BERLIN — On a cloudy day in mid-September, I biked throughout Germany’s capital to satisfy up with Oliver Richtberg, a consultant of the VDMA, at his group’s annual political convention. The VDMA is an business affiliation (whose identify is a German acronym that interprets to Affiliation of German Mechanical and Plant Engineering). It represents 1000’s of German firms that manufacture industrial machines and gear. The businesses are an enormous a part of what Germans name the “Mittelstand,” that are small and medium-sized producers that are broadly thought of to be “the guts of the German economic system.”
The VDMA has actual political clout, and their annual convention, “the German Mechanical Engineering Summit,” has develop into a must-go-to occasion for German leaders. Simply the day earlier than, Germany’s chancellor, Friedrich Merz, had spoken there. Earlier than he gave his speech, Merz listened because the president of the VDMA stated their firms are “offended and dissatisfied” over the depressing state of the German manufacturing business.
“Just about each statistic that we now have goes within the mistaken path proper now,” Richtberg advised me once we met up on the convention. Exports are nose-diving. Job cuts and furloughs are mounting. Up to now six months alone, manufacturing is down 4.5 p.c. It is a part of a multi-year droop. The VDMA is now ringing the alarm bells that one thing large wants to alter.
Germany is going through an financial disaster.
Financial development has sputtered for greater than 5 years, and its world-famous manufacturing sector is in serious trouble. There are a number of causes of the disaster, together with the upper worth of power within the wake of Russia’s 2022 invasion of Ukraine and the consequences of U.S. tariffs.
However there’s an excellent larger shock starting to hit the German economic system, and it is one which may be acquainted to People who lived by means of the early 2000s. Solely this time, the risk Europe’s largest economic system faces is even scarier than something the US confronted again then.
Economists are calling this risk “the second China Shock.” The primary China Shock occurred within the early 2000s. That is when exports from China started surging and producers world wide discovered themselves unable to compete. In America, this primary China Shock led to over one million manufacturing staff dropping their jobs and plenty of industrial cities falling into doomspirals. Within the view of quite a few analysts, it contributed to a populist backlash that’s nonetheless upending American politics (we have written in regards to the first China Shock a number of instances in the Planet Cash e-newsletter).
Germany was largely spared from the primary China Shock. Nonetheless, economists are actually warning that the second China Shock quantities to an earthquake that’s shaking the very foundations of Germany’s export-led industrial economic system.
“It is an existential shock for Germany,” says Dalia Marin, an economist on the Technical College of Munich. Marin sees the second China Shock as doubtlessly resulting in a “deindustrialization” that’s “a lot worse than the US skilled through the first China Shock.”
So why was Germany one of many few industrial nations to see their manufacturing sector thrive within the face of the primary China Shock? What precisely is that this second China Shock? And why is it doubtlessly so cataclysmic for the German economic system?
Why Germany was insulated from the primary China Shock
After China joined the World Commerce Group in 2001, it kicked its industrialization into excessive gear and flooded world markets with low-cost manufactured items. The economists David Autor, David Dorn, and Gordon Hanson later dubbed this “the China Shock.” This shock vaporized chunks of the economic bases of countries world wide, together with the US.
Germany, nonetheless, was largely insulated from the primary China Shock.
Sander Tordoir, an economist on the Centre for European Reform, a assume tank, says an enormous motive was that China’s export increase again then was in low-end manufactured merchandise like textiles, toys, client electronics, and furnishings, “not within the industries which are the hallmark of the German economic system, particularly autos, chemical substances, and machines.”
Jens Südekum, a professor of economics at Düsseldorf College who’s presently advising the German finance minister, printed influential analysis on the primary China Shock in Germany. He says it did disrupt some low-end manufacturing sectors in Germany, together with their shoemaking business. “However these had been small sectors,” he says.
Actually, Südekum says, the German manufacturing sector really flourished because of commerce with China. As China constructed sprawling new factories, they wanted industrial machines and gear that German firms (together with VDMA members) concentrate on making.
“After China joined the WTO in 2001, the German equipment sector and China, we had the right complimentary relationship,” Richtberg says. “We made some huge cash in China.”
And China’s newly affluent center and higher courses more and more needed German-made automobiles manufactured by the likes of Volkswagen, Mercedes-Benz, and BMW. “The Chinese language had been loopy about German automobiles, so the German automotive business made a fortune within the Chinese language market,” Südekum says.
In the meantime, within the early 2000s, Germany pursued essential labor market reforms that helped cut back unemployment and hold its manufacturing sector aggressive. And the mixing of post-communist nations into the European Union buying and selling bloc proved to be an enormous boon for German producers, who had been capable of finding new clients and set up extra environment friendly provide chains with entry to cheaper labor and sources throughout the previous Iron Curtain.
