China is waging a trade war with Europe and winning
Beijing has used industrial policy and a weak currency, not tariffs, and they are working
US President Donald Trump has torn up the World Trade Organization rule book and unilaterally raised tariffs on almost everyone, including the European Union.
The EU even agreed not to retaliate against a 15% across the board tariff hike in its deal with Trump, to the dismay of some. Imports are now running ahead of their 2024 pace, even excluding pharmaceuticals.
China, on the other hand, is squeezing foreign imports out of its market. It hasn’t quite mastered top-of-the-line chips, protecting Taiwan. But it has mastered autos – both EVs and ICEs. And construction equipment. And industrial robots.
As well as most specialty chemicals, batteries, permanent magnets, solar PVs and their chemical precursors, industrial diamonds, wind turbines, and high-speed rail.
While China hasn’t quite mastered the production of top-line civil aircraft, Comac is ramping up the production of the C919. Plus, there are signs that the Chinese content of the made-in-China Airbus narrow bodies is rising.*
And in part because of competition among local levels of government, China often doesn’t know when to stop investing – as competing local governments add subsidized capacity in priority and non-priority sectors alike.
That drives profits down, and pushes firms to export capacity that China’s domestic market cannot absorb. In other words, its continued manufacturing boom is eating into core European export strengths.
EU trade war with China
% EU of GDP
Exports have been in a steep fall as a share of Europe’s economy since 2022. That is obvious in autos. Extend that series into a forecast, and its exports of vehicles will be down to around US$10 billion by 2027. No wonder Germany has been hit hard.
China Trade in autos with the European Union
USD Billions, trailing 12-month sums
It is now more widely recognized that falling exports to China are an important reason why the EU’s largest economy has stagnated over the last five years.
But the slump is visible in most industrial sectors. European exports to China, measured by China’s imports, are now down about half a percentage point of European GDP during the last few years.
Germany exports to China | from Chinese import data
% German GDP
While European imports from China are rising again, the EU’s trade deficit with the world’s second-largest economy is set to double between 2020 and 2025 in euro terms. That is a negative shock for a struggling Europe.
These calculations also ignore the additional impact of increased Chinese competition in third party markets.
European Union goods trade deficit with China
US billions, deficit w/ sign reversed
The second China shock – which for Germany is really the first China shock – now shows up basically everywhere. The auto crunch, for example, is not over. EV exports in volume terms have overtaken ICE exports in leading China’s flood.
This continues to rise in volume terms (I’m pinging Adam Tooze of Chartbook here…) EV exports in the second-quarter were running at a pace of three million cars on a rolling three-month basis.
China vehicle exports
Millions of vehicles, trailing 12-month sums
It is significant relative to global demand for EVs once China’s own large domestic market is netted out of the data. Of course, these EVs show up in the continued Chinese dominance in global exports as they outperform global trade.
They also show up in the large contribution to growth that exports have provided to China in recent quarters of around 2%. That is a bump Europe would have loved for itself. China saw this level over last four quarters from net exports alone.
China new energy vehicles exports
Millions of cars, trailing three-month sums annualized
Ursula von der Leyen, the president of the European Commission or the executive arm of the EU, told China’s leaders that the bloc’s trading relationship is at an inflection point. She needs to back that point up with additional action if Beijing doesn’t change.
Counter-industrial policies could be used. If China isn’t going to change, countries have to find ways to either wall off their domestic market or subsidize production.
Europe’s wind industry shouldn’t be allowed to follow the path of Germany’s solar industry. And permanent magnets are too important to autos and rearmament, such as fighter jets and missiles for example, for their production to be remain concentrated in China.
Broader tariffs on Chinese auto exports should be considered. China isn’t just exporting battery electric cars, and the 17% tariff that emerged from the countervailing duties investigation on BYD is rather low.
The yuan’s depreciation against the euro has more or less offset the tariff on BYD, and Tesla for that matter.
A new approach to pressuring China to allow its currency to rise would also be welcome. This would involve addressing the underlying macroeconomic imbalances that have led to a weak currency and reliance on exports for growth.
Chinese yuan weekly exchange rate w/ dollar and euro
Change from 2022 average
I would hope that France’s President Emmanuel Macron, Italy’s Prime Minister Giorgia Meloni, and Germany’s Chancellor Friedrich Merz would all back such a policy shift.
There are lessons here for Trump’s team too, if they are serious about an American manufacturing revival and not just letting him enjoy his Oval Office tariff joyride.
His advisors will note, correctly, that China has long had significant tariffs.***
But China’s success has also stemmed from industrial policy and a Chinese private or civil-state fusion sector that was willing to accept low returns on equity and get out and build. Often too much.
More recently, success in China has stemmed from a willingness to let its currency slide – first against the dollar, and then against the euro. No worries about losing “yuan dominance.”
Set that aside, though, Europe is clearly getting hit hard by China’s industrial policy successes – and now by a weak yuan. Its response has been inadequate. It is time Europe stepped up with a counter industrial policy of its own.
And start to take the issues around China’s macroeconomic imbalances seriously.
* That could change. US firms will not keep eating the tariffs cost for much longer.
** See German customs data. Exports of civil aircraft to China have trended down, and Airbus Germany makes the 320/321.
*** China’s auto sector was developed behind a 25% tariff wall back when Europe’s tariff was 10%, the US tariff was 2.5%, and Japan’s tariff was zero. China only reduced the tariff to 15% when it knew that there was more than enough Chinese capacity to meet its internal demand.
Brad W Setser is the Whitney Shepardson senior fellow at the Council on Foreign Relations.
This edited article was published by the Council on Foreign Relations under a Creative Commons license. Read the original here.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of China Factor.