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 trade affiliation (whose title 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 tools. 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 heart of the German economy.”
The VDMA has actual political clout, and their annual convention, “the German Mechanical Engineering Summit,” has turn out to be 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 mentioned their firms are “angry and disappointed” over the depressing state of the German manufacturing trade.
“Pretty much every statistic that we have is going in the wrong direction right now,” Richtberg advised me after we met up on the convention. Exports are nose-diving. Job cuts and furloughs are mounting. Prior to now six months alone, manufacturing is down 4.5 %. It is a part of a multi-year stoop. 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 vitality 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 financial system, and it is one which may be acquainted to People who lived by means of the early 2000s. Solely this time, the menace Europe’s largest financial system faces is even scarier than something the USA confronted again then.
Economists are calling this menace “the second China Shock.” The primary China Shock occurred within the early 2000s. That is when exports from China started surging and producers around the globe discovered themselves unable to compete. In America, this primary China Shock led to over one million manufacturing employees 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 concerning the first China Shock a number of occasions in the Planet Money e-newsletter).
Germany was largely spared from the primary China Shock. Nonetheless, economists at the moment are warning that the second China Shock quantities to an earthquake that’s shaking the very foundations of Germany’s export-led industrial financial system.
“It’s an existential shock for Germany,” says Dalia Marin, an economist on the Technical College of Munich. Marin sees the second China Shock as probably resulting in a “deindustrialization” that’s “much worse than the United States experienced during 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 probably so cataclysmic for the German financial 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 international 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 around the globe, together with the USA.
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 cause was that China’s export growth again then was in low-end manufactured merchandise like textiles, toys, client electronics, and furnishings, “not in the industries that are the hallmark of the German economy, namely autos, chemicals, and machines.”
Jens Südekum, a professor of economics at Düsseldorf College who’s at the moment 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 trade. “But those were small sectors,” he says.
In reality, Südekum says, the German manufacturing sector really flourished because of commerce with China. As China constructed sprawling new factories, they wanted industrial machines and tools that German firms (together with VDMA members) concentrate on making.
“After China joined the WTO in 2001, the German machinery sector and China, we had the perfect complimentary relationship,” Richtberg says. “We made a lot of money in China.”
And China’s newly affluent center and higher courses more and more needed German-made vehicles manufactured by the likes of Volkswagen, Mercedes-Benz, and BMW. “The Chinese were crazy about German cars, so the German car industry made a fortune in the Chinese market,” Südekum says.
In the meantime, within the early 2000s, Germany pursued essential labor market reforms that helped scale back unemployment and maintain its manufacturing sector aggressive. And the combination 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, a minimum of throughout sure durations, trade charges might 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 massive commerce surpluses — one thing that tends to push up the worth of a foreign money — German exports might have benefited from a weaker foreign money than the nation in any other case would have had. This was particularly the case in periods 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 shoppers (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 really an outlier,” Tordoir says. He says a superb a part of that was luck: German producers occurred to make the stuff that China wanted to industrialize and needed to eat.
By 2012, German exports of products to China reached virtually 3% of its GDP. “That’s a very big export business to one country,” Tordoir says. By comparability, the worth of U.S. exports of products to China has by no means surpassed one % of its GDP.
Why the second China Shock is completely different
Many economists at the moment are warning the world concerning the onslaught of “a second China Shock.” Tordoir says the one essential driver of this shock is that, primarily, China has been making an attempt to export its approach out of a home stoop ever since its real-estate bubble burst round 2021. Chinese language exports have exploded since then.
However, in contrast to the primary China Shock, the sequel is putting the core of Germany’s financial system. Chinese language firms have leapfrogged to turn out to be worthy rivals in a slew of superior manufacturing sectors, from equipment and tools to electronics to vehicles, and China’s homegrown rivals at the moment are starting to eat the lunch of German producers. Demand for German-made merchandise is in free fall, each in China and in export markets around the globe.
For a very long time, China was considered one of Germany’s largest — if not largest — clients. Now the nation has emerged as considered one of Germany’s largest rivals.
The numbers on this reversal are beautiful. For instance, in 2019, China was a web importer of passenger autos, importing about one million extra vehicles than they exported. With its advances in making electrical autos, by 2023, it emerged because the world’s largest exporter of vehicles, exporting round 5 million greater than it imported.
An essential a part of China’s metamorphosis could be tracked again to 2015, when Chinese language political leaders unveiled “Made in China 2025,” a ten-year plan aimed toward making China a sophisticated manufacturing powerhouse. Since then, China has invested closely in analysis and growth and pursued a spread of business insurance policies aimed toward upgrading their technological and manufacturing prowess and lowering their dependence on international rivals. A 2024 evaluation from The South China Morning Put up discovered that China had achieved 86% of the 260 targets set out within the plan.
