Europe’s China Shock 2.0: Where does it go from here?

Their responses follow.

The current EU-China trade trajectory serves China’s interests. Beijing will use carrots and sticks to sustain its open access to the EU common market, which is the only major market in the world with high purchasing power that remains open to China’s surging exports. China may pay lip service to European concerns, but it will not offer any concessions or meaningful voluntary restraints on its exports. If there is going to be any rebalancing of EU-China trade relations, Europe will need to instigate it.

Whether justified or not, China’s confidence in its capacity to sustain the current trade trajectory is borne of three factors. First, Beijing judges Europe’s leaders as politically weak, divided on China, and lacking a mandate to launch a trade war against China amidst an actual war in Ukraine and a widening transatlantic rift with U.S. President Donald Trump. Second, Beijing is confident it can build an image of its market as a key driver of future demand for European products, and thus a key opportunity that European industrial giants cannot afford to squander. And third, China is confident it has punitive tools at its disposal to prevail in any trade war with Europe, should it become necessary to use them.

On its current trajectory, China’s surging export wave will decimate key European sectors, including autos, chemicals, green energy, machinery, and industrial tools. This, in turn, will alter Europe’s political center of gravity. The only question is whether Europe will be compelled to push back now or later on China’s unfair trade practices, including China’s suppressed domestic demand, its subsidies, and its undervalued currency.

EU leaders stiffened their collective spine in recent months by imposing new anti-subsidy and anti-dumping duties on China, cutting steel imports, sanctioning more Chinese entities for supporting Russia’s aggression against Ukraine, and launching investigations into Chinese clean technology and industrial overcapacity. They hope to talk Beijing into reducing its growing trade surplus, now over $1 billion a day. The EU says it expects “tangible results” from China by October.

As the deadline nears, Brussels is preparing new defensive measures. These include updated cybersecurity rules and the Industrial Accelerator Act, which could reduce the EU’s excessive strategic dependencies on imports from China, let Brussels block some Chinese products from public contracts, and limit Chinese takeovers of European companies.

Nonetheless, don’t expect the EU to take decisive action anytime soon. Beijing is adept at exploiting differences among EU countries, many of which worry that Europe’s defense buildup, clean-tech shift, and pharmaceutical and chemical sectors remain highly dependent on critical minerals from China.

If the EU ever finds the will, it has cards to play: ramping up investigations into heavily subsidized Chinese companies, blocking Chinese investments in the EU when EU bidders are shut out of the Chinese market, and sanctioning more companies that use coercive practices or are complicit in Russia’s war on Ukraine. Beijing also needs the large EU market and advanced European capabilities. China is twice as dependent on the EU for strategic imports as the EU is on China. Brussels can’t decouple from Beijing, but it can make itself indispensable, for instance by leveraging Chinese reliance on leading-edge semiconductor equipment, advanced automotive chips, and specialized machinery. It can also do more to harness its own considerable strengths. A true European Single Market and an integrated European Capital Markets Union would spark new investment and enable European innovators to scale up to compete with continental-sized rivals.

EU Trade Commissioner Maroš Šefčovič has set an October deadline for China to produce “tangible results” toward rebalancing a rapidly deteriorating EU-China trade relationship before his next trip to China. The EU is walking a fine line here as, unlike the United States, it is not trying to decouple from the trading relationship with China. Its shift in tone is nonetheless significant: Rather than attempt to negotiate yet another deal with China, the EU wants to push Beijing to modify its unfair trade practices—which European leaders are convinced are threatening the very survival of Europe’s core industries. The bloc is signaling its readiness to play hardball by readying its toolbox of trade defense measures.

Whether Europe puts the necessary political leverage behind the EU’s instruments depends very largely on Germany, because it is by far the bloc’s largest economy. When Germany blocks, smaller European economies hesitate; when Germany moves, that gives the smaller neighbors cover. Indeed, while “China Shock 2.0” affects all of Europe, it is a peculiarly German drama, much as Russia’s weaponization of Europe’s energy dependency was before it. Successive German governments downplayed China’s increasingly aggressive behavior. Now, staring at the possibility of the extinction of key German industries, Germann Chancellor Friedrich Merz has greatly sharpened his tone. The analyst Noah Barkin reports that a Franco-German government paper in July called for the “swift and systematic” use of EU trade defense mechanisms against unfair Chinese practices.

However, Merz’s own economics minister, Katherina Reiche, has been openly challenging Berlin’s shift, “sabotaging it with a kind of shadow diplomacy,” in the words of German China expert Thorsten Benner. Merz’s authority may soon take another dent when the hard-right Alternative for Germany (AfD) will likely sweep September elections in two eastern German states. In a recent prime-time interview, the AfD’s national co-chair, Alice Weidel—an economist with a Ph.D. on the Chinese pension system who has worked for the Bank of China and lived in China for six years—first drew a blank when asked how German auto manufacturers should compete with cheaper Chinese electric vehicles. She then angrily added that “the DNA of the CDU [Merz’s Christian Democrats] is the lie.” So, one thing for China-in-Europe watchers to keep track of in the coming weeks and months will be whether Merz manages to tackle these two very disparate political challengers at home.

