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30 April 2024

Friends with China

It first appeared like a gaffe when Olaf Scholz criticised the EU during a visit to China. The German chancellor warned the EU not to impose tariffs on electric cars from China. A few days later, at a summit in Brussels, he doubled down and criticised the EU for its lack of success in concluding free trade agreements. He is clearly not happy with Brussels. The Chinese state media were unsurprisingly full of praise of Scholz' courage to break with the western establishment views.

Can he possibly succeed? I don't think so, but this will be the next big battle. The overwhelming consensus in Brussels is that the EU needs to respond to unfair trade practices from China. Thierry Breton, the French industry commissioner, is the driving force behind an EU investigation into unfair Chinese subsidies for electric cars. His investigation will almost surely be followed by a tariff. Washington, too, is expected to do the same. 

So how can it be that the US-China and the EU-China relationships are getting colder, whereas the Germany-China relationship is getting warmer? 

I doubt that Scholz has thought this through to the end. He stands in an old corporatist tradition - to follow workers' interest at home and company interests abroad. Scholz is surprisingly deaf to complaints from companies about taxes and bureaucracy. He recently said "The lament is the merchant's song." Then he goes off to China with a planeload full of businessmen in tow, and calls for a deepening of the commercial relationship between the two countries. It is as though geopolitics has never intruded.

A reminder that it has never gone away came with the news of the arrest of a German couple this week, who are accused of facilitating the sale of critical military equipment to Chinese ministry of state security. The German prosecutor said such spying rings had become increasingly common. 

During a visit to Washington last week, I noted US officials were far more worried about China than about Israel or Ukraine. The Biden administration recently strong-armed the Dutch government into stopping ASML, the maker of sophisticated lithography machines, from servicing their products in China. From its base near Eindhoven, ASML manufactures machines with which semiconductor producers can etch high-performance chips. The Dutch government ended up bowing to US pressure. If you are dependent on the US for your security, what else can you do?

There is an old joke in the EU that there exist only two types of member states. Countries that know they are small. And those  that don't. Germany falls into the category of EU countries that thinks it can have an independent China strategy - or even an independent trade policy. Good luck with that! 

One immediate consequence of this illusion is the attempt by the German government to shield companies from the influence of geopolitics. That worked well - until it did not. A good case of the geopolitical naivety of German business leaders came with the reported comments by Ralf Thomas, the head of Siemens. Thomas said global value chains had built up for over 50 years. It would take decades for them to unravel. Germany company may work that way. History does not. The Russia-Germany relationship that took decades to build up. It unravelled in a few months. 

When you believe that your government protects you from geopolitics, you are far more likely to expose yourself to risks that those with a greater awareness of the geopolitical environment would not have undertaken. China accounts for almost 40% of the sale of Mercedes. Do they have nobody in their boards who would raise their hands and warns about the risk?  BASF is betting the house on a future in China. This is Germany's subprime.  

If Scholz wanted to help German companies he would alert them to their risk exposure. I have no idea whether the US and China will end up in a military conflict over Taiwan. But it is clearly a scenario with a non-trivial probability. Corporate leaders behave as though probability of an escalation is zero.

Ultimately, the reason why Scholz' softness on China will fail is a lack of allies. President Emmanuel Macron of France favours a much more assertive China policy, a position on which he is more closely aligned with the US and the UK than with Germany. The only European leader I can think of as aligned with Scholz over China is Viktor Orbán, the Hungarian prime minister. 

But I also have a warning for geopolitic hardliners who are full of contempt for economic reasoning. The dismantling of globalisation and the break-up of the world into adversarial trading blocks will be the most expensive thing anyone has ever done. I am saying that without qualification. The opportunity costs of the new cold war will run in the tens of trillions of dollars. Its bill in the form of lower productivity growth, less public investment, more defence spending, more inequality, a weakening of multilateral institutions, and of democracy itself. Be careful what you wish for. 

Many European countries are at risk of falling further behind in critical technology. When western governments banned Huawei, the rollout of 5G mobile services slowed down everywhere. China, meanwhile, is already preparing for 6G, a technology so fast that you can run factories on it. Unless our geopolitics-first approach is accompanied by an economic policy focused on investment and innovation, we risk losing both the geopolitical and the commercial wars at the same time. Indeed, this is my baseline scenario. 

I see the tariffs on Chinese electric cars as the beginning of a trade war that we will not win. It is also a tax on voters.

Scholz clearly has not thought this through. But other leaders have not either. 

 

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