Germany struggles with its dependency on China

Rarely has a deal encountered such strong government opposition. Six German ministries came out last month against Chinese shipper Cosco’s planned acquisition of a stake in a Hamburg container terminal. But it went through anyway.

The man who ensured its safe passage through the German cabinet was Chancellor Olaf Scholz. He insisted on a compromise — Cosco would have to make do with a 25 per cent stake, rather than the 35 per cent that was initially proposed.

But the German foreign ministry remained opposed, even after Scholz pushed it through. State secretary Susanne Baumann wrote an angry letter to Scholz’s chief of staff, Wolfgang Schmidt, saying the transaction “disproportionately increases China’s strategic influence over German and European transport infrastructure and Germany’s dependence on China”.

Scholz, however, clearly could not afford to see the deal collapse. On Friday he will become the first G7 leader to hold talks in Beijing with Chinese president Xi Jinping since the start of the Covid-19 pandemic. Nixing the Cosco transaction would have cast a long shadow over a trip with huge symbolic importance to both Beijing and Berlin.

Still, China-watchers found his intervention puzzling. “It gives the impression he’s offering the newly crowned Xi Jinping a gift before the trip — one he was under no obligation to make,” says Noah Barkin of Rhodium Group, a New York-based research firm.

The Cosco affair also disappointed those who had hoped that Scholz would adopt a new approach to Beijing and break definitively with the mercantilism of the Angela Merkel era.

The coalition agreement negotiated last year by Scholz’s Social Democrats, the Greens and the liberal Free Democrats was notable for its critical tone on China and its focus on human rights. But the Hamburg deal shows deep divisions persist between the Greens and parts of the SPD about the future of the relationship.

Green scepticism about China has only grown since last month’s Communist party congress, during which President Xi stacked the Politburo Standing Committee with loyalists and cemented his position as the most powerful Chinese leader since Mao Zedong.

China’s lurch towards one-man rule, combined with the economic disruption caused by its zero-Covid policy, sabre-rattling over Taiwan and tacit support for Russia’s war in Ukraine have turned a country that was once one of the most exciting markets for German business into one of its biggest risk factors.

A map of Taiwan shows where Chinese military exercises took place in August. If Beijing were to invade, sanctions that would likely follow could end up leaving German companies among the casualties
A map of Taiwan shows where Chinese military exercises took place in August. If Beijing were to invade, sanctions could end up leaving German companies among the biggest economic losers © Florence Lo/Reuters

Berlin is being stalked by a fear that history might be about to repeat itself — on a much grander scale. The Ukraine war exposed the folly of Germany’s decades-long reliance on Russian gas. Now, the pessimists fear, it may be about to pick up the tab for its even deeper dependence on China, a country that has long been one of the biggest markets for German machinery, chemicals and cars.

Thomas Haldenwang, head of German domestic intelligence, summed up the concern at a hearing in the Bundestag last month. China, he said, presented a much greater threat to German security in the long term than Russia. “Russia is the storm,” he said. “China is climate change.”

The focus of much of the anxiety is Taiwan. Xi’s rhetoric on “reunification” has raised fears that China may be planning to invade the island, a move that would bring down a hail of international sanctions against Beijing and likely decouple China from the western world. In the resulting turmoil, German companies could end up among the biggest casualties — with huge implications for an economy already reeling from its worst energy crisis since the second world war and teetering on the brink of recession.

Germany’s president, Frank-Walter Steinmeier, a former foreign minister, said Germany must “learn its lesson” from Russia’s war on Ukraine. “And the lesson is that we have to reduce our lopsided dependencies, wherever we can,” he told public broadcaster ARD last week. “That applies in particular to China.”

It is for that reason that the German government is engaged in a fundamental reassessment of its approach to Beijing — a process that will reach its fulfilment next year with the presentation of a new “China Strategy” designed to recast the relationship in more realistic terms.

“It will designate China as an important trading partner but the Communist party as a systemic rival,” finance minister Christian Lindner says in an interview.

German foreign minister Annalena Baerbock, left, has emphasised the risks of dealing with China, while Chancellor Olaf Scholz, centre, has warned against cutting ties with the country
German foreign minister Annalena Baerbock, left, has emphasised the risks of dealing with China, while chancellor Olaf Scholz, centre, has warned against cutting ties with the country. Also pictured in this August cabinet photo are finance minister Christian Lindner, second right, and interior minister Nancy Faeser © Florian Gaertner/Photothek/Getty Images

Part of the planning for the strategy has been to evaluate German companies’ vulnerability to an escalation in tensions between China and the west. “There might come a time when the Chinese market is no longer available to us,” says one official. “After what happened with Russia, we can no longer say that will never happen. And we must act to prevent that becoming an existential threat to German companies.”

The rethink is being driven by the Greens, who have long been mistrustful of China. Since entering the government last December they’ve wasted little time putting their China-sceptical stamp on policy.

Germany’s experience with Russia had shown “that we can no longer allow ourselves to become existentially dependent on any country that doesn’t share our values,” the Green foreign minister Annalena Baerbock told Süddeutsche Zeitung last month. “Complete economic dependence based on the principle of hope leaves us open to political blackmail.”

