China Shock 2.0: The "Mercantilism versus Mercantilism" Dilemma of German Industry

Opening: When "China Shock" Becomes a Key Word in Berlin

At the Summer Davos (Dalian) Forum in 2026, Chinese Premier Li Qiang drew laughter from the audience with an off-the-cuff quip that "China is too poor" to sustain massive export subsidies. This scene was surprising not only because of the forum's customary serious atmosphere, but also because the remark was a direct response to a concept that is shaking European industry: "China Shock 2.0." The term, coined by American economist Brad Setser and others, has now entered the public discourse of German Chancellor Friedrich Merz.

For German industry, "China Shock 2.0" is no longer an academic label but is turning into actual production contraction and job losses. Volkswagen's announced large-scale layoff plan, together with the sharp widening of Germany's trade deficit with China, constitutes an industrial turning point worthy of in-depth examination.

Background: The Violent Swing of the Trade Balance

According to data from Gavekal Research, the EU's trade deficit with China has nearly doubled since the COVID-19 pandemic. Germany's trade balance with China deteriorated by roughly 27 billion euros between 2021 and 2025, with 60% of that coming from automobiles and parts. This stands in stark contrast to the "China Shock 1.0" of the early 2000s: the core of the previous shock was U.S. labor-intensive industries, while this time the epicenter is in Europe, especially in German capital goods and high-end manufacturing.

The hallmark of this round of shock is not low prices but technological upgrading. The unit value of Chinese export products has continued to rise, converging with the export structures of Japan and South Korea. A large share of the increment in Europe's imports from China consists of green energy equipment, directly linked to Europe's own energy transition needs; another portion is chemical products, whose European local production has shrunk because of high natural gas prices.

Root Causes: A Policy-Driven Industrial Leap

The widening of China's trade surplus with Europe is not the result of shrinking domestic demand in China, but is driven by an industrialization sprint backed by deep policy support. Although Chinese officials emphasize that subsidies are not the main cause, it is undeniable that large-scale industrial policy has played a key role. An estimate by the U.S. Center for Strategic and International Studies (CSIS) shows that between 2009 and 2023, China's total subsidies to the electric vehicle industry reached 231 billion U.S. dollars.However, attributing “China Shock 2.0” entirely to subsidies would obscure a deeper industrial logic. China’s systemic competitive advantages in green technology, batteries, and electric vehicles are the result of its engineering-demographic dividend, industrial-chain clustering effects, and policy continuity working in tandem. For Germany, the real point that needs reflection is this: in the same time window, the German automotive industry, against a backdrop of record profits, distributed €31 billion in dividends to shareholders in 2023 alone, without sufficiently converting those capital resources into investment in next-generation technologies. This “complacency” is precisely the critical weakness of European industrial policy.

Impact on German Industry: A Clash Between “Mercantilists”

What makes China Shock 2.0 distinctive is that Germany itself has long been a chronic trade-surplus country. Therefore, this is not simply a linear conflict of “exporter shocking importer,” but rather a collision between two models of mercantilism. German industry faces not only a loss of market share, but also a macroeconomic dilemma: despite a widening deficit with China, the EU as a whole still runs a historically high manufacturing trade surplus. This means that Germany’s problem is not a collapse of overall competitiveness, but a structural misalignment of specific industrial clusters.

The automotive industry is the cornerstone of Germany’s industrial politics, and it is precisely in electric vehicles and smart vehicles that China has achieved leapfrog development. German OEMs are under intense pressure from local brands in the Chinese market, while at the same time their home European market faces competition from Chinese-imported electric vehicles. This “pincer attack” effect has placed unprecedented pressure on the German automotive industry to transform.

Even more worthy of attention is the impact of the exchange-rate mechanism. Because China imposes capital controls and engages in foreign-exchange intervention, its nominal exchange rate is kept undervalued, while its real exchange rate (after accounting for relative price changes) has been depreciating further. Western price increases, combined with deflationary pressure in China, have further enhanced the competitiveness of Chinese exports. For export-dependent German companies, this means that simply “making better products” is no longer sufficient to cope with the dual squeeze on price and cost.

Impact on Europe and the World: An Accelerator of Industrial-Chain Restructuring

China Shock 2.0 is reshaping the industrial-policy consensus within Europe. On the one hand, countries such as France and Germany are demanding countervailing duties on Chinese electric vehicles, and the EU’s trade-defense instruments have been reactivated. On the other hand, the European Green Deal and the U.S. Inflation Reduction Act are both attempting to use subsidies to build new domestic manufacturing capacity. The question is whether Europe’s subsidy scale and implementation efficiency can match China’s.

From the perspective of the global competitive structure, China Shock 2.0 marks the end of the era of “trading market access for technology.” China is no longer a low-end assembly base, but an exporter of high-end manufacturing technology. For Europe, the most urgent challenge is not to copy China’s industrial policy, but to re-establish a rapid translation mechanism from R&D to commercialization. Germany’s “hidden champion” enterprises still retain advantages in machinery, precision engineering, and other fields, but the barriers in these fields are being eroded by digitalization and smart technologies.## Long-term Trend Assessment: Key Variables for the Next 3-10 Years

Over the next three to ten years, the trajectory of German industry will depend on several key factors:

First, will China allow the renminbi to appreciate? If China's economic rebalancing policies make progress, real exchange rate appreciation would partially alleviate competitive pressure on European manufacturing. However, in the short term, given domestic deflationary pressures, such an adjustment is difficult to achieve.

Second, can Europe forge a unified and effective industrial strategy? Germany plays a core role in the EU, and the success or failure of its automotive industry's transformation will affect the entire European industrial landscape. Volkswagen's job cuts are just the beginning; we may see more supply chain restructuring in the future.

Third, will the green transition become a new arena for cooperation rather than confrontation? China's leading position in green energy equipment poses both a challenge and an opportunity for Europe's energy transition. If Europe can incorporate Chinese products into its own decarbonization process while nurturing domestic manufacturing capabilities, a new equilibrium of "competitive coexistence" could emerge.

Understanding China Shock 2.0 should not remain at the surface level of trade friction. It is essentially a turning point in the global industrial system, moving from "complementary division of labor" to "head-on competition." The future of German industry lies not in complaining about rivals' subsidies or currency manipulation, but in redefining its own position in the next long technological cycle. The industrial moats that were taken for granted over the past two decades are being reshuffled. Rather than a crisis, this is a belated awakening.

Conclusion

German industry was once one of the biggest beneficiaries of globalization, yet now it stands at the epicenter of globalization's structural transformation. China Shock 2.0 reminds Europe that industrial competitiveness is not a one-time asset but a dynamic process requiring sustained investment, institutional innovation, and strategic vigilance. Whether Germany can draw lessons from this will determine its true coordinates on the world manufacturing map in the 2030s.

(This article references Adam Tooze's analysis; original source: https://adamtooze.substack.com/p/chartbook-454-china-shock-20-and）