Germans' View On Chinese Investments

The relationship between Germany and China has been characterised by a high degree of complementarity, with German companies investing heavily in China and vice versa. However, in recent years, this dynamic has begun to shift, with China emerging as a formidable competitor to Germany in several industries. Despite the German government's pleas for companies to reduce their exposure to China, German direct investment in China reached a record high of €11.9 billion in 2023, and China remained Germany's most important trading partner for the eighth year in a row in 2023. This has caused a headache in Berlin, as the government struggles to balance economic interests with security concerns.

German companies' direct investment in China reached a record high in 2023

This increase in investment comes as the EU steps up scrutiny of these investments due to security concerns. German companies have been eager to expand in China, the world's second-largest economy. The investment was financed by the retained profits of German-controlled enterprises in mainland China and Hong Kong.

According to Juergen Matthes of the IW institute, German companies in China are increasingly relying on local suppliers and local research. This is partly due to subsidies offered by the Chinese government and partly to protect themselves from the impact of potential conflicts.

While the German government and the EU want to reduce their economic dependence on China, German companies do not appear to be significantly diversifying away from China. China remains Germany's most important trading partner, and many German companies continue to invest heavily in the Asian country.

Germany's government screening of Chinese investments

Germany has been considering tightening its government screening of Chinese investments. In February 2024, Germany's deputy chancellor and economy minister, Robert Habeck, proposed tougher rules on Chinese foreign direct investment. The measures would increase scrutiny of Chinese investments in critical sectors such as semiconductors and artificial intelligence. This proposal came at a time of heightened debate in Europe and the US about western economic relations with Beijing.

Germany's government has expressed concern about China's growing authoritarianism, aggressive behaviour towards Taiwan, and continued close ties with Russia following the invasion of Ukraine. In response to these geopolitical risks, Germany aims to reduce its reliance on China and protect its economic security. The proposed legislation would simplify and consolidate existing rules, including tighter restrictions on sectors where Chinese dominance is seen as a threat, such as semiconductors, AI, and quantum computing.

Germany has already blocked several Chinese investment attempts, including a satellite communications startup and the sale of a stake in a Hamburg port terminal. The German government has also been working on a new framework for investment screening regulations to keep Chinese entities out of industries crucial to its national interests.

However, there are differing opinions within Germany's ruling parties regarding the tightening of investment screening. Chancellor Olaf Scholz, a Social Democrat, is less inclined to take drastic measures that could harm economic ties with China, Germany's largest trading partner for seven consecutive years. Some business organisations have also criticised the proposed measures, arguing that Germany should remain open to foreign investors and avoid protectionism.

In March 2024, Germany agreed on new rules to lower the threshold for screening and blocking purchases of stakes in German firms by non-Europeans. These rules allow the government to intervene if a non-European investor buys a 10% stake in a company, down from the previous threshold of 25%. The German government aims to protect vital infrastructure and key technologies while balancing the need for an open investment environment.

China's plan to become a manufacturing superpower

China's manufacturing prowess is the result of a combination of factors, including favourable policies, aggressive entrepreneurship, a disciplined work culture, and sheer luck. Here is a detailed look at China's plan and journey to becoming a manufacturing superpower:

Favourable Policies:

China implemented economic reforms and opened up to foreign investment, creating Special Economic Zones (SEZs) with attractive terms for foreign manufacturers. These zones offered fast clearances, infrastructure for rapid export, and cheap credit. The Chinese government also kept input costs low by regulating prices of raw materials and energy, ensuring they remained favourable for manufacturing industries.

Learning from the World:

China learned from its neighbours, such as Taiwan, South Korea, and Japan, which had already achieved export-driven development success. Additionally, the presence of Hong Kong as a world-class port and trading hub provided China with access to global trade routes and modern economic infrastructure.

Geography and Timing:

China's geographical proximity to these successful East Asian economies and its timing with the advent of global production chains due to reduced long-distance shipping costs further accelerated its growth. The rise of a sophisticated electronics industry in Taiwan, which then moved to China in the late 1990s, also played a significant role.

Cheap Inputs and Patient Capital:

China ensured that manufacturing companies had access to cheap inputs, including raw materials, energy, land, and finance. The country kept commodity and energy producers in the public sector, regulating their prices. Additionally, the financial system provided patient and cheap funding to manufacturers, with low deposit rates and negative real deposit rates in some periods.

