H+K Policy Brief

The COVID-19 pandemic, the ongoing war in Ukraine as well as the energy crisis have left a lasting impact on our collective view of the global order. The dogma of globalization, of ever more interconnected societies and economic areas, which seemed inevitable for decades, has lost some of its persuasive power as a result of these developments.

Significant cracks to the persisting economic worldview started to show during the pandemic –lockdowns and the “zero Covid” policies of the Chinese government in particular offered a first reminder of the fragility of global supply chains. Russia’s attack on Ukraine then was the push that fully shook the existing order. By then, the idea of effecting “change through trade” no longer stood up to reality and the dangers of depending on other countries’ resources – on Russian gas at the time – became glaringly obvious.

German’s relationship to China did not remain unaffected by these developments. Soon after the discussions about Germany’s energy dependence on Russia, attention turned to Sino-German relations. The topic is not new. Rather, it should be seen in the context of the ongoing discussions about the role of Germany and the EU in a new world order. In view of China’s foreign policy, which is perceived as increasingly aggressive, and China’s enormous importance for the German economy – and thus the country’s prosperity – debates about the future shape of German-Chinese relations began years ago. The current German government’s coalition agreement of November 2021 also already mentioned the preparation of a “China Strategy” to adjust the future relationship with the People’s Republic. 

After long and apparently difficult discussions among political actors, the German government’s China Strategy was finally published in July 2023. It documents the German government’s attempt to define a new balance to the relations in which both the existing differences as well as continued cooperation find their place. The magic word is de-risking, rather than the more aggressive decoupling approach that has dominated U.S. rhetoric.

What exactly does this new balance look like?

Germany is seeking to diversify its supply chains

The German and Chinese economies are heavily intertwined. With a total trade volume of 298 billion euros in 2022, China was Germany’s most important trade partner for the seventh year in a row. In the same vein, Germany is China’s most important trade partner in the EU by some distance. But with these close relations come dependencies. In 2022, Germany imported 65.9% of its rare earths, which are indispensable for many electronic products, from China – for some metals like Scandium and Yttrium, the proportion was as high as 94.4%. In addition to this, 65% of the raw materials needed for electric motors, and over 50% of materials needed for wind turbines or photovoltaic panels were sourced from China in 2022.[1]

Thus, a central tenet put forward in the China Strategy is the reduction of supply chain dependencies in areas where Germany previously relied on just one or only a few countries to supply any product or raw material. In order to reach this goal, Germany plans to enter closer trade relations, both at the EU level and bilaterally, with the ASEAN countries, Japan, South Korea and India, as well as Africa and Latin America. At the EU-ASEAN summit in December 2022, Germany’s chancellor advocated “making rapid progress in negotiations for a free trade agreement between the European Union and Indonesia. And in perspective, conclude a free trade agreement between the EU and ASEAN.”[2]  China expert Joerg Wuttke, longtime president of the European Union Chamber of Commerce in China, recently said that 50 to 60 percent of companies producing in China are now increasingly looking to the ASEAN region.[3]   

Germany also plans to cooperate more closely with India in the future. However, and to put things in perspective, the volume of trade between Germany and India in 2022 stood at around 30 billion euros, only one tenth of Germany’s trade volume with China. Reasons for this named in the “German Indian Business Outlook 2023,” in which the German companies surveyed outline major challenges standing in their way of doing business in India, include: bureaucracy, administrative hurdles, corruption and the regulatory environment.[4]

The China Strategy classifies Germany’s dependence on rare earths from China in particular as critical and emphasizes that the German government supports regular EU-wide monitoring of dependence on raw materials. This is an important component of the “Critical Raw Materials Act” presented by the EU Commission on March 16, 2023. The proposed legislation includes other items designed to increase the EU’s security of supply of critical raw materials and reduce dependencies:

• facilitate mining projects for raw materials in the EU;
• establish raw material partnerships with non-EU countries;
• diversify the EU’s imports;
• and strengthen the circular economy.

