Are the Gloves Coming Off in China-Germany Economic Relations?

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Are the Gloves Coming Off in China-Germany Economic Relations?

As Germany shifts its China approach, Huawei is in the crosshairs.

Are the Gloves Coming Off in China-Germany Economic Relations?

German Finance Minister Olaf Scholz, left, and Chinese Vice Premier Liu He arrive for the China-Germany High Level Financial Dialogue at the Diaoyutai State Guesthouse in Beijing, Jan. 18, 2019.

Credit: AP Photo/Andy Wong, Pool

Throughout the past two years, China has increasingly encountered obstacles in its relations with other major economies. Besides the simmering trade war with the United States, a growing number of other Western countries have tightened the reins on Chinese investments and have pondered restrictions on Chinese products. Amid Beijing’s wider commercial tussle with Washington and its allies, one Chinese company in particular has become the focus of attention and controversy: Shenzhen-based electronics giant Huawei. The company is currently stuck in a legal battle with Washington that kicked off when Huawei chief financial officer Meng Wanzhou was arrested in Canada last December, prompting Beijing’s retaliatory arrest of two uninvolved Canadian citizens in China. Various U.S. allies have begun to restrict Huawei’s activities on their soil.

Berlin’s Beijing Blues

The case of Germany has been different, however. For a long time, it appeared as if China’s fourth-largest trade partner would remain a safe haven for Beijing’s commercial ambitions. Berlin frequently distanced itself from U.S. President Donald Trump’s scathing attacks on Beijing and it rarely engaged in vocal debates about the potential national security risks posed by Chinese companies. In the high-profile spat about Huawei, Berlin repeatedly rejected U.S. demands to restrict the company’s operations in Germany. Overall, in a world of growing protectionist urges even among erstwhile champions of free trade, Beijing-Berlin emerged as an axis of staunch defenders of globalized trade and multilateralism.

Or so it seemed. Cracks in the “axis” have long begun to show, and for years Germany has expressed guarded frustration about its economic relations with China. In recent months, these muted criticisms have given way to unprecedentedly vocal and orchestrated calls for action by some of Germany’s leading economists and officials. One of their central concerns has been the demand for genuine economic reforms in China and for a greater opening of China’s economy to foreign competitors and investments. German Finance Minister Olaf Scholz, for instance, during an official visit to China in mid-January, urged Beijing to open up its financial industry and its market for financial goods and insurance to foreign companies. So far, none of the roughly 5,200 German firms working in China is a financial institution, and German companies active in China have increasingly complained about their difficulties in obtaining loans.

Germany’s major business associations – which normally work in close coordination with government officials – have been even more outspoken in their criticism of the perceived stalling of economic reforms in China. Most notably, the powerful Bundesverband der Deutschen Industrie (BDI), the leading organization of German industry and industry-related businesses, published a strongly-worded strategy paper in January wherein it urged the German government and the EU Commission to develop more effective economic instruments against foreign competitors, particularly China. According to the BDI paper, the sooner China conducts credible economic reforms and truly opens its market to foreign investors, providing a “level playing-field” between Chinese and European companies, the fewer of these control instruments would have to be applied. It claimed that the “contest of economic systems” with Beijing’s “state capitalism” requires more long-term, strategic thought and it formulated 54 concrete policy demands, including a more proactive use of EU subsidy laws. Many German business representatives have criticized the paper’s general tone and demands, advocating a more cautious approach toward China considering its importance as a trading partner. But the BDI’s demands also received a lot of interest and support from German politicians, economists, and other business associations.

Most importantly, the BDI paper informed the subsequent decision by German Minister of Economics Peter Altmaier, a leading member of Angela Merkel’s governing party CDU, to initiate a “National Industry Strategy 2030.” In the wake of the rejection of a major corporate merger between the French rail car producer Alstom and the rail subsidiary of German industrial conglomerate Siemens by the European Commission’s anti-monopoly watchdog, Altmaier – who had long warned against blocking the Siemens-Alstom merger – told German parliamentarians that Brussels should allow the creation of “national and European champions” in crucial fields of technology that can compete globally with China and the United States. Altmaier claimed that, in order to remain competitive in their respective market segments, specific German and European companies need to bulk up to attain a minimum size, so as to establish a “level playing-field” between them and their overseas – particularly Chinese – competitors. Accordingly, on February 5, Germany’s Ministry of Economics presented a draft for the National Industry Strategy 2030, a major macro-economic planning reform that follows many of the BDI’s earlier proposals. It includes provisions such as: an overhaul of European competition law to facilitate company mergers when a larger company could better compete in the global market; encouraging German and European companies to take over key technology companies up for purchase; and allowing the government to partially and temporarily nationalize such a company in “exceptional situations,” in order to avoid takeovers by foreign investors and the loss of the firms’ know-how overseas.

