the Chinese government in 1978, and establishing Shanghai Volkswagen as a joint venture with Shanghai Automotive in 1984 and FAW Changchun Volkswagen in 1991. The first five “Santana” cars were delivered in 1983 in cooperation with Volkswagen. In 2002, Volkswagen sold 513,000 vehicles in China – setting a new high and exceeding the company’s own sales in Germany, becoming its most important foreign market. Today, the Volkswagen Group in China has factories across the country, producing vehicles and components in more than 40 plants.
China’s opening came alongside globalization, which allowed capital to break free from the control of state governments and become more mobile. Capital is not only important for democracies but can be even more useful for authoritarian regimes. This dynamic inevitably increases the influence of German businesses on the country’s own lawmakers when it comes to designing and implementing China policy.
Disillusionment
In line with globalization, Western governments began seeking to promote trade to bring about political change in China. Various policies were implemented to encourage entrepreneurs to invest there, reinforcing the economic world’s passion for the Chinese market. The 16 years of German Chancellor Angela Merkel’s administration were the culmination of this “love affair,” and its inertia remains strong even after her departure from office.
For the past six years, China has been Germany’s largest trading partner, with annual trade volume between the two countries exceeding 245 billion euros last year. Currently, the German government has made investment guarantees in China of up to 11.3 billion euros. In 1990, trade with China accounted for less than 1 percent of Germany’s foreign trade; by 2021, it had risen to 9.5 percent.
The trust that China had built up over the years with many EU members, especially Germany, has been almost completely depleted.
In parallel with this development, German economic dependence on China reached a new high in the first half of this year. This reliance would not seem so significant if political trust was in greater supply. But China’s relations with the world, especially the West, have changed dramatically since Mr. Xi came to power in 2012. The expansion of trade and the spread of authoritarian values through its Belt and Road Initiative (BRI), the obfuscation around the origin of Covid-19, the second “handover” of Hong Kong, its bullying “wolf warrior” diplomacy, the recent intimidation of Taiwan, and the rapid expansion of China’s own military power – all have forced Western countries, including Germany, to recognize the failure of using trade to promote political change.
More importantly, the past decades have shown that it is not Europe that has changed China, but rather China that has changed – or even divided – Europe. For instance, Beijing’s BRI drew support from Greece and Italy, two European states most in need of foreign investment. At the political level, the trust that China had built up over the years with many European Union members, especially Germany, has been almost completely depleted. Russia’s war against Ukraine has made countries more sensitive to their reliance on foreign powers.
The inertia of comfort
To some extent, economic dependency can foster a certain laziness. To take solar technology as an example: In 1978, a “solar village” was established near Beijing with the technical assistance of Germany. Today, Germany’s solar panels rely heavily on Chinese imports, as more than 80 percent of solar panel manufacturing is concentrated in China. In the past decade, China has invested about 49 billion euros in photovoltaic production capacity – 10 times more than Europe.
Massive Chinese investment has brought down the cost of solar power worldwide by 80 percent, but it has also created a strong Western reliance on it. A similar dynamic is reflected in China’s price control of solar panels, which effectively throttles Germany’s energy transition. Beijing also controls raw materials that are crucial for green energy, such as lithium, with almost 90 percent of rare earths and 60 percent of lithium processed in the country.
This dependence is aided by Western countries, especially Germany, and there are still many companies unbothered by it. The CCP under President Xi is aware of the need to treat Western capital nicely, despite the fact that it has decided to follow a completely different political path. This strategy is apparently still working for a significant number of German companies. German chemical giant BASF recently announced a major investment project in Zhanjiang, Guangdong province, worth up to 10 billion euros. Audi and BMW are also investing heavily in China this year.
Foreign direct investment (FDI) in China is still growing steadily. 2021 will see foreign investment in the mainland total about 1.2 trillion yuan (about 165 billion euros), an annual increase of 15.8 percent. The proportion of FDI inflows to the country has now reached 11.4 percent of the global total, ranking second in the world. Notably, large companies such as BASF and Volkswagen have recognized the immense potential of the Chinese market.
Paradigm shift
As the 50th anniversary of ties with China approached, Berlin sought to make clear for the first time that a tough line is being translated into practical policies. Economy Minister Robert Habeck vowed no more “naivety” in Germany’s trade dealings with Beijing. His ministry is working on a package of measures to make the Chinese market less significant for German companies, including abolishing state investment export guarantees to German companies operating in China, an end to small projects like promotional events in China or manager training, and others.
