According to a recent report from Xinhua News Agency, the latest statistics from the German central bank show that in the first half of 2024, Germany's investment in China reached a record high of EUR 7.3 billion. Coincidentally, Germany's investment in China also set a year-on-year record high in 2023. As of August this year, Western countries, including Germany, have been implementing a "de-risking strategy" toward China for over two years. However, the continuous rise in German investment in China seems to contradict such a strategy, leading some to see that Germany is still reliant on China, and there will be no substantial change in this dependency.

Among major Western nations, Germany is among the earliest to expand economic and trade relations with China, investing the most and having the most in-depth cooperation. The potential cost of abruptly severing or significantly reducing these ties would be extremely high. Recently, the Mercedes-Benz Group announced it would further increase its investment in China and continue to deepen its presence in the Chinese market, which seems to be at odds with the notion of Germany's de-risking efforts. However, to conclude that Germany and the entire EU's de-risking strategy toward China is ineffective based solely on the notable increase in German investment may be overly simplistic.

First of all, regarding Germany's new economic strategy toward China, whether it was the initial "decoupling" or the current "de-risking," a sudden and complete severance or significant reduction of economic and trade cooperation has never been a policy choice for Germany. Through a comprehensive analysis of relevant documents from the German government and think tank reports, researchers at ANBOUND have found that, in the eyes of the German government and business community, the ideological and geopolitical confrontations between Germany and China, as well as between Europe and China, have intensified in recent years, thereby highlighting the risks of politicization in economic relations. At the same time, the nationwide lockdowns in China during the pandemic have significantly disrupted the global supply and industrial chains. As the Western nation most dependent on economic and trade relations with China, Germany has been deeply affected by these disruptions. Additionally, conflicts in Israel and the crisis in the Red Sea have further obstructed the maritime supply chains from China to Europe.

Therefore, Germany must make corresponding adjustments to its supply chains in Asia, primarily focused on China. There are two main strategies: First, Germany will treat the Chinese market as an independent regional market rather than a critical link in the global industrial chain. All German companies operating in China will continue to produce and sell there, with all activities directed toward the Chinese market. The subsidiaries of German companies in China will gradually move toward independent operations. In the event of a complete deterioration in Germany-China or Europe-China relations, these companies will be able to sever all business ties with their headquarters in Germany and operate as fully independent entities. Second, Germany will disperse its highly concentrated industrial supply chains in China to neighboring countries and other regions around the world, creating a "China +1" strategy. Given the substantial existing investments of German enterprises and capital in China, a sudden severance or drastic reduction in economic cooperation with China would incur excessive costs, making it an impractical choice for the German business community and government. Thus, pursuing a "de-risking" strategy while simultaneously increasing investment in China is entirely feasible and not contradictory. However, the Chinese market is gradually being excluded from the global operational chains of German companies.

Additionally, the deeper changes in Germany's foreign economic and trade relations are becoming increasingly evident. As things stand, the economic ties between China and Germany (or Europe) still lag behind those between Germany (or Europe) and the United States. German officials and business leaders frequently state that China is Germany's largest trading partner, but in 2022, the trade volume of goods and services between the two was USD 348.45 billion, approximately 10% less than the USD 394.15 billion trade volume between Germany and the U.S. Both U.S.-China and Europe-China trade weakened in 2023, while U.S.-European trade saw an increase.

In terms of investment, this difference is even more pronounced. In 2022, the U.S. investment stock in the EU (USD 2.7 trillion) was over 21 times greater than its direct investment stock in China (USD 126.1 billion). In the same year, the EU's investment stock in the U.S. (USD 2 trillion) was twice that of the comparable investment level in all of Asia (USD 1 trillion). Data compiled by the Financial Times shows that last year, German companies announced 185 investment projects in the U.S., with 73 in manufacturing, amounting to a record USD 15.7 billion, significantly higher than the USD 8.2 billion from the previous year, with Volkswagen making the largest single investment. For Germany's large enterprises, such as Volkswagen and BASF, their annual investment in China typically accounts for about one-third to one-fourth of their total annual foreign investments. While this proportion is indeed considerable, it does not reach a critical level of dominance.

Additionally, due to the Russia-Ukraine conflict, Germany's primary source of natural gas has shifted to the U.S., which means Germany is increasingly reliant on the U.S. for its energy supply. Furthermore, with the promotion and deepening of the "close produce model" as mentioned by ANBOUND’s founder Kung Chan, the focus of economic and trade cooperation for Germany and the entire EU is likely to further shift toward North America. This will strengthen the economic influence of the U.S. on Germany, making the Germany-U.S. economic relationship even more important, surpassing that of Germany-China. In the first half of this year, Germany's total trade with Poland also exceeded its total trade with China.

Unsurprisingly, Germany is firmly and actively advancing its "China +1" strategy. In the past two years, many industry professionals in Germany have noted that India and Vietnam currently cannot fully replace China's role in the supply and industrial chains. However, Germany's investment trends and attitudes toward these two countries are rather positive. In the first seven months of last year, German investors made nearly USD 197 million in new, additional, and equity investment projects in Vietnam, with 21 new projects launched. Among German companies operating in Vietnam, over 90% expressed a willingness to increase their investments in recent years, compared to 78% among German companies in China. Regarding India, in February last year, Chancellor Olaf Scholz visited India and signed trade cooperation projects worth over USD 5 billion. Additionally, leveraging the EU's cooperative framework, Germany has intensified its collaboration in the mining and trade of critical metal resources in Central Asia, Africa, and South America. These developments indicate that China's irreplaceability in the industrial and supply chains is not absolute. Germany has been actively working to reduce its dependence on China, though this process will take time.

Third, economic friction between Germany and China is also increasing. A report from the Kiel Institute for the World Economy (IFWK) this year states that 99% of China’s new energy companies have received substantial government subsidies, which severely impact related industries in Germany and the EU, making it difficult for European companies to compete on price. At the beginning of this year, Volkswagen even called for the destruction of imported cars produced by its subsidiary in China due to their excessively low prices. Additionally, two rounds of surveys conducted by the German Chamber of Commerce in China in the first half of this year showed that nearly two-thirds of German manufacturers complained of being at a competitive disadvantage regarding market access, making it hard to compete with Chinese companies, especially state-owned enterprises. The escalation of economic friction raises questions about the stabilizing effect of economic relations on bilateral ties.

Furthermore, China's economy is showing signs of weakness, with consumer spending on the decline. This ongoing unfavorable macroeconomic environment is likely to affect the profitability of German companies operating in the country. If these companies find it difficult to achieve profits or face increasing challenges in doing so, it is hard to envision them continuing to invest heavily in the Chinese market.

Final analysis conclusion:

On August 9, China’s State Administration of Foreign Exchange released the international balance of payments data for the second quarter of 2023, revealing that direct investment from foreign enterprises experienced negative growth for the first time in three quarters, with foreign direct investment in China decreasing by USD 14.8 billion. The annual net inflow of foreign direct investment into China for 2023 is expected to be USD 33 billion, following a 47.6% year-on-year decline in 2022 and an additional 81.7% drop this year, bringing the net inflow to its lowest level since 1994. Given the positive role of foreign investment and its importance, the increase in Germany’s investment in China warrants serious reflection.

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Zhou Chao is a Research Fellow for Geopolitical Strategy programme at ANBOUND, an independent think tank.