The National Industry Strategy 2030 further proposes to boost 10 strategic industries, including steel and aluminium, chemicals, mechanical engineering and plant construction, optics, automobiles, medical devices, green technologies, defense, aerospace, and 3D-printing. Altmaier also plans to commit hundreds of millions of euros to promoting battery cell production, in order to compete with dominant producers in East Asia. In his words, the new industrial strategy is about surviving in a competitive world that is increasingly divided into three major economic blocs – Europe, Asia, and the United States – where Germany risks being relegated to a passive observer status and becoming “the workshop extension of others.”

Altmaier’s controversial economic strategy marks a shift in Germany’s industrial policy. It has been criticized as being protectionist and overly interventionist by many economists and policymakers (including the German EU Commissioner and fellow CDU member Günther Oettinger), while other political and business representatives have lauded his plan as an adequate reaction to the challenges posed by rising Chinese competition. Altmaier’s approach has also been endorsed by CDU party leader Annegret Kramp-Karrenbauer (a likely candidate to succeed Angela Merkel as German chancellor) who, in a recent interview, stated that Europe finds itself in a “contest of systems” with China and needs to change its competition policy to create “European champion” companies.

Tightening the Reins on Chinese Investors

The BDI paper and the Altmaier plan are not the only economic initiatives in Germany that have taken aim at China in recent months. In December 2018, the German government agreed to impose stricter rules on the acquisition of shares by foreign (non-EU) investors in German companies that operate in “security relevant” economic sectors, particularly those forming part of Germany’s critical national infrastructure (including the energy sector, telecommunications, IT security, power stations, electricity grids, water supply, food production, payment systems, stocks and derivatives, hospital technology, aviation, defense, railways, shipping, software, and the media). The share threshold at which the government is authorized to block such corporate investments was lowered from 25 percent to 10 percent of shares, and most analysts have identified China as the intended target of this measure.

Since 2016, Chinese investments in, and attempted takeovers of, German high-tech companies (such as the semiconductor producer Aixtron and the energy provider 50Hertz) have been controversially discussed in Germany. Chinese state-backed investors initially refrained from interfering in the daily operations of newly acquired companies, but in some cases, such as the industrial robot producer Kuka and the automobile supplier Grammer, they later began to forcibly restructure the companies’ managements and to assume more direct control over business operations. This contributed to the first instance when the German government formally blocked a Chinese takeover bid for a German firm (the planned acquisition of manufacturing company Leifeld Metal Spinning by the Chinese metal processing company Yantai Taihai in August 2018). Some German officials, like former Foreign Minister Sigmar Gabriel, have regarded these developments as indications that the government’s previous support for these corporate takeovers had been a mistake, particularly since it might have led to an outflow of valuable technological know-how. Altmaier, when explaining his rationale for initiating the National Industry Strategy 2030, stated that the 2016 acquisition of Kuka by a Chinese company had left a lasting impression on him.

Germany was also one of the initiators (besides France and Italy) of a broader legislative project at the EU level that aims to provide a solid legal footing in EU law for monitoring and restricting state-directed foreign investments in sensitive European industries, with the primary aim of controlling Chinese FDI. In February, the European Parliament approved the relevant legislation for an EU-wide framework for foreign investment review. The endorsement of the EU Council at ministerial level followed in early March. In addition, the European Commission presented a comprehensive new China strategy designed to improve reciprocity with Beijing, which it labeled a “systemic rival.” Manfred Weber, the conservative frontrunner to become the next president of the Commission and a political ally of Angela Merkel, has repeatedly stated that key European industries must be better protected from foreign – specifically Chinese – takeovers.

Among German officials, the specific concerns raised about Chinese investors generally surround three issues. First, there’s the lack of reciprocity in opening the Chinese market to European investors – a criticism that has consistently grown louder in Germany. Second is the risk of technological knowledge transfer – a frequently expressed concern in government and business circles. The German Mechanical Engineering Industry Association (VDMA) has stated that it is the “declared goal of the Chinese government to push foreign technology out of the market and replace it with domestic technology” and that one way of doing this is to pursue targeted acquisitions of foreign, particularly German, companies in order to acquire technological know-how. Finally, there’s the risk of espionage, subversion, and foreign interference in security relevant sectors of Germany’s national infrastructure – a relatively novel concern which, unlike in some other Western countries, had not previously been a frequent subject of public debates about Chinese influence in Germany.

The Huawei Saga Reaches Germany

It is within this context of increasing concerns about the involvement of Chinese enterprises that the global controversy surrounding Huawei began to erupt in Germany as well, leading to heated debates about the company’s involvement in the construction of a new 5G mobile telecommunications grid. That became the dominant China-related talking point in the German media throughout the first months of 2019. As Huawei’s ties to the Chinese government became a major policy concern in North America, Washington began to urge its allies to avoid integrating Huawei technology in their critical national infrastructure. The U.S. government dispatched officials to Berlin in early 2019 to dissuade it from including Huawei in 5G development, and Washington’s ambassador to Germany, Richard Grenell, warned that the United States would scale back data-sharing with German security agencies if Huawei got a role in the 5G project. While the German government dismissed Grenell’s demands, the concerns about Huawei’s inclusion in the development of 5G infrastructure are widely shared in German official circles, particularly in the intelligence community.

