The reporter for Xinhua, the Chinese state news agency, cut straight to the chase: “You never plan to get out of the Chinese market, do you?” she asked.

She was addressing Jeffrey Lou, the president and chairman of Greater China at BASF, the German chemical giant, in a televised interview published on October 1, 2022. BASF had just started production at its newest site in China, with the promise to make its largest ever investment of €10 billion there by 2030 — all at a time when many Western companies are talking about “decoupling” from the Chinese market. 

Lou, who was born in China, responded in Mandarin and in the matter-of-fact business style that fits his advanced degrees from the Massachusetts Institute of Technology and the University of Pennsylvania. BASF still hadn’t captured the country’s full potential, he said, “therefore, we believe that BASF’s investments in China can be further increased.” 

In other words, no — despite the many tensions and pressures, BASF isn’t planning on leaving China anytime soon.

BASF is one of those enormous but invisible companies: significant in the business world but almost unknown to the everyday consumer. Its products — which generated €78.6 billion in revenues last year — can be largely grouped under the heading ‘chemicals,’ but they run the gamut from agricultural pesticides to advanced manufacturing plastics and raw pharmaceutical ingredients. 

For China — a country with a seemingly never-ending hunger to upgrade its industrial, agricultural and medical sectors — BASF’s products are essential. China is currently the company’s second largest customer (behind the U.S.) and its biggest growth opportunity. 

This is true for many of Germany’s largest companies. Since German industry specializes in goods that other countries need to modernize and industrialize — like cars, chemicals and factory machinery — many of the country’s most prized companies are doubling down in China. Volkswagen, for instance, which delivered 40 percent of its vehicles to Chinese customers in 2021, recently committed €2.4 billion to a joint venture with Chinese AI firm Horizon Robotics. BMW, too, extended its joint venture with Chinese carmaker Brilliance to 2040, and increased its stake in the partnership from 50 to 75 percent. According to the German Economic Institute, a think tank, German foreign direct investment flows into China reached record highs in the first half of 2022, at around €10 billion.

“The German economy is really amenable to success in China,” says Pepijn Bergsen, a research fellow at Chatham House, a think tank in London. “Given the preponderance of high tech manufacturing in Germany, [a close economic relationship with China] has made sense for a long time — there are synergies with the Chinese economy.”

Indeed, Germany’s economic relationship with China is unique among Western countries. While Germany, like most of the West, has imported more from China than it has exported over the last two decades, the imbalance is much less significant than for other countries, including the United States.

Germany has also fostered a special political relationship with China. While many Western countries embraced “engagement” with China, experts say the philosophy is more embedded in the German psyche. As Olaf Scholz, Germany’s Chancellor since 2021, recently wrote in Foreign Affairs, “Our experience of being split in half during an ideological and geopolitical contest gives us a particular appreciation of the risks of a new cold war.” 

And just like Germany’s largest companies, Scholz is meeting words with action. In November, he was the first Western leader to visit Beijing since the COVID-19 pandemic, and he traveled there with a delegation of business leaders. Despite opposition from within his own government, he even pushed through a deal in October that saw Chinese state-owned shipping company COSCO take a 24.9 percent stake in the port of Hamburg, a major trading hub.¹This was lower than the initial proposal of 35 percent. 

“Traditionally, he has viewed China more through a trade perspective than a geostrategic perspective,” says Liana Fix, an expert on German foreign policy at the Council on Foreign Relations.

Scholz is not alone in this. German policymakers have long stood by a foreign policy philosophy known as ‘Wandel durch Annäherung,’ or ‘Change through Rapprochement’ — a phrase that was first coined in the 1960s to guide Germany’s normalization of relations with communist Eastern Europe. The principle was later applied to China and is now more commonly referred to by its pithier formulation ‘Wandel durch Handel,’ or ‘Change through Trade.’

Years from now, we may look back on [Scholz’s] outreach to Beijing as a last gasp attempt to preserve a relationship veering toward competition and rivalry.

Noah Barkin, a managing editor at research firm Rhodium Group

Germany’s fusion of business interests with ideological mission helped boost its extraordinary export success during the past half century, and it has meant that German firms like BASF have grown accustomed to going about their business, free from government intervention. 

But many observers say the German system is now under pressure as the world around it changes — specifically regarding China. With much of the West turning on the idea of ‘engagement,’ a growing chorus of German business leaders and politicians are questioning the Wandel durch Handel tradition, especially after Russia’s invasion of Ukraine and subsequent weaponization of energy supply. 

“I want to say very clearly that one-sided economic dependency makes us open to political blackmail,” German Foreign Minister Annalena Baerbock said at a policy forum in Berlin in October. 