But, as the row over the Cosco deal showed, the government is deeply divided on China. While Baerbock emphasises the risks of dealing with Beijing, Scholz has warned repeatedly of the negative consequences of severing ties with China.

“Decoupling is the wrong answer,” the chancellor told a business conference last month.

‘Don’t put all your eggs in one basket’

Scholz, who used to be mayor of Hamburg, has long believed that Germany has no choice but to trade with countries such as China. “You dance with whoever’s in the room — that applies to world politics just as much as the village disco,” he famously noted in 2018.

On the other hand, though, basic risk management dictates that companies diversify into other markets. “It’s a basic lesson you’re taught in the third term of business school . . . that you don’t put all your eggs in one basket,” he said in August. “That goes for imports and supply chains as well as exports.”

It is a message other prominent cabinet figures are pushing, too. “German business would be well advised to continue to open up new markets in the world, to invest in Asia, Africa, South and North America, so as to dilute the importance of China for the German economy,” Lindner says in the interview.

“A sudden decoupling” would destroy many of the economic benefits and welfare gains of globalisation, he says. But China itself, he adds, is already moving to “decouple parts of its economy from the global division of labour”, and that should be a trigger to action. “Diversifying our technologies and supply chains will strengthen our resilience,” he says.

An Aldi store in Shanghai. The discount retailer is planning to open hundreds more stores in China, while German businesses have already invested €10bn in the country this year
An Aldi store in Shanghai. The discount retailer is planning to open hundreds more stores in China; German businesses have already invested €10bn in the country this year © CFOTO/Future Publishing/Getty Images

The problem for Scholz’s government, though, is that some of Germany’s biggest companies do not seem to be heeding that message. Instead of reducing their exposure to China, many are doubling down. BASF, for example, announced in July it had given final approval to a plan to build a massive new factory in the southern Chinese city of Zhanjiang that will cost €10bn. Meanwhile, it also plans to “permanently” downsize its presence in Europe, a region it says that high energy costs have made increasingly uncompetitive.

BASF’s chief executive Martin Brudermüller has defended the approach and hit out at critics of his China investments. “I think it’s urgently necessary to stop this China bashing and look at ourselves a bit more self-critically,” he said last week.

Experts say BASF has little choice but to focus its efforts on China. “China has 60 per cent of the world’s chemical companies and talent and 40 per cent of the resources,” says Wang Yiwei, professor of international relations at Renmin University and an adviser to the Chinese government. “If they don’t invest in China, where do they go?”

BASF is not alone. Aldi, the German discounter, is planning to open hundreds of new shops in China. Automotive supplier Hella is doubling capacity at its factory in Shanghai. And Siemens said last week it was planning a major expansion of its “digital industries” division in China.

According to the German Economic Institute, German businesses invested a record €10bn in China in the first half of this year alone. The title of the institute’s study: “full steam ahead in the wrong direction”.

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Irked by such statistics, ministers are taking action. Their weapon of choice are the guarantees the government offers to German companies in emerging markets, which protect their investments from political risk. In May, Habeck’s economy ministry refused to extend Volkswagen’s investment guarantees for China, citing the repression of Muslim Uyghurs in the western region of Xinjiang. The ministry is now working on plans to cap the number of such guarantees for China.

“They . . . are massively skewed to China right now,” says one official.

On the other hand, many in Berlin are sceptical that such moves have much impact. The evidence suggests that companies will continue to invest in China, if necessary without the guarantees. Officials acknowledge they wield little influence over corporate decision makers.

“If Brudermüller thinks investing €10bn in China is the right thing to do, it’s ultimately a question for BASF’s shareholders,” says the official. “But I do think we have to send a signal to companies that if their shareholders endorse it — fine, but please don’t count on the German government to underwrite it.”

Others, however, say no amount of government cajoling will persuade German companies to walk away from China. “You talk to businessmen and they say, ‘Are people crazy?’” according to one official. “They say, ‘Don’t they realise where all our wealth comes from?’”

The era of ‘win-win’

For years, Germany was one of the key beneficiaries of China’s opening to the world. Its appetite for German tools, fridges and automobiles seemed insatiable, and German exports to the Chinese market fuelled a 10-year economic boom last decade that was one of the longest in Germany’s postwar history. In 2021, China was Germany’s largest trading partner for the sixth consecutive year, accounting for 9.5 per cent of its trade in goods.

Angela Merkel’s frequent trips to China — she went there 12 times during her 16-year reign as chancellor, often accompanied by huge business delegations — symbolised the close ties. She would occasionally criticise China’s human rights abuses in Xinjiang and Hong Kong, but the economic relationship always had primacy.

