Germany Sets Out on 'De-Risking' Its Relations With China

(INA FASSBENDER/AFP via Getty Images)

Chinese shipping containers are seen at a seaport terminal in Duisburg, Germany, on July 13, 2023.

Germany's new push to de-risk its relations with China highlights growing operational, reputational and financial risks for German companies that are particularly exposed to the Asian giant. On July 13, the German government published its long-awaited, first-ever China strategy, which focuses on ''de-risking'' its ties with the Asian superpower (a view that Berlin shares with the broader European Union) through a three-prong approach. The most important element of the strategy is diversifying Berlin's trade and economic ties with other countries as a way to reduce its reliance on the Chinese market as an export and investment destination, as well as its reliance on China for supplies of critical raw materials (such as lithium and rare earth minerals). Secondly, Germany will seek to further reduce the presence of Chinese companies (like Huawei) in the country's critical infrastructure (like its 5G network). And as the final pillar, the strategy document promises to address calls from the European Union to reduce sensitive technology transfers to China that could increase the Asian country's intelligence and military capabilities by, for example, implementing the outbound investment screening and export controls proposed in the European Commission's new Economic Security Strategy.

In its new China strategy, Germany pledges to continue strengthening the country's military presence and cooperation with partners in the Indo-Pacific. When it comes to Taiwan, the document confirms Germany's formal adherence to the ''One China'' policy, but also reiterates Berlin's intent to expand its ties with Taipei and its stance that a change in the island's status quo would be acceptable only through peaceful means and mutual consent.
On June 20, the European Commission presented its first-ever economic security strategy, which stressed the need to ''de-risk'' the bloc's economic relations by restricting EU members' exports to and investments in adversarial countries. While not explicitly called out by name, China was heavily implied as the main target of the strategy, which highlighted the risk of becoming too reliant on ''a single country, especially one with systemically divergent values, models and interests.''
Germany's new China strategy acknowledges that Beijing is increasingly becoming a ''systemic rival'' due to its efforts to change the rules-based international order and to expand its relationship with Russia. This largely echoes the National Security Strategy that Berlin published in June, which described China as a ''partner, competitor and systemic rival'' and noted that Berlin's competition with Beijing had increased in recent years amid the latter's push to ''deliberately exe[rt] its economic power to reach political goals.'' Similarly, the Bundesamt fur Verfassungsschutz (BfV), Germany's domestic intelligence agency, deemed China as ''the greatest threat'' in terms of foreign direct investment and scientific and economic espionage in its annual report published in June.
The three parties in Germany's ruling coalition agreed to formulate a new China strategy as part of government formation talks in late 2021. However, infighting within the fractious coalition government significantly delayed the process.

The strategy confirms Germany's desire to abandon its former policy of pure economic engagement with autocracies (namely, China and Russia), which underpinned its economic success of the past decades but has proven increasingly risky in today's changing geopolitical landscape. Its new China strategy marks a shift from the policy Germany had pursued for almost two decades under the leadership of former Chancellor Angela Merkel, which focused on engagement with China under the guiding principle of ''Change through Trade.'' Through this strategy, Berlin had hoped to influence Beijing (and autocratic regimes in general, including Russia) to become more liberal and democratic in exchange for a mutually beneficial strengthening of trade relations. As a result, China became Germany's largest trading partner, a key source of critical raw materials and technologies for the energy transition, and a crucial market for German industries in the automotive, technology and chemical sectors. However, China's growing authoritarianism, human rights violations, increasingly aggressive posture in the Taiwan Strait and in the South China Sea, and ever-closer ties with Moscow (coupled with long-standing concerns over the lack of protection and unfair conditions for German companies operating in China) have led to a fundamental rethinking of this strategy both in Brussels and Berlin in recent years. On top of this, as Russia's invasion of Ukraine in 2022 and the energy and economic crises that followed underscored the risks associated with Germany's deep reliance on Russian natural gas, the need to reduce economic dependence on other non-democratic countries such as China acquired even more urgency. While Germany has been able to wean itself off of Russian energy exports over the past year, its economy is still heavily reliant on China, leaving the European country exposed to risks that its new strategy document seeks to mitigate.

