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REBALANCING

Covid-19 is a defining moment in the relationship between Europe and China

Reuters/Jason Lee/Pool
Frenemies.
By Annabelle Timsit
Published Last updated This article is more than 2 years old.

The novel coronavirus has provided the European Union a unique opportunity to rebalance its relationship with China—if only it could get on the same page about it.

When EU member states needed face masks during the early days of the Covid-19 pandemic, they couldn’t get any, because China had shut down its factories. The crisis illustrated the dangers of depending on a single country for medical equipment. And it’s prompted some politicians to push for the bloc to accelerate its long-term strategy of becoming more autonomous in key sectors, including digital infrastructure, space and defense, raw materials, and pharmaceuticals.

That would mean shifting supply chains away from China, procuring base materials from elsewhere, and generally trying to make Europe’s economy depend as little as possible on China—a process known in the US as “decoupling.”

What’s missing, experts say, is a unified European response.

The EU’s 27 members all have very different levels of economic dependence on China, making it difficult for the bloc to reach a consensus on its relationship with the country. A consequence, writes Philippe Le Corre, a senior fellow at the Carnegie Endowment for International Peace, is that “when it comes to China, national interests still prevail.”

Take the controversial issue of Chinese technology giant Huawei and its 5G networks. Germany has said it will not ban Huawei from supplying it with next-generation telecommunications networks. The UK, after saying the same thing, appeared to reverse its decision, with the Daily Telegraph reporting that prime minister Boris Johnson planned to cut China out of the UK’s network entirely by 2023. France, meanwhile, appears to have decided to allow Huawei partial access to its 5G network rollout.

Covid-19 has ushered in “a huge rethinking phase about our vulnerabilities when it comes to China,”  says Agatha Kratz, associate director at the research consultancy Rhodium Group. The bloc’s fundamental political differences with Beijing are now seen as liabilities. But the pandemic has also underscored the challenge of moving away from China economically. Fully decoupling major manufacturing industries, like automobiles, may be impossible. And an impending recession has also given the EU less room to impose demands.

To illustrate the challenges of weaning Europe away from China, look no further than the bloc’s biggest economy, a leading industrial partner of Beijing.

Where Germany leads, the EU goes

In the early 2010s, Chinese companies took advantage of the opportunities presented by the euro zone debt crisis to heavily invest in or take over many German manufacturers. From China’s Midea Group taking over Kuka, a high-end factory robotics manufacturer, to Chinese automaker Geely (which already owns Volvo) taking a close to 10% stake in Daimler, the makers of Mercedes-Benz cars, the list of acquisitions goes on.

These moves are part of China’s long-term strategy to transform its manufacturing sector into a global leader in high-end technology, and surpass countries like Germany. But the prospect of Chinese competitors in Germany’s backyard worried Berlin enough that it tightened its rules on foreign investments, and has repeatedly called for EU-wide measures to prevent Chinese corporate takeovers tied to Covid-19.

Yet Germany benefits disproportionately from its economic relationship with China, which is a huge market for German cars and engineering tools. According to the government’s latest figures, it exported €93 billion ($104 billion) worth of goods and services to China and imported goods and services worth €106 billion in 2018.

There are also perverse incentives at play. As the US and others decouple from China, there are opportunities for German companies to make a profit. The same applies for Europe as a whole, which produces many of the top commodities that the US sells to China, including civilian aircrafts, motor vehicles, and machinery.

It’s clear that, even inside Germany, there is a lack of consensus on what to do about China. Chancellor Angela Merkel has prioritized a joint investment agreement between Brussels and Beijing that has been under negotiation for eight years, and which focuses mostly on issues like market access, capital transfers, and the treatment of state-owned enterprises. Meanwhile Norbert Röettgen, a contender to succeed her as chancellor, has said that standing up to China is an issue of European credibility.

According to Andrew Small, a senior fellow at the German Marshall Fund of the United States, Berlin knows that something needs to be done about its over-reliance on a country that “is prepared to weaponize its position as a production hub.” But it stands to make a lot of money if it deepens its ties with China.

Even if Germany did agree on what to do internally, it might not be able to afford it. The country’s GDP shrank by 2.2% in the first quarter of the year, the sharpest quarter-on-quarter fall since 2008.

The post-2008 years showed Germany that, in spite of its comparative advantage in manufacturing, pharmaceuticals, and technology, Chinese firms are quick to catch up to, and even overtake it, by way of strategic acquisitions, better access to domestic markets, and investments in research and development.

Berlin now faces a dilemma: It can fight for greater access to and integration with China—in spite of what Merkel euphemistically described as “differences” on human rights and other issues—and make a lot of money. If it pursues this route, it risks technology transfers and further dependence on a single, volatile country. Or it can try to decouple from China, which would represent a huge loss for the German economy.

Either way, “this is a wake up call for Germany,” says Alicia Garcia Herrero, a senior fellow at the European think-tank Bruegel.

