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Treasury & Capital Markets / Europe / Viewpoint
EU should adopt Chinese industrial, tech policies
For decades, China has required Western companies to establish partnerships with domestic manufacturers to access its vast market. To remain competitive and avoid a painful China shock, the European Union should reverse-engineer the policies that enabled Chinese companies to become world leaders in green technologies
Dalia Marin 16 Jun 2024

Over the past two decades, the productivity gap between Europe and the United States has steadily widened, with labour productivity in the US growing at more than twice the pace of the eurozone’s. The European “competitiveness crisis” can be attributed to several factors, including insufficient public and private investment, a shortage of tech firms and venture capital funds, and the continent’s demographic decline. Another possible explanation that is often overlooked is the decline in foreign direct investment (FDI).

FDI is a crucial driver of productivity growth, introducing recipient countries to new technologies, knowledge, and management skills. After falling by 4% in 2023, Europe’s FDI inflows are now 14% below their 2017 peak. Germany experienced a sharp 12% drop in foreign investment last year, undermining its post-pandemic recovery. In the United Kingdom, inward FDI declined by nearly 30% since 2016-17, as Brexit prompted foreign firms to redirect investments to other European countries. French policymakers seem determined to benefit from this shift, with President Emmanuel Macron actively marketing his country to foreign investors.

Attracting FDI is crucial for the European Union as it grapples with two emerging challenges: de-risking its supply chains and preventing member states’ economies from experiencing a China shock similar to the one the US experienced after China joined the World Trade Organization in 2001.

FDI flows may play a key role in addressing both of these challenges. Climate change and heightened geopolitical tensions have made global supply chains increasingly vulnerable, especially since most inputs for green industries, such as semiconductors and battery cells for electric vehicles (EVs), come from Taiwan, South Korea and China. A 2012 paper by MIT economist Daron Acemoglu and co-authors suggests that such geographic concentrations of input suppliers increase the risk of economic shocks. As supply disruptions reverberate across the global economy, they create multiplier effects that compound the initial disruption.

Moreover, firms cannot protect themselves against such disruptions by diversifying their suppliers, since no alternative sources are available outside Asia. This vulnerability was underscored in 2021 when the Taiwan Semiconductor Manufacturing Company (TSMC) had to shut down some of its factories due to the Covid-19 pandemic and a severe drought, halting automobile production worldwide.

To foster diversification, the EU has begun subsidizing foreign investments in battery cells and semiconductors through the European Chips Act and the European Battery Alliance. Much like the Inflation Reduction Act and the CHIPS and Science Act in the US, these measures aim to ensure that enough alternative suppliers are available in the event of a climate disaster or geopolitical conflict.

Despite these efforts, however, there are signs that Europe has begun to experience its own China shock. In 2022, for the first time ever, Germany imported more cars and machinery from China than it exported. A recent study by Allianz Research finds that China has surpassed Germany in key sectors of the global export market. For example, China’s share of machinery and equipment exports increased to 29% in 2022, compared with Germany’s 15%. While Germany still leads in exports of automobiles and transport equipment, with a 17% share compared with China’s 9%, its lead is diminishing.

This should alarm policymakers for two reasons. First, losing its lead in critical high-tech sectors poses a major threat to Germany’s economic model. Second, a European China shock could fuel the rise of far-right parties like the German Alternative für Deutschland (AfD).

The US should serve as a cautionary tale. The China shock of the early 2000s had a devastating impact on manufacturing regions, as workers displaced by Chinese competition struggled to find new jobs and often had to settle for significantly lower wages. The decline in manufacturing employment contributed to an epidemic of “deaths of despair” – from suicide, drug overdoses and alcoholism-related liver disease – and set the stage for Donald Trump’s victory in the 2016 presidential election.

With this in mind, EU policymakers are considering imposing import tariffs on Chinese EVs. In a recent speech, European Commission president Ursula von der Leyen said that the commission has launched an anti-subsidy investigation into the Chinese EV industry and accused China of violating fair competition rules in an effort to “flood our market with massively subsidized electric cars”.

US President Joe Biden’s decision to impose a 100% tariff on Chinese-made EVs is likely to redirect Chinese EV exports from the US to Europe, which leaves European policymakers with no choice but to impose their own import tariffs.

Such a move could have the added benefit of boosting Chinese FDI flows to the EU, as Chinese carmakers might try to bypass import tariffs by building new factories in Europe and selling EVs directly to European consumers.

But more must be done. By forming partnerships with companies in technologically advanced economies like China, Taiwan, South Korea and Israel, European firms could bridge the EV and digital knowledge gap and increase FDI flows to the EU. For decades, China has used this strategy to become a world leader in green technologies, forcing Western companies to form joint ventures with domestic manufacturers to access the vast Chinese market.

Today, the roles are reversed: China is now a technologically advanced economy seeking access to the large EU market for its EVs, and European countries lack the necessary technical expertise to remain competitive. To boost FDI flows and improve its competitiveness, the EU should reverse-engineer China’s industrial policy and require Chinese EV manufacturers to establish joint ventures with domestic companies in exchange for market access.

Dalia Marin is a professor of international economics at the School of Management of the Technical University of Munich and a research fellow at the Centre for Economic Policy Research and a non-resident fellow at Bruegel.

Copyright: Project Syndicate

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