Critics of Germany's strategy of trade and economic engagement with China argue this was a way for Berlin to profit from China's economic rise while ignoring (or at least putting off) difficult conversations about non-economic issues concerning democracy and human rights.
Germany's trade relations with both China and Russia significantly contributed to its economic success and were in fact seen by many as a model of globalization. Access to China's ever-growing market enabled Germany to weather the 2008-09 global financial crisis and the 2010-11 eurozone crisis that followed by providing a vital export destination for German industries. Since then, Germany's economic dependence on China has only grown, with the volume of bilateral trade (imports and exports) reaching a record of nearly 300 billion euros ($337 billion) in 2022.
Prior to the war in Ukraine, Russia served as Germany's largest gas supplier. Now, Russian oil and gas exports to Germany are near zero following cut-offs in supply through the Nord Stream pipeline from Russia and thanks to efforts from the German government to phase out the remaining energy imports from Russia.

But while the document confirms Berlin's intent to recalibrate its relationship with Beijing, Germany will seek not to cut trade and economic ties with China. China remains a vital market and supplier for some of Germany's largest companies, including chemical producer BASF, tech giant Siemens, and carmakers Volkswagen and BMW. Berlin will thus still seek to avoid severing ties with Beijing, which would prove economically catastrophic. This will see the German government largely leave the onus of de-risking its relationship with China to profit-motivated companies and investors. In fact, the strategy urges German companies particularly exposed to China to take geopolitical risks into account in their decision-making ''so that state funds do not have to be tapped into in the event of a geopolitical crisis,'' but it fails to mention any concrete policy measures to ensure such warnings do not fall on deaf ears.

According to the German Council of Economic Experts' most recent annual report, China ranks first among the countries on which Germany is most dependent regarding strategically important imports, with 45.1% of total German imports of products with strong import dependencies coming from China.
A February 2023 report by the Kiel Institute for the World Economy shows how China dominates global and German supplies of rare earths and raw materials needed to produce technology classified as critical by the European Union, as well as supplies of a number of products (mainly electronics) that ''could not be replaced as a supplier in the short term.''

Although Germany's de-risking strategy does not include specific policy measures, future regulations may expose German companies to growing operational, reputational and financial risks. So far, Germany has not enforced its de-risking strategy with any concrete policy measures, enabling German companies to keep investing in China. However, Berlin may eventually adopt foreign trade regulations to block or downsize Chinese acquisitions of German companies in sectors of the economy considered of strategic importance. The government could also prohibit critical infrastructure operators from contracting Chinese vendors and using Chinese equipment, with upcoming measures to ban certain Chinese components in the country's 5G network offering an important indication of how far the government intends to go in pursuing this goal. Finally, Berlin may decide to interrupt or impose caps on investment guarantees (which the government normally offers to German companies in emerging markets to protect their investments from political risk) for German investment in China. As a result, German companies could face increasing pressure to reduce critical dependencies on China, diversify supply chains and export markets, and create contingency plans to decouple from China should a geopolitical crisis arise. German companies that fail to do so risk losing access to investment protection schemes and/or lowering their creditworthiness and company valuations on financial markets due to perceived high levels of geopolitical risk. Moreover, should Germany's de-risking efforts significantly escalate, Beijing may retaliate by more strictly regulating German firms operating in China or by limiting exports of critical raw materials to Germany.

A 2021 study from Germany's Kiel Institute for the World Economy estimates that an abrupt break in Germany-China trade relations would cost Germany about 1.4% of GDP (roughly 48.4 billion euros, or $54.21 billion) in real income. The study also estimates that this decoupling would cost the European Union 1% of GDP.
In a study published earlier in 2023, the Cologne Institute for Economic Research estimated that Germany's exports to China accounted for 2.7% of its total economic added value and 2.4% of employment.
A report in December 2022 from Denmark-based telecommunications consultancy Strand Consult showed that Chinese companies Huawei and ZTE, which the EU considers high-risk vendors, account for about 59% of Germany's 5G infrastructure. In 2021, the German government passed measures allowing it to ban or recall certain components from the country's telecommunications infrastructure in case security risks were identified (pursuant to the 2020 EU toolbox for 5G security) but has yet to apply them.