Chinese language firms at the moment are making — and designing — smartphones as technologically subtle as iPhones. China leads the world in lithium-ion battery and photo voltaic panel manufacturing. It has AI and robotics firms which can be placing many European ones to disgrace. It is making fast progress in manufacturing airplanes and ships. And, probably devastating for Germany’s financial system, it is now producing world-class electrical vehicles and competing face to face in making industrial machines and tools.
“What’s really special about China is they have those long-term strategic plans — and they actually execute them,” Südekum says. He says the perfect instance is the automobile trade. “China has orchestrated this transformation of their own domestic car market towards electric vehicles. They became the major exporter for electric vehicles, and now they don’t need the imports from Germany anymore.”
Richtberg, who serves as the top of the Overseas 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 employees had stopped making journeys to China in the course of the pandemic. “ And then when they got back to China after two or three years,” Richtberg says, “our machine makers said, ‘Wow, they’ve developed a lot.'”
Richtberg says that Chinese language producers now provide machine merchandise which can be, on common, round 30 % cheaper than German-made ones. These merchandise could also be decrease high quality, he says, however clients typically appear to consider they’re “good enough” for his or her functions.
An important query concerning the second China Shock is how a lot of China’s aggressive edge is the results of unfair competitors? Richtberg advised that Chinese language rivals 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 unimaginable provide chains, the lengthy hours they work, their willingness to work for comparatively meager pay, their investments in innovation, decrease taxes and a scarcity of onerous laws.
Nonetheless, Richtberg says, there are many non-legitimate elements to Chinese language competitors that make it an uneven taking part in subject. For one, he says, their Chinese language rivals are likely to skirt laws.
For instance, he says, European firms mark their merchandise with an emblem, “CE,” when their merchandise adjust to European regulatory requirements and meet well being, security, and environmental safety necessities.
“And when European companies put it on their machine, we believe them,” Richtberg says. “What Chinese language firms are doing, they’re placing a emblem on their merchandise — which seems just about precisely the identical — however it means exported from China.”
Moreover some variations in spacing, the symbols look virtually equivalent. It is virtually as if Chinese language producers are messing with their Western rivals. “It would be funny if it weren’t so sad for our industry,” Richtberg says.
A fair larger concern that might 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 turn out to be worthwhile. A latest IMF research estimated that annual Chinese language subsidies to their industries quantity to a staggering 4 % 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 international competitors unfair. However, he says, China hasn’t been listening. The VDMA is looking on the German authorities to decrease taxes and scale back laws so their firms could be extra aggressive. And, in a break with the previous, the VDMA is now expressing help for erecting countervailing tariffs when international 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 defend German firms inside Europe. An important downside for Germany is that its financial system has been extremely depending on exports. In keeping with knowledge from the World Financial institution, in 2024, German exports accounted for greater than 42 % of its GDP. Examine that to the USA, the place exports accounted for lower than 11 % 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 USA. 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 employees 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 financial system within the early 2000s, manufacturing (value-added) accounted for about 13 % of US GDP. Immediately it accounts for under about 10 % of U.S. GDP. Manufacturing accounts for about 18 % of Germany’s GDP, based on 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 USA behind a tariff wall. Meaning Germany is struggling to promote merchandise in what had been lengthy its two largest 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 products are bouncing off the U.S. tariff wall and are being rerouted.” So, Tordoir says, Chinese language exporters wish 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 shoppers do not eat sufficient, and he hopes that one win-win answer for everybody will likely be convincing China to pursue coverage reforms that improve their home consumption and cease their export onslaught.
Germany — which itself lengthy pursued an export-led development mannequin and ran enormous commerce surpluses, typically to the chagrin of different nations — has lately begun working to extend home spending. The nation, beneath Chancellor Friedrich Merz, has handed constitutional reforms that permit the federal government to spend extra, and the federal government has begun to take action on issues like protection and infrastructure.
“The only way out that I can see is that we need to rely on internal demand, demand from the European Union really,” Südekum says. He thinks that Germany’s latest 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 shoppers to “Buy European.”
So far as different insurance policies to assist Germany overcome its present struggles, a few of the economists we spoke with, paradoxically, pointed to China as worthy of some emulation.
Tordoir mentioned it is value finding out how the Chinese language authorities made strategic investments and pursued far-sighted industrial insurance policies that at the moment are paying unimaginable dividends. It could be more durable to wrangle a various group of liberal democracies with completely different pursuits, however he hopes that Germany will be 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 autos and batteries. A brand new guide titled Kaput: The Finish of the German Miracle, by German enterprise journalist Wolfgang Münchau, presents a somewhat harsh critique of German leaders in latest many years for clinging to an previous 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 trade — and even its world-famous automakers have been gradual to pivot to electrical autos and the combination of cutting-edge software program into their vehicles.
Marin says an enormous cause for China’s technological leapfrogging was because of a specific mannequin during which it received Western firms to type joint ventures with Chinese language firms, thereby transferring expertise and know-how to their employees and entrepreneurs. She argues that Germany ought to “reverse-engineer” this mannequin, and get international firms — together with from China — to now assist German employees and firms advance technologically since they’ve fallen behind in essential areas.
