In this issue of MERICS Europe China 360°, we cover the following topics:
- China’s overcapacity and the EU – All you need to know
- Germany’s China policy under Merz: A rocky road towards risk-aware pragmatism
- Europe-China Diplomatic Tracker: Spain and France top Beijing’s high-level diplomatic outreach to Europe
- Soapbox-MERICS Data Highlight: Germany has been asleep at the wheel in the face of China’s EV policy
Table of Contents
- China’s Overcapacity and EU-China Trade: A Deep Dive
- Understanding China’s Overcapacity Challenge
- The EU’s Response to China’s Overcapacity
- German China Policy Under Merz: A Shift in Tone?
- The Impact of China’s EV Overcapacity on the EU
- EU-China Trade: Beyond Overcapacity
- Case Study: The Steel Industry and China Overcapacity
- Benefits and practical Tips for European Businesses
- Firsthand Experience: Navigating the Complexities
By Esther Goreichy, Jacob Gunter and Grzegorz Stec
In its pursuit of self-reliance and technological security, Beijing’s economic model is generating intense overinvestment, overproduction, and overcapacity in its industrial base. Effectively, China is producing more and more goods across a range of industries while consumption fails to grow in any meaningful way. China now accounts for roughly one third of total global value-added manufacturing, and its trade surplus hit nearly USD 1 trillion last year. The resulting glut of supply is driving down prices globally as more and more China-made goods enter global markets.
The fierce price wars within China’s own market have driven down profitability, and nearly a quarter of its industrial enterprises are now loss-making. In a normal market economy, this would lead to consolidation as the least efficient players exited the market, and prices and profits stabilized. This is not happening at the pace necessary in China, largely due to China’s extensive industrial policy, massive subsidies, cheap financing, and other support measures.
The resulting waste and inefficiencies are tolerated ideologically under the current leadership, which views self-reliance and technological security as essential goals and the scale of its still-growing manufacturing base as one of China’s core geopolitical strengths. China’s overcapacity issue is troubling not because China is a net exporter, but because it is exporting market distortions that warp prices in market economies on an unsustainable scale.
This is deeply problematic for global markets, including in Europe. The European common market, with its robust competition law that binds companies by fiduciary responsibility to their shareholders, is simply not designed for competition with the firms emerging from China’s new economic model.
China’s overcapacity issues are well established and have already impacted some traditional European industries like steel and aluminum. But the current wave is different in that it involves more value-added sectors, like passenger vehicles and EVs.
In a recent report, MERICS identified common drivers and indicators of overcapacity across four case studies, then highlighted other industries with the same drivers and indicators, making them more susceptible to overcapacity in the future. The results are concerning for European industry:
- In the short term: Legacy semiconductors, low- to mid-range industrial machinery and components, IT equipment, low- to mid-range medical devices, and pharmaceuticals.
- In the medium to long term: Electrolyzers, advanced medical devices, advanced industrial machinery and components, and new materials.
The spillover of Chinese overcapacities did not begin with Trump’s tariffs and will not end with their “suspension”. The issue has impacted the EU for some time, as now painfully experienced by a growing range of sectors, particularly the automotive industry.
But it is too early to assess the impact of tariffs, and uncertainties created by their intermittency is creating a new dynamic. China’s exports rose in Q1 2025 over Q1 2024, with a decline in exports to the US more than compensated by an increase in exports to ASEAN (most likely partly to circumvent the tariffs on China) and to the EU. This is aligned with the recent trend, which is not likely to be disrupted by Donald Trump’s stop-and-go tariffs, even if they are disruptive.
In sectors where China exports goods to the US, we expect Trump’s tariffs to cause some exports to be redirected to the EU and third markets, intensifying competition for European companies. The impact will be greater where the EU has strong players, for example machinery and components rather than textiles and footwear.
It is less likely that the tariffs will open opportunities for EU firms in the US market. Evidence from the 2018 US-China trade tensions showed the gap in the US market was not filled by exports from the EU, but rather from South and Southeast Asia, which have a structure closer to China’s (and may be used by Chinese firms to reroute exports to the US).