And, not less than throughout sure intervals, change charges could have helped too. On the flip of the millennium, Germany joined along with different European nations in a financial union and adopted the euro. Most of the nations in that union have tended to have weaker economies. And, as Germany ran giant commerce surpluses — one thing that tends to push up the worth of a foreign money — German exports could have benefited from a weaker foreign money than the nation in any other case would have had. This was particularly the case during times like the European debt disaster. This decrease worth for his or her foreign money meant that German exports had been comparatively cheaper for Chinese language customers (though many different European nations additionally use the euro, and none of them appear to have benefited as a lot from commerce with China).
In comparison with the manufacturing sectors of different Western nations, which shriveled within the face of Chinese language competitors, “Germany was actually an outlier,” Tordoir says. He says a very good a part of that was luck: German producers occurred to make the stuff that China wanted to industrialize and needed to devour.
By 2012, German exports of products to China reached nearly 3% of its GDP. “That is a really large export enterprise to at least one nation,” Tordoir says. By comparability, the worth of U.S. exports of products to China has by no means surpassed one p.c of its GDP.
Why the second China Shock is totally different
Many economists are actually warning the world in regards to the onslaught of “a second China Shock.” Tordoir says the one essential driver of this shock is that, primarily, China has been attempting to export its method out of a home droop ever since its real-estate bubble burst round 2021. Chinese language exports have exploded since then.
However, not like the primary China Shock, the sequel is hanging the core of Germany’s economic system. Chinese language firms have leapfrogged to develop into worthy opponents in a slew of superior manufacturing sectors, from equipment and gear to electronics to cars, and China’s homegrown opponents are actually starting to eat the lunch of German producers. Demand for German-made merchandise is in free fall, each in China and in export markets world wide.
For a very long time, China was one in every of Germany’s greatest — if not greatest — clients. Now the nation has emerged as one in every of Germany’s greatest opponents.
The numbers on this reversal are gorgeous. For instance, in 2019, China was a internet importer of passenger automobiles, importing about one million extra automobiles than they exported. With its advances in making electrical automobiles, by 2023, it emerged because the world’s largest exporter of automobiles, exporting round 5 million greater than it imported.
An essential a part of China’s metamorphosis might be tracked again to 2015, when Chinese language political leaders unveiled “Made in China 2025,” a ten-year plan geared toward making China a complicated manufacturing powerhouse. Since then, China has invested closely in analysis and improvement and pursued a spread of business insurance policies geared toward upgrading their technological and manufacturing prowess and lowering their dependence on overseas opponents. A 2024 evaluation from The South China Morning Publish discovered that China had achieved 86% of the 260 objectives set out within the plan.
Chinese language firms are actually making — and designing — smartphones as technologically refined as iPhones. China leads the world in lithium-ion battery and photo voltaic panel manufacturing. It has AI and robotics firms which are placing many European ones to disgrace. It is making speedy progress in manufacturing airplanes and ships. And, doubtlessly devastating for Germany’s economic system, it is now producing world-class electrical automobiles and competing face to face in making industrial machines and gear.
“What’s actually particular about China is that they have these long-term strategic plans — and so they really execute them,” Südekum says. He says the perfect instance is the automotive business. “China has orchestrated this transformation of their very own home automotive market in direction of electrical automobiles. They grew to become the key exporter for electrical automobiles, and now they do not want the imports from Germany anymore.”
Richtberg, who serves as the top of the International Commerce Division on the VDMA, advised me their producers started noticing one thing large had modified of their enterprise relationship with China round 2022 or 2023, within the waning days of the COVID-19 pandemic.
Their executives and staff had stopped making journeys to China through the pandemic. “ After which once they received again to China after two or three years,” Richtberg says, “our machine makers stated, ‘Wow, they’ve developed loads.'”
Richtberg says that Chinese language producers now supply machine merchandise which are, on common, round 30 p.c cheaper than German-made ones. These merchandise could also be decrease high quality, he says, however clients typically appear to consider they’re “ok” for his or her functions.
An important query relating to the second China Shock is how a lot of China’s aggressive edge is the results of unfair competitors? Richtberg steered that Chinese language opponents have a ton of pure benefits over them, whether or not it is the economies of scale they’ve from working in a large market, their unbelievable provide chains, the lengthy hours they work, their willingness to work for comparatively meager pay, their investments in innovation, decrease taxes and an absence of onerous laws.
Nonetheless, Richtberg says, there are many non-legitimate features to Chinese language competitors that make it an uneven enjoying discipline. For one, he says, their Chinese language opponents are likely to skirt laws.
For instance, he says, European firms mark their merchandise with a logo, “CE,” when their merchandise adjust to European regulatory requirements and meet well being, security, and environmental safety necessities.
“And when European firms put it on their machine, we consider them,” Richtberg says. “What Chinese language firms are doing, they’re placing a brand on their merchandise — which seems just about precisely the identical — but it surely means exported from China.”
Apart from some variations in spacing, the symbols look nearly similar. It is nearly as if Chinese language producers are messing with their Western opponents. “It might be humorous if it weren’t so unhappy for our business,” Richtberg says.
