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The horror of the Taiwan scenario

By Jens Suedekum
Jens Suedekum, 47, is Professor of International Economics at Heinrich Heine University in Duesseldorf. He is also a member of the Scientific Advisory Board at the German Federal Ministry for Economic Affairs and Climate Action (BMWK).

The entry of the shipping company Cosco into a terminal in the Port of Hamburg, the planned takeover of the Dortmund chip manufacturer Elmos, Huawei’s participation in the German 5G mobile network – more and more Chinese investments are currently becoming a public bone of contention. The concern is clear: After the disaster with Russia, we do not want to become increasingly economically dependent on the next autocracy – especially one that tramples on human rights at home and possibly harbors its own war plans against Taiwan.

But a coherent strategy by the German government regarding China is not yet discernible. It shambles from case to case and relies too much on defensive measures. Now would be the time for an offensive investment agenda to make Europe more attractive, more sovereign and more crisis-proof as an industrial location.

Corporate headquarters and ministries currently play out a severe crisis scenario. If China were to invade Taiwan in the near future, the West would impose extensive economic sanctions. The USA would set the pace. In extreme cases, it could act as it did with Iran and impose secondary sanctions on all those who refuse to join in.

This could result in a fatal decision for German companies: Doing business either with the USA or with China – both would no longer be possible. For many years, the equidistant tightrope act with good relations on all sides was a politically dubious but economically highly effective recipe for success of the German export industry.

Trading volume of 250 billion

Such a Taiwan scenario may seem unlikely – at least that is how interested parties keep emphasizing it. But if it were to happen, it would be an economic shock for the global economy and for Germany in particular that would dwarf anything seen before. Germany’s trade volume with China is around 250 billion euros per year, more than four times as much as with Russia. And the dependencies are far more diverse.

With Russia, it “only” concerned energy imports that had to be replaced. As a sales market, however, Russia is practically irrelevant. China is a completely different story. Renowned German DAX companies, above all the carmakers, generate more than a third of their total corporate sales there. If these sales were to suddenly disappear, they would have to fight for survival, because no other market could absorb such volumes in such a short time.

Moreover, we are dependent on all kinds of imports. In the event of a sudden loss of Chinese suppliers, all wheels would come to a standstill in faraway Europe, because often no alternative is available at short notice. The German Council of Economic Experts recently identified 248 cases of critical import dependency in Germany. These include raw materials and intermediate products that are essential for value creation – and for which there are also very few sources of supply worldwide.

Rotor blades and solar panels

Looking at the total trade volume of these goods, around half come from China. Specifically, this includes various IT devices, antibiotics, rotor blades for wind turbines and solar panels. It is bitter, but without China, the German energy transition has died – a late consequence of the industrial policy disaster of 2013, when the solar industry and more than a hundred thousand jobs were simply allowed to move to Beijing at lavish subsidies.

In short, a sudden end to trade relations with China would be an economic disaster. That is why no one wants to force it. Nevertheless, there could be circumstances in which it does happen – such as in the Taiwan scenario. To somehow prepare for this eventuality, all kinds of political initiatives are currently being developed, including the German government’s national security strategy, which is to be presented next year.

The same happens in many companies. The key word here is “diversification”. Nolens volens, many companies are restructuring their supply chains toward “China plus 1”. From now on, there should be at least one alternative in another country at all levels. That is why so many business delegations are traveling to Vietnam, India or Singapore right now. Chinese company bosses also go there and specifically set up production facilities. In the event of a crisis, business with Western partners could possibly continue.

Another strategy to save the China business is localization. The Bundesbank recently recorded a significant increase in German direct investment in China. Behind this are often DAX-listed companies and large SMEs that want to set up a local closed production line, sometimes in the hope that they will hold even in the event of a conflict because it can do without goods flows from the West.

When in doubt, the state helps

Produced in China and for China – but under the umbrella of a German holding company. Whether this strategy will really work remains to be seen. Politicians can often only look on, because investment decisions are made by the companies. Some may even speculate that further expansion of their China business is worthwhile simply because the state will somehow come to their rescue in the event of a possible downfall.

Privatize profits, socialize losses – this is a popular motif of corporate governance, and not just since the financial crisis. Policymakers could indeed try to nip this fully-comprehensive insurance mentality in the bud and step in to exert more control. But how credible is that in an emergency? Furthermore, the German government would then need a strategic goal of what it wants to achieve with its policy. But it is lacking this.

Instead, individual Chinese investments are arbitrarily made the subject of a public debate. It remains unclear by what criteria. Wherever Germany’s vital security interests are affected, intensive scrutiny is a given. If there is even the slightest risk that a Chinese state-owned company could control a German data network and send it into blackout at the behest of the state leadership, all lights must immediately turn red.

The situation is similar for the loss of critical intellectual property. However, the rather general argument that an investment such as Cosco’s should not be approved because China could potentially expand its global market position, as a result, is not really enough to justify a ban. After all, such a quest for a strong market position is inherent in many investments, regardless of their origin. In general, the control approach is a dangerous one.

The core message that comes across fairly quickly is that Chinese investments are generally no longer welcome. However, anyone who thinks this should be aware of the consequences. Because sooner or later, Beijing would naturally find an answer and restrict German investment. The problem with such an intervention spiral is that far more money and jobs are on the line for us. Because Germany continues to invest much more in China than the other way around.

Investing in domestic production

Instead of being purely defensive, Germany and Europe would do better to take the offensive. If we want to break away from China and other autocracies, we need more domestic investment in strategically important areas that are still critically dependent on imports. First and foremost in renewables and hydrogen, but also in important components such as semiconductors or batteries. Such industrial policy is not per se protectionist or anti-China.

It does not throw a spanner in the works of others, but constructively builds up domestic production capacities. That is a huge difference. Government money will also have to flow for this. But we should not deceive ourselves: In our age of geo-economic bloc formation, there is no way around it anyway. State-capitalist China has always heavily nurtured and subsidized its companies.

And with Joe Biden’s Inflation Reduction Act (IRA), the United States is about to become the second major player in this field. For example, he is laying out billions to promote electric mobility. For us, this is both a curse and a blessing. On the one hand, from a global perspective, there are truly worse things than the promotion of climate-friendly technologies in the USA. On the other hand, we are risking losing market share in future-oriented sectors where we actually thought to still be at the forefront.

That is why Europe must act to maintain a balance with the subsidies of others. At the EU summit meeting taking place in Brussels these days, leaders are trying to come up with a powerful response. But it is not yet clear whether they will succeed, or whether the issue risks being lost in the dispute and the plethora of other crises – from the Ukraine war to Viktor Orbán.

The good thing is that the right answer could answer several open questions at once. Because a European investment agenda with corresponding reforms of EU state aid and fiscal rules would not only be the right response to the new American industrial policy. In the end, dependencies on China can also only be reduced through an offensive strategy.

The focus should lie on building on own strengths – not on the media scandalization when Chinese investors try to become active in Europe.

This text was first published in the German weekly newspaper Wochentaz on 17.12.2022.

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