(See also: Don't Get Caught in the Middle - A Geoeconomic Strategy for Germany to Survive US-Chinese Rivalry)
US-Chinese geopolitical rivalry is here to stay. America will require the support of its allies to successfully balance a rising China. Not only will Washington dedicate fewer resources to Europe. But it will also expect its allies to support its China strategy. Germany will be forced to assume greater responsibility for European security. It will also be faced with demands to align its policies with Washington’s geo-economic strategy towards Beijing.
Ø As US-Chinese competition intensifies, so will American demands on Germany (and the EU) to support its China balancing strategy, especially in the economic realm. A high degree of economic dependence on both China and America means that Germany will find itself in a particularly awkward position, compared to other European countries.
Ø Germany must devise a strategy for dealing with intensifying US-Chinese geo-economic conflict, not least in view of a possible military confrontation between Washington and Beijing. The war in Ukraine should serve as an urgent reminder of the significant economic costs armed conflict can cause to third parties.
Ø Germany should (1) create a National Economic Security Council charged with monitoring geo-economic risks and proposing economic mitigation measures, (2) address its most critical economic vulnerabilities (ideally in close cooperation with its EU partners), and (3) accelerate efforts to mobilize the EU’s latent economic power to mitigate vulnerabilities and deter third countries from exploiting them politically.
Extensive Economic Relationship with Both America and China Makes Germany Particularly Vulnerable
As Karl Marx observed, history repeats Itself, first as tragedy, then as farce. Russia’s war in Ukraine demonstrates the risks associated with economic dependence on a potential geopolitical antagonist. A US-Chinese military confrontation in East Asia over, for example, Taiwan would be even more costly for Germany than the Ukraine war. But even if war can be avoided, Germany will be vulnerable to intensifying US-Chinese geo-economic conflict.
Last year, German trade with Russia amounted to EUR 60 billion. Trade with China was nearly EUR 250 billion. German foreign direct investment in Russia was EUR 24 billion, while investment in China amounted to EUR 90 billion. True, Germany’s vulnerability vis-à-vis Russia is magnified by its energy dependence. But Germany is also dependent (directly or indirectly) on Chinese rare earth exports. A voluntary or involuntary Chinese export stop would be hugely consequential. But how consequential?[1] And what can be done to mitigate this risk and other economic risks? These are questions that the German government needs to answer urgently.
Even if an armed conflict in Asia does not come to pass, the prospect of geopolitical competition and geo-economic conflict between Germany’s two most important economic partners should lend good reasons for devising policies for dealing with economic vulnerability (and concomitant political coercibility). Among the EU members, it is Germany that has the most extensive economic relationship with both China and the United States in euro terms. It will therefore be a particular focus of American and Chinese policies, compared to other European countries. Germany is also the country most susceptible to US and Chinese geo-economic pressure given the importance of its bilateral trade and investment relationship as a share of GDP. Total trade with the US is worth nearly EUR 200 bn, and German foreign direct investment exceeds EUR 400 bn. What is Germany to do when faced with pressure to support American geo-economic policies as well as the prospect of Chinese retaliation against German economic interests in case Berlin aligns its policies with America’s geo-economic strategy?
US-Chinese Rivalry Will Intensify
Germany should certainly not hope for US-Chinese rivalry to miraculously dissipate. The United States is going to remain focused on countering China’s rise. Ever since it emerged as an international power in the late 19th century, the United States has sought to prevent the eastern (and western) end of the Eurasian landmass from falling under the domination of a single power – most recently during the Cold War.
It is no coincidence that US goals have been relatively constant across subsequent administrations, beginning with Obama’s ‘pivot to Asia’ to Trump’s ‘great power competition’ and Biden labelling China ‘the greatest geopolitical test of the 21st century.’ Meanwhile, China is intent on changing the status quo in its favor by weakening America’s position, particularly in East Asia. Talk of ‘peaceful rise’ or ‘peaceful development’ has long given way to territorial (or maritime) revisionism, military modernization, geo-economic rivalry, and even ‘wolf warrior diplomacy.’[2] Neither side is going to back down. At best, there will be ‘managed strategic competition;’[3] at worst, military conflict.
