An economically highly integrated country like Germany is at greater risk of sustaining significant losses in the event of economic fragmentation. All other things equal, it is also more vulnerable to geo-economic coercion. An analysis of Germany’s foreign trade and financial relationships allows high-level evaluation of bilateral economic and geo-economic vulnerabilities.
Economic decoupling is obviously a bad idea. But this does not meant Germany should not prepare for such a possibility. After all, a war in East Asia may lead to involuntary decoupling. De-risking is therefore the right approach in the sense of re-calibrating policies so as to achieve the desired risk-reward trade-off.
Geo-commercial vulnerabilities are broadly manageable, but dependence on critical intermediate inputs needs to be addressed
Germany is G7 country that is most open to international trade. According to the World Bank, exports and imports of goods and services are equivalent to almost 90% of GDP. For Japan, the respective figure is less than 40% of GDP, for the United States 25% of GDP. Admittedly, the bulk of Germany’s trade is with EU partners and geopolitical allies. This limits geo-commercial risks.
In 2022, China was Germany’s single-largest trading partner with combined exports and imports equivalent to EUR 300 billion. The United States is Germany’s second most important partner with EUR 250 billion worth of bilateral trade. China was Germany’s fourth-largest export market and its largest import market (see charts). German exports to China accounted for 6.7% of total exports, and imports from China for 12.8% of total imports. As a share of GDP, exports accounted for 2.8% and imports for 5% of GDP.
By comparison, Russia is relatively insignificant in terms of the value of goods traded. In 2022, it was Germany’s 23rd largest export and its 14th largest import market, accounting for a mere EUR 15 billion of exports and EUR 36 billion in imports. As a share of German GDP, exports to and imports from Russia amounted to a quantitatively negligible 0.4% and 0.9%. Qualitatively, however, Germany’s reliance on critical energy imports from Russia proved a significant vulnerability following the beginning of the Ukraine war and led to significant economic output losses and higher inflation.
The IFO Institute[1] estimates that 2.7% of total German value-added depends on demand from China, while Chinese imports account for 2.2% of total value added. This is significant, but not catastrophically large from an output and employment perspective.
While Germany is much more dependent on China in terms of trade, the EU as a whole is less so. EU exports to and imports from China account for 3.1% and 1.6% of EU GDP, respectively. Chinese exports to and imports from the EU account for 1.4% and 3.9% of Chinese GDP, respectively. This establishes a broad mutual dependence between the EU and China, which in the event of broad-based decoupling would lead to losses on both side. Hence the mutual interest in avoiding a broader trade conflict. In the context of Brussel’s trade defense policy, the more balanced EU-China trade relationship affords Germany protection from geo-commercial coercion.
The most significant vulnerability, and the vulnerability most easily and efficiently exploited is to do with German imports. China accounts for 7% of all imported intermediate inputs , which in turn presents 1% of German final output (see chart). An IFO Institute survey also showed that almost half of all German industrial firms that rely on intermediate inputs from China. To the extent that these inputs are critical in the sense of low substitutability, restricting them has significant potential to cause significant economic losses.
Again, China is unlikely to restrict European and German imports on a large scale. Similarly, it is highly unlikely to restrict exports. However, selective export restrictions targeting critical and difficult-to-substitute goods is a much more cost-effective way to exercise geo-economic leverage. Export restrictions are efficient in that they limit the costs to the coercer and have the potential to cause substantial economic disruption in the target economy. German and the EU would be well-advised to mitigate their systemically most important import-related vulnerabilities through a combination of stockpiling, diversification, innovative substitution and reshoring. [2]
Geo-financial vulnerabilities are also manageable, at least at the macro-financial level
Germany is not just the most trade-dependent country among the G7, but it is also the greatest net creditor in terms of GDP. German net claims amount to nearly EUR 3 trillion (or 70% of GDP), while gross foreign claims stand at a significant EUR 12.6 trillion (or 300% of GDP). Similar to trade disruption, a breakdown of international and especially financial relations can lead to significant losses, as the recent partial severing of financial ties with Russia demonstrates.