China’s domestic demand would need to grow significantly to absorb enough excess production to offset its current trade imbalances. It seems unlikely that the current leadership will change course in the economic system it has spent the last 12 years building. Beijing continues to prioritize the supply side of the economy over the demand side. That is unlikely to change, as the entire economic model depends on high savings rates and the deprivation of resources from households to fund industrial policy.
date: 2025-05-16 20:42:00
China’s Overcapacity and EU-China Trade: A Deep Dive
Understanding China’s Overcapacity Challenge
China’s economic growth over the past few decades has been phenomenal,but it has also led to notable industrial overcapacity in sectors like steel,aluminum,and electric vehicles (EVs). This China overcapacity stems from various factors,including:
- Government Subsidies: Generous subsidies to state-owned enterprises (SOEs) and strategic industries encourage production beyond market demand.
- Investment-Driven Growth: A past reliance on investment as a key driver of GDP growth leads to excess capacity, especially in heavy industries.
- Local Government Competition: Local governments often prioritize GDP growth and job creation,leading to overlapping and inefficient investments.
- Technological Advancements: Rapid technological advancements sometimes outpace market absorption rates, creating surplus production.
This overcapacity creates several problems:
- Depressed Prices: Excess supply puts downward pressure on prices, impacting profitability for producers globally.
- Market Distortions: Subsidies and artificially low prices distort global markets, creating unfair competition.
- Environmental Concerns: Overproduction in heavy industries contributes to pollution and resource depletion.
- financial Risks: Over-leveraged SOEs with excess capacity pose systemic financial risks within the Chinese economy.
The EU’s Response to China’s Overcapacity
The European Union is deeply concerned about the implications of China’s overcapacity. The EU’s response is multifaceted, focusing on:
- Anti-Dumping and Anti-Subsidy Investigations: The EU actively investigates allegations of dumping (selling goods below cost) and unfair subsidies, imposing tariffs when warranted. This impacts the EU-China trade balance.
- Trade Defence Instruments (TDIs): The EU utilizes TDIs, such as anti-dumping duties and countervailing duties, to protect European industries from unfair competition.
- Dialog and Engagement: The EU engages in dialogue with China to address overcapacity concerns and promote market-oriented reforms.
- Investment Screening: The EU has strengthened investment screening mechanisms to prevent foreign (particularly Chinese) acquisitions that could undermine strategic European industries.
- Supporting EU Industries: The EU supports its own industries through research and progress funding, skills training, and initiatives to promote innovation and competitiveness.
The EU aims to create a level playing field in EU-China trade, ensuring fair competition and protecting European jobs and industries.
German China Policy Under Merz: A Shift in Tone?
Germany,as the EU’s largest economy,plays a crucial role in shaping the EU’s approach to China. Under the leadership of Friedrich Merz, leader of the Christian Democratic Union (CDU), there’s been a notable shift towards a more assertive stance on German China policy.
While maintaining the importance of economic ties,Merz has emphasized the need for:
- De-risking,not Decoupling: Merz aligns with the EU’s strategy of “de-risking,” which aims to reduce dependence on China in critical sectors without entirely severing economic ties. This is crucial in sectors affected by China overcapacity.
- Protecting Critical Infrastructure: Merz advocates for stricter regulations to protect German critical infrastructure from Chinese investment.
- Human Rights Concerns: Merz has been more vocal about human rights issues in China, including the treatment of Uyghurs in Xinjiang and the crackdown on democracy in Hong Kong.
- Reciprocity in Market Access: Merz calls for greater reciprocity in market access, demanding that China provide European companies with the same opportunities it provides to Chinese companies in Europe.
This shift in tone reflects growing concerns about China’s assertive foreign policy, its human rights record, and its unfair trade practices. The CDU, traditionally a strong supporter of close economic ties with China, is now taking a more cautious and critical approach.
