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Can Germany's economy avoid a China shock?

May 15,2023 - Last updated at May 15,2023

MUNICH — The German and American automobile executives attending this year’s Shanghai motor show may have expected to take a victory lap following their three-year pandemic-related absence. Instead, Western manufacturers were met with a harsh reality: Dozens of new Chinese-made electric vehicles (EVs) are coming for their market share.

Over the past few years, the rise of EVs has propelled the Chinese auto industry to global prominence. China’s auto exports already overtook Germany’s in 2022, following a 54 per cent increase, and the country is projected to surpass Japan to become the world’s largest car exporter this year.

The shift was evident in Shanghai, where Chinese consumers ignored the offerings from BMW, Volkswagen and Mercedes in favour of new models from Chinese manufacturers BYD and Nio. Compared to the new Chinese cars, with their cutting-edge batteries and sensors, the German-made EVs seemed almost outmoded. For decades, German engineers perfected the internal combustion engine; now, the EV revolution is threatening to render all their technological know-how obsolete.

Given that the auto sector accounts for 4 per cent of German employment, the country could be facing a “China shock” comparable to the one that the United States and other high-income countries experienced in the early 2000s. Following China’s entry into the World Trade Organisation in 2001, Western manufacturers faced fierce competition from Chinese firms, beginning with low-value-added products such as textiles, furniture, and clothing but then in more sophisticated industries like computers and electronics.

Between 2000 and 2010, Chinese-made goods’ share of total US imports increased by 25 percentage points, contributing to the de-industrialisation of the Rust Belt and transforming America’s economy and politics. Contrary to what trade economists predicted, the contraction of import-competing sectors was not offset by an increase in exports to China. Moreover, displaced workers could not easily find new employment, and those who did experienced reduced wages. The decline in manufacturing employment contributed to the increase in “deaths of despair” and set the stage for Donald Trump’s victory in the 2016 US presidential election, as the region most exposed to Chinese import competition underwent a right-ward shift.

There are clear signs that Germany is already experiencing its own version of the China shock. Until last year, Germany was a net car exporter. Now, for the first time ever, it is importing more cars from China than it exports. From January to August 2022, Germany imported 1.8 million cars from China but exported only 1.7 million. (A similar trend is apparent in the machine tools sector, where China’s exports have surpassed Germany’s.)

The irony is that China’s rapid industrialisation was facilitated by massive imports of German machinery, particularly cars and machine tools, which are crucial to the German economy. Over the past three decades, Germany trained a generation of Chinese workers through joint ventures with Chinese companies. These technology transfers were mandated by China as a prerequisite to accessing its market. But now that China has become an industrial powerhouse in its own right, it has outgrown the need for Germany’s assistance.

China holds two significant advantages over Germany. First, at a time of technological disruption, past experience is irrelevant. China does not need to master the combustion engine to beat Germany in the EV market. Second, China’s size enables it to scale up production, expedite the learning process, and reduce costs swiftly. This is how China became a global leader in lithium-ion batteries, and why it is now on the cusp of developing sodium-powered batteries.

In the past, several factors helped Germany avoid the China shock. Initially, Chinese imports competed with goods that Germany previously imported from low-wage countries like Turkey and Greece, resulting in job losses in those countries rather than in Germany. Similarly, the expansion of production networks to ex-communist Central and Eastern Europe enabled German firms to boost productivity and reduce costs. For years, Germany benefitted from China’s economic boom, as Chinese demand for high-quality German cars and machinery soared.

But as China continues to expand its economic influence, Germany may no longer be able to avoid the negative impact that other countries have experienced. While the reconstruction of Ukraine could give the German economy a boost similar to the one it experienced following the fall of the Iron Curtain in 1989, the war there must first end, which seems unlikely in the foreseeable future.

German policymakers could take several steps to avoid repeating America’s painful de-industrialisation process. They could seek to attract foreign direct investment from Chinese battery firms and Asian semiconductor manufacturers. Germany could also emulate China by forming joint ventures between domestic companies and Israeli artificial-intelligence startups. That would help Germany bridge the knowledge gap in AI technology, which will be crucial for autonomous cars, and enable German engineers to acquire the necessary skills to remain globally competitive.

Finally, Germany can and must take the lead in creating a European version of the US government’s Defence Advanced Research Projects Agency. By reverse engineering the Chinese approach to industrial policy and the US approach to innovation, Germany could boost economic dynamism at home and elsewhere in Europe, avoid the negative consequences of a China shock, and prepare its economy for the challenges of the twenty-first century.

 

Dalia Marin,  professor of International Economics at the School of Management of the Technical University of Munich, is a research fellow at the Centre for Economic Policy Research and a non-resident fellow at Bruegel. Copyright: Project Syndicate, 2023. www.project-syndicate.org

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