Over the past 20 years, the productivity gap between Europe and the United States has been steadily widening. Labor productivity in the United States has grown at more than twice the rate in the euro area. Europe’s “competitiveness crisis” can be attributed to several factors, including insufficient public and private investment, a shortage of technology companies and venture capital funds, or the continent’s demographic decline. But another possible explanation, which is often overlooked, is the decline in foreign direct investment.
Foreign direct investment brings recipient countries closer to new technologies, knowledge and managerial skills, which is a critical driver of productivity growth. After falling by 4% in 2023, FDI flows to Europe are today 14% below their peak in 2017. Last year, Germany saw a sharp 12% decline in foreign investment, hurting the post-pandemic recovery. In the United Kingdom, foreign direct investment has fallen by about 30% since 2016-17; Britain’s exit from the European Union has prompted foreign companies to redirect their investments to other European countries. French lawmakers appear determined to capitalize on this shift, and President Emmanuel Macron is actively promoting his country among foreign investors.
Attracting foreign direct investment is crucial for the EU, which has to confront two emerging challenges: eliminating risks from its supply chains and preventing member states’ economies from experiencing a “China shock” similar to the one the United States experienced after China joined the WTO. world Trade. In 2001.
Foreign direct investment flows play a key role in addressing these two challenges. Climate change and worsening geopolitical tensions have made global supply chains increasingly vulnerable, especially when we consider that most supplies for green industries, such as semiconductors and battery cells for electric cars, come from Taiwan, South Korea and China. A 2012 study by MIT economist Darun Acemoglu and other authors suggests that this type of geographic concentration of suppliers increases the risk of economic shocks. When supply disruptions reverberate through the global economy, they create ripple effects that exacerbate the initial disruption.
The European “China shock” could lead to the rise of far-right parties such as the AfD
Moreover, companies cannot protect themselves from such disruptions by diversifying their suppliers, because there are no alternative sources outside Asia. This vulnerability was highlighted in 2021 when Taiwan Semiconductor Manufacturing Company (TSMC) was forced to close some of its factories due to the COVID-19 pandemic and severe drought, causing automobile production worldwide to halt.
To encourage diversification, the European Union has begun to support foreign investment in battery cells and semiconductors through the European Chip Act and the European Battery Alliance. As in the United States with the Limit Inflation Act and the CHIPS and Science Act, these measures are intended to ensure that there are enough alternative suppliers in the event of a climate catastrophe or geopolitical conflict.
But despite these efforts, there are signs that Europe is beginning to suffer its own “China shock.” In 2022, for the first time in history, Germany imported more cars and machinery from China than it exported. A recent study by Allianz Research indicates that China has overtaken Germany in key sectors of the global export market. For example, China’s share of machinery and equipment exports rose to 29% by 2022, compared to 15% in Germany. Although Germany still leads the way in exports of automobiles and transportation equipment, with a 17% share compared to China’s 9% share, its lead is shrinking.
This should concern lawmakers for two reasons. First, because the loss of leadership in vital high-tech sectors represents a major threat to the German economic model. Second, the European “China shock” may lead to the rise of far-right parties such as the AfD.
The case of the United States should serve as a lesson. The “China shock” of the early 2000s had a devastating impact on manufacturing regions. Workers affected by Chinese competition found it difficult to find new jobs and were often forced to accept much lower wages. Declining industrial employment has contributed to an epidemic of “deaths of despair” – from suicide and drug overdoses to alcohol-related liver disease – and paved the way for Donald Trump’s 2016 presidential election victory.
For decades, China forced Western companies that wanted access to its huge domestic market to form joint ventures with local manufacturers. Now the roles have been reversed
Recognizing this, EU leaders will impose tariffs on Chinese electric vehicle imports. In a recent speech, European Commission President Ursula von der Leyen accused China of violating fair competition rules and wanting to “flood our markets with heavily subsidized electric cars.” US President Joe Biden’s decision to impose a 100% tariff on electric vehicles made in China will likely redirect US exports of these Chinese vehicles to Europe, leaving leaders with no choice in the European Union. In this scenario, European tariffs could have the added benefit of boosting Chinese FDI flows into the EU, because Chinese automakers might try to circumvent the tariffs by building new factories in Europe and selling electric cars directly to European consumers.
But we have to go further. By forming alliances with companies in technologically advanced economies such as China, Taiwan, South Korea and Israel, European companies can bridge the knowledge gap in the electric and digital vehicle sectors, and increase foreign direct investment flows into the EU. For decades, China has used this strategy to become a world leader in green technologies, forcing Western companies that wanted access to the giant Chinese market to form joint ventures with local manufacturers.
Now the roles have reversed: China is now a technologically advanced economy seeking access to the large EU market for its electric vehicles, and European countries lack the technical expertise needed to remain competitive. To boost FDI inflows and improve competitiveness, the EU should reverse engineer China’s industrial policy and require Chinese EV manufacturers to set up joint ventures with local companies in exchange for market access for their vehicles.
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