Assuming China continues to rise, resource constraints will force Washington to mobilize greater external as opposed to domestic resources to counter Beijing. In IR theory speak, Washington will pursue a strategy of both ‘internal’ and ‘external balancing.’ In short, Washington will expect its allies to support its China policy. A military conflict between the United States and China would leave Europe little choice but to support Washington. But even in a less dramatic scenario of intensifying US-Chinese security competition and geo-economic conflict, Germany and Europe will face increasing pressure to align their policies with US strategy. As geopolitical tensions rise, the risk of international economic instability and uncertainty will increase. [4]
Germany Will Be Unable to Sidestep US-Chinese Geo-Economic Conflict
What’s more, Germany maintains an extensive economic relationship with China. Washington will therefore be especially keen for Berlin to fall in with the economic aspects of US China strategy, including trade and investment restrictions, particularly regarding technology and other critical goods, such as rare earths. But this will increase the risk of Chinese retaliation against German interests. These cross-cutting pressures already exist and will only intensify in the coming years. Admittedly, Beijing will not want to sink the bilateral economic relationship with Germany wholesale if Berlin follows US policies. But to preserve credibility Beijing will have no choice but to retaliate in some form. And as time goes by, geo-economic risks for Germany will only increase as the Chinese economy continues to grow and becomes relatively less dependent on trade with Germany than vice versa.
Moreover, as America rebalances towards Asia, Germany will find it more difficult to free ride on America’s defense commitments. (This, too, has been a constant theme since at least the Obama administration.) Given Germany’s economic and demographic size as well its ability to mobilize financial and technological resources, a credible European defense policy is simply not viable without a greater German contribution.
Supporting a Level Playing Field is Not a Strategy
Germany and the EU largely share America’s objectives in as far as preserving the territorial status quo in Asia and creating an economic level economic playing field are concerned. After all, the EU has labelled China a ‘strategic rival’ and a ‘systemic competitor’. But Germany’s extensive economic relationship with, and its less immediate security concerns in relation to, China will make it less keen to support US policies it deems overly confrontational (whatever this might mean in practice). Germany will also be reluctant to support US policies to the extent that they weaken the very rules of multilateral economic cooperation that Berlin wants to be seen upheld.
Simply put, Washington’s policies will be driven by a more immediate need to counter China’s economic and military rise and facilitated by a much lesser degree of US economic vulnerability vis-à-vis China. America would not – and as Biden administration criticism of, for example, the EU-US Comprehensive Agreement on Investment demonstrated, does not – take kindly to its European allies, advertently or inadvertently, undermining US geo-economic policies. Washington does have reasons to prefer a joint, cooperative approach to countering China in the economic realm, not least because such an approach is more effective than a coercive one, the latter causing greater enforcement costs. But it will not hesitate to resort to unilateral measures, including secondary sanctions, to bring its European allies in line, especially in areas where the United States has leverage, such as with respect to critical and emerging technologies and the dollar. Washington, and least of all Congress, is not going to accept Europe playing the role of a ‘third-party spoiler’ in relation to China. As US-Chinese competition intensifies, US policy will become less accommodating.
Germany (and Europe) Needs to Devise Policies for Dealing with Geo-Economic Conflict
The German government therefore needs to devise a plan to deal with these challenges. The previous government’s Indo-Pacific Strategy was long on goals but vague on effective means to realize them, while curiously (but not surprisingly) barely mentioning China or US-Chinese competition.[5] But Germany’s policy towards China or the United States cannot be divorced from the broader strategic context represented by US-Chinese rivalry. What is Germany to do?