Fierce Competition and Scale:

China encouraged competition and entrepreneurship, with numerous companies operating in many sectors. This competition, combined with disciplined and eager workers, led to improvements in quality and efficiency. The scale of Chinese manufacturing is also impressive, with large factories and infrastructure that further reduced production costs.

High-Tech Industries:

China has moved beyond low-end textiles and cheap consumer goods to become a leader in advanced industries. These include automotive, shipbuilding, machinery, electronics, chemicals, and precision instruments. Chinese firms are now important producers of ships, high-speed trains, mining equipment, and power generation equipment, including nuclear reactors.

Skilled Workforce:

China's workforce is highly skilled, with a strong work culture. Piece-rate compensation structures in factories incentivise increased productivity, and skilled workers are respected and appreciated, contributing to planning and discussions in their fields.

Environmental and Investment Costs:

While China's manufacturing success has come at enormous environmental costs, the country has also faced the risk of overinvestment. As demand changes, China may have to confront financial and social costs associated with bad loans and sudden unemployment.

In summary, China's journey to becoming a manufacturing superpower has been characterised by supportive policies, aggressive entrepreneurship, a skilled and disciplined workforce, favourable economic conditions, and sheer luck. The country's manufacturing prowess has had a significant impact on global supply chains and trade dynamics.

Germany's dilemma of reducing exposure to China

Germany's economic ties with China are deep and complex. As the country's largest trading partner since 2016, bilateral trade between the two countries has reached nearly 300 billion euros, even surpassing that of the United States. This has led to a dilemma for the German government, which aims to reduce economic dependence on China, a goal referred to as "de-risking."

German companies have been warned by economists and politicians about the risks of relying heavily on Chinese businesses and are encouraged to de-risk. However, this advice has been challenging to follow for business leaders in Germany's industrial heartland. Despite the warnings, German firms continue to increase their investments in China. According to preliminary data from the German Economic Institute IW, German direct investment in China rose by 11% in 2022, a similar increase to that seen in 2021.

The close economic relationship between Germany and China has been fuelled by booming bilateral trade and substantial investments by German manufacturing companies in the world's second-largest economy. German exports to China account for a significant share of the country's GDP, with a record high of 123 billion euros in exports in 2021. German companies in China are increasingly relying on local suppliers and research, partly due to subsidies offered by the Chinese government and to protect themselves from potential conflicts.

However, the relationship is evolving. China is becoming a formidable competitor to Germany in industries it once dominated, such as construction, cement, steel, rail, and solar. German companies are facing increasing competition from Chinese rivals in third markets, including Latin America, the Middle East, Southeast Asia, and Europe. Additionally, some German companies have soured on the Chinese market due to geopolitical tensions, rising compliance costs, and policies that favour local firms.

The German government's efforts to reduce economic exposure to China are complicated by the significant presence of German companies in the country. The increased investment in China by German firms is seen as a transitional phase by Germany's BDI industry body, with companies strengthening their value chains in various regions, including the U.S. and South America. The German government's planned foreign investment-screening law, which aimed to tighten scrutiny of Chinese investments, may be scaled back due to concerns about hurting economic revitalisation efforts.

China's outbound industrial policy

China's outbound investment rules have evolved in recent years, with a focus on curbing "irrational" investments and reducing capital outflow. The Administrative Measures for Enterprise Outbound Investment (AMEOI), implemented in 2017, categorizes investments based on size, industry, and region, with a particular emphasis on sensitive areas. This shift in policy aims to keep investment capital within the country to finance domestic development and support national interests.

The AMEOI has introduced a new system for monitoring outbound investments, enhancing information sharing among regulators and increasing supervision effectiveness. It differentiates between small and large investors, investors in sensitive industries and regions, and domestic investors versus domestically controlled foreign entities. While it has eased the approval process for some investments, it has also imposed additional compliance requirements and costs for others.

China's outbound investment policy has had a significant impact on its economic relationship with Germany. German companies have long invested heavily in China, taking advantage of the complementary nature of the two economies. However, the dynamics have shifted, with China emerging as a formidable competitor in industries previously dominated by Germany. This has led to a souring mood among some German companies, particularly small and medium-sized enterprises (SMEs), due to geopolitical tensions, rising costs, and policies favoring Chinese firms.

Despite these tensions, German firms continue to invest in China, driven by the potential for growth in the world's second-largest market. This has resulted in a complex political and economic situation, with the German government aiming to "derisk" its relationship with Beijing while industry leaders argue against cutting economic ties. The future of the Germany-China economic relationship remains uncertain, with potential implications for Europe's positioning on China.

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