Entry into the port of Hamburg, a suspected spy balloon over the USA, a merger with Russia and conflict with Taiwan: China is fueling the scepticism and changing mood of its economic partners all on its own, say some. The China bashing is exaggerated, say others. But one thing is certain: China's strategy is not leaving Germany unscathed. Can German-Chinese relations continue as before? What would be the impact of a decoupling? And a “golden mean”: What would it look like? Three scenarios with Martin Hammer.
Mr. Hammer, the term “budding superpower” is often used in connection with China. How do you assess the developments?
China is unreservedly the second superpower - alongside the USA. Although China is trying to overtake the USA. China is a nuclear superpower, has a huge population, is the “workbench of the world” and has an ultra-modern industry.
Is that enough? To become an economic superpower, it needs trading partners. However, China's strategy has recently unsettled many. Doesn't it need stability and reliability for good business relations?
It absolutely does. And yes, China's increasing unpredictability - the arbitrariness of the pandemic, the hard lockdowns, the closed ports and interrupted supply chains - all of this has had serious consequences for parts of German industry. Added to this is China's closeness to Russia. Isolation from the West is growing, as are tensions. In Germany, these geopolitical and international trade crises have at least heightened awareness of how dependent we are on China.
One could assume that the way out of this dependency is “decoupling”. But the figures from the latest IW short report show that China is still Germany's largest economic partner. The trade deficit was “exceptionally high” at over 40 billion euros in the first half of 2022, according to the report. In the second, it doubled to around 84 billion euros.
It has to be said: there have been good trade relations with China in the past, but never before! Historically speaking, this extreme dynamic only picked up speed after the collapse of Lehman Brothers. In 2008, the shift away from US industry began: Europe opened up massively to the East. Everyone benefited from this. In my view, China is still the “workbench of the world” today - despite technological leaps - and has an export surplus compared to other countries such as Japan and the USA. There is only a trade deficit with a few Western countries.
To remain the “workbench of the world”, it needs resources. And China is running out of them in the long term: Its birth rates have been falling for many years. The number of people in employment recently fell by over 13 million within a year. According to forecasts, China is facing a serious shortage of labor and skilled workers. Isn't decoupling a necessary evil in the long term?
Large parts of the economy do not think in the long term - times are volatile: most business leaders think at most in the medium term, analogous to their own contract terms. Although the demographic factor in China - too few women, too few young people - will still have an impact overall, the People's Republic currently has enormous resources at its disposal: the country has over 1.4 billion inhabitants. The scenario of a lack of resources may loom in ten to 15 years, if not later. This could slow down China's economic growth. But it will not stop it.
China's demographic change is therefore not an argument for economic decoupling.
Not at the moment.
What then?
We are still talking about interdependencies: China and Germany are mutually dependent on each other. But decoupling is coming. It is already underway. Both countries are striving to reduce interdependencies. The pandemic has already made Europe aware of the fragility of global supply chains. The ESG goals further flank these developments. Local sourcing has increased. I am convinced that this will continue to increase. But it will not be a radical transformation process. The only thing that would trigger a sudden decoupling would be of a political nature - such as armed conflict between China and Taiwan. Then there could be a dramatic decoupling. Something like what we are currently experiencing with Russia - only worse.
How bad exactly? What would decoupling explicitly mean?
Economically, a super-GAU. Not least because of the strong supply chain obligations. We have already experienced this on a “small scale”. When ships were stuck in closed ports due to the pandemic, goods were delayed for several weeks. On a large scale, decoupling would massively endanger the German economy. According to the IW report, a mutual decoupling of China and the EU would cost China minus 1.3% of GDP in the long term. If we talk about a trade war with the West, it would even be minus 2.3 percent. That would be fatal for a country like China, which is expecting double-digit growth in some cases.
And for Germany? Will we have to “trade” our prosperity for our independence?
Because the interdependence is so great, it would also be blatant for Germany. Let's take the example of Russia - even if the proportionality to China is different: Germany has become independent of Russian gas within a few months and everyone - whether end consumer or industry - continues to feel the consequences. Germany's dependence on China is of a different nature: it is particularly high for certain raw materials and product groups and therefore also very critical, primarily in the electronics sector. Experts have calculated on the basis of models that Germany would lose out on 36 billion euros in added value every year if it were to decouple. In the long term, this would mean a reduction in German GDP of 1 percent - provided that Germany makes a timely and successful move towards diversification and new supply structures.
I suppose my next question about scenario 2 - “Everything stays the same” - is superfluous. In November 2022, Economics Minister Habeck banned the sale of the German chip company Elmos to Chinese owners. Is Germany already too far away from “back”?
My geopolitical assessment is not so positive. I think we need to recognize that China's ambition to become the world's biggest superpower means replacing the USA as such. This currently includes the merger of China and Russia. But China will also expand strategically in other countries. Just look at Africa: All major strategic investments there are made by China. Many African countries are now firmly in Chinese hands.
Nevertheless, there are also voices from the business world who believe that the “China bashing” is exaggerated.
That is true. They mainly come from large-scale industry. I think there will be a dichotomy: The big players in the chemical and automotive industries, such as BASF and BMW, will continue to invest in China. The market is simply too big to give up. They will therefore continue to produce locally and for the Chinese market. The rethink will take place elsewhere: Among the classic SMEs that use China as an extended workbench for the European market. Companies that have one or two production sites there: Decoupling has already begun for them. In my view, they will gradually decouple themselves from China by 20 to 25 percent.
Which business question about China has surprised you recently?
“How do we establish expats in China?” This is actually becoming more difficult. The shortage of skilled workers here is a completely different scenario. The problem is of a political nature: living in China has become less attractive for Western European professionals. Many expats fear the arbitrariness of the Chinese government - keyword “zero Covid strategy”.
China experts such as Janka Oertel speak of a “readjustment”, a “recalibration” of the German economic model. So instead of isolation, the “golden mean”? What could it look like?
I think the Russia-Ukraine conflict has taught us one thing: the country must not become even more dependent on China in view of the situation. Let me give you an example from my day-to-day work as a consultant: if I analyze companies and don't find a diversified customer structure, that means a huge risk for the company. It's the same with Germany: it has to diversify. It also needs other suppliers and other supply chains. This is where a rethink is taking place. If you ask me, the key to the future success of the EU lies in the EU itself: With its 27 member states, it has sufficient opportunities to make targeted use of subsidies. This will enable it to establish new, economically successful production sites and supply chains in EU regions with weaker industries, for example in northern Finland or southern Italy.
What specific developments are you observing?
I am observing that more and more companies are trying to minimize risks and are therefore looking for production capacities outside of China. Those who are now looking at expansion and setting up additional plants are looking very closely at Eastern and Southern European countries. There are very good alternatives in Europe for the criteria of availability of labor and skilled workers, industrial standards, reliability and political security. Specifically, I am following how major bicycle manufacturers are moving away from China and having their products manufactured in Eastern Europe, for example. In Portugal, the so-called “Valley of Bicycles” has formed near Porto. Here, an active alliance of producer associations and other companies is taking place directly on site. Outside Europe, I see good opportunities in Japan and South Korea. But also in Brazil, Indonesia and Australia.
So the question is “How to Diversify?” rather than “To Decouple or not?”.
In my opinion, it will increasingly be a question of which countries Germany can work with. These will be countries that cultivate business practices that are similar in terms of values and whose overall political situation is stable.
Thank you very much for your assessment, Mr. Hammer.
