Germany eyes Southeast Asia amidst a faltering Chinese economy

Amid signs of China’s economy faltering, countries worldwide are bracing for impact, looking for strategies to sidestep the anticipated fallout. The EU’s strategy focuses on ‘de-risking’ its supply chains, and Germany is following suit. Its new approach is to turn its investment towards a different region, namely, Southeast Asia. Last week, German Chancellor Olaf Scholz hosted leaders of Malaysia, the Philippines, and Thailand in Berlin. However, as German companies continue to double down on their economic activities in China, we are reminded of how difficult it is to envisage an economic system without China’s domineering presence.

Germany’s move to reduce its reliance on China emerges as a sensible strategy for reasons that are not purely economic. It is becoming increasingly difficult for democratic countries to justify their investment in a country that goes against the values they want to promote. And now, as China’s future economic activity seems increasingly uncertain, the reasons to review Chinese economic ties are becoming stronger.

For Germany, this is particularly important. China is their largest trading partner, accounting for approximately 1/5 of their total trade. More worryingly, as the volume of trade between the two has risen, so has Germany’s trade deficit widened. A decline in demand, stemming from China’s economic deceleration, is contributing to this. Coupled with a hike in import prices, this bilateral trade deficit with China reached €81.9 billion in 2022.

In response, Scholz has called for an updated China strategy, highlighting the need to diversify the country’s supply chains and turn investment elsewhere. And where better to turn to than Southeast Asia. Already last year, a series of diplomatic trips around the area by the German President and Minister for Foreign Affairs expressed Germany’s heightened interest in building strong relationships in the region. The reasons for this are clear. Firstly, they have many of the raw materials that Germany currently relies on China for. For example, Indonesia mines significant amounts of nickel, a metal that can be used for batteries. As the economies of the region are strengthening, they are rapidly expanding their development of electric vehicles, a market that Germany already dominates in Europe. Germany’s largest semiconductor manufacturer, Infineon Technologies, is already building a plant in Malaysia for EV batteries. Stronger economic ties with the region could therefore yield significant returns.

But a transition away from China is not going to be easy. Firstly, it requires the cooperation of German companies. As it stands, many of the largest German firms are still profiting from their deals in China, with some doubling down on their investment. Their dependency is twofold, reliant on both China’s vast reserves of raw materials and the demand from its massive consumer base. This is particularly true for Germany’s automotive industry giants, namely Volkswagen, Mercedes-Benz, and BMW.  Another major example of this is the German company and largest chemicals producer in the world, BASF, who have continued their expansion in China whilst cutting back investment in Europe. As the financial aims of these companies continue to diverge from their home country’s policies, many are increasingly reliant on Chinese demand, producing in China for China. The implications of this for the German economy cannot yet be understood.

Germany still relies on China for 95% of solar cells, 80% of laptops, and raw materials that are essential for electronics

Furthermore, even if companies were more proactive in moving away from China, Germany cannot end its dependence overnight. It still relies on China for 95% of solar cells, 80% of laptops, and raw materials that are essential for electronics. For the moment, there seems to be no single nation or collective that can fill the void China might leave. While Southeast Asia holds many opportunities, much of their infrastructure remains underdeveloped, especially in regard to the production of EVs. Because of this, their markets are significantly smaller. For example, in 2022, EVs accounted for 2.1% of total vehicle sales in Southeast Asia, compared to 29% in China.

Thus, Germany’s reduction of its trade deficit with China might not actually be good enough. Because it is not about the quantity of trade, but the kinds of goods being traded. As long as the German economy is dependent on China for strategic resources, it is still vulnerable. Investing in Southeast Asian countries, while being a step in the right direction, will only partially mitigate this. Ultimately, Germany’s predicament serves as a stark reminder of the challenge ahead for countries aiming to unravel their economic dependencies on China.