Divergence Time: After the energy break with Russia, Europe must more responsibly assess the risks of trade dependence on China

Component dependence

The economies of Italy, Spain, and Germany will face significant risks if the supply of critically important resources from China is halted, according to an article by a group of economists posted on the portal of the European Centre for Economic Policy Research (CEPR). The article is based on a survey conducted by the central banks of Italy, Spain, Germany, and the European Central Bank. Approximately 14,000 firms were surveyed with the aim of finding out the extent of European companies' dependence on China.

The problem is most acute in Germany, where more than a third of companies rely on critical resources from China that would be difficult to replace. In Spain and Italy, this share reaches 20% and 17% respectively. Moreover, the largest companies are the most dependent on Chinese resources, almost twice as much as small and medium-sized enterprises.

European businesses recognise the dangers of this dependence: nearly 40% of companies surveyed said that China is an exporter of critical resources for them, and more than 60% see it as a potential threat to supply chains in their sector. Currently, risk mitigation strategies related to purchases in China are being implemented by 40% of companies in the German sample, 30% in Italy, and 22% in Spain. By the end of this year, approximately 20% of companies in Germany and Italy, and 27% in Spain, each intend to implement such measures. Most often European businesses are looking to substitute Chinese suppliers with those from EU countries: about 40% of companies in Germany, about 70% in Spain and about 45% in Italy. This is natural, as increasing supplies from non-European countries is more profitable but involves higher costs (as it implies long-term investments).

Moving away from Chinese components and making supply chains more resilient inevitably comes at a cost which will at least partially fall on consumers, the report says. About half of the multinational companies that have already started implementing risk reduction strategies expect their product prices to increase in the next five years. However, this share is lower than in the past five years. This may reflect the fact that Europe's largest businesses were previously forced to reassess supply chains on the fly, influenced by shocks such as the pandemic and Russia's invasion of Ukraine. Now, multinational companies are implementing risk mitigation strategies in advance, which should help them to mitigate future cost pressures on consumers, the authors of the study believe. 

Although Germany is the most dependent on trade ties with China among EU countries, the benefits of breaking with Beijing will outweigh any short-term costs for Berlin, writes Andreas Fulda, author of ‘Germany and China: How Interdependence Undermines Freedom, Prosperity and Security,’ in a commentary for the Royal United Services Institute for Defence Studies (RUSI). In his opinion, the relationship between Germany and China over the past 30 years has become a vivid example of the erosion of a Western country's sovereignty due to growing closeness with an autocratic superpower. Amid dependency on Chinese raw materials and components, as well as revenue from the Chinese market, Berlin has developed a fear of possible prohibitive measures from China. In 2012, the Merkel administration downplayed the significance of unfair trade practices in China's solar panel industry during EU negotiations with Beijing, which eventually allowed cheaper Chinese panels to flood the European market, displacing the former world leader Germany. According to Fulda, this was done out of fear that high tariffs on imported panels would prompt China to retaliate against German automakers. In 2019, Chinese Ambassador Wu Ken warned that German automakers in China might face negative consequences if Huawei equipment was excluded from German 5G networks. In the end, neither the Merkel government nor the Scholz administration decided to ban the Chinese company from supplying equipment for Germany's critical IT infrastructure.

According to calculations by the Kiel Institute, a break with China would lead to a contraction of the German economy by approximately 5% in the first year, comparable to the decline experienced during the 2008 financial crisis or the COVID-19 pandemic. However, after four to five years, once the German economy adapts to the new reality, this figure would decrease to about 1.5% per year. The losses for individual large companies, such as Siemens and Volkswagen, which have long invested in China, could be significantly greater. As Politico writes, China accounts for about 50% of Volkswagen's global car sales. With Germany's economy continuing to stagnate for the second consecutive year (its exports have fallen by more than 2% this year), German Chancellor Olaf Scholz will be unable to break business ties with China, the publication believes.

Rethinking the paradigm

However, the situation should be viewed in a broader historical and geopolitical context. Essentially, it involves revising the concept of ‘change through trade’, which was popular in the previous half-century (especially in Germany), Fulda argues. According to this concept, the development of trade ties eventually leads to political convergence, meaning the liberalisation of authoritarian regimes. But the formation of the ‘Russia-China-Iran’ political and economic axis of autocracies makes the concept obsolete, he insists. Experts from the Ukrainian Razumkov Centre have discussed this turn in their report ‘Rapprochement Intentions or Readiness for Disengagement’. With regard to Russia, Western politicians believed that as Putin's autocratic regime strengthened economic ties with the West, it would continue to drift towards Western values; however, this expectation was not fulfilled, they argue. The same concept underpinned the ‘Eastern Partnership’ - the development of gas supplies from the USSR/Russia to Germany and other EU countries. In the 1970s and 1990s, it appeared as though the concept was working. However, over the next two decades, gas trade increasingly became a zone of conflict, culminating in the energy war of 2021-2022.

At a time when, after the collapse of the Soviet bloc, the concept of ‘change through trade’ seemed successful, it was also the impetus for the development of economic ties with China and massive Western investment in the country. Now, having experienced a painful energy divorce from Russia, Europe must consider its ‘component’ dependence on China. Last year, Brussels unveiled an ‘Economic Security Strategy’ that would ban European businesses from manufacturing products based on key modern technologies, including supercomputers, artificial intelligence and advanced chips, in countries with which the EU has ‘differences in values, models and interests’. The European Union is also considering the possibility of imposing tariffs on the import of Chinese cars this summer.

The break with Beijing is complicated by the lack of unity within the EU on the China issue. Different levels of interests collide here. Italy, which was the first G7 country to join China's Belt and Road Initiative, exited the project in December last year. Meanwhile, during French President Emmanuel Macron's visit to Beijing in April 2023, 18 cooperation agreements were signed between companies from the two countries. During Xi's reciprocal visit to Paris in May 2024, the leaders of China and France reaffirmed their mutual commitments to strengthening relations between China, France, and the EU. Macron stated that relations with Beijing are important for maintaining Europe's strategic independence. China has already become France's main trading partner outside the EU, with bilateral trade totalling $78.9 billion in 2023. During a recent visit to Beijing, Olaf Scholz also demonstrated Europe's intention to build its own relationship with China, independent of Washington. 

Beijing uses the EU's lack of political unity to its advantage, demonstratively favouring contacts with individual countries over direct interaction with EU institutions, the experts from the Razumkov Centre note in their study. At the national level, governments are much more dependent on the interests of business and the national economy and are inclined towards political opportunism, as demonstrated by the experience of gas relations between Russia and individual European countries.

However, the experience of the energy divorce with Russia demonstrates that autocracies are capable of sacrificing economic interests worth tens and hundreds of billions of dollars for the sake of maintaining power under the banner of geopolitical ambitions. European politicians have, for decades, been talking about reducing energy dependence on Russia, but their inability to realise these intentions has only served to reinforce Moscow's belief in the power of its ‘energy weapon’, which has increased rather than decreased the likelihood of a brutal conflict.