MERICS EU-China Opinion Pool: Calibrating interdependence with China

One of the EU’s most heated current debates about China concerns the question of how to reduce risks arising from interdependencies with the country. Over the last years, Beijing has demonstrated its readiness to make use of economic coercion. And the Covid-19 pandemic and looming geopolitical crisis over Taiwan has made Europe acutely aware of supply-chain risks. Business leaders and politicians in Europe are now discussing options to ensure competitiveness and economic resilience. MERICS Analyst Grzegorz Stec has asked experts:

“Calibrating interdependence with China - how should the EU proceed?”

There are concerns the EU is too economically dependent on China, leading to calls for it to diversify its trading relationship. When evaluating how best to achieve this, the EU must avoid overestimating the risks and underestimating the benefits of engagement. To successfully do this, better intelligence will be needed. 

First, more work should be done to identify where the EU’s critical dependencies on China lie specifically. China is the EU’s largest trading partner, however its exports to the EU consist mostly of non-essential and easily substitutable goods. There are critical dependencies in some areas, most notably concerning Chinese rare-earth metals and pharmaceutical products. But it is important that blanket policies are not adopted in response.

Second, there is a need to better understand the potential limitations of China’s willingness to exert economic leverage on the EU. The European market’s importance as a destination for Chinese exports is roughly double that of the Chinese market’s importance for Europe. EU-China trade also creates a healthy number of jobs in China. With China’s growth projected to be underpinned by exports for the foreseeable future and US-China tensions rising, there are likely limitations to China’s willingness to risk undermining its relations with a second major trading-partner. 

Finally, the costs to Europe of not fully engaging with China should be further explored. European multinational companies regularly report that operating in China keeps them profitable, innovative and globally competitive. Furthermore, from a government perspective, global challenges, including climate change, cannot be tackled without the involvement of China.

The overall objective should be to mitigate risk. The EU should deploy different strategies in parallel and not focus on one exclusively.

Market diversification both regarding imports as well as exports is an important strategy, especially when the goal is to achieve results in the short term. The EU should also look at increasing investments and production in Europe and cooperating with other partners to reduce certain dependencies that represent higher risks.

But we must also continue to engage and do business with China. We need to continue being insistent with China that our bilateral relationship needs to be rebalanced and more mutually beneficial. Critical raw materials are a good example of an area in which the EU needs a multilayered strategy to mitigate risk.  It needs to diversify supply, increase processing and other domestic capabilities in a sustainable way, and also promote recycling and circularity.

The objective should not be to disengage from China, but to make our relationship more equilibrated and therefore less exposed to economic and political pressure and risk.

First and foremost, the EU and its member states need to act in unity. Easy said, difficult to do as we learnt when the French and German governments tried to coordinate their China visits in late 2022. The heavyweights in the EU should compromise more to reach EU-consensus.

Second, the EU must proceed with installing instruments to counter unfair competition by state-backed enterprises from third countries. The EU has come a long way since the introduction of a new anti-dumping methodology in 2017, a new investment screening mechanism in 2019, the international procurement instrument and the regulation to counter state subsidies in 2022, and the planned anti-coercion instrument. We need such instruments to defend market processes and national security.

Third, we must be willing to pay the price of autonomy in strategic economic issues. An often-cited example are rare earths and other minerals. The EU must engage in new partnerships, for example with Chile, which has huge lithium resources. The EU’s lack of autonomy cannot be solved by companies and the market alone, we need government programs to achieve more independence in critical economic components.

Despite all our differences, we continue to count on intense economic cooperation between the EU and China. Trade and investment ties between the two economic powerhouses contribute to wealth and innovation in both regions. We should maintain these ties wherever geoeconomic risks are manageable.

Germany is more dependent on China than other EU countries. Accordingly, the need for trade diversification is also greater. That means Germany has a strong interest in EU initiatives to foster diversification.

While only around 3 percent of German jobs depend directly and indirectly on exports to China, there are also critical dependencies. They affect some large German firms and there is also a high import dependency (particularly in certain raw materials) that Germany shares with many other EU countries. These dependencies can be exploited by China and limit the wiggle room for potential Western sanctions should China invade Taiwan. It is therefore high time to act.

However, developments in Germany in the first half of 2022 went full steam in the wrong direction. German imports from China rose to record levels and German companies invested more in China than ever before. While diversification is mainly the task of companies, it remains to be seen whether companies can really break away from China, a lucrative market and attractive supplier of cheap (subsidized) goods.

Policymakers must incentivize and flank corporate diversification – with new free trade agreements (FTAs), especially with other Asian countries and Latin America, and also with extensive export and investment support. However, FTAs with attractive emerging markets are still lacking. One reason is the EU’s schoolmasterly demands for ambitious sustainable development goals (SDGs), something many potential partners reject. This approach is not working in our geostrategic interest, so the EU needs to reprioritize and make some compromises to get FTAs done as soon as possible.

Having loosened its state-aid framework to facilitate collective industrial policies, the EU has witnessed a flurry of projects in sectors it regards as strategic – batteries, hydrogen, cloud, or semiconductors. It has been considering further industrial policies regarding semiconductors, solar panels and health products, and there is a policy on critical raw materials pending.

Member states largely drive the financing of these industrial policies. There are real and recognized risks that such initiatives favor financially strong countries and so fuel intra-European imbalances. This would endanger the reception of such projects, hamper the efficient allocation of resources among member states, even weaken the resilience benefits of such endeavors by concentrating strategic production geographically. EU funding would lower these risks and give the Union a greater say in policy implementation.

Ursula Von der Leyen announced the creation of the European Sovereignty Fund in 2023. With it, the EU is getting an instrument with which to overcome the legal and administrative complexities that make it difficult to raise and use financing at the EU level. A more centrally driven and implemented industrial policy is a unilateral instrument to respond to foreign distortion and potential economic pressure. The EU should further incentivize international partners to seriously contribute to discussions about designing new internal rules to combat distortive practices.

This MERICS EU-China Opinion Pool is part of the “Dealing with a Resurgent China” (DWARC) project, which has received funding from the European Union’s Horizon Europe research and innovation programme under grant agreement number 101061700. 

Views and opinions expressed are however those of the author(s) only and do not necessarily reflect those of the European Union. Neither the European Union nor the granting authority can be held responsible for them.