A new age of EU-China relations

Angela Merkel recently said that Europe’s relationship with China will be a focus of Germany’s upcoming presidency of the European Council. “The European Union,” she said, “has a great strategic interest to improve its cooperation with China, which is one of the major actors in this century.”

This doesn’t mean all is well. A high-level summit in Leipzig between the EU and China was recently postponed, reportedly due to coronavirus. Many observers speculated that EU-China tensions and a lack of progress on negotiations for the joint investment agreement also played a role. This shows how quickly people projected their own hopes and fears for the Sino-European relationship on the fate of a single conference.

From the EU’s perspective, that relationship is in dire need of a rebalancing.

Relations between Beijing and Brussels have deteriorated over the last few years, following a wave of diplomatic incidents sparked by overzealous Chinese officials, human rights violations in Hong Kong and Xinjiang, and the fallout of the US-China trade war. China is Europe’s second-largest trading partner, and Europe is China’s largest export market. But by some measures, the relationship isn’t as profitable for Europe as it once was.

Chinese foreign direct investment in Europe has declined every year since it peaked in 2016 as Chinese regulators started to clamp down on domestic capital outflows. And European companies have been making less money in China because of rising labor costs, and a challenging business environment and economic slowdown there. In 2018, Beijing promised to accelerate reforms and improve market access for foreign companies. But, according to the European Chamber of Commerce in China, those reforms largely failed to materialize.

“European companies used to be able to compensate for their unequal position due to their advanced technology and business acumen,” a spokesperson for the Chamber told Quartz. “China’s fierce private companies are increasingly at parity with European firms in certain areas, and have surpassed them in others, meaning that the unfair position that European firms find themselves in becomes a significant problem.” In a survey of European firms in China, 20% said they felt compelled to transfer technology (pdf, p. 8) to maintain market access. This means that many companies were already looking elsewhere to make their goods.

“Business decisions are for businesses, but respect and trust that a country’s authorities will respect its commitments, and not arbitrarily change the rules of the game, are crucial, whether in China or elsewhere,” says Josep Borrell, the EU’s foreign policy chief.

In 2019, the bloc surprised the world (pdf, p. 1) by calling Beijing a “systemic rival” in a strategic outlook paper published by the European Commission. Since then, the EU’s approach has been haphazard and not overtly critical. That’s partly because Brussels has little appetite for finding itself in the same position as Australia. After Canberra called for an inquiry into the origin of the novel coronavirus, China slapped tariffs on its barley and stopped buying meat from its major abattoirs.

What now?

Max Zenglein, chief economist at the Mercator Institute for China Studies, points out that the promise of developing new markets and the potential of cheaper production costs are what first drove European companies to China. Now, he argues, “companies need to factor political risk much more into the equation if they want to maximize their returns. That should be incentive enough to seek alternatives.”

And yet, says Jean-François di Meglio, president of the Paris-based research group Asia Center, the pressure on companies not to exit the Chinese market entirely is huge. “You’re not going to tell China, I’m divesting, because your funds will be frozen. You will not be able to repatriate your capital.”

While some European companies (pdf) have shifted supply chains out of China due to higher labor costs and regulatory factors, it’s been piecemeal and not backed by a concerted EU policy of decoupling—or, as officials like to call it, “supply chain diversification.” And the countries in line to serve as Europe’s alternative to China, such as India, have challenges of their own.

The US provides another illustrative example of the challenges ahead for the EU if it chooses to aggressively pursue a path of becoming more self-reliant. In spite of president Donald Trump’s efforts to decouple from Beijing, the US is struggling to secure its own rare-earth supplies and refining capabilities, which are necessary not just for civilian goods like smartphones and car batteries, but also for weapons like F-35 fighter jets.

“It’s easy to talk about decoupling. It’s much more difficult to actually do it,” summarizes John Seaman, a research fellow at the French Institute of International Relations.

The EU’s “new industrial strategy for Europe,” released in March, is a first step towards greater self-reliance. But much will also depend on external factors, from the economic impact of the coronavirus pandemic to the outcome of the US-China trade war. EU states will have to adapt to future moves the US makes against China, and decide how to respond. It’s a balancing act that is extremely difficult to coordinate amongst 27 countries.

China “is a competitor, a partner, an ally, a rival. Everything at the same time. So it is a complex relationship that cannot be reduced to a single dimension,” says the EU’s Borrell.

For now, Beijing seems eager to move forward on the joint investment agreement, perhaps seeking to project an image that China is once again open for business. Andy Mok, a senior research fellow at the Center for China and Globalization, a Beijing-based think tank, said China hopes to “as quickly as possible and with as little disruption as possible, get back to this path [to] a greater integration with the world.”

Mok acknowledges that it may be an uphill battle for Beijing to win public and political goodwill in Europe. But he also points out that China is playing a long game that is as economic as it is political. “Public opinion is reasonably malleable and perhaps fickle,” he argued, “whereas business, especially global business, is very patient.”