As a highly open economy, Germany is at greater risk of sustaining losses in the event of international economic fragmentation, let alone a systemic breakdown of international economic relations. Economic openness also makes it more susceptible to geo-economic coercion. In the event of a war over Taiwan, for example, international and trade financial flows might be severely impacted. Germany’s close economic relations with China would translate into significant losses. Germany should therefore continue to de-risk, particularly with respect to critical imports from China and, less urgently, German direct investment in China.
Trade-related risk is broadly manageable, but dependence on critical imports must be addressed
In terms of trade, Germany is the most open G7 country. Exports and imports of goods and services are equivalent to nearly 90% of GDP. For Japan, the respective figure is less than 40% of GDP and for the United States it is 25% of GDP. However, the bulk of Germany’s trade is with EU partners and geopolitical allies. This helps limit 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 was Germany’s second most important partner with EUR 250 billion worth of bilateral trade. The United States and China were Germany’s largest and fourth-largest export market with goods being shipped accounting for 4% and 2.7% of GDP.
While Germany is much more dependent on both China and the United States in terms of trade than vice versa, EU-China and EU-US trade relations are more balanced. Broad-based decoupling would lead to tangible economic losses on both sides. Hence the mutual interest in avoiding a broader trade conflict. In the context of the EU’s trade defense policy, the more balanced EU-China and EU-US trade relationship affords Germany significant protection from potential Chinese geo-commercial coercion.
Germany’s most significant trade-related vulnerability, and the vulnerability most easily and efficiently exploited is its dependence on critical imports – an import is critical if it is difficult to substitute at a reasonable cost and its lack of availability risks significant economic or social disruption, or lowers national security (e.g. energy, rare earths, semiconductors, medical supplies, defense goods). China accounts for 7% of Germany’s imported intermediate inputs or 1% of German final output. Almost half of all German industrial firms that rely on intermediate inputs from China. This suggests that a selective or wholesale stop of Chinese imports would cause significant economic disruption, even if quantitative measures fail to capture the actual impact of a sudden import stop.
A broad trade war between the EU and China is unlikely given their somewhat comparable level of interdependence. However, selective export restrictions targeting critical goods is a source of potential geo-commercial leverage as well as a potential source of economic losses for Germany. Export restrictions are efficient in that they limit the costs to the coercer, while potentially imposing significant economic costs on the target economy (e.g. 1973 Arab oil embargo). Hence the need to address import-related vulnerabilities.
Geo-financial vulnerabilities are also manageable – at the macro-financial level
Germany is not just the most trade-dependent country among the G7. It is also the largest net international creditor with claims amounting to 70% of GDP. Gross foreign financial claims amount to a massive EUR 12.6 trillion or 300% of GDP. Similar to trade disruption, a breakdown of international and especially financial relations has the potential to cause sizeable financial losses, as the recent (partial) severing of financial ties with Russia demonstrated.
The geographic breakdown of the financial claims matters in view of likely patterns of economic fragmentation and geo-economic coercion risks. In 2023, German companies’ credit claims vis-à-vis non-residents amounted to EUR 1.4 billion (or roughly 35% of 2023 GDP), their liabilities to EUR 1.75 trillion. Again, EU partners and geopolitical allies account for the bulk of international claims. By comparison, credit-related claims vis-a-vis China are small at just EUR 31 billion. This compares to EUR 24 billion of German liabilities vis-à-vis China, which translates into a “net exposure” of just EUR 7 billion. Put differently, German companies’ credit-related financial claims vis-à-vis China amount to less than 1% of GDP. On a net basis, they amount to almost zero. German companies’ credit exposure to China is insignificant from a macro-financial perspective, even if they may represent sizeable risks to individual German companies.
German companies’ foreign direct investment amounted to EUR 1.4 trillion in 2021, or a sizeable 40% of 2021 GDP. Overseas FDI is strongly concentrated in other EU countries, the UK and the USA. Compared to credit-related claims, however, German FDI in China is a sizeable EUR 100 billion. This pales in comparison to the EUR 400 billion worth of German foreign direct investment in the United States, but it is sizeable. German FDI related claims on China are equivalent to 2% of GDP. German foreign direct investment is also highly concentrated with ten companies accounting for 70% of German FDI in China. China also accounts for roughly 10% of German foreign investment enterprises’ annual turnover; America account for almost double . Unlike in the case of companies’ credit claims, German FDI liabilities vis-à-vis China are less than USD 5 billion and therefore do not provide much of an offset in case of losses are incurred on German FDI in China. In short, German FDI in China is sizeable, but from a macro-financial point of view it does not look unmanageable – though a more detailed analysis is required to work out how financial losses might cascade through the German economy in various geopolitical scenarios.