At the diplomatic level, a joint transatlantic approach is generally desirable. Transatlantic cooperation is under way in the guise of the EU-US Trade and Technology Council.[6] Berlin and Brussels should offer Washington support for geo-economic policies that seek to establish a level playing field. They should also support a coordinated approach to export controls and investment restrictions as far as ‘dual use’ and other critical technologies are concerned. Washington will certainly want these restrictions to be defined much more narrowly than its European partners. Washington restricts Chinese investment in and the export of certain critical technologies to China. It may also introduce restrictions pertaining to US investment in China. This is precisely where Germany and Europe may be able to exert some (limited) influence to the extent to which a joint, cooperative approach will be recognized as being more effective than a conflictual approach due to enforcement costs by Washington.
But even if America and Europe manage to agree on the ‘defensive’ part of the strategy (addressing geo-economic vulnerabilities) in the context of the EU-US Trade and Technology Council, the ‘offensive’ part will prove much more contentious, particular in terms of the means. Germany feels more than queasy about deploying discriminatory policies in blatant violation of established international rules. Moreover, China is not likely to make any significant concessions in terms of creating a level playing field in view of intensifying security competition. Tactically, it will not want to be seen as being responding to coercion and, strategically, it will not make any concessions that would weaken government control over critical economic sectors.
Washington will not hesitate to resort to policies that fall afoul of multilateral rules and provoke Chinese retaliation. Washington, intensely involved in security competition with China, may deem such ‘offensive’ measures a success if they weaken China in terms of economic growth and development. But for Berlin, the economic costs related to such measures will be greater and the security benefits smaller than for Washington. Nevertheless, the merit of a joint approach is that it might provide Germany with some cover to deflect Chinese geo-economic retaliation, as China will be reluctant to take on all the advanced economies simultaneously. What should Berlin do to mitigate the risks related to US geo-economic pressure and Chinese retaliation?
Step One: Create Bureaucratic Structures Necessary to Identify, Assess, and Monitor Geo-Economic Risks
Germany must enhance its bureaucratic capacity to identify and assess vulnerabilities as well as formulate effective mitigation policies. It must also strengthen its political-institutional capacity to coordinate and implement mitigation policies. In addition to a National Security Council, the German government should create a National Economic Security Council (attached to the NSC) to allow for the close coordination of national security and economic policies. The recent experience with German economic dependency on a geopolitical antagonist demonstrates the need to be formulated and implemented with a much higher degree of coordination.
The creation of these two councils should be complemented by a policy unit attached to the chancellery charged with identifying, assessing, and monitoring economic vulnerabilities as well as proposing risk mitigation strategies and policies based on prospective geopolitical and geo-economic scenarios. Attaching it to the chancellery would give it visibility, underline its importance, and remove it somewhat from the day-to-day concerns of the line ministries and party politics. The division of labor would look something like this: the policy unit serves as a high-level advisory body and proposes policies, the cabinet accepts or rejects the proposed strategy, and the National Security Council coordinates policy implementation with the support of the relevant line ministries.
Step Two: Address Critical Economic Vulnerabilities
Trade and investment dependence can be mitigated at the EU level, among a group of like-minded partners, or at the national level. Various EU level coordination efforts are under way, but outside certain aspects of external commercial policy, policies largely remain under national purview (see below). It is more effective, but also politically more difficult to pursue economic risk mitigation at the EU level.
What are the major vulnerabilities? First, import dependence refers to a country’s reliance on ‘critical’ (aka difficult-to-substitute) goods necessary to support domestic production or deemed otherwise critical, such as medical supplies. Second, export dependence consists of the ability of another country to limit imports, which may negatively affect economic growth and employment in the target country. Third, outward investment is at risk of discriminatory treatment by a host country, up to and including expropriation. Such hostile measures lead to financial losses, and they can disrupt supply chains (see import dependence). In extremis, such losses might be financially destabilizing in case companies are over-exposed to a geopolitical antagonist.
