Germany Faces Test on China --- Beijing's drive to flood global markets with exports is the latest threat to the German model

"Remember the previous "China shock" when "comparative advantage" was all the rage? This time, it is all about industrial policy. The question is whether Europe's industrial powerhouse, Germany, is in with the new trend.

Germany actually emerged as a winner during the initial export flood in the early 2000s, when cheap Chinese goods decimated manufacturing employment in most rich countries. China couldn't compete in advanced manufacturing with Bosch, BMW and Siemens, which instead made big inroads there.

Now that economic model is all but spent: Whereas China has managed to turn on the export taps again to escape its woes, Germany's trade surplus has gone from 6% of annual output before the pandemic to less than 4%. Industrial production is 10% below December 2018 levels, despite figures published Monday showing a big rebound in February.

Even if the cyclical downturn is over, long-term woes remain. Although it has had a great 2024, the DAX stock-market index has severely lagged behind broader eurozone equities for the past three years.

While German automakers were late to embrace electrification, Chinese firms learned much from Western companies and are now encroaching on Germany's core markets. In January, the industry-sponsored German Economic Institute, or IW, issued a warning: 13% of the European Union's imports of sophisticated manufactures -- including pharmaceuticals, machinery and autos -- came from China in 2022, up from 2.5% in 2000.

The EU has toughened its stance against China and is mobilizing capital into its own green and semiconductor sectors. But its efforts pale in comparison with Beijing's subsidies, and even the Biden administration's industrial policies, which could end up costing more than $1 trillion over a decade. 

Crucially, Germany keeps lobbying to stop short of "decoupling" from the Asian giant. Its foreign direct investment there hit a record in 2023, even as other countries exited.

If industrial policy is the new trend, Germany should be in a position to outpace its peers. It has low debt and a deep industrial base. Its sway over EU institutions should allow it to waive prohibitions against state aid when convenient, strengthen trade barriers and, if Beijing retaliates, engineer greater demand for its products in Europe.

Some of this has played out. For one thing, Germany's trade surplus with the eurozone has actually widened. Or take its Chinese investments: Since 2017, all of it has, in fact, been retained earnings by established firms, not "new" money. As Helena Graf and Salome Topuria at the Institute for International Political Economy Berlin argued in a recent paper, German officials embraced industrial policy even before the pandemic -- the so-called Industrial Strategy 2030, triggered by the megamerger between Siemens and Alstom getting blocked in 2019 -- and took it to the EU level. Ever since, they have aided specific firms in a more explicit way than many of their European counterparts.

Germany also is overcoming disagreements with France about joint defense projects, including a next-generation tank that could give the shares of firms like Rheinmetall another boost.

Still, the shift has been inconsistent. University of Vienna researcher Etienne Schneider points out that political unity was galvanized by Donald Trump's presidency but "has gone into the background during the Biden administration." Also, the "debt brake" that Germany wrote into its constitution in 2009, while popular, is a painful straitjacket.

Ultimately, though, the paralysis in Germany's corporatist politics is explained by differing corporate constituencies.

The multinationals that bid for the "national champion" label and are more aligned with the IW, such as Siemens, have become open to breaking with the past. Meanwhile, domestically oriented firms and the "hidden champions" -- a term coined by businessman Hermann Simon to describe medium-size companies that dominate specialized global markets -- mistrust the big players. They aren't as fearful of Chinese competition and care less if Germany loses ground in consumer industries. Their interests are a wedge issue for the Free Democratic Party, which has taken a hit in the polls and is trying to distance itself from its government partners by calling for an end to state subsidies.

But deindustrialization would damage the entire German ecosystem -- even hidden champions. The latter's ability to meet clear export and investment goals is precisely what makes them ideal recipients of well-designed industrial policies. Free-market reforms alone can't offset the end of cheap Russian gas, nor China's policy of slowly supplanting Western producers. And, as the U.K. example highlights, a shift toward services comes with big costs in terms of inequality.

Maybe Germany's leaders will eventually get there. But the clock is ticking." [1]

1. Germany Faces Test on China --- Beijing's drive to flood global markets with exports is the latest threat to the German model. Sindreu, Jon.  Wall Street Journal, Eastern edition; New York, N.Y.. 11 Apr 2024: B.10.