Inside Europe’s China dilemma: Trade war or economic opportunity?

SINGAPORE: He played a central role in negotiating China’s entry into the World Trade Organization (WTO). Then he became the director general of the global trade body.

Now a trade and economic adviser, Pascal Lamy has sounded a warning note about the political consequences if Europe’s trade deficit with China — at 1 billion euros (US$1.1 billion) a day — continues to widen.

“Look at the speed of the surge of Chinese exports. If you project this (for) five, 10 years from now, this is simply unsustainable,” he tells CNA’s When Titans Clash.

“The EU (European Union) has come to the conclusion that serious measures now have to be taken. Otherwise, we’ll have huge social problems, which will translate into huge political problems, which will make xenophobic political forces in Europe stronger.”

Just in September, the Alternative for Germany party won a regional election. The result raises the prospect of Germany’s first far-right state government since World War II. Far-right parties are also making gains in France, Spain and Italy.

In Paris, the protests that have spiralled out of control are symptomatic of a larger problem confronting Europe — a polycrisis with fiscal pressure on governments, soaring energy prices, two wars and industrial decline.

Many European leaders blame part of the industrial decline on a China Shock 2.0. They point to the trade deficit, alongside Germany’s loss of 10,000 to 15,000 manufacturing jobs every month, as evidence of the growing pressure on European industry.

This mix of unemployment, populism and a large trade deficit with China is something the world has seen before in another election.

United States President Donald Trump’s 2016 election campaign alleged that China was causing the US’ economic woes and loss of millions of manufacturing jobs, hollowing out American industry.

Economists and policymakers debate how much Chinese competition is responsible. But politically, the fear of industrial decline is becoming potent. “It plays (out) in some countries or in some regions (in Europe) like it did in the US,” observes Lamy.

“The Chinese should understand that if these extremist forces would come to power, their attitude vis-a-vis China would be much tougher than whoever runs the European system with, let’s say, the traditional centre-left or centre-right parties.”

As Europe and China continue their trade negotiations and approach a critical moment in their economic relationship, When Titans Clash explores some of the thorny questions European leaders face.

WATCH: Europe’s China dilemma — Trade war or economic partnership? (45:28)

WHAT SHOULD EUROPE DO?

Unlike the first China shock from cheap manufactured goods, the country now competes directly with Europe in advanced industries.

The China Shock 2.0 argument is that Chinese government subsidies support the production of high-tech manufactured goods on a massive scale, flooding global markets with inexpensive products and driving European competitors out of business.

France and Germany, the EU’s two most powerful and populous countries, believe some form of trade protectionism could be part of the solution. On Oct 5, the leaders of both countries jointly proposed a new trade instrument.

French President Emmanuel Macron and German Chancellor Friedrich Merz said the European Commission should be empowered to restrict, or even cut off, imports from countries deemed to be creating “severe and systematic distortions” in the EU.

As this trade kill switch was being discussed — and still is — across European capitals, China agreed on Oct 9 to halve its hybrid car exports to the EU.

“It’s a welcome change of position, because the week before, the Chinese minister was saying, ‘No way we’ll ever accept voluntary export restrictions,’” says Lamy, who was the WTO chief from 2005 to 2013.

“The view on the EU side is that this is a first step. And it probably has to be followed by steps of the same kind, i.e. export restraints in areas where our production system is most threatened.”

As many as 44 European industry bodies, from the solar to steel to cement to glass sectors, said in a joint statement last month that they faced threats from Chinese trade practices.

The list may look long, but it “doesn’t mean that we’ll indulge in a whole range of total protectionism all along the manufacturing supply chains”, says Lamy.

“There are areas where losing our industrial capacity and know-how is a big problem. There are areas where we have to compromise.”

Further dialogue is scheduled this month between senior European and Chinese finance and banking officials, according to a South China Morning Post report.

The EU hopes to persuade China to allow the yuan to appreciate, arguing that its undervaluation is contributing to the competitive pressures associated with China Shock 2.0.

While the headline figure for their trade imbalance continues to focus attention on the threat Chinese competition poses to European jobs, the data goes deeper than that — and a more complicated picture emerges.

This same competition is also creating new jobs as Chinese companies, such as battery giant CATL and electric vehicle maker BYD, invest in manufacturing plants across the continent, helping Europe pursue its decarbonisation goals, for example.

Last year, Chinese foreign direct investment in the EU and the United Kingdom reached a seven-year high of 16.8 billion euros, up 67 per cent year on year. Lamy welcomes these inflows.

“I’m all in favour of facilitating Chinese investments in Europe, including in areas like the car industry,” says the Frenchman.

“Thirty years ago, China told us, ‘Welcome to China. But we need technology transfers.’ We were ahead at the time. We’re now lagging behind. They’re ahead. Why not the same recipe — 30 years (later) — the other way around?”

IF YOU CAN’T BEAT THEM, JOIN THEM?

Meanwhile, European companies cutting jobs at home are expanding their operations in China despite mounting domestic pressure. Volkswagen, for example, has announced plans to cut 100,000 jobs by 2030, citing high costs, weak demand and fierce competition from Chinese carmakers.

Yet the German automotive giant continues to invest heavily in China, including 3.5 billion euros in its research and development hub in Hefei, its largest R&D facility outside Germany, and 2.4 billion euros in a joint venture with Chinese technology company Horizon Robotics.

Joerg Wuttke, a partner at the DGA-Albright Stonebridge Group and ex-president of the EU Chamber of Commerce in China, argues that European companies have little choice but to deepen their presence in China.

“You want to be competitive in the biggest car market in the world in order to then be competitive against Chinese competitors in third markets,” he says.

“Volkswagen and others are exporting from China into the Southeast Asian economies. They wouldn’t be competitive if this would come out of Europe because of the high euro, but also because of the cost structure that you face in Europe.

“What’s the companies’ decision? Of course they want to stay in business. Of course they want market share, hence they have to be more Chinese. And hence the investment has to go up.”

Wang Yiwei, the director of the Centre for European Studies at the Renmin University of China, offers a similar perspective, comparing China’s business environment to a training ground for global companies.

“China today is like a gym. If companies don’t come to China to train themselves, they won’t be competitive enough,” he says.

“This is the key reason why companies, despite facing domestic pressure questioning why they invest in China instead of their home markets, still choose to invest here.”

Beijing calls it China Opportunity 2.0, arguing that Europe should embrace rather than fear China’s increasingly sophisticated technologies.

So, is China a partner or a threat? Should European companies reduce their dependence on China, or integrate more deeply into what some describe as the world’s most competitive industrial training ground?

And will Europe and China slide into a trade war, or can their leaders find a way to compromise and collaborate?

There may be no easy answers to Europe’s China dilemma, but one thing is clear: Europe must also strengthen its own economic competitiveness. And the pressures of China Shock 2.0 could provide an impetus for change.

“(It) might be a good reason,” says Wuttke, “to tell our public audience that now is the time … to (carry out) reforms (in) the labour market, to knock down local protectionism, … to get going on the capital union that we should have.

“The China Shock could be a good thing for us. But again, this transition period is definitely challenging.”

The EU must fix its internal problems if it is to fix its external problems, agrees Lamy. Making Europe’s economy more efficient and innovative is the priority for him.

“We still don’t have a proper internal market in finance, in energy, in connectivity. We have to do that,” he says.

“Europe won’t be stronger against (Russian President Vladimir) Putin, Russia or against the US — if Trump was to indulge in stupid things — if we aren’t economically stronger … than is the case for the moment.”

Watch this episode of When Titans Clash here.

Source: CNA/dp