Baerbock is a member of the more hawkish Green Party, which governs alongside Scholz’s Social Democratic Party and the Free Democrats in a coalition and which holds both the Foreign Affairs and Treasury portfolios. She has also said Germany needs to come “to grips” with the fact that “interdependence also involves risks.” Robert Habeck, the Vice Chancellor and member of the Green party, summed up the position simply: “We are of course interested in trade with China, but not stupid trade with China.”

With the historically powerful pro-engagement alliance between German politicians and business leaders under strain, the tension is increasingly spilling into the public arena. Scholz’s November trip to Beijing was accepted, it seems, through gritted teeth by his coalition colleagues — “the Federal Chancellor has decided the timing of his trip,” Baerbock told German newspaper Der Spiegel at the time. Just two weeks earlier, in the midst of debate over the COSCO-Hamburg port stake, German intelligence officials told Parliament they were “very, very critical of the participation of China in critical infrastructure,” according to Reuters. 

Feeling the pressure and sensing the shift, a group of German business leaders, including the CEOs of BASF, Bosch, and Siemens, jointly penned an op-ed in November, in which they argued the public discussion had become too focused on rivalry with China, and not on the benefits cooperation could bring. 

“Despite all the challenges facing China and with China, we are convinced that its fundamental growth momentum will remain,” they said. “A withdrawal from China would cut us off from these opportunities. It is therefore in Germany’s own interest that we continue to use the momentum in China to stimulate growth and strengthen Europe.”

It’s unclear which side will prevail, but some observers say the Wandel durch Handel logic could be irreversibly cracked, marking an end to the approach that has defined Germany for more than half a century.

“Years from now,” says Noah Barkin, a managing editor at research firm Rhodium Group, “we may look back on [Scholz’s] outreach to Beijing as a last gasp attempt to preserve a relationship veering toward competition and rivalry.”

OPPORTUNITY KNOCKS

German leaders are experienced in the art of doing business across political divides. In November 1999, German Chancellor Gerhard Schröder and Chinese Premier Zhu Rongji clinked champagne coupes in Beijing to celebrate the more than $3 billion worth of deals signed during the Chancellor’s short visit. Yet, alongside trade, the men also discussed issues that would seem unspeakable today — such as China’s human rights violations and democratic values.

“I’m glad we agreed on a new way forward in our dialogue about the democratic state,” the Chancellor said.

“Democracy, legal reform or legitimacy and human rights — we have already set up a channel of exchange and communication with Germany,” said Zhu. “China is willing to learn from other countries about the experience of democracy and legitimacy.”

The event encapsulated the Wandel durch Handel approach. Hiccups in the Berlin-Beijing relationship and disagreements about values were manageable so long as German cars, chemicals and machinery continued to flow into China. 

While many Western democracies profited from selling raw materials into China’s industrial machine, most began importing manufactured goods from the booming Chinese economy at a much faster pace than they exported their own.

Not Germany. 

[Schröder] realized that Russia, and particularly China, were export markets Germany could benefit from, which is why he started going regularly to China, taking business delegations with him. It was a win-win for both sides.

Gert Hilgers, an honorary research fellow at Warwick University

“Germany’s industrial model has two prime sectors: automobiles and machine engineering,” says Etienne Schneider, an expert on German industry policy at the University of Vienna. “Those two sectors were almost perfectly complementary to Chinese demand.”

In 1984, for example, Volkswagen became the first foreign carmaker to launch a Chinese joint venture, producing the Santana for the Chinese market. Bosch, the appliance manufacturer and auto-parts supplier, opened an office in Beijing in 1990, and had at least nine joint ventures in the country by 1995. In 1986, German pharmaceuticals and chemical materials leader Bayer established representative offices in Beijing and Shanghai, and signed an agreement with China’s Ministry for Chemical Industry in 1993 to expand its business there, which led to the founding of 12 joint ventures between 1995 and 1997. By 2003, when China’s rise was well on its way, Daimler — parent company of Mercedes-Benz — and BMW had both set up joint ventures to produce cars in China, for the Chinese market.

As China modernized and industrialized, German exports to China soared from just over $7.5 billion in 1995, to more than $50.4 billion in 2008, according to UNCTAD data. For comparison, French exports to China rose from $2.6 billion to just $13.3 billion in that same time period. German foreign direct investment flows into China also rose, from €267 million in 2000 to almost €2.5 billion in 2008, according to Rhodium data. France’s FDI flows to China in 2008 were less than half Germany’s.

“At the time [Chancellor] Schröder came into office in 1998, Germany was seen as the ‘sick man of Europe,’” says Gert Hilgers, an expert on Germany’s China policy and an honorary research fellow at Warwick University. “But he realized that China was an export market with tremendous potential for the German economy, which is why he started traveling there every year of his chancellorship, taking large business delegations with him. It was a win-win for both sides. German exports rose really quickly and helped the German economy get back on track.”

