China-German economic ties set for rebalancing

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Germany’s export machine will be hit by a rebalancing of China's economy, but the special relationship between the world’s second- and fourth-largest economies might provide a springboard for the development of more sustainable economic ties.

That future will see a blurring of their respective traditional economic roles: China selling Germany textiles, electronic goods and toys; and Germany selling China capital goods – the machinery and equipment that helped turn it into the world’s factory.

If China delivers on the domestic-driven growth it has promised, Germany might sell less machinery and power-station turbines, but it will sell more and more of the quality consumer goods it is so good at producing, from cars to luxury kitchens, and high-end audio equipment to sporting goods.

Although two-way trade is down, Germany ran a trade surplus of €4.7 billion with China in the first six months of this year, according to figures from Eurostat, placing it on track to reverse the €10.7 billion surplus registered by China in 2012. Germany accounted for 45%, or €32.4 billion, of the EU's exports to China in the first half of 2013, according to Eurostat. 

 
Source: Eurostat 
Investment is already an increasingly important feature of the Sino-German relationship. In addition to an ever increasing tally of joint ventures, China is buying up a small but growing number of Germany’s Mittelstand – small and medium-sized private firms – and Germany is investing in manufacturing plants in China.

But analysts warn that slower Chinese growth will hit both sides, as China transitions from its current export-led investment growth model to a consumption-driven domestic economy.

“The old Schumpeter idea of creative destruction sounds good, but the fact is in the real world the destruction comes first and the creation comes later. A big change for an economy like China invariably involves a slow patch,’’ says Charles Dumas, Lombard Street Research’s chief economist. “In the past 10 years China has been growing at 10% a year and consumption growing at 7%, but investment was hugely increasing its share. In future we expect consumption to continue to grow at 7% but GDP to grow at only about 5% a year.

“This means investment, which is the main source of German sales to China, is hardly growing at all. If China is slowing down in general, and particularly in the area of investment, then that does mean that the German export machine will see very much less growth than in the past.’’

Dumas says German exporters are feeling the impact already, with weaker October orders. Orders for capital goods from outside the eurozone are down more than 5%.

“Ultimately, domestic-driven growth can replace investment growth. But if you have an investment rate of 48% of GDP when it should be 35%, if investment is falling the other 52% has to do quite a lot of work just in order to keep the economy moving at all, let alone going up.” He adds: “The 52% is mostly government or personal consumption, but also a little bit of net exports and since they’re heavily overvalued as well, the net exports piece is not very constructive, so you don’t get this rebalancing in any easy kind of way.’’

The days of Sino-German interdependence might already be numbered. China’s growing importance to Germany can be seen in the number of German firms attributing their resilience to European austerity to China orders, and Berlin’s reluctance to confront China on virtually any issue.

China is moving up the manufacturing value chain, becoming an increasingly effective competitor in Germany’s traditional industrial domains. A recent study by a global investment bank identifies several sectors expected to face rivalry from China before long, from power generation to high-speed rail.

With rebalancing likely only to slow, not halt, the rise of China’s industrial power, German industry’s competitiveness might increasingly depend on retaining its edge in technology, design, and quality.

That edge shows little sign of being eroded. For example, BMW is launching its new cutting-edge i3 all-electric car in China next year but Brilliance Auto, its local partner of 10 years, is lagging behind with its own green-car projects, and will need BMW’s help to try to catch up.

So far this year, there have been 13 Chinese acquisitions of German firms, worth $1.3 billion, according to Squire Sanders, a law firm that advises Chinese clients on outbound investment and M&A. That’s down on last year when 15 deals worth around $3.2 billion were four times the value of deals in 2011.

By comparison, VW alone is investing €18.2 billion in China in new production facilities and products between 2014 and 2018. However, like most foreign investment in China, it will be through VW’s joint ventures with Chinese partners.

Most of the Chinese takeover deals were for German companies in the automotive and industrial sectors – areas that are seen as complementing China’s industrial development goals.

Benjamin Kroymann, a Shanghai-based partner at Squire Sanders, says German exporters will eventually be adversely affected by rebalancing but it will take 10 to 15 years before they really start to feel the effects. “I don’t see demand for the machinery and industrial equipment that Germany sells to China falling in the near term,” he says. “Demand will also be supported by infrastructure requirements away from the developed coastal regions that remain considerable.

“Over the longer term, slower orders growth in these sectors will be offset by increased demand for German consumer products. Awareness of German brands is already very high.’’

Joachim Heine, partner in the firm’s Frankfurt office, acknowledges that the Chinese are becoming more competitive in various fields. But he says that by and large German industry’s capacity for continuous technological innovation means it is unlikely to face any big threat from China for some time to come. "This is something at which the auto industry, in particular, excels,” he says. “For example, in new technology such as electric cars.”

Chatham House argues that the recent step-up in German investment, particularly by the auto makers, is a sign of Germany positioning itself to capitalize on potential future consumer consumption in China. “Developing and building up an auto industry has traditionally been part of the developmental-modernization process and the Chinese clearly want to do the same,’’ says Asia programme associate fellow Rod Wye.

“The Chinese don’t seem to have put any sort of breaks or concerns on that kind of process where there are questions over the value of having millions and millions more cars on China’s roads.’’

Wye concludes: “The economic relationship is going to remain a strong and important one, both because the Chinese do still want the types of goods the Germans produce and are likely to for a while to come, and because of the investment relationship.’’

 
Source: Centre for Eastern Studies/Ośrodek Studiów Wschodnich