EU-China trade relations are at a fork. China’s economic challenge to Europe has become increasingly consequential, and it is responding with greater urgency. Europe has stepped up traditional trade remedies, notably countervailing duties on imports of electric vehicles from China, while building new tools to defend its market against foreign subsidies, security risks, and economic coercion. China has responded with countermeasures rather than a willingness to accept disciplines on the spillovers its economic model imposes. How this contest unfolds could leave Europe more resilient and competitive—or more protected but less dynamic.

But stronger defenses can accomplish only so much. China’s export surge reflects a deeper imbalance between its expanding production and relatively weak domestic demand, pushing more of its production into global export markets. European and Chinese firms increasingly compete in markets around the world, particularly in sectors such as electronics and transport equipment. Those markets provide the scale European firms need to support investment and industrial capacity. But European trade defenses stop at Europe’s borders. The question is whether Europe’s response can protect European competitiveness—or merely protect the European market. The geopolitical environment makes that harder. Russian aggression has increased Europe’s security and economic burdens, raising the costs of confrontation with China. Meanwhile, Europe is moving closer to Washington’s diagnosis of China’s economic model just as U.S. appetite for the slow and politically costly work of organizing allies around a coordinated response has diminished.

Without coordination among major trading partners, expect proliferating defenses, trade redirection, and greater fragmentation. That may help protect industries Europe wants to preserve today. It is much less clear it will make Europe more secure and competitive tomorrow.

In 2015, the EPA discovered that German car manufacturers had been manipulating diesel engines’ emissions tests to buy time in the transition to electric vehicles. The delay allowed Chinese producers to become market leaders. Around the same period, German photovoltaic manufacturers lost their global preeminence, largely because of aggressive, state-backed Chinese competition.

These examples suggest that the former China shocks reflected a combination of European managerial failures, misleading lobbying power, and Chinese market distortions. Distinguishing these factors is essential when designing a response now that competition has moved into higher-technology sectors.

Automakers and chemical companies face substantial pressure from Chinese manufacturing. Yet the automotive sector represents only around 1% of European market capitalization—one-fifth of aerospace and defense and one-eleventh of health care. Although autos have a greater employment impact, their lobbying power should not distort European industrial policy. Even semiconductor investments have been driven largely by automotive needs rather than more advanced activities. 

The export shocks are rooted in China’s persistent savings surplus, which translates into sustained export capacity. Changing the savings habits in the Chinese economy may take decades. Europe therefore needs a long-term strategy to strengthen competitiveness rather than protect incumbent industries.

The Draghi Report offered a tentative blueprint, but member states remain reluctant to embrace it. Since industrial policy is still largely funded and implemented at the national level, resources tend to favor existing constituencies rather than innovative sectors. Financial systems also remain fragmented along national lines.

Europe’s challenge is ultimately a political one: Europe needs a stronger European-level strategy and financial infrastructure to direct investment toward the sectors that will determine its future competitiveness.

The EU is overdue to take serious and concerted action against the surging volume of Chinese exports. The good news is that the EU should have more economic leverage over China than it did even a couple of years ago. That is a result of China’s growing reliance on exports in general to pull along its dragging economy, as well as China’s increasing reliance on Europe as U.S.-China trade has diminished following President Donald Trump’s second trade war against China. The bad news is that the EU’s current geopolitical predicament makes it much more difficult to muster a meaningful response to this challenge. The EU already faces a belligerent Russia and a cantankerous United States. And the reprisals from China for any EU trade measures are likely to be at least as swift and as painful as the retaliatory measures Beijing deployed last year to get the Trump administration to back off many of its tariffs on China.

Indeed, the question on the minds of many EU officials now is whether they can afford a trade war with China at this moment. Yet the EU can ill afford the costs of further delay. It must be willing to weather the blowback from Beijing now, or it will pay a higher cost later as its manufacturing base attrits and its leverage with Beijing diminishes. The EU already has few good options—and it will have fewer the longer it lets the bleeding of its manufacturing sector continue.

However, the trade measures being considered by the EU, such as tariffs, will likely only buy it time. They do not address how Chinese companies can still outcompete global European companies in third-country markets and may only make European companies less competitive over time. Other trade measures, such as requirements to diversify supply chains, will take time to organize and implement—perhaps too long to be relevant for addressing the EU’s exigencies at the current moment. Moreover, any trade measures need to be paired with robust reforms to make the EU—and its companies—more competitive. Former European Central Bank chief Mario Draghi suggested a number of such reforms in his 2024 report for the European Commission, but many have not yet been implemented. Indeed, domestic reforms are likely the best prescription for the EU—or any country confronting the so-called “China Shock 2.0.” Strength abroad is born at home.