China’s overcapacity and the EU + German China policy under Merz + EU-China trade

In this issue of MERICS Europe China 360°, we cover the following topics:

1. China’s overcapacity and the EU – All you need to know
2. Germany’s China policy under Merz: A rocky road towards risk-aware pragmatism
3. Europe-China Diplomatic Tracker: Spain and France top Beijing's high-level diplomatic outreach to Europe
4. Soapbox-MERICS Data Highlight: Germany has been asleep at the wheel in the face of China’s EV policy

China’s overcapacity and the EU – All you need to know 

By Esther Goreichy, Jacob Gunter and Grzegorz Stec

In its pursuit of self-reliance and technological security, Beijing’s economic model is generating intense overinvestment, overproduction, and overcapacity in its industrial base. Effectively, China is producing more and more goods across a range of industries while consumption fails to grow in any meaningful way. China now accounts for roughly one third of total global value-added manufacturing, and its trade surplus hit nearly USD 1 trillion last year. The resulting glut of supply is driving down prices globally as more and more China-made goods enter global markets.

The fierce price wars within China’s own market have driven down profitability, and nearly a quarter of its industrial enterprises are now loss-making. In a normal market economy, this would lead to consolidation as the least efficient players exited the market, and prices and profits stabilized. This is not happening at the pace necessary in China, largely due to China’s extensive industrial policy, massive subsidies, cheap financing, and other support measures.

The resulting waste and inefficiencies are tolerated ideologically under the current leadership, which views self-reliance and technological security as essential goals and the scale of its still-growing manufacturing base as one of China’s core geopolitical strengths. China’s overcapacity issue is troubling not because China is a net exporter, but because it is exporting market distortions that warp prices in market economies on an unsustainable scale.

This is deeply problematic for global markets, including in Europe. The European common market, with its robust competition law that binds companies by fiduciary responsibility to their shareholders, is simply not designed for competition with the firms emerging from China’s new economic model.

Which European sectors are particularly vulnerable?

China’s overcapacity issues are well established and have already impacted some traditional European industries like steel and aluminum. But the current wave is different in that it involves more value-added sectors, like passenger vehicles and EVs.

In a recent report, MERICS identified common drivers and indicators of overcapacity across four case studies, then highlighted other industries with the same drivers and indicators, making them more susceptible to overcapacity in the future. The results are concerning for European industry:    

• In the short term: Legacy semiconductors, low- to mid-range industrial machinery and components, IT equipment, low- to mid-range medical devices, and pharmaceuticals.
• In the medium to long term: Electrolyzers, advanced medical devices, advanced industrial machinery and components, and new materials.

Has the situation worsened due to Trump's tariffs?

The spillover of Chinese overcapacities did not begin with Trump's tariffs and will not end with their “suspension”. The issue has impacted the EU for some time, as now painfully experienced by a growing range of sectors, particularly the automotive industry.

But it is too early to assess the impact of tariffs, and uncertainties created by their intermittency is creating a new dynamic. China’s exports rose in Q1 2025 over Q1 2024, with a decline in exports to the US more than compensated by an increase in exports to ASEAN (most likely partly to circumvent the tariffs on China) and to the EU. This is aligned with the recent trend, which is not likely to be disrupted by Donald Trump’s stop-and-go tariffs, even if they are disruptive. 

In sectors where China exports goods to the US, we expect Trump’s tariffs to cause some exports to be redirected to the EU and third markets, intensifying competition for European companies. The impact will be greater where the EU has strong players, for example machinery and components rather than textiles and footwear. 

It is less likely that the tariffs will open opportunities for EU firms in the US market. Evidence from the 2018 US-China trade tensions showed the gap in the US market was not filled by exports from the EU, but rather from South and Southeast Asia, which have a structure closer to China’s (and may be used by Chinese firms to reroute exports to the US).  

Would an increase in Chinese demand be the silver bullet?

China’s domestic demand would need to grow significantly to absorb enough excess production to offset its current trade imbalances. It seems unlikely that the current leadership will change course in the economic system it has spent the last 12 years building. Beijing continues to prioritize the supply side of the economy over the demand side. That is unlikely to change, as the entire economic model depends on high savings rates and the deprivation of resources from households to fund industrial policy.