An excellent larger concern that would make this unfair competitors is that the Chinese language authorities has been showering their nation’s producers with subsidies. Chinese language producers are coddled by the federal government by, for instance, being given free or low-cost land, entry to low-cost credit score, and help even once they fail to develop into worthwhile. A current IMF examine estimated that annual Chinese language subsidies to their industries quantity to a staggering 4 p.c of their GDP.
How Germany ought to reply
For years, Richtberg says, the VDMA has been urging Germany and the EU to get China to play by the principles, comply with laws, and finish subsidies that make world competitors unfair. However, he says, China hasn’t been listening. The VDMA is looking on the German authorities to decrease taxes and cut back laws so their firms might be extra aggressive. And, in a break with the previous, the VDMA is now expressing help for erecting countervailing tariffs when overseas merchandise are discovered to be made with the help of presidency subsidies. Many of the economists we spoke to additionally expressed help for countervailing tariffs.
Nonetheless, European Union tariffs will solely shield German firms inside Europe. An important drawback for Germany is that its economic system has been extremely depending on exports. In accordance with information from the World Financial institution, in 2024, German exports accounted for greater than 42 p.c of its GDP. Evaluate that to the US, the place exports accounted for lower than 11 p.c of GDP. How will Germany compete with China in export markets exterior the EU?
This will get to why the second China Shock in Germany might show rather more devastating than the primary one proved to be in the US. For one factor, the primary China Shock centered on the imports of low-end manufacturing items. Even then, it killed greater than one million manufacturing jobs within the US and staff and communities struggled to adapt.
And the US has lengthy been much less reliant on manufacturing than Germany. When the China Shock was hitting the US economic system within the early 2000s, manufacturing (value-added) accounted for about 13 p.c of US GDP. At this time it accounts for under about 10 p.c of U.S. GDP. Manufacturing accounts for about 18 p.c of Germany’s GDP, in keeping with the World Financial institution.
The export-led industrial mannequin that Germany has pursued for many years is now at a crossroads. Along with the China Shock, there’s the retreat of the US behind a tariff wall. Which means Germany is struggling to promote merchandise in what had been lengthy its two greatest export markets.
And, Tordoir says, excessive U.S. tariffs in opposition to Chinese language items are hurting Germany by means of one other channel: “Chinese language merchandise are bouncing off the U.S. tariff wall and are being rerouted.” So, Tordoir says, Chinese language exporters want to promote extra in Europe, the place there are a lot decrease tariffs.
Tordoir says one core concern in all of that is that Chinese language customers do not devour sufficient, and he hopes that one win-win resolution for everybody might be convincing China to pursue coverage reforms that enhance their home consumption and cease their export onslaught.
Germany — which itself lengthy pursued an export-led development mannequin and ran enormous commerce surpluses, generally to the chagrin of different nations — has lately begun working to extend home spending. The nation, below Chancellor Friedrich Merz, has handed constitutional reforms that enable the federal government to spend extra, and the federal government has begun to take action on issues like protection and infrastructure.
“The one method out that I can see is that we have to depend on inner demand, demand from the European Union actually,” Südekum says. He thinks that Germany’s current spending reforms, which he was concerned in, are an essential first step. As a subsequent step, he and Tordoir each expressed help for the concept that the European Union ought to develop incentive schemes to encourage European customers to “Purchase European.”
So far as different insurance policies to assist Germany overcome its present struggles, a few of the economists we spoke with, sarcastically, pointed to China as worthy of some emulation.
Tordoir stated it is value finding out how the Chinese language authorities made strategic investments and pursued far-sighted industrial insurance policies that are actually paying unbelievable dividends. It might be more durable to wrangle a various group of liberal democracies with totally different pursuits, however he hopes that Germany will be a part of different EU nations to develop EU-wide industrial insurance policies to spice up their very own strategic sectors.
Marin worries that Germany has been failing to innovate in essential technological sectors, together with electrical automobiles and batteries. A brand new ebook titled Kaput: The Finish of the German Miracle, by German enterprise journalist Wolfgang Münchau, gives a quite harsh critique of German leaders in current a long time for clinging to an outdated industrial mannequin and being unwilling to make essential investments and coverage adjustments within the face of epic technological adjustments. Germany lacks a vibrant digital sector and a big enterprise capital business — and even its world-famous automakers have been gradual to pivot to electrical automobiles and the mixing of cutting-edge software program into their automobiles.
Marin says an enormous motive for China’s technological leapfrogging was as a consequence of a specific mannequin through which it received Western firms to type joint ventures with Chinese language firms, thereby transferring expertise and know-how to their staff and entrepreneurs. She argues that Germany ought to “reverse-engineer” this mannequin, and get overseas firms — together with from China — to now assist German staff and firms advance technologically since they’ve fallen behind in essential areas.
