Few companies are more quintessentially German than Volkswagen, but for Herbert Diess, the carmaker’s boss, the heart of the business is now in China. Last year, Chinese car sales fell for the first time in 20 years. To deal with the problem, Diess flew to Beijing, telling staff that “The future of the Volkswagen Group will be decided in the Chinese market.”
Car sales are not the only problem in China: The economy is teetering on the brink of a slowdown. Annual GDP growth fell to 6.5 percent this year. That is excellent by world standards but is China’s lowest growth rate in nearly 3 decades. In addition, many economists say official figures should be taken with a pinch of salt. One way or another, the Chinese economy is clearly decelerating.
When China slows down, Germany will take a particularly painful hit. Twenty years ago, China was not important to the German economy. Back then, German exports to the People’s Republic amounted to just €5.4 billion ($6.2 billion). By 2007, that figure was €30 billion. Last year it was €90 billion, almost 3 percent of German GDP.
Germany’s 2018 economic growth was just 1.5 percent, with the country narrowly avoiding a recession in the fourth quarter. Although Brexit and American tariffs did not help, the main reason seems to have been the Chinese slowdown.
In recent years, Germany has become remarkably dependent on the Chinese market. Three years ago, it was Germany’s fifth most important export market. Last year China was third, behind the United States and France.
Sleepless nights ahead
The average German firm raises 7 percent of its revenues in the Middle Kingdom. But for large German corporations, however, that figure is a lot higher. For the 30 companies that make up the DAX blue-chip index, the Chinese market represents an average 15 percent of revenues, totaling around €200 billion.
For carmakers BMW, Daimler and Volkswagen, semiconductor manufacturer Infineon and Covestro, the specialist chemicals maker, the proportion is strikingly high: All five companies earn over 20 percent of their annual revenues in China, more than in the German market.
Estimates of future German corporate earnings rely heavily on continued Chinese growth. If that market falters, it could mean sleepless nights for many executives and investors, with the recent slump in Apple’s stock market valuation pointing the way. Earlier this month, when Apple’s share price fell heavily on news of slowing Chinese demand, the price of Infineon stock fell with it: The semi-conductor manufacturer is, if anything, even more dependent on Chinese demand than the California tech giant.
Tech companies are not the only casualties of an apparent Chinese deceleration. Ford’s revenues in the country fell by more than one third in 2018. Jaguar Land Rover is laying off thousands of staff due to a collapse in Chinese sales. Germany’s Mechanical Engineering Industry Association (VDMA) has warned of an imminent fall in demand for plant machinery.
Economists say some pullback from China’s remarkable growth of the last three decades was inevitable. But the key factor in recent months has been trade tensions between Beijing and Washington. These have dented Chinese consumer confidence, with worries about the employment and housing markets prompting a slowdown in spending.
Trade war looming
And those tensions could get worse soon as a moratorium on new tariffs between the two countries runs out at the end of February. If the US-Chinese trade war escalates, it would have ominous knock-on effects for the German economy. Talks between the two sides are currently taking place in Beijing, but progress has been slow, with agriculture and technology transfer proving particularly gnarly issues.
German carmakers have been doubly hit by the trade dispute: Not only has Chinese demand fallen but Beijing has slapped tariffs on cars they produce in the United States for export to China. BMW and Daimler are already warning of an impact on sales, profits and profit margins.
The company under the biggest threat is surely Volkswagen. No other carmaker has tied its fortunes to the Chinese market to quite the same degree as VW. In 2018, the company's 12 brands sold more than 3 million vehicles in China, compared to just 1.3 million in Germany. China represents around 20 percent of the company’s operating profit, and in 2017, VW’s Chinese subsidiaries supplied around €3.6 billion in dividends to the Volkswagen Group.
The economic slowdown has begun to have social and political effects on China; industrial unrest has been simmering in the southern part of the country for months now. Increasing incomes have eased social tensions throughout China’s recent history, and Beijing will go to extremes to prevent economic discontent.