When Angela Merkel came to the Chancellery after Gerhard Schröder, in 2005, German industry was going from strength to strength in China. China’s accession to the World Trade Organization had opened even more doors for Germany’s so-called Mittelstand –– the mid-sized firms specializing in everything from auto parts to electrical wires –– to sell their products into China’s booming manufacturing marketplace. 

Despite Merkel’s many disagreements with her predecessor, she continued his tradition of regular visits to Beijing, often traveling with business delegations. After growing up in East Germany — she was 35 when the Berlin Wall fell — Merkel believed deeply in the power of engagement. “The alternative to globalization would be shutting ourselves off from others, but this is not a viable alternative. It would lead only to isolation and misery,” she told the U.S. Congress in 2009.

This philosophy, coupled with Germany’s longstanding commitment to free markets, meant that China’s rise was a welcome idea — especially if Germany would benefit from it. By 2016, following a series of pro-China policies under Merkel, China became Germany’s largest trading partner, overtaking the United States.

Germany, of course, had the same frustrations as many Western governments and businesses during this time. China’s glacially-paced improvements in market access and intellectual property protections, for instance, were a constant struggle. But the pain points were often considered irritants that paled in comparison to the opportunity, and which could potentially be overcome through political engagement and negotiations. 

“For a long time, it was all seen as the necessary cost of doing business with China,” says Hilgers. “There was, and still is in part, this belief in Wandel durch Handel.”

With Germany’s largest manufacturers still reaping the benefits of engagement with China well into the 2010s, Berlin held out as a staunch defender of free trade even as Washington began to reconsider its approach to Beijing. 

But, in hindsight, many observers say the cracks were starting to form as early as 2016, when the Chinese company Midea made a pitch to acquire the German robotics champion Kuka. The €3.7 billion deal went through in January 2017, shocking Berlin and prompting the government to tighten its investment screening rules. Then, in January 2019, Germany’s influential business lobby, the Federation of German Businesses (BDI), released a white paper entitled “China – Partner and Systemic Competitor.”

BDI’s paper rippled through European business and political circles because it did what few expected from a group with such deep interests in the Chinese market: it outlined the threats posed to German companies by China’s state-dominated industry, and for the first time, acknowledged that China was not only a market, but also a competitor.

“Everyone describes this paper as a turning point, an outstanding moment for industry,” says Patricia Schetelig, a China expert at BDI and a contributor to the paper. “But we didn’t really write anything totally new in the paper. It was more the fact that we said it as the Federation of German Businesses, because it was new for businesses to be critical [of China].”

Indeed, despite voices like BASF’s CEO Martin Brudermüller, Noah Barkin, from Rhodium, says Germany now has “a silent majority” of businesses that are much more skeptical about conditions in China. In addition to market access and intellectual property frustrations, smaller and mid-size German businesses have been rattled by revelations about the scale and extent of forced Uygher labor in Xinjiang, the escalation of the trade war between the U.S. and China, and China’s intense response to the COVID-19 pandemic.

While Germany’s loudest business voices remain committed to China, Barkin says there are “big divisions in the business community.” 

By the time of Germany’s September 2021 elections, which saw Merkel finally stepping down as Chancellor and the more hawkish Greens party winning popular support, the scene was set for a re-evaluation of Germany’s China policy.

STRESS TESTS

In the winter of 2021, the new Government’s coalition agreement explicitly promised a new ‘China Strategy,’ but it wasn’t until two months later, in February 2022, when Russia invaded Ukraine, that the issue exploded in the public debate.

Germany’s increasing reliance on Russian gas has long been justified by Wandel durch Handel logic: Germany and Russia were mutually dependent, the argument went –– Germany on Russian gas, and Russia on German revenues. They could work together economically even as geopolitical foes.

But Moscow’s ensuing use of energy as a weapon with which to punish Europe for the imposition of sanctions was a clear signal that mutual dependency had neither protected Germany nor changed Russia.

Once this realization sunk in, all eyes turned to China. Not only did Beijing fail to condemn Russia’s clear abrogation of international rules of the game, it had also begun speaking about Taiwan in increasingly belligerent terms.

This new coalition government came in last year, dedicated to being tough on China. But then we saw record high investment by German companies in China in the first half of 2022. From the government side, you’re seeing some mixed signals.

Liana Fix, from the Council on Foreign Relations

“Beijing’s support for Russian narratives around the war and Xi Jinping’s strategic alignment with Vladimir Putin have reinforced the view of China as a geopolitical rival and competitor. It has become very hard to make the case that China is still a partner,” says Barkin, from Rhodium.

Or, as Germany’s spy chief put it to the German Bundestag, “Russia is the storm, China is climate change,” according to Reuters.