Germany’s economy ministry will also aim to reduce dependence on Chinese raw materials, batteries and semiconductor products. Finally, Berlin wants to scrutinize Chinese investments in Europe more closely. The German government will present a national security strategy at the end of this year, followed by the publication of a new China strategy.
Many German companies remain fixated on the Chinese market, and accuse Berlin of being disconnected from reality.
It appears that Germany is looking to the United States for its China policy, albeit in a different fashion and less rigorously. But it remains the case that, like the United States, Germany is losing its competitiveness in the face of an increasingly powerful China.
The German government may have an even bigger problem than Washington: American investment in China is only 2 percent of its foreign investment, while Germany’s investment there is 14 percent of its total foreign investment. According to the China-Europe Chamber of Commerce, the top 10 European companies (which include five German companies) are still heavily invested in China. German companies invested up to 10 billion euros directly in China between January and June of this year; before that, the highest six months of direct investment by German companies in the country since 2000 was 6.2 billion euros.
Germany’s industry has contributed heavily to China’s growing competitiveness, through today. But the price has been its own deindustrialization – in other words, Germany is destroying its own industrial base by fostering its very competitors.
With the country’s painful dependency on Russian oil and gas top of mind, German Foreign Minister Annalena Baerbock recently called on companies doing business with China not to make similar mistakes. While acknowledging that it is not feasible to decouple from China, she warned that the fate of businesses should not be tied too tightly to its market.
Nevertheless, many German companies remain fixated on the Chinese market, and accuse Berlin of being disconnected from reality. Moreover, the timing of the government’s shift in its China policy is not completely in its favor, as it must simultaneously help small and medium-sized companies overcome the ongoing energy crisis. Many of these enterprises in Germany are very much afraid of being swallowed up by Chinese competitors.
Meanwhile, Germany’s “traffic light” coalition as well as state governments have at times been divided on dealing with China’s rise, such as on issues like the purchase of ports and other assets by Chinese companies.
The recent compromise allowing the China Ocean Shipping Company (COSCO) to acquire a stake in a Hamburg container terminal reflects the competing interests facing the German government. There are fears of provoking Beijing, particularly among Mr. Scholz’s Social Democrats. It also seeks to incorporate the views on China held by influential companies doing big business there. Although the German Greens and Free Democratic Party appear more vigilant about the threats China poses to the region and global economy, given the regime’s ambitions of seizing Taiwan by force, Chancellor Scholz seems reluctant to accept this reality.
To diversify corporate investments, the German government and the European Union will likely establish a more attractive environment for other Asian countries, such as India, among other tools. But in both Berlin and Brussels, these measures will take time to plan and more still to implement.
Without unity in Berlin on a new China policy and incremental, effective adjustments on capital flows, the government and the German companies now feasting on Chinese business will increasingly clash over their presence in the country. And if Germany is unable to diversify its investments in the next few years, German industry will soon be synonymous with a declining empire.
Scenarios
A “tug-of-war” between China and Germany has begun in terms of capital flow. Three scenarios have emerged.
The first scenario is that Berlin will support German companies that are successful in the Chinese market to continue to make more profits. This is why Chancellor Scholz’s delegation this week will include an economic contingent. While Berlin wants to guide companies to diversify their investments, in the short term the government is not able to create such an environment. Beijing will meanwhile adopt policies to retain foreign companies in the country. But, as the government Mr. Xi has put together for his third term is no better than the previous one, China’s economy will continue to have difficulties. More importantly, domestic cries to seize Taiwan by force will grow louder – forcing foreign businesses to think about relocating, at least partly, to neighboring countries.
In this first case, it is President Xi’s flawed domestic policies and management, rather than the German government, that will force German companies in China to diversify their investments. At the same time, Germany itself will not have the means to help small and medium-sized businesses out of the energy crisis, so its own manufacturing sector will take a big hit.
In a second scenario, China’s economy, in apparent decline during President Xi’s third term, will be rescued, and the country’s domestic consumption and manufacturing capacity boosted. Berlin will fail to convince German companies based in China to diversify their production sites in the short term. Failing German companies will become targets for Chinese mergers and acquisitions, and, due to hiking energy prices, energy-dependent companies decide to move to China. Germany will experience an accelerating process of deindustrialization.
In a third scenario, thanks to more domestic support for small and medium-sized enterprises, Germany will survive the energy crisis in the winter, thus preserving or even growing much of its own industry. There will also be an agreement between German businesses active in China and the government over their involvement in the Chinese market in the medium and long term, resulting in a kind of win-win for both countries. Over time, it will become possible to transfer part of the production in China to other countries and regions.
