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Decoupling from China expensive for the German economy, but survivable

If trade with China were to be abruptly halted, Germany's economy would collapse by around 5 per cent. The shock would be comparable to that following the financial crisis or the coronavirus crisis. This is the result of simulations led by the Kiel Institute for the World Economy. In the medium to long term, the loss will stabilise at around 1.5 per cent annually. A gradual, cautious reduction in trade relations would avoid the high initial costs.

"Trade with China brings us prosperity and is practically irreplaceable in the short term. A break would have high costs for Germany, yet our country has enough resilience in macroeconomic terms to survive even such an extreme scenario," says Moritz Schularick, President of the Kiel Institute for the World Economy (IfW Kiel). The occasion is the presentation of a new analysis by an international research team led by the IfW Kiel.

In terms of methodology, the calculations are based on the much-discussed study on decoupling Germany from Russian gas, on the basis of which some of the authors predicted early on that this would be manageable.


Hostile trading blocs: Loss of prosperity of up to 5 per cent

In the current analysis, the research group models a disintegration of the global economy into hostile trading blocs. The European Union together with the USA and the G7 states on the one side and China with its allies, in particular Russia, on the other. All direct trade relations between the two blocs are cut. There is also a group of neutral states, such as Brazil, Indonesia and Turkey, with which both blocs continue to trade.

Such a disintegration would result in a considerable loss of prosperity for Germany if it were to occur abruptly and hit the country unprepared (cold turkey scenario). According to the calculations, Germany's economic output would then collapse by up to 5 per cent in the first year.

In the medium to long term, i.e. after 4 to 5 years, when the German economy has adjusted to the new reality and organised alternative trade relations within its allies and with neutral countries, the permanent loss of prosperity will be around 1.5 percent per year.


Existing trade links with China cannot be compensated for ad hoc

The high costs for Germany are therefore primarily caused by the short-term effects of a sudden trade disruption, because existing trade links with China cannot be compensated for ad hoc.

The authors compare the trade shock with a scenario in which German-Chinese trade relations remain intact.

"German politicians have allowed themselves to be unsettled by exaggerated warnings from interest groups on the question of whether Germany can afford to stop supplying Russian energy. Our current calculations are intended to provide politicians with scientific facts as a basis for decision-making in their dealings with China, for example when it comes to the question of what economic measures Germany or the EU should or can take in response to a Chinese invasion of Taiwan," says Schularick.

A gradual, cautious reduction in trade relations between the Western allies and China and its allies, culminating in a trade freeze after three years, would result in the same loss of prosperity in the long term as the abrupt termination of trade - around 1.5 per cent of economic output per year (gradual decoupling scenario). However, the sharp economic slump in the first months and years would be avoided; instead, the loss of prosperity would be gradual.

A so-called de-risking scenario, in which the German economy only partially detaches itself from China but basically maintains trade relations, would result in an annual loss of prosperity of around half a per cent in the medium to long term.

In intermediate scenarios, in which trade relations end abruptly but Germany has previously partially decoupled from China, the economy falls back onto the path of the cold turkey scenario and then follows its adjustment path to a long-term loss of prosperity of around 1.5 per cent. The slump following the trade shock is therefore far less severe than in the original scenario.

In all simulated scenarios, the costs for China in relation to its economic strength are significantly higher than for Germany, namely by around 60 per cent.


Decoupling from China a political decision

"Every decoupling of German-Chinese trade relations is associated with costs for Germany. The comparatively low costs of partial decoupling, or decoupling only in certain sectors, can be understood as an insurance premium against a painful economic slump that occurs if the interdependence remains close and ends abruptly," says Julian Hinz, trade researcher and research director at IfW Kiel and lead author of the study.

"Whether and to what extent Germany wants to move away from trade with China is a political decision. It is primarily linked to the question of whether the geo-economic negotiating position of the West or Germany is strengthened or weakened by close trade links with China."

In their paper, the authors emphasise a number of limitations that are inherent in the nature of model calculations. The most important is that the result is decisively influenced by the assumption of how quickly Germany can organise new trade links when the old ones end, i.e. how high, economically speaking, the so-called trade elasticity is. The authors orientate themselves here on the latest literature and use the elasticities rather conservatively, calculating the costs at the upper end of the scale.

In addition, the model calculations do not include all cyclical amplification effects. However, the authors emphasise that this does not alter the fundamental conclusions of the study.

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