Just last Thursday, the Chinese central bank launched a €73 billion stimulus package, the largest in the country’s history. Companies have been granted rebates on unemployment insurance, to help prevent layoffs, and easier access to credit and new capital.
State stimulus is nothing new in the Chinese economy: For years now, growth has relied heavily on massive programs of public investment, with new highways, airports and bridges springing up across the country.
But the government is now switching emphasis, away from infrastructural investment and toward consumer-driven growth, which today accounts for around two-thirds of economic growth. Last week, the state development commission announced new help for consumers to make expensive purchases, including cars and washing machines.
Help will also be extended to small- and medium-sized businesses. This could be good news for German exporters: Alongside cars, machine tools and other factory equipment makes up a substantial portion of exports to China, much of it supplied by Germany’s own high-performing medium-sized industrial companies.
Heard that one before
Unfortunately, the downside to this economic stimulus is becoming increasingly obvious. Twenty years ago, the Chinese private sector, not including the financial industry, had debts amounting to around 88 percent of GDP. Today, the figure is over 200 percent.
For years, observers have warned of an impending Chinese debt crisis. Two years ago, financier George Soros cautioned investors about the “unsustainable credit expansion.” But the Chinese government has shown great macroeconomic shrewdness in warding off the much-predicted credit crunch.
Nonetheless, German companies are worried. Infineon, Germany’s biggest chip manufacturer, is particularly exposed. One-third of its earnings come from China versus just 15 percent from Germany. Four years ago, both markets contributed around 20 percent each. Around 40 percent of Infineon’s recent growth has been made in China.
For the Munich-based company, things could go either way. Falling overall demand is a threat, but Infineon is pinning its hopes on Chinese plans for a huge expansion of electric-car production. E-vehicles require twice as many chips as conventional cars; not to mention an entire new network of 10,000 smart charging points, to be constructed by 2020. Unfortunately, the Chinese also have plans to develop their own semi-conductor industry, and someday homegrown chip makers may muscle foreign competitors like Infineon out of the market.
“Become more Chinese”
Volkswagen is another company pinning its future hopes on the Beijing-ordered electrification of China’s tens of millions of vehicles. By next year, some 2 million electric cars are expected to be sold annually. Volkswagen wants a piece of that pie: It has plans to invest up to €10 billion in 40 new, Chinese-produced electric models. By 2025, it hopes to be selling 1.5 million hybrids and all-electric vehicles there.
But success in China is more than an end in itself. For Volkswagen, the Chinese market is a template for global success in a transformed transportation market. “Volkswagen has to become more Chinese,” said CEO Herbert Diess recently.
Chinese consumers are far more open to innovation than more conservative markets, like Germany. Soon, VW hopes to spread that innovation to its operations in the rest of the world, above all in areas connected with tech. The carmaker wants to hone in smart new technologies — like automatic payment of parking or fuel charges —in China, then use them elsewhere.
That, at least, is the plan. But the best intentions could be upended by a full-blown US-China trade war. There are signs that President Trump, embattled at home, with the US economy starting to creak, could choose to step back from the conflict. But Germany will have little say over a decision so crucial to its economic future.
Some German managers are optimistic, like BASF boss Martin Brudermüller, who has many years of personal experience of the Chinese business world. The chemical giant is ploughing money into new Chinese factories: confidence in the country’s future outweighs any short-term concerns. Some observers also point to the recent recovery in Chinese real-estate prices, seen as another sign that rumors of an economic slowdown are greatly exaggerated.
But the truth is that when it comes to China, the export-dependent German economy does not have much of a plan B. If a trade war breaks out, damaging both the US and Chinese economy, Germany could be caught in a perfect storm.
Handelsblatt reporters and correspondents Siegfried Hofmann, Joachim Hofer, Sha Hua, Thomas Jahn, Stefan Menzel and Ulf Sommer, all contributed to this story. To reach the authors: [email protected], [email protected], [email protected], [email protected], [email protected], [email protected].