China Shock 2.0: Structural Turning Point and Mercantilist Clash Facing German Industry

Opening: When laughter can't mask the warning bells

When this year's Summer Davos was held in Dalian, Chinese Premier Li Qiang's remark that "China is too poor to subsidize such a huge export success" drew laughter from the audience. But for German industry, this may have been a bitter joke. In the same week, Volkswagen announced plans to cut up to 100,000 jobs—despite the euphemistic official wording, German industry's anxiety has already come out into the open.

This scene aptly captures the reality of the so-called "China Shock 2.0": China is no longer using cheap labor to crush low-end manufacturing, but rather, through policy support and technological upgrading, is directly hitting Germany's most advantageous sectors—automobiles and high-end manufacturing. For Germany, this is no longer ordinary trade friction, but a head-on collision over the future of industry.

Background: The dramatic turnaround in the trade balance

According to data from the economic research institute Gavekal, between 2021 and 2025, Germany's trade balance with China fluctuated by approximately 27 billion euros, with more than 60% of that coming from vehicles. In other words, automobiles almost single-handedly reversed Germany's long-standing trade surplus with China.

This stands in stark contrast to the first "China Shock." In the early 2000s, China's main impact was on low-end manufacturing in Europe and the United States, with the U.S. bearing the brunt. The main battleground of version 2.0, however, is in Europe, concentrated especially in Germany. Among China's exports to Europe, green energy products (such as electric vehicles, batteries, and solar panels) account for the largest share, while chemicals have also lost competitiveness due to high natural gas prices in Europe.

More crucially, domestic demand in these industries in China has not shrunk—on the contrary, domestic production and sales in many sectors are growing. Therefore, this is not export dumping driven by weak demand, but an industrialization sprint driven by industrial policy.

Deeper causes: Subsidies, capital misallocation, and exchange rate distortions

So how do we explain the explosiveness of China's exports? Premier Li Qiang denied that subsidies are the only reason, and there is some truth to that. But the fact is that China's subsidies in the past have been quite substantial. The Center for Strategic and International Studies (CSIS) estimates that between 2009 and 2023, China's total subsidies to the electric vehicle industry amounted to as much as $231 billion. Even if this figure cannot fully explain the results, it is enough to show the intensity of policy support.

However, blaming everything on Chinese subsidies would obscure Germany's own lessons. In that same year of 2023, as Chinese electric vehicles flooded in, Germany's three major automakers (Volkswagen, Mercedes-Benz, and BMW) paid out 31 billion euros in dividends to shareholders. That capital could have been invested in the critical transformation toward electrification, digitalization, and battery technology. As economists Tordoir and Setser have argued, complacency is precisely the chronic ailment of European—and especially German—industrial policy.Moreover, China's exchange rate mechanism exacerbated the shock. Owing to capital controls and central bank intervention, the renminbi did not appreciate with the trade surplus; instead, the real effective exchange rate depreciated as a result of the divergence between China's deflation and Western inflation. This made Chinese goods more price-competitive, further amplifying its industrial advantages.

Germany's Industrial Impact: Erosion of Core Advantages

For Germany, the most profound blow from China Shock 2.0 has been in the automobile industry. Automobiles are not only Germany's largest export product but also the pillar of its industrial system, engineering culture, and employment. When Chinese electric vehicles enter the European market in full force with technological, cost, and supply-chain advantages, German automakers face not just a loss of market share but a challenge to the entire industrial ecosystem.

More concerning is that Germany has not yet established sustainable competitive advantages in key areas such as batteries and software-defined vehicles. Although traditional automakers still hold brand power and internal combustion engine technology, their transformation is clearly lagging. Volkswagen's large-scale layoff plan is a true reflection of this structural crisis.

It is worth noting that Germany is not a declining industrial country. Germany still maintains global leadership in fields such as machinery manufacturing and precision engineering. Yet what China Shock 2.0 strikes is precisely the pillar industries on which Germany relies most for exports. If the automobile industry remains under sustained pressure, the spillover effects will spread to R&D investment and supply chain networks across German manufacturing.

Europe and Global Impact: An Arena of Mercantilists

China Shock 2.0 has an often-overlooked feature: it is taking place between two mercantilist systems. Germany has long maintained a huge trade surplus, and the EU as a whole still runs a manufacturing surplus with the rest of the world. Therefore, this is not simply an imbalance between economies, but a collision between two export-oriented industrial powers.

This collision brings a double consequence. On the one hand, it highlights the heterogeneity within Europe—surpluses in Germany and Northern Europe coexist with deficits in Southern Europe, and since China Shock mainly targets core manufacturing, the pressure on Germany is far greater than on other euro-area countries. On the other hand, it also renders traditional macroeconomic policy tools ineffective. If Europe tries to compress demand through austerity, it will only weaken its own overall competitiveness, because the EU does not face an overall trade deficit.

From a global competition perspective, China is transforming from the "world's factory" into an "industrial power." Meanwhile, traditional manufacturing powers such as Germany and Japan have to redefine their positions in the global value chain. This is not merely a trade war; it is a competition of industrial systems and innovation paradigms.

Long-Term Trend Assessment: Key Variables for the Coming Decade

Looking ahead three to ten years, China Shock 2.0 will not end with short-term policy adjustments. The following trends deserve continued attention.

First, China's industrial upgrading will continue to advance, especially in new energy, electric vehicles, and industrial digitalization. Subsidies may gradually be phased out, but technological accumulation and supply chain clusters have already formed a self-reinforcing ecosystem.Second, the response of Germany and the EU will determine their industrial fate. Relying solely on tariff protection—such as the EU's additional tariffs on Chinese electric vehicles—can only buy time; it cannot solve the fundamental problem. The real challenge lies in reshaping their own industrial policy: increasing public investment, directing capital toward transition sectors, and breaking down the bureaucratic systems that constrain innovation.

Third, the role of exchange rates and market mechanisms cannot be ignored. If China fails to effectively expand domestic demand, its deflationary pressures will continue to suppress global price levels and force other countries to adopt more aggressive trade defense measures.

Finally, German industry still retains its resilience. A strong engineering tradition, clusters of small and medium-sized enterprises, and a deep R&D foundation mean Germany is still capable of securing a place in global competition. But the prerequisite is that Germany must confront the internal weaknesses exposed in this "mercantilism versus mercantilism" clash, rather than simply blaming external factors.

China Shock 2.0 is not the end of German industry, but a necessary wake-up call. The truths concealed by laughter will ultimately determine the future direction of "Made in Germany."