However, though European business representatives are in favor of a ramp-up in the exploration and extraction of raw materials in the EU, they are also skeptical: approval procedures are lengthy, environmental requirements are very complex, and acceptance among the population directly affected by extraction activities is often low.

Germany and the EU strive for technological sovereignty

The diversification of supply chains will also be an important step towards securing the technological sovereignty of Germany and the EU. According to the German Federal Ministry of Education and Research, technological sovereignty “describes the aspiration and ability to shape key technologies internationally on an equal footing.”[5] Germany and the EU must be able to understand, develop and produce key technologies themselves because they are the basis for economic welfare, the creation of high-quality jobs, competitiveness and the preservation of a society’s values. After all, the standards for security, data protection and sustainability applied during the development of a technology also shape the requirements expected of it during its mature stages. The technologies identified as especially relevant for technological sovereignty by the Federal Ministry of Education and Research include artificial intelligence, microelectronics, software and data, high-performance computing, and personalized medicine. But also technologies that are particularly relevant for a successful energy transition, such as battery and storage technologies or green hydrogen are critical for technological sovereignty.

In its “Made in China 2025” strategy, the Chinese government has made it clear that it is striving for global market and technology leadership in several sectors that are of considerable strategic relevance. These include the semiconductor industry, robotics, the automotive sector with new drive technologies, and the energy sector with technologies that are groundbreaking for the energy transition. China has been promoting these efforts for years with generous subsidies. Now the EU is following suit with its Chips Act, which is intended to mobilize 43 billion euros from public and private funds for investment in semiconductor manufacturing in Europe.[6] However, the EU itself will provide only a small share of this, totaling 3.3 billion euros. The rest is to be provided by the member states and companies themselves. Germany is already showing how the domestic semiconductor industry is to be expanded: The U.S. company Intel plans to build two chips’ plants in Magdeburg with an investment volume of 30 billion euros. The German government is bearing one-third of the costs by subsidizing the construction with 9.9 billion euros.

Additionally, in March 2023 the EU decided to relax the state aid rules for climate-friendly technologies. The new rules, which will apply until the end of 2025, will allow member states to match subsidies granted in other countries “if there is a real risk that investments will be diverted away from Europe.”[7] This applies especially to subsidies for key climate-friendly technologies such as solar modules, batteries, heat pumps, or electrolyzers for hydrogen production. In the China Strategy, the German government also announces that it will actively use its options for subsidies as part of the Important Projects of Common European Interest (IPCEI). The currently approved IPCEI, all of them with German participation, include projects to promote battery production, microelectronics, and communication technologies, as well as the development of a European hydrogen market.

Germany’s new approach to inbound and outbound investments

According to the China Strategy, a new approach to investments by German companies in China will be a key instrument for reducing German companies’ dependence on the Chinese market. During the presentation of the strategy, Federal Minister of Foreign Affairs Annalena Baerbock made clear that companies will have to shoulder the consequences of risky business decisions themselves in the future:

„Trusting in the invisible hand of the market in good times and calling for the strong arm of the state in difficult times, in times of crisis, will not work in the long term. Even one of the strongest economies in the world cannot support this. […] Therefore, companies that are highly dependent on the Chinese market will increasingly have to bear the financial risk themselves in the future.”

A tangible measure in this direction is the already implemented cap on state investment guarantees of 3 billion euros per company per country. Through this cap for investment guarantees, the German government intends to incentivize a reallocation of investments by German companies in such a way as to avoid concentrations of investments in a single country. However, the aim of this measure is not to reduce existing investments, but rather to direct future investments in such a way that they lead to a gradual reduction in dependencies.

Conversely, with a view to safeguarding technological sovereignty, investments in Germany and Europe are also to be more tightly controlled. In 2019, the “Regulation establishing a framework for the screening of foreign direct investment in the Union” (Screening Regulation (EU) 2019/452) already established a European framework on which German investment screening is based.

Accordingly, the German government can impose conditions on or prohibit the acquisition of parts of a domestic company if the investment is likely to have a “probable adverse effect on public order or security.” According to the China Strategy, such a risk exists, among other things, if an investment or takeover may result in the outflow of security-sensitive high or foundational technologies. The more important the sector affected by a possible investment is for public order and security, the lower the thresholds for the investment to be reviewed.