German gross foreign assets consist of EUR 3 trillion of foreign direct investment, EUR 3.7 trillion of portfolio investment, EUR 1.9 trillion in derivative-related claims, EUR 3.8 trillion of loans and deposits and 0.3 trillion of central bank reserve assets (see chart for foreign assets as a share of GDP).
As in case of trade, the geographic breakdown of the financial claims matters in terms of their potential to incur losses due to economic fragmentation or geo-economic coercion. In terms of German companies’ loans and trade credit claims and liabilities vis-à-vis non-residents,[3] which amount to EUR 1.4 trillion of claims and EUR 1.75 trillion of liabilities as of November 2023, EU members, EFTA members, the UK and the USA account for the largest share of both assets and liabilities.
By comparison, claims on China are vanishing small at EUR 31 billion. This compares to EUR 24 billion in German liabilities vis-à-vis China, which translates into a net exposure of just EUR 7 billion. Moreover, of the EUR 31 billion in claims, EUR 27 billion are lower-risk, often short-term trade credits, which have a lower loss potential. Similarly, claims on Hong Kong are small accounting for EUR 6.8 billion, compared to EUR 10.6 billion in liabilities. And claims on Russia are even smaller, amounting to a mere EUR 4.5 billion, compared to liabilities of EUR 7.5 billion.
In short, Germany companies’ credit-related financial claims vis-à-vis China and Russia amount to less than 1% of German GDP. On a net basis, they amount to almost zero. Total claims on China and Russia are insignificant from a macro-financial perspective, even if they may represent more significant risks to individual German companies.
German companies’ foreign direct investment amounts t EUR 1.4 trillion, or a sizeable 60% of GDP. Once again, overseas FDI is strongly concentrated in other EU countries, the UK and the USA. However, German FDI in China is significant at more than EUR 100 billion, even if it pales in comparison with the EUR 400 billion worth of German foreign direct investment in the United States. Moreover, China also accounts for 10% of German foreign investment enterprises’ annual turnover.
German FDI in Russia is comparatively small. In 2021, it was EUR 23.2 billion (on a “gross” basis). And a significant share of this amount may already have been written down since 2022.
Finally, Germany’s “net” FDI exposure vis-à-vis China and Russia is less favorable than in the case of credit claims, for Chinese FDI in Germany amounts to less than USD 5 trillion and Russian FDI to less than USD 3 billion.
German financial exposure to China is significant, but it also happens to be highly concentrated in the sense that ten German companies account for ¾ of German FDI in China. The credit exposure of German companies is pretty insignificant at the macro-financial level.
Overall, Germany’s trade and financial vulnerabilities vis-à-vis China and Russia are manageable, particularly on a “net” basis. On the trade side, the dependence in terms cost-effective alternatives and China dominant or monopoly supplier represents a more serious risk.
Ultimately trade matters more than finance to the extent that the loss of access to critical intermediate inputs has the potential to cause far greater economic harm than a trade-related reduction in GDP, or financial losses.
German government and the EU should therefore address the most critical trade-related vulnerabilities to limit their geo-economic exploitability and the economic costs that would be incurred in case of disruption of trade relations. The government can help support risk mitigation by providing the private sector with economic and financial incentives in terms of diversification of supply chains, stockpiling of critical goods, re-shoring of production and innovative substitution, all aimed at limiting economic losses in the event the import of critical inputs is disrupted for economic or geo-economic reasons.
[1] IFO Institute, German-Chinese Trade Relations, 38 (6), 2022
[2] Markus Jaeger, Economic Security Strategy Should Focus on Import-Related Vulnerabilities, Memo, 2024
[3] Loans and trade credits do not include participating interests in foreign companies, non-residents’ participating interests in the equity capital of domestic companies or securitized claims and liabilities vis-à-vis non-residents.