For three decades, Europe viewed China primarily as a market. Now that the relationship has changed, it is struggling to protect its industrial base.
Fifty thousand jobs are set to disappear immediately. As many as 100,000 positions could eventually be cut across the group’s brands. That is the latest round of belt-tightening Volkswagen is preparing to impose on itself, on top of previous workforce reductions already announced.
The German giant is embarking on a restructuring programme aimed at drastically reducing costs, halving its model range and making its factories more productive. The prospect of ending car production at some German plants is even on the table. The group’s net profit fell 30% in the first half of the year.
Volkswagen has plenty of problems of its own. Overhead costs are too high, according to CEO Oliver Blume. The transition to electric vehicles has been hampered by mistakes and delays. US tariffs have added another challenge. Energy costs, following the break with Russia and Germany’s decision to phase out nuclear power, have made matters worse. But looming over all these problems is a much bigger one: China.
Volkswagen is a perfect symbol of what is happening to European industry. For three decades, Germany viewed China primarily as a market. German companies sold Mercedes, BMWs and Volkswagen-Audis to Chinese consumers, along with industrial machinery and chemicals. China supplied the West with T-shirts, toys, furniture and consumer electronics. It was an international division of labour that worked particularly well for Germany: Beijing became the world’s factory, while Berlin sold it the factories.
That world no longer exists.
China now produces electric cars, batteries, industrial machinery, solar panels, drones, sophisticated chemicals and telecommunications equipment. It is moving into virtually every sector where Germany and Europe had built competitive advantages.
This is the “second China shock”.
The first China shock was studied mainly by US economists. It began with China’s accession to the World Trade Organization in 2001. A flood of cheap Chinese goods swept through entire segments of US manufacturing. The adjustment proved far more painful than expected: factories and jobs disappeared in the regions most exposed to Chinese competition, while the shift towards new economic activities was slow.
Europe, and Germany in particular, experienced that period differently. It lost some low-value-added manufacturing, but gained in other areas. The more factories, highways, metro systems and cities China built, the more German technology it bought. And as China’s middle class expanded, demand for German cars grew.
The second shock is reversing that relationship.
Chinese consumers no longer want to buy Volkswagen cars. They are buying BYD and other domestic brands instead. China is not merely meeting its own domestic demand. It is exporting. And when Chinese companies face barriers in the United States, an increasing share of their excess production capacity is looking for markets elsewhere, including Europe.
The phenomenon extends far beyond cars.
Shannon O’Neil, in an analysis published by Bloomberg, notes that China’s enormous trade surplus is not simply the result of greater efficiency. Beijing has built an industrial system in which subsidised credit, cheap land, tax breaks, state support and protection of the domestic market artificially lower the cost of capital and allow companies to expand production even when domestic demand is insufficient to absorb it.
According to an estimate by the International Monetary Fund, Chinese government support for businesses amounts to 4.4% of GDP, nearly three times the European level. Public support allows a very large number of struggling and inefficient Chinese companies to survive — firms that, in a market economy, would be forced into bankruptcy.
Then there is the exchange rate.
Brad Setser, an economist at the Council on Foreign Relations and one of the world’s leading specialists on trade imbalances, argues that official Chinese statistics underestimate the true size of the country’s external surplus. Applying the same methodology used by the IMF points to an undervaluation of the renminbi, or yuan, of more than 30%.
This is not an academic dispute. An undervalued currency amounts to an additional price advantage for exporters.
The second shock is reaching Europe with particular force at a time when China itself needs to export more. The property crisis has weakened domestic demand. Chinese households continue to save heavily. Xi Jinping has resisted any decisive rebalancing of the economy towards consumption. He has also refused to build a stronger welfare system that would give citizens greater security and make them less inclined to save.
Beijing’s chosen solution remains the one it knows best: more investment, more industry and more production.
But if China produces far more than it consumes, someone elsewhere in the world has to absorb the surplus.
That is where Europe’s problem begins.