The Russian example felt particularly ominous given the high visibility and vulnerability of Germany’s flagship companies in China. Of Germany’s top fifteen companies by revenue in 2021, six (VW, BMW, Mercedes-Benz, BASF, Bosch and Siemens) have significant exposure to the Chinese market. For example, Bosch, the engineering and technology company, made just over €16 billion in sales in China in 2021 — about 20 percent of its global revenue. And China is Mercedes-Benz’s biggest sales market — it sold around 40 percent of its cars there in the third quarter of 2022, with almost three times as many vehicles going to Chinese buyers as U.S. customers. 

Many experts say it makes sense that these companies are doubling down in China, especially given how much they’ve already invested there. In many sectors, especially automotives and chemicals, China represents growth markets as well as innovation opportunities. 

“These days for innovation you can say that China is ahead of the game,” says Andreas Feege, a former partner for KPMG Germany who was first stationed in Beijing from 2007 to 2012. “If you can make it there you can make it everywhere.” 

The business case might be understandable, but Scholz’s tacit support for an approach that many say is risky has stirred controversy.

“This new coalition government came in last year, dedicated to being tough on China,” says Fix, from the Council on Foreign Relations. “But then we saw record high investment by German companies in China in the first half of 2022. From the government side, you’re seeing some mixed signals.”

“It’s not that Scholz is too stupid to see the China challenge. Everyone agrees there is a challenge out there,” says Janka Oertel, Director of the Asia Programme at the European Council on Foreign Relations. “The question is: Are we going to go through a 10 year transformation process, where we slowly steer the big tanker of the German economy slightly away from China? Or are we assuming we will see some sort of disruptive change, like the Russian invasion of Ukraine, where all of a sudden, the German economy needs to revamp itself overnight?” 

Scholz, she says, falls in the former camp, and his logic is reinforced by concerns that confrontation with China now could hit the German economy while it’s already on its knees due to the energy crisis.

Still, the potential for a “disruptive change” in the geopolitical landscape is putting pressure on these companies to account for the risk. Liana Fix, from CFR, notes that within Germany, they are considered “too big to fail,” which means that if anything went wrong for them in China, “the state would have to come in and most definitely have to save those companies.”

When asked by The Wire, Germany’s marquee brands all acknowledged that the geopolitical terrain had changed on them because of China, but that they remained committed to the principles of Wandel durch Handel. 

“We are in favor of globalization and open world trade,” a Volkswagen spokesperson told The Wire. “Our company has the opinion that in critical or more complicated times, trade and dialogue are still the right choice.”

Similarly, a BMW spokesperson told The Wire, “We will continue to focus on free trade-based economic cooperation. Our activities in China ensure jobs and prosperity in Germany.”

The extent to which these brands’ China exposure ties to the broader German economy remains in question. Large German firms have localized much of their production for the Chinese market in China, for instance. And although Germany still relies on China as an export market more than other EU countries,²China consumes about 7.6 percent of German exported goods, compared to about 4.8 percent of French exports, according to UNCTAD data. only about 3 percent of German jobs depend directly and indirectly on exports to China, according to Jürgen Matthes, from the German Economic Institute. That means any big trade rupture with China would be painful, but not existential. 

“The German economy overall is much less dependent on selling to China than some large German firms are,” he says.

In any case, it’s possible that the more structural threat to Germany’s economy comes not from the hypothetical bailout of a future VW or BASF, but from the rise of Chinese firms in sectors traditionally dominated by small and medium-sized German enterprises — the very issue canvassed in the 2019 BDI paper. Working out how to meet the challenge of competition from subsidized Chinese companies will be harder than asking companies to conduct geopolitical stress tests, or limiting investment insurance for German firms in China — two policy ideas contained in a leaked draft of Berlin’s China strategy, according to Reuters. 

The fact that the state is back in large economies like China and the U.S. may not be something Germany wants… We’re in that transition zone at the moment — a moment of redefinition of what German power looks like.

Janka Oertel, Director of the Asia Programme at the European Council on Foreign Relations

“I perceive German industry as finding it very, very hard to ask the state or government for support or direction,” says Schetelig, from BDI. “We will always say, ‘Leave the economy to us, we know how to deal, business is independent and we don’t need state guidance and regulation.’ At the same time we now realize there’s a competitor such as China pushing and subsidizing.”³Indeed, BDI’s 2019 White Paper stopped short of advocating government intervention à la the China model, focussing instead on improving Germany’s competitiveness through so-called “framework conditions”, like tax settings, research and development funding, and supporting infrastructure.

It’s not just China, either. The U.S. is increasingly embracing a form of industrial policy that, analysts say, also poses a challenge to German industry, especially in sectors like electric vehicles.

“The fact that the state is back in large economies like China and the U.S. may not be something Germany wants,” says Oertel, from the European Council on Foreign Relations. “You can sit there with a pouty face and say ‘This is not how we like things,’ but that’s not going to stop anyone from doing it. We need a public conversation about what this means. We’re in that transition zone at the moment — a moment of redefinition of what German power looks like.”

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