Neither with you nor without you do my ills have a remedy. This is how the economic relationship between Germany and China could be summarized. On the one hand, Berlin is trying to put distance with the giant Asian country following what was seen with supply chains during the Covid pandemic and fierce competition in sectors such as automotive. On the other hand, its industrial engine, which is currently struggling, still largely depends on orders placed from Beijing. If it’s not blowing and sucking at the same time, it’s very similar: reducing dependence on China while hoping that the recovery of its economy will bring some vigor back to the battered German industrial sector (winter is getting long without Russian gas). The bad news for Berlin, some experts warn, is that things have changed too much and not even a strong recovery of a hesitant Chinese economy post-Covid would guarantee some oxygen for the traditional European locomotive, always so focused on exports.
The zigzag movements of Chancellor Olaf Scholz’s government with China are a faithful reflection of all this. Last summer, the Executive presented a risk reduction strategy, which distanced itself from the “decoupling” advocated by Washington but at the same time sought to reduce dependence on China, precisely under an unappealable argument: China is selling more and more to Germany (diodes, transistors, semiconductors, and integrated electronic circuits) and Germany is selling less and less to China (machinery, chemicals, and automobiles).
Recently, in February of this year, the German leader has expressed a strengthening of ties with Beijing. “The relations between Germany and China remain on the path of pragmatism, as evidenced in the dialogue held in Munich between Chancellor Scholz and Chinese Foreign Minister Wang Yi,” point out strategists Allan Von Mehren and Minna Kuusisto in a recent newsletter on geopolitics from the research department of Danske Bank.
In the meeting, Wang Yi stated that China and Germany “should adhere to openness and free trade” and advocated for Berlin to “play a more important role in international and regional affairs.” Scholz, for his part, stated that Berlin is against protectionism and decoupling and that Germany is willing to provide a “quality business environment to companies from other countries in Germany.”
Why all these back-and-forth movements? “For years, German companies thrived thanks to the Chinese appetite. Beijing has become Germany’s largest trading partner (sum of exports and imports) and almost half of German manufacturers depend on intermediate inputs from China (three-quarters in the case of the automotive industry),” explained Aila Mihr, an analyst at Danske Bank, a few months ago in a report.
“Chinese-German trade maintains more than a million direct jobs and of the ten most valuable listed companies in Germany, nine generate at least 10% of their revenue from China (compared to two in the U.S.),” Mihr added. In the most recent report by her colleagues, it is noted that Germany is by far the European country that generates the most revenue in the Chinese market. The Economist estimates that Germany’s total exposure is 10% of GDP, including sales from subsidiaries in China.
A review of Germany’s exports to China is quite revealing. After China’s accession to the World Trade Organization in 2001, German exporters have massively benefited from the country’s growth over two decades. In 2021, they had increased their exports from $14 billion to over $120 billion. The share of China in German exports quadrupled to just under 8% during this period. This made China the second most important foreign market for German companies after the US.
However, the situation has changed in the last two years. Both the value of goods exported to China and their share in German exports have decreased. The Federal Statistical Office (Destatis) puts the flow of goods at only $105 billion for 2023. Excluding the effect of price changes, exports had already peaked in 2018 according to Commerzbank’s calculations, before nominal exports fell significantly in 2022 and 2023.
While the initial impulse is to blame China’s weakness post-Covid (the de-escalation was slower and more difficult in the giant Asian country), a recent client note from Commerzbank finds more powerful reasons. “German exports to China have considerably declined in recent years. The weakness of the Chinese economy plays only a secondary role here. Structural changes are much more important: German companies are increasingly producing for China in China, and the People’s Republic is moving up the value chain, reducing the demand for highly developed products from Germany,” write economists Jörg Krämer and Bernd Weidensteiner. Beijing is closing a historic gap which will harm Germany.
“Apparently, German companies have relocated a greater portion of their production from Germany to China. This is evident from the observation that German companies have generated significantly higher revenues in China in recent years than before. Part of these higher profits returned to Germany (primary income). However, a substantial portion of the increased profits in 2021 was used for additional investments. This suggests a further increase in the production of German companies in China. This is likely to further curb exports in the coming years,” add the authors of Commerzbank’s note.
A study by the German institute IW cited by Reuters shows that German companies continue to invest heavily in China. German direct investment in China increased by 4.3% to reach a new record in 2023. It also increased as a percentage of Germany’s total direct investment abroad. The report showed that German companies had invested as much in the past three years as in the previous six. According to the study, investments are dominated by large German companies, while small and medium-sized businesses seek to reduce their dependence on the Chinese market.
The evolution shows that the level of de-risking of German companies remains low, as assessed by Danske Bank, in contrast to the goals of the EU. A recent survey by the German Chamber of Commerce in China showed that 9% of German companies had exited the country or were considering doing so. Although this percentage has doubled compared to the survey four years ago, the reality is that 91% of companies are still not considering an exit.
Another reason for the weak development of German exports to China is found by both economists in the technological surge of the Asian power and the role it now plays in value chains. “After joining the WTO, China imported capital goods from Germany, such as airplanes and machinery. In return, China sold labor-intensive mass produced goods and intermediate electronic products. This has changed in recent years,” they point out.
The truth is that Chinese companies are increasingly focusing on the production of capital goods and goods of greater technological complexity. As a result, imports of capital goods have fallen since 2014 and imports of intermediate goods have increased significantly since 2016. This affects countries like Germany and South Korea, while developing countries in Southeast Asia, such as Vietnam and Indonesia, are benefiting from this trend.
The authors acknowledge that, “of course,” China will continue to demand products made in Germany in the future, and demand for some products will continue to grow, as seen with exports of medical technology and measuring instruments to China in recent years. For this same reason, they add, it makes a lot of sense for German companies to expand production of goods in China: “Not only do they benefit from lower transportation costs, but they also avoid tariff increases in case of a trade war.”
However, the outlook is not encouraging: “Beyond geopolitical tensions, it is unlikely that China will be the economic engine for the German industry that it has been for much of the last 20 years. This is true even after overcoming its current economic issues. This is not only due to the relocation of production and the resulting losses for suppliers and service providers in Germany. The technological advantage over China will continue to shrink, and as a result, demand for German products from the People’s Republic will decrease,” conclude the experts from Commerzbank.
“German exports of goods do not fit so easily into the trend of artificial intelligence,” briefly notes Paul Donovan, chief economist at UBS, in one of his recent morning comments. “It will be interesting to see how Germany positions itself in the conclusion of the EU’s investigation into Chinese electric vehicles once the European Commission has completed its investigation at the end of this year,” point out the geopolitical analysts at Danske Bank with intent.
Aside from the Chinese situation, the U.S. could contribute to the negative dynamics. “The German economy is very sensitive to the global manufacturing cycle, and the revival of global growth is a positive event for Germany’s short-term prospects. However, the United States -which has been a major driver of the revival of world trade- is likely to enter a recession by late 2024 or early 2025,” explain Roukaya Ibrahim and Nicholas Gordon, strategists at BCA Research.
