Germany is the epicentre of the China Shock 2.0 reverberating in global markets

In a new paper, @Brad_Setser and I show the shock is a key driver of Germany’s economic malaise. And it's accelerating

Berlin needs to stop admiring the problem, and join efforts to fight back

1/ China’s exploding exports are squeezing German firms in cars, machinery, chemicals and aerospace in China, third markets and increasingly Europe itself.

The drag from falling net exports has accelerated sharply since 2023, amounting to roughly 3% of German GDP.

2/

A lot of commentary on Chinese investmeint in the EU miss the most importat observation.

Chinese FDI in the EU is tiny, a fraction of what it was 10 years ago. But EU's trade deficit with China is ballooning, up another 30% this year. The implications should be obvious.

1/ With Chinese FDI in Europe tiny, but the export juggernaut continuing apace, it's clear Chinese firms show little incentive to localise production.

So the idea that without flanking policies Chinese investment will bring Europe up to the technological frontier is wrong.

2/

Some reflections in the New York Times today, in a good tour-de-force on the global macroeconomic ripple effects of Trump’s Iran war.

Can Europe afford deploying fiscal measures to buttress the Hormuz energy shock?

It’s painful but by and large yes.

1/ “The classic ‘worry children’ are not really of any concern,”.

I think I accidentally coined a Dutchism, highlighting the former eurozone crisis countries, are now some of our best fiscal performers.

2/

EU Leaders meet tomorrow to discuss measures to lift Europe's anaemic growth rate.

But the summit risks being a nothing burger. EU Leaders have cherry-picked a macroeconomically meaningless simplification agenda from the Draghi report

New oped.

1/

politico.eu/article/europe… Lucas, Nils and I argue a few significant things have gone awry.

First and foremost: the diagnosis. Europe, the current consensus goes, has smothered itself in unnecessary regulation, and growth will return once red tape is cut.

2/

Good work by the Commission and the majority of EU member-states.

They have approved the long-term immobilisation of the Russian assets under Article 122, which requires only a qualified majority.

This is a key stepping-stone for the reparations loan.

1/ This is EU speak for a done deal:

"The Danish Presidency can inform that COREPER has agreed on a revised version of the Art. 122-proposal and approved a written procedure for formal Council decision by tomorrow around 5 pm"

2/

Can anything halt the decline of German industry?

I'm afraid rearmament won’t turn things around. As the FT's Storbeck notes, Germany employs fewer people building tanks than making toys.

To counter China, macroeconomic and civilian industrial policies are indispensable.

1/ The changing role of China from customer to fierce competitor is a key reason why German industrial production has slumped back to 2005 (ouch) levels.

Good to see the FT give China the attention it deserves in Germany’s decline -- that wasn’t always the case in the debate.

2/

Illusions about trade with China still run deep in Europe.

At a chatham house event yesterday, one economist claimed it was “baseless” to suggest China would dominate most industries. Europe, they argued, would simply retain and develop new comparative advantages.

1/ But that theory, or hope, only holds if demand adjusts.

China suppresses consumption, shields its market, runs persistent trade surpluses, and funnels credit and subsidies into industrial capacity, exporting (over)capacities to the world.

2/

We’ve just published a new report, based on our annual economics conference. It distils the big policy debates on the European economy post-Draghi, drawing on the brainpower around the table.

Some journalist friends convinced me it’s worth sharing — so here’s a thread.

1/x The problems are clear. European economies grew 2-3% py throughout the 90s, early 00's. But growth never recovered from the 2008 financial crisis. While Europe continues to rank highly on broader measures of wellbeing, its meagre growth has fallen well behind that of the US

2/

Alan Beattie outlines the dark clouds headed for the global economy.

“The trading system needs buyers not sellers”.

Yup. Neither tariff-fest USA, hurling towards stagflation/recession, nor demand black-hole China will provide it. There won’t be enough demand to go around.

1/ The US has long been the consumer-of-last-resort. China's consumption is depressed.

I sympathise with US policy-makers who fret about the perpetual dance of Chinese debt-fuelled capacity expansion meeting US debt-fuelled consumption expansion.

But blowing it all up...

2/

Germany now has the right fiscal policy to stoke domestic demand and offset lost export markets to the second China shock - as @Brad_Setser and I argued.

But to stop China deindustrialising Germany this will need to be flanked by industrial and trade policy.

1/ A dovish CDU/SPD China policy would be bad.

Scholz opposed the EUs China EV tariffs. He seemed willing to sacrifice industrial cities like Ingolstadt and Wolfsburg on the altar of CEO payouts from a few more more quarters of profits from a dying china business.

2/

I wrote a new piece in foreign policy.

The US's postwar role as guarantor of Europe’s security is over – and may even turn adversarial.

But Europe has an overlooked trump card: when it comes to manufacturing Europe blows the US out of the water.

1/x

foreignpolicy.com/2025/03/07/eur… For European leaders, meeting this historical moment means preparing to defend their national interests on their own. Merz, Macron (+Starmer) seem on the ball

Their trump card: Europe collectively outproduces the United States in steel, vehicles, ships, and civil aircraft.

