Value chain-infused EU-China debate

The discussions about the shape of EU-China relations are missing the export dependency angle. Value chain analysis provides insights into both direct and indirect trade relations with China, which in turn point to specific policy tools.

French President Emmanuel Macron’s recent trip to China has resulted in stirring up a pan-European debate on the nature of China-EU relations. Macron’s conciliatory advances toward the Chinese leadership have been met both with praise as well as pushback, particularly loudly professed by the Central and Eastern European nations.

The punditry has since glossed over the diminished position of the traditional Franco-German motor of the EU, a core-periphery split, a divide between presentism and future-oriented thinking, as well as a divergence in the positions on the strategic autonomy and the nature of transatlantic relations.

While the majority of the disagreement was focused on the questions of diplomacy, security, and international relations, Macron’s large entourage of businesspeople has also brought economic relations under scrutiny. The French appetite for increased trade and investment with China contradicts the EU Commission’s desire to “de-risk,” a Brussels codeword for decreasing trade and investment dependencies on China.

The de-risking narrative has been enthusiastically embraced by the Baltic states, Poland, and Czechia, all of which seek to re-evaluate their trade and supply chain exposures to China. However, as the 2021 events in Lithuania demonstrate, complex trade relations in the 21st century may prove more difficult to disentangle than expected.

In the widely publicized case of the Sino-Lithuanian spat, the Lithuanian government opted for a high-profile falling out with China after having assessed the potential economic damage to be low and manageable. However, China’s unprecedented weaponization of supply chains in order to attack Lithuania has revealed a weakness: the reliance on bilateral trade data has not shown the full picture of Lithuania’s economic exposure towards China, and the Baltic state’s politicians based their decisions on imprecise figures.

Had they derived their decisions from the analysis of global value chains, their choices might have been different. As the recently published econometric analysis by the Central European Institute of Asian Studies shows, when counting indirect trade linkages, Lithuania is almost 250% more exposed to Chinese demand as the official records show.

Figure 1: Countries within the European supply chain have a higher indirect trade relations than what bilateral statistics indicate.

The debate on China in the wider region of Central and Eastern Europe (CEE) has been awash with contradictions since its inception due to the ignorance of value chain data. Neither the China-friendly nor the more critical politicians had reflected indirect exposures in their rhetoric. Although the indirect trade data clearly positions China as a more important export destination than what the traditionally used bilateral data would have us think, China enthusiasts never used this as an argument in the debate and often conceded defeat when the counterparty put bilateral data on the table. China hawks, on the other hand, constantly underestimate the extent of exposure and dependence on China, which in turn further emboldens them in pursuing China-critical symbolic actions. Paradoxically, the CEE region – or 16+1 in Beijing’s parlance – has been professing a growing disappointment over the meager trade volumes with China just as the indirect trade linkages were deepening.

An analysis of global value chains may also prove useful in the current heated debate on the nature of Sino-European relations. The often-repeated figure of the EU countries conducting more than two-thirds of trade among themselves is only true to some extent. A large part of these trade exchanges is a cross-border movement of intermediate goods within a manufacturing supply chain. A component can traverse borders multiple times back and forth before production is complete, which leads to double counting and inflating the intra-EU trade figures.

When the movement of components is removed from the equation and only the final demand is considered, the picture changes rapidly. The intra-European trade proportion falls by several percentage points, which is mostly compensated by the rise of the importance of US and Chinese consumption. The final demand analysis thus allows us to assess the effectiveness of certain policy tools. For instance, the recent focus on reshoring or near-shoring may result in boosting the supply chain resilience; however, it will not decrease the dependence on extra-European markets for exports and production. Protecting production chains does not address final demand dependence.

Take any other trade policy tool recently discussed and adopted by the EU, and you will find that they are primarily concerned with the European dependence on imports from China. This is certainly a significant issue; nevertheless, the vulnerabilities running in the opposite direction – export dependence on the Chinese market – seem secondary for policymakers.

This is likely related to the fact that mitigating export dependence using a palette of trade policy tools has its limits. Achieving robust risk management of export dependence would, in the long run, entail significant changes in the economic structure, a politically highly salient topic in the EU. In particular, Germany’s economic model of depending on export manufacturing and a relatively subdued domestic consumption would require a shakeup that no one dares to picture, let alone pursue.

Speaking of Germany, it has a special position as an anchor within the European supply chain. A high proportion of the indirect trade between the EU countries and China is routed via Germany. This was one of the reasons the Lithuanian officials did not see the full scope of their trade linkages to China. It was also the avenue that China chose to exert pressure on the Baltic country – German companies that were summoned and threatened by Chinese officials to drop their Lithuanian suppliers.

The complex web of Germany-centred supply chain networks increases other EU countries’ indirect exposure to China, obfuscates these linkages for most observers, and makes it difficult for individual countries to implement effective policies.

This has implications for both sides of the Macron-in-China debate. The supporters of the French president’s renewed economic foray into China need to recognize the supply chain-embedded vulnerabilities and the potential for their exploitation. On the other hand, the decouplers’ agenda can only be pursued in partnership with Germany, while the Central European industrial behemoth does not seem too keen to reduce its linkages with China.

The low priority of this agenda in Brussels, coupled with the East-West divide on this topic, indicates that the problem of Europe’s export dependence will most likely be dealt with by muddling through unless China’s exploits cause a stronger call to action.

Martin Sebena
Martin Sebena
Martin Sebena is a Chief Economist at the Central European Institute of Asian Studies. He works in the financial services industry in Hong Kong and holds a Ph.D. degree in area studies from the University of Hong Kong.