In late 2018, the German government had stated that there is no concrete legal basis for completely or partially excluding any particular company from the construction of 5G networks in Germany, nor were any such measures planned. By January 2019, however, the government was conducting a “reassessment” of the charges against Huawei. Germany’s intelligence and security agencies provided a new threat assessment regarding Huawei, and they explicitly advised the government to exclude the company from the development of 5G networks, which they described as a highly sensitive part of the country’s critical national infrastructure. Germany’s foreign intelligence service, the Bundesnachrichtendienst (BND), warned that the Chinese government could use Huawei technology for espionage and surveillance purposes through so-called electronic “backdoors” and could even compromise the networks’ safety of operations by installing hidden “kill switches” to effectively disable the 5G infrastructure. According to Gerhard Schindler, a former BND director, “such a scenario is definitely conceivable” and Germany would not be prepared for – or able to react to – such a situation. Schindler declared that “China is an authoritarian regime where security interests have absolute priority” and that these interests are being “ruthlessly implemented, domestically and externally.” According to the BND, particular risks emanate from the unprecedented degree of interconnectedness between 5G and other sectors of the critical national infrastructure. The agency also pointed out that China’s security laws provide Beijing with a practically limitless ability to request data and information that Chinese companies (including private ones) have gathered abroad.

In the wake of these warnings, the German government progressively hardened its stance toward Huawei’s 5G involvement. In January through March, it organized various high-level meetings to debate the issue. Germany’s largest telecommunications companies warned against the exclusion of Huawei, claiming that such a move could delay the construction of the 5G network by several years and would be extremely costly. Nonetheless, the Ministries of Interior and the Economy prepared a modification of the German telecommunications law to ensure that components by foreign companies and providers can only be included in 5G network development if they can demonstrate that they are free from government influence and that foreign governments cannot obtain access to their products.

Overall, the German government never managed to adopt a unified stance, and it presently remains highly divided on the issue of whether to exclude Huawei from 5G development. The intelligence services remain adamantly opposed to Huawei’s involvement – a position that is broadly shared by the Foreign Ministry, as well as prominent parliamentarians such as Norbert Röttgen, the former deputy leader of the CDU and current chairman of the Bundestag’s foreign affairs committee, who has likened Huawei’s capacity to potentially disrupt Germany’s critical infrastructure to the threat posed by nuclear weapons. The Interior Ministry has been more ambivalent in its stance on Huawei, while the Ministry of Economics and the Office of the Chancellor have primarily been focused on trying to avert any disruption of the good economic relations with Beijing and on fulfilling longstanding election pledges to rapidly extend Germany’s digital infrastructure at an acceptable cost.

Since the auction of spectrum licenses to build 5G networks was set to begin on March 19, leaving little time for further deliberation, Merkel and Altmaier ultimately announced that Germany would not bar Huawei technology from the process. Instead, the government increased security requirements for all 5G vendors and mandated that mobile providers can only use critical network equipment after scrutiny and certification by Germany’s federal cybersecurity agency and that “core components may only be procured from trustworthy vendors and manufacturers.” While it remains unclear what the exact implications of these new framework rules will be, some observers interpret them as implying that Huawei could be allowed to supply 5G masts but not components in the center of the 5G network. Senior U.S. government representatives have even claimed “that a rigorous application of those frameworks … will lead inevitably to the banning of Huawei” from 5G development in Germany, since the company would be unable to meet these high security standards which are de facto incompatible with China’s national intelligence law.

At present, the controversy over Huawei’s commercial activities in Germany continues, while new macro-economic initiatives such as the National Industry Strategy 2030 have yet to come to fruition. The broader EU-wide projects to restrict China’s economic influence likewise remain at an early stage and are bound to progress slowly through the EU’s sluggish decision-making apparatus. What is certain, however, is that Berlin has grown increasingly wary of Beijing’s intentions and concerned about its business practices, raising questions about how amicable Sino-German trade and investment cooperation can remain in the future. While Huawei’s involvement in 5G infrastructure development has been condoned for the moment, it has proven extremely controversial in Germany, as the company has become a focal point of the West’s growing suspicion toward Beijing. Simultaneously, pressure to reduce Huawei’s involvement in critical infrastructure development has also grown within NATO and the EU, where initiatives to restrict the company’s operations in Europe are likewise gaining momentum. There is therefore much to indicate that Beijing’s relations with Berlin will only become bumpier in the near future.

Björn Alexander Düben is an assistant professor at the School of International and Public Affairs, Jilin University. He holds a Ph.D. in International Relations from LSE and an MPhil in International Relations from the University of Oxford. His research has been published by Reuters, The National Interest, The Diplomat, the Lowy Institute and the Royal United Services Institute (RUSI), among others.