Already today, investments from outside the EU in defense equipment, IT security and telecommunications components, as well as critical infrastructure are audited by the German Federal Ministry for Economic Affairs and Climate Action if the investment exceeds 10 percent. Investments in important medicines, quantum computers, specialized robots and the like are examined starting at a stake of 20 percent. In its China Strategy, the German government has now announced its intention to amend the investment auditing legislation and consolidate it in a separate legal act. Under discussion are steps like lowering the thresholds for audits or classifying further sectors of the economy as relevant for public order and security.

Collaboration remains a priority

Despite these measures to reduce dependencies, China – and representatives of the German government and the EU never tire of emphasizing this – remains an important partner, especially with regard to overcoming many global challenges.

For example, the fight against climate change will only be possible together with China. In 2020, 30% of the greenhouse gases emitted worldwide and 28% of global CO2 emissions could be attributed to China. Whether the Paris Climate agreement’s goal of limiting global warming to a maximum of 1.5 degrees above pre-industrial levels will be anywhere near achievable will depend largely on China’s climate protection efforts.

China has set itself ambitious goals, as the country is already feeling the effects of climate change on a massive scale. At the World Economic Forum 2023, the Chinese leadership announced that it wants to achieve its climate targets even earlier than previously planned: China wants to peak its CO2 emissions as early as 2025 instead of 2030.[8]  In the decades that follow, the country aims to transform its economy and energy system so that it is climate-neutral by 2060. Other goals include increasing the share of non-fossil energy sources in the energy mix to 25% by 2030 and increasing the installed capacity of wind and solar power to 1200 GW by 2030. China is making great progress in this transformation. Nevertheless, the country continues to rely on coal to avoid energy shortages and to boost economic growth after the COVID-19 pandemic. For the period of the 14th Five-Year Plan (2021-2025), coal-fired power plants with a total capacity of 200 GW are to be connected to the grid. China also remains the world’s largest financier of coal abroad, despite its announcement that it will no longer finance new coal-fired power plants abroad.

The German government wants to use the newly established high-level climate and transformation dialogue to convince their Chinese counterparts of a faster coal phase-out. In doing so, Germany wants to share its experience from its own coal phase-out with China, in particular regarding the reskilling of coal industry employees, so that they can play a new role in the transformation of the economy and the energy system.

Outlook

Traditionally, the views of China by various German governments have been dominated by economic considerations, shying away from upsetting Germany’s most important trade partner. The new China Strategy is an attempt to define a better balance here, based on a more realistic assessment of geopolitical and security realities.

Next to industrial policy, the strategy affords more space than previously to security interests and human rights principles. It finds clear words on existing differences but also highlights the importance of cooperation regarding global challenges. At the same time, the German government sees the China Strategy as firmly embedded in the EU’s overall plans for dealing with China in the future.

But a strategy is not a law. Only the coming months and years will show how the strategy will be translated into concrete policy and legislation. For the German business community this cannot happen quickly enough as the lack of clarity as to what the strategy means in specific terms has resulted in more uncertainty in already turbulent times, while planning and investment security are needed instead.

Thus far, the new approach does not appear to have damaged Sino-German relations. Although the Chinese government reacted predictably reserved to the publication of the strategy, it also remained conciliatory in its replies – too important are the relations for both countries.

[1] Abhängigkeit deutscher Unternehmen von Rohstoffimporten (bundestag.de)

[2] ASEAN-Gipfel: Kanzler Scholz in Brüssel | Bundesregierung

[3] Pioneer Briefing, 21.07.2023

[4] Jedes 4. dt. Unternehmen will Indien für FuE nutzen – KPMG Deutschland

[5] Technologische Souveränität – BMBF

[6] Europäisches Chip-Gesetz (europa.eu)

[7] Klimafreundliche Technologien: EU lockert Beihilferegeln für Industrie – EURACTIV.de

[8] Emissions targets: China set to beat its 2030 climate goals | World Economic Forum (weforum.org)