The Impact of China’s EV Overcapacity on the EU
The surge in Chinese electric vehicle (EV) production and exports is a major concern for the EU. This is a prime example of China overcapacity impacting a critical sector.
- Price Undercutting: Chinese EVs, often subsidized by the government, can be sold at lower prices than European-made evs, putting pressure on European manufacturers.
- Market Share Gains: Chinese EV manufacturers are rapidly gaining market share in Europe,potentially displacing European companies.
- Job Losses: The increased competition from Chinese EVs could lead to job losses in the European automotive industry.
The EU is considering various measures to address this challenge,including:
- Anti-Subsidy Investigations: The EU has launched an anti-subsidy investigation into Chinese evs to determine whether they are unfairly subsidized.
- Tighter Safety Standards: The EU could implement stricter safety standards for EVs, which could potentially disadvantage Chinese manufacturers.
- Investment in Battery Technology: The EU is investing heavily in battery technology to support the development of a competitive European battery industry.
- Promoting Innovation: The EU is encouraging innovation in the European automotive industry to ensure that European EVs remain competitive.
EU-China Trade: Beyond Overcapacity
While overcapacity is a significant concern, EU-China trade encompasses a wide range of goods and services beyond the sectors facing overproduction. Key aspects of this trade relationship include:
- Trade Imbalance: There is a significant trade imbalance between the EU and China, with China exporting far more to the EU than the EU exports to China.
- Investment Flows: Both the EU and China are major investors in each other’s economies.
- Supply Chain Dependencies: Many European industries are heavily reliant on Chinese suppliers, particularly for raw materials and components.
- Geopolitical Considerations: Geopolitical tensions, such as those related to Taiwan and the South China Sea, can impact EU-China trade relations.
The following table illustrates the general trade balance trend:
| Year | EU exports to china (approx. € Billions) | EU Imports from China (Approx. € Billions) | Trade Balance (Approx. € Billions) |
|---|---|---|---|
| 2021 | 225 | 472 | -247 |
| 2022 | 230 | 626 | -396 |
| 2023 | 235 | 560 | -325 |
Case Study: The Steel Industry and China Overcapacity
The steel industry provides a stark example of the impact of China overcapacity. For years, Chinese steel producers have been accused of dumping subsidized steel on the global market, driving down prices and harming steel industries in Europe and elsewhere.
Key Highlights:
- Massive Overcapacity: China accounts for over half of global steel production, and its capacity far exceeds domestic demand.
- Subsidized Production: Chinese steel producers benefit from significant government subsidies, giving them an unfair competitive advantage.
- Trade Disputes: The EU has imposed numerous anti-dumping and anti-subsidy duties on Chinese steel products.
- Impact on European Steelmakers: European steelmakers have struggled to compete with cheap Chinese steel, leading to plant closures and job losses.
This situation highlights the need for effective trade defense measures and international cooperation to address the problem of China overcapacity in the steel sector.
Benefits and practical Tips for European Businesses
Despite the challenges posed by China overcapacity, there are opportunities for European businesses to navigate the EU-China trade landscape successfully:
- Focus on High-Value Products and Services: European companies can focus on producing high-value products and services that offer unique competitive advantages.
- Diversify supply Chains: Reducing dependence on Chinese suppliers by diversifying supply chains to other countries.
- Invest in Innovation: Investing in research and development to develop innovative products and services that can compete effectively with Chinese offerings.
- Protect Intellectual Property: Taking steps to protect intellectual property rights in China, such as registering patents and trademarks.
- Seek Government Support: Utilizing government programs and initiatives that support European businesses in their trade with China.
A European business owner shared their experience dealing with China overcapacity in the solar panel industry. “We faced intense competition from heavily subsidized Chinese solar panel manufacturers,” they said. “To survive, we focused on offering high-quality, customized solutions, invested in local R&D, and emphasized our commitment to sustainability. While competing on price was impossible,we built a loyal customer base willing to pay for superior quality and service. EU-China trade is complex, but with the right strategy, European companies can still thrive.”