The United States has long opted for a tough response. From Biden to Trump, despite their very different tools and political ideologies, there has been considerable continuity in Washington’s view that China’s industrial capacity represents a strategic problem.
The US uses tariffs, investment controls, technology restrictions, rules of origin and sanctions. Trade agreements pursued by the Trump administration have even sought to prevent Chinese goods from circumventing US barriers by passing through third countries.
Europe, by contrast, continues to behave largely as if its overriding priority were to preserve the old global trading order.
That is a noble position. Faced with an adversary such as the People’s Republic of China, however, it risks becoming self-defeating.
Over the past five years, Brussels has concluded or renewed trade agreements with a long list of countries, including New Zealand, Kenya, the Mercosur bloc, Singapore, Indonesia, India, Chile, Ukraine and Mexico. Together, these agreements cover economies representing almost a third of global GDP.
O’Neil identifies a paradox here. Europe is building a broad commercial coalition, but it is not using that coalition to confront what may be the biggest distortion in global trade. China continues to operate under a model that is incompatible with many of the conditions Brussels demands from its own trading partners.
The European Union is not powerless. It has imposed tariffs on Chinese electric vehicles. It has launched a record number of anti-dumping and anti-subsidy investigations. It has introduced measures targeting foreign subsidies in public procurement. It also has a carbon border adjustment mechanism.
The problem is the scale of the response — and, above all, its speed.
European procedures are slow, proceeding sector by sector and product by product. Authorities must establish the damage, measure the subsidy, consult governments and overcome political divisions. By the time protection against unfair Chinese competition finally arrives, part of Europe’s productive capacity may already have disappeared, been destroyed or written off.
That is what happened with solar panels.
This is why the idea of a much more radical response is beginning to gain traction: a kind of European Section 301, modelled on the US mechanism that allows Washington to respond quickly to unfair trade practices.
Others have proposed limits on the share of imports that can come from a single country. Another option would be to use tariffs to pressure Beijing into allowing the renminbi to appreciate.
Behind this debate lies a reality Europe was slow to recognise: the Chinese market is becoming less important as a source of growth for European exports.
The numbers are striking. Over the past five years, European exports to China have fallen by around 15%. Over the same period, exports to the United States have risen by roughly 30%.
A similar trend can be seen among other US allies. Exports to China have fallen by about 20% for Japan, South Korea and India, while exports to the United States have increased by around 30% for South Korea and India.
The US now absorbs between 20% and 30% of the exports of its main allies.
These figures complicate the conventional picture of transatlantic relations considerably.
Europe devotes enormous energy to protecting itself from American protectionism. That is understandable. Trump’s tariffs represent a real cost for European companies. But at the same time, the US market is becoming increasingly important to them, while the Chinese market is shrinking.
The American threat is visible because it takes the form of a tariff announced — and usually loudly proclaimed — by the White House.
The Chinese threat is more insidious. It manifests itself through the gradual loss of market share, shrinking profit margins, excess European production capacity and, ultimately, layoffs.
For Europe, the China question is therefore becoming more than a trade dispute. It concerns the future of its industrial base itself.
The United States has decided, perhaps excessively and chaotically, that certain productive capabilities must be protected even at the cost of sacrificing some of the efficiency associated with free markets.
Europe continues to hope that refining the rules will be enough.
But rules work only when the players accept comparable constraints.
If an economy the size of China can massively subsidise production, keep its currency weak, suppress domestic consumption and push an increasing share of its industrial capacity onto the rest of the world, defending free trade risks becoming a one-sided defence of a system that the other player is exploiting to its own advantage.
Europe is discovering too late that it has been fighting the wrong battle.
It fears becoming dependent on America. Yet in trade, its dependence on the US market is increasing because that is where its exports are growing.
It fears protectionism in Washington. But the deeper threat to its industrial base may come from the country it continues to describe as an indispensable trading partner.
The 50,000 Volkswagen jobs being cut immediately are a warning sign.
The second China shock is no longer a forecast.
It has begun.
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