2/x

The German fiscal package is massive (10-20% GDP).

- 500 billion 10Y fund for public investment
- All defence spending above 1% of GDP not counted for debt brake.
- Federal states can borrow 0.35% p.y. for investment.

Germany is back - economically +militarily.

1/x CDU (Merz) and SPD (Klingbeil) CSU (Söder) just gave the presser. Big question is whether greens will sign up - my guess is yes.

Focus of the package is on defence and infrastructure.

But money is fungible: tax cuts can be paid by reshuffling stuff into special fund.

2/x

Italy's @Corriere with key observations and data, picking up on @Brad_Setser and my work.

The newspaper highlights how China's aggressive export-led growth model hammering Germany is having serious knock-on effects for Italy.

The German crisis is a European crisis.

1/x The paper isn't mincing words: "China's domestic consumption, always been weak, is now completely depressed. The Communist Party is reacting by subsidising exports of increasingly sophisticated product ranges in every way possible."

Auto's are ofc at the heart of it.

2/x

In a new study, @Brad_Setser and I unpack how badly Germany’s trading relationship with China has backfired. And how a new government might help its industry weather the 2nd China shock.

With terrific accompanying reporting in Handelsblatt and FT.

1/

cer.eu/publications/a… I could sparsely have thought of a more fitting week.

Germany just confirmed its two-year economic downturn, held back by the malaise in manufacturing, good for ~20% of GDP and 5.5M jobs. And China just clocked a $1tn annual trade surplus

The two trends are interrelated.

2/

“Only net ~150k manufacturing jobs were created during Biden’s tenure” - despite billions spent on greentech(IRA)/Chips production.

So the policy failed? Let’s give Biden a fair shake on his way out. Hammering that data point overlooks goals, counterfactuals, and time lags. 1/ First, the goal of the IRA/CHIPS acts was not only to create jobs - perhaps not even primarily so, despite obvious political rhetoric.

But also to have - a reserve of- manufacturing capacity at home to ensure supply chain resilience vis-a-vis authoritarian regimes. 2/

Letta/Draghi's plea to save the fading EU economy in one truly staggering IMF stat:

„Existing barriers in Europe's single market are equivalent to an ad-valorem tariff of 44% for manufacturing, between U.S. states it is 15%, and 110% for services between EU countries.”

1/7 The EU needs a more coherent trade & industrial policy to counter China.

But there can be no doubt: the most potent way to unlock growth is to reduce the barriers in our internal market.

Thát piece of homework EU leaders can do without looking at DC or Beijing.

2/7

Some reflections on Germany’s no-vote on European duties on Chinese EVs.

Scholz is trying to signal détente to China and protect the interests of car multinationals.

In the long-run, Berlin may end up thanking the Commission and EU partners for avoiding a strategic blunder. 1/

https://twitter.com/vonderburchard/status/1841899516267487283

The stakes are hard to overstate.

If Scholz would have succeeded in overturning the tariffs at the 11th hour, it would have vindicated China’s efforts to lean on individual member-states.

And been the final nail in the coffin of EU efforts to have a foreign economic policy. 2/

Last year, Draghi was given a task: figure out why Europe’s economy is struggling. The results of his investigation: stagnant productivity, little innovation, high energy prices, brutal competition in global markets.

Sound familiar to German ears?🧵
1/8

https://x.com/lucasguttenberg/status/1835965649027269025

Unlike during the Eurozone crisis, Germany is now at the center of the storm. Since 2019, the German economy has practically flatlined.

And no other EU country suffers as much as Germany from China’s aggressive state-backed push into key sectors of its economic model.

2/8

Draghi’s strategic economic growth agenda for the EU does not disappoint.

It channels aspects of the thinking of Jean Monnet (EU defense integration), Jacques Delors (EU single market) and Bidenomics (cleantech / economic security).

But above all, Draghi’s own vision.

🧵 The diagnosis is hard to argue with. The EU economy grew at around 2 to 3 per cent a year throughout the 1990s and early 2000s.

But growth has never fully recovered from the 2008 financial crisis, and has fallen well behind that of the US.

2/

"When Germany sneezes, the Netherlands catches a cold".

So goes an old saying in Dutch economistland. But we may have to junk the expression.

The Dutch economy is not only dramatically outperforming its bigger brother Germany, it's also slowly diversifying away from it.

1/5 In terms of GDP per capita the lowlands are far ahead, and the gulf has grown as Germany remains stuck in multi-year stagnation.

The post-pandemic growth gap is around 5% of GDP.

(Of course the difference in GDP level is smaller if you compare only former West-Germany).

2/5

“Europe has a China problem.”

Don't take it from me. But from the EU's budding new trade Commissioner @WBHoekstra.

In a new speech in Eindhoven, he raises alarm about restoring a level playing field w. China.

And points to another specific area of concern: electrolysers. 1/ Punchy wording, for example:

"In the past decade, Chinese players came in, undercut (...) our market with ultra-low prices thanks to massive government support, and almost wiped out our solar industry. We see the same thing happening in other sectors (...) unacceptable".

2/