Economic Risk Mitigation Options
Diversification is typically the most desirable option in terms of an ‘economic cost/ economic risk reduction’ tradeoff. A robust and credible deterrence policy is another ‘cost-effective’ option of limiting economic vulnerability. (Deterrence can and does fail, of course, particularly in case of military conflict.) Reshoring is often economically very costly, and while it may reduce dependence on foreign markets, it can increase concentration risk. This is why diversification is generally a more resilient option. Much depends on the specific details and on the desired cost-risk tradeoff.
Step Three: Mobilize EU Geo-Economic Power
Endowing itself with the requisite bureaucratic-political framework and implementing economic vulnerability reduction policies (at the national level), Germany should also continue to push for a common EU-level approach to geo-economic defense as well as the mitigation of economic vulnerabilities.
The EU is the second largest economy in the world. It is a major importer and exporter as well as a major creditor and debtor. The euro is the second most widely used international currency. All this gives it significant geo-economic leverage provided it can mobilize it.[7] In parallel, however, Germany would be well-advised to strengthen its national defenses and address its national economic vulnerabilities in case joint EU policies go nowhere or make insufficient progress.
Again, aside from certain aspects of external commercial policy, most policies remain ultimately under the purview of EU member states. Joint action therefore typically requires political consensus and policy coordination. EU member-states under the leadership of the European Commission have intensified efforts to coordinate, streamline and even integrate policies in various relevant areas:
The EU has begun to assess its dependence on critical imports, and it has put forward an action plan.[8] But it needs to accelerate and intensify efforts, not least in view of the recent experience with Russian energy imports. The EU is working on an anti-coercion Instrument[9] (allowing it retaliate against trade restrictions without waiting for a WTO ruling, using trade, investment and other economic restrictions), an anti-subsidy Instrument[10] (preventing companies from non-EU countries receiving national subsidies from acquiring EU companies), an international procurement instrument[11] (limiting non-EU companies’ access to the EU’s public procurement market if home country does not grant reciprocity), and a so-called single market emergency instrument[12] (allowing the EU to impose export restrictions for a variety of goods). It has also sought to streamline and coordinate national export control policies (to enhance their impact and credibility as a geo-economic tool)[13] as well as national-level policies with respect to inward investment (to make it more effective and prevent third parties from circumventing national-level restrictions). [14] The German government should lend its strong support to all these efforts in an attempt to reduce EU and German economic vulnerabilities and to make European deterrence policies more effective and credible. The EU should think about making it easier not to just to impose EU-wide trade but also financial sanctions, such as limiting third-party access to EU financial markets and currencies.[15]
The EU’s geo-economic power in many areas is inhibited by the need for political consensus. Mobilizing EU power will require a combination of outright delegation to the European Commission and lower majority thresholds.[16] It is important that the parameters within which delegation takes places precludes the possibility of these policies being hijacked by protectionist and vested interests. They need to be narrowly targeted at limiting economic vulnerabilities and deterring third parties from exploiting these vulnerabilities. Their purpose must be to strengthen the EU’s ability and credibility to deter and, if necessary, retaliate against third-party geo-economic coercion.
Germany should throw its weight behind strengthening EU competencies provided the parameters under which delegation occurs allows for calibrated and effective geo-economic deterrence. A sensible and effective joint policy capable of mobilizing the combined economic size of the EU in terms of trade, investment and finance would go some way in addressing German and European economic and, by extension, geo-economic vulnerabilities.
Whether a war breaks out in East Asia, or whether Germany goes along with pressure to support US geo-economic policies and runs the risk of Chinese retaliation, Berlin needs to adopt a more strategic approach to national economic security involving national bureaucratic-institutional reform, the formulation and implementation of specific risk-reduction policies, and more effective mobilization of the EU’s largely latent geo-economic power. The Ukraine war should serve as a reminder of just how urgent this task has become. Nobody should be in doubt that a war in East Asia would have even more nefarious consequences.
[1] China accounts for about 40% of global rare earth exports and produces 85-90% of all rare earths globally.
