Why Europe Will Struggle to ‘De-Risk’ From China – Foreign Policy

Buzzwords in Brussels come and go. In 2021, the concept of “strategic autonomy” was all the rage in Europe’s corridors of power. In theory, it was meant to signal greater European independence in global affairs. But many of its ostensible goals—in trade, finance, and the economy—were primarily aimed against the United States, not least to protect Europe from the effects of U.S. tariffs and extraterritorial sanctions.

Buzzwords in Brussels come and go. In 2021, the concept of “strategic autonomy” was all the rage in Europe’s corridors of power. In theory, it was meant to signal greater European independence in global affairs. But many of its ostensible goals—in trade, finance, and the economy—were primarily aimed against the United States, not least to protect Europe from the effects of U.S. tariffs and extraterritorial sanctions.

The COVID-19 pandemic’s exposure of supply chain risk and Russia’s 2022 invasion of Ukraine have completely reshaped Europe’s economic strategy. “De-risking” is now the magic word to catch the attention of European policymakers. Instead of trying to shield itself from U.S. economic policies, Brussels is now following Washington’s efforts to reduce economic dependence on China.

However, European plans are trailing far behind those of the United States. In part, this is due to the fact that European views on Beijing are typically less hawkish than Washington’s. Yet Europe’s slow progress on de-risking also reflects the fact that curbing economic ties to China will be much harder for Europe than for the United States. Here are five reasons why.

1. Excessive reliance on China is mainly a German problem, not a European one. Germany’s exports of goods and services to China represent more than 3 percent of German GDP—the highest rate in the European Union and more than double the levels recorded in France, Italy, and Spain. German firms also have a huge presence in China, where their annual revenues represent a staggering 6 percent of German GDP, about double the average of Europe’s six biggest economies. The auto and chemicals industries, in particular, are particularly exposed to China. This gives Beijing leverage to retaliate against EU de-risking plans—for instance through boycotts against German firms.

Diverging degrees of reliance on China help explain why views on China are so fragmented across Europe. On the one hand, Berlin and Paris are not averse to closer relations with China, as the recent visits of German Chancellor Olaf Scholz and French President Emmanuel Macron to Beijing illustrate. On the other hand, most Eastern European countries have long been hawkish on China, and Beijing’s tacit support for Moscow’s invasion of Ukraine only hardened their stance. EU fragmentation is not new; hardly any topic unites Europeans. Yet without a consensus on China, any start on de-risking will be hard.

2. The EU has more to lose from de-risking than the United States. Despite all the talk of de-risking, Chinese firms remain by far the largest suppliers of goods to Europe, accounting for around 20 percent of imports during the first six months of 2023. The United States, by contrast, did more trade with Mexico and Canada than it did with China over the same period, the first time that has happened in nearly 20 years. Even if some of this reflects a diversion of Chinese goods via third countries, the shift is significant. Europe’s dependence on China is especially high for goods required for the bloc’s ambitious energy transition: The EU imports more than four-fifths of its lithium-ion batteries from China, for example.

The investment picture is even more striking. Sky-high investment flows in the 2010s have given Chinese firms a solid presence in Europe’s infrastructure, including ports (in at least 10 EU countries), power grids (notably in Portugal, Italy, and Greece), and subsea telecommunication cables (such as the Peace cable connecting Pakistan to France). Over the past three years, Chinese investments in Europe have decreased as Chinese firms focus their attention on high-quality projects, notably in clean tech. Yet inflows of Chinese money remain solid, at $26 billion from 2020 to 2022—compared with almost nothing in the United States.

3. Europe’s ability to get companies on board is limited. Governments can formulate the best de-risking plans, but it will always be up to private firms to implement them. Convincing European businesses to de-risk will be easier said than done. A first option to convince companies to diversify away from China and relocate production to Europe would be to offer them carrots in the form of financial incentives or public investment programs. Yet most EU member states have little fiscal space to implement such policies. A European Inflation Reduction Act, which showered U.S. firms with subsidies to reshore production, is a far-fetched prospect.

Absent carrots, resorting to sticks is the other option, for instance in the form of penalizing firms heavily exposed to China by reducing public subsidies or restricting export credit guarantees. But this would not be a great move: Punishing EU firms for doing too much business with China would weaken Europe’s economy and could even convince businesses to leave the EU, a massive own-goal. Besides, such policies would likely be implemented at the member-state level, creating distortions among European economies and thereby incentivizing firms to relocate to more lenient EU states.

4. For many critical goods, the creation of European supply chains is unrealistic. U.S. firms control the technology to build advanced semiconductors, giving the United States a massive trump card to relocate semiconductor supply chains to U.S. soil. Short of creating an entire semiconductor supply chain—an unrealistic prospect—Europe will therefore continue to depend on the United States in this field. If de-risking is not only about China but about building European self-sufficiency in critical sectors, semiconductors may not be the best place to start.

Even outside the high-tech sector, new European supply chains for other critical goods look far-fetched. Another priority area where the EU wants to de-risk is critical raw materials, a group of metals that will be essential for the energy transition. Brussels has set itself a target of producing 10 percent and refining 50 percent of its annual consumption of critical raw materials by 2030. Given how polluting these activities are, commodity extraction and processing firms know that trying to increase their presence in Europe is unrealistic. Any such plans would meet with intense popular backlash.

5. Europe’s de-risking plans could backfire. The European Commission considers deepening trade ties with Southeast Asian countries to be a sure way to reduce European reliance on China. In theory, this looks like a great idea: Many Southeast Asian economies have succeeded in positioning themselves as industrial alternatives to China in recent years.

The U.S. experience with diversifying trade should serve as a cautionary tale, however. Since 2018, U.S. firms have been doing less business with China and more with members of the Association of Southeast Asian Nations (ASEAN). On paper, this is a clear win, but there is a catch: Over the same period, trade between China and ASEAN has also increased sharply. This suggests that Southeast Asian economies may have become transit or packaging hubs for Chinese goods en route to the United States. In other words, the United States may be relying on China just as much as before, despite what the statistics say. This highlights how de-risking plans can sometimes backfire. By trying to reduce its reliance on Chinese firms, the United States could instead be deepening Beijing’s clout in Southeast Asia and making China’s global economic advances even harder to track.

The bottom line is clear: Europe will struggle to implement its ambitions to de-risk from China, and “de-risking” may one day become only one more item in the long list of Brussels’s bygone buzzwords. This is not good news for U.S.-EU relations. There appears to be little chance that Washington will change tack and mend ties with Beijing, especially as China’s imperial ambitions concerning Taiwan become increasingly clear. China is the clear winner of any U.S.-EU discord, and we should expect the Chinese leadership to do everything it can to deepen the de-risking wedge between Europe and the United States. Seen from Beijing, Europe’s continued economic dependence on China is the greatest possible insurance against EU sanctions should China make good on its threats to invade Taiwan.