Since the end of the cold war, German foreign policy has been guided by the classically liberal belief that integration into the world economy will lead to prosperity, peace and, eventually, political liberalism. Fostering economic relations with China was seen as no exception, and the partnership between the two economic powerhouses has grown substantially in the past few decades. For the seventh consecutive year, China ranks as Germany’s largest trading partner.
But what was once seen as a mutually beneficial bilateral relationship is now being seriously reconsidered as Germany’s political leadership seeks to distance their country from the growing superpower.
This shift is the result of both political and economic calculus. First and most acutely, the Russian invasion of Ukraine was a turning point in Germany’s foreign policy. As witnessed with the European energy crisis last year, allowing critical infrastructure and/or access to key commodities to fall into the wrong hands was understood to be a grave misstep. Within German political and economic circles, there is a growing weariness of conducting business with countries exhibiting divergent political interests. Hence, reducing external dependency has become a policy priority.
Politically, in addition to China’s subdued response to Russian aggression, the issue of Taiwan is of increasing concern to the German government. It was one of the key topics of discussion at Chancellor Olaf Scholz’s visit to President Xi Jinping last November. Economically, there is renewed concern in Germany over an increasing trade deficit with China – which reached a historic high of €39.4bn ($42.9bn) in 2021 and is set to grow – as well as frustration over the ‘unequal playing field’ behind the growing gap.
Figure 1. Increasing dependency: Germany’s growing trade deficit with China
€bn
Source: German Federal Statistical Office, German Trade and Industry. Dashed lines represent projections.
According to the European Chamber of Commerce’s 2022 Business Confidence Survey, European companies in China continue to face restrictions and discrimination in comparison to domestic Chinese firms. Areas of concern for German companies include forced joint ventures, lack of access to certain sectors of the economy and limited participation in the financial industry, according to the Federal Ministry for Economic Affairs and Climate Action.
While the challenges of operating in the Chinese market are nothing new, the degree of unevenness coupled with a more tense geopolitical environment has led to a growing impatience for China to address some of the more egregious protectionist measures – or to reassess economic co-operation.
Bilateral relations between the two countries have been marred by a series of stalled deals on inward investment as well. In November, the German city of Duisburg cited China’s ties with Russia as a reason for letting a memorandum of understanding for a ‘smart city’ infrastructure project with Huawei expire. Similarly, while Chinese state-owned enterprise Cosco originally intended on taking a 35% stake in a terminal in the Hamburg port, a compromise within the German governing coalition resulted in limiting Cosco’s stake to a maximum of 25%. Two months later, the deal is still not resolved and may fall through.
Germany’s coalition government is due to determine a new strategy for China later this year. Meaningfully reducing economic dependence on China will not be easy, but any new strategy will certainly aim to reduce the trade imbalance and level the playing field for German (and European) business and labour. It will most likely pare back comprehensive trade and investment ambitions, especially those involving state-owned enterprises, in favour of more targeted areas of co-operation, namely in pharmaceuticals, electric vehicle manufacturing and rare earth metals. Co-operation on sustainable initiatives will be met with a greater level of scrutiny regarding both transparency and fairness.
What does this mean for international economic relations more broadly? It could be that Germany is taking a harder line than other countries in its bilateral relations with China. As the largest net importer of Russian gas last year, the German economy suffered disproportionately compared with other European Union member states, necessitating a more profound reassessment of its economic and foreign policy strategy.
But when considered alongside the US’ move towards ‘friendshoring’, in addition to the more aggressive move to preclude China’s access to semiconductors late last year, it is more likely that Germany’s re-evaluation of its economic and foreign policy towards China is a harbinger of a greater schism in international economic relations.
Taylor Pearce is Economist at OMFIF.