Xi Jinping with Angela Merkel during a trip to Berlin in 2017. During her 16 years as German chancellor, Merkel visited China a dozen times, often accompanied by business delegations
Xi Jinping with Angela Merkel on a trip to Berlin in 2017. During her 16 years as German chancellor, Merkel visited China a dozen times, often accompanied by business delegations © Michele Tantussi/Pool/Getty Images

It was, in Merkel’s oft-repeated phrase, a “win-win” for both countries. When China allowed foreign car brands to enter its market through joint ventures with state-owned manufacturers, companies like VW were quickly able to access the country’s rapidly growing consumer base. And imports of German machinery, components and chemicals helped fuel China’s booming manufacturing and construction sectors.

As a result, Germany’s footprint in the Chinese market continued to grow. Volkswagen now sells 40 per cent of its cars in China and the country accounts for 13 per cent of Siemens’ revenues and 15 per cent of BASF’s. A recent survey by the Ifo think-tank found that 46 per cent of industrial firms rely on intermediate inputs from China.

But over the years Chinese companies have grown to overtake many of their German partners, through both fair means and foul. In the mid to late 2010s, China announced a series of targets for increasing domestic innovation and decreasing dependence on foreign technology. Germany’s machinery business association, the VDMA, listed the problems this created for its companies: subsidies to domestic competitors, standard-setting that discriminated against foreign firms, as well as the continuing issue of intellectual property theft.

Volkswagen showcases an electric car in Shanghai in January this year. The German automaker now sells more than a third of its cars in China
Volkswagen showcases an electric car in Shanghai in January this year. The German automaker now sells more than a third of its cars in China © CFOTO/Future Publishing/Getty Images

China’s industrial upgrading is one reason Germany increasingly sees it as a rival, says Wang, the Chinese academic.

“In the global value chain, China has shaken and challenged the advantages of Germany’s manufacturing sector, particularly German companies’ profits in China, which are no longer as easily gotten as before,” says Wang. “But at the same time, the companies can’t leave China.”

Anecdotal evidence, however, suggests that some are — or are, at least, considering their options. Jörg Wuttke, president of the EU Chamber of Commerce in China, said that while big companies were staying put, “other segments, mostly SMEs, are putting their China operations on autopilot and looking for alternatives around the world”.

“Businesses can’t afford to wait until China sorts out its Covid exit strategy,” he added.

According to Ifo’s recent survey, nearly half the German manufacturers that receive significant inputs from China plan to reduce their Chinese imports. When asked why, 79 per cent cite “diversification of supply chains and the avoidance of dependencies”.

One factor driving this development is the financial sector’s changing perception of the risks of being too reliant on China. “It’s actually quite interesting to see that American rating agencies . . . are now including an assessment of geopolitical risk,” Franziska Brantner, state secretary at the economy ministry, told a recent conference in Berlin. “And it might become very expensive for European companies to refinance themselves if they don’t diversify.”

Already, German companies that are heavily exposed to the Chinese market are facing real problems with their business. “We are getting the first German Mittelstand companies saying they are being shut out of international tenders if they say that certain parts only come from China, from their factories in China,” says Martin Wansleben, head of the association of German chambers of commerce and industry.

The Hamburg terminal

It was in the midst of Germany’s continuing debate about China that the row about Cosco’s investment in Hamburg suddenly took centre stage.

In a deal agreed last year, Cosco Shipping Ports was to acquire 35 per cent of the Tollerort container terminal in Hamburg port for €65mn, from logistics company HHLA. But the deal first had to be approved by the German cabinet, and six ministries opposed it on national security grounds. Chinese companies, they argued, should not be allowed to acquire Germany’s critical infrastructure.

Scholz’s aides defended the deal. Cosco was “merely” buying a small stake in the operator of one of Hamburg port’s many terminals, not a share of the port itself, which is largely state-owned. Cosco already has interests in other European ports, such as Antwerp and Zeebrugge. And blocking the deal could be detrimental to Hamburg’s interests. “There is a danger it could lose Cosco’s business,” said one official.

Cosco Shipping Ports planned to acquire a 35 per cent stake in a Hamburg container terminal, but six German ministries opposed the deal on national security grounds
Cosco Shipping Ports planned to acquire a 35 per cent stake in a Hamburg container terminal, but six German ministries opposed the deal on national security grounds © Michael Probst/AP

Other ministries, however, sounded the alarm. Some officials drew parallels with the sale of some of Germany’s largest gas storage facilities to Gazprom, the Russian gas export monopoly, over the past decade.

Scholz insisted on a compromise. That emerged late last month when Cosco was told it could only acquire a 24.9 per cent stake and would have no veto rights over strategic business or personnel decisions.

Most ministries grudgingly accepted the compromise — but not Baerbock’s foreign ministry, which continued to oppose the Cosco deal.

In a protocol notice, Anna Lührmann, German minister of state for Europe, said China had made clear “that it’s prepared to deploy economic measures to achieve political goals”. Allowing the sale of the terminal stake “would give China the ability to exploit a part of Germany and Europe’s critical infrastructure for political ends”.

Barkin, of Rhodium Group, says by pushing through the Cosco acquisition, Scholz is making things too easy for Beijing. “China needs Germany, especially when US-China competition is heating up,” he says. “So Scholz has a degree of leverage. But with the message he’s sending, he appears to be relinquishing it.”

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