[2] Bonnie Glaser & Evan Medeiros, The changing ecology of foreign policy-making and the demise of the theory of “peaceful rise”, The China Quarterly 190, 2007.
[3] Kevin Rudd, The Avoidable War (New York 2022).
[4] “Over the past four centuries, the most powerful nation-states have fought global wars four times. These conflicts have occurred at approximately 80- to 100-year intervals. In the periods between the major wars, well-ordered liberal economic subsystems have emerged, only to collapse as a major war approaches (…). Liberal international subsystems emerge from periods of widespread warfare because the victor of global war can use its power to organize and then then maintain a stable international community. Over time, as the organizer or leader weakens relative to other nation-states, cohesion and order in the subsystem decline.” Mark Brawley, Liberal Leadership (Ithaca 1993), p. 1. This is bad news for a middle power like Germany, given its dependence on rules-based, multilateral economic governance.
[5] Auswärtiges Amt, Leitlinien zum Indo-Pazifik, 2020: https://www.auswaertiges-amt.de/blob/2380500/33f978a9d4f511942c241eb4602086c1/200901-indo-pazifik-leitlinien--1--data.pdf (last accessed: 25 June 2022).
[6] Among other things, the TCC seeks to establish a common approach to such issues as supply chain security, technological cooperation and standards, coordination of export control and investment policies. Office of the United States Trade Representative, US-EU Trade and Technology Council: https://ustr.gov/useuttc (last accessed: 25 June 2022).
[7] Markus Jaeger, Designing Geo-Economic Policy for Europe, DGAP, 2022: https://dgap.org/en/research/publications/designing-geo-economic-policy-europe(last accessed: 25 June 2022).
[8] European Commission, Strategic Dependencies and Capacities, Commission Staff Working Document, 2021: https://ec.europa.eu/info/sites/default/files/swd-strategic-dependencies-capacities_en.pdf (last accessed: 25 June 2022). European Commission, Action Plan on Critical Raw Materials, 2021: https://ec.europa.eu/docsroom/documents/42852 (last accessed: 25 June 2022).
[9] European Commission, Trade Defence, April 17, 2020: https://ec.europa.eu/trade/policy/accessing-markets/trade-defence/ (last accessed: 25 June 2022). European Commission, EU strengthens protection against economic coercion, 2021: https://ec.europa.eu/commission/presscorner/detail/en/ip_21_6642 (last accessed: 25 June 2022).
[10] European Commission, Trade Defence Instruments, 2018: https://trade.ec.europa.eu/doclib/docs/2018/may/tradoc_156892.pdf (last accessed: 25 June 2022).
[11] European Parliament, EU International Procurement Instrument, 2012: https://www.europarl.europa.eu/RegData/etudes/BRIE/2020/649403/EPRS_BRI(2020)649403_EN.pdf (last accessed: 25 June 2022).
[12] European Parliament, Single Market Emergency Instrument, 2022: https://www.europarl.europa.eu/legislative-train/theme-a-europe-fit-for-the-digital-age/file-single-market-emergency-instrument: (last accessed: 25 June 2022).
[13] DLA Piper, Export controls: the EU’s new dual-use regime, September 27, 2021: https://www.dlapiper.com/en/slovakrepublic/insights/publications/2021/09/export-controls-the-eus-new-dual-use-regime/: (last accessed: 25 June 2022).
[14] Kirkland & Ellis, New EU foreign investment regulations take effect, October 29, 2020: https://www.kirkland.com/publications/kirkland-alert/2020/10/eu-fdi-regulation (last accessed: 25 June 2022).
[15] European Commission, Restrictive Measures (Sanctions): https://ec.europa.eu/info/business-economy-euro/banking-and-finance/international-relations/restrictive-measures-sanctions_en (last accessed: 25 June 2022).
[16] Markus Jaeger, Deterring and Defending Against Geo-Economic Coercion, DGAP, 2022: https://dgap.org/en/research/publications/defense-and-deterrence-against-geo-economic-coercion (last accessed: 25 June 2022).