Earlier this month, European Commission President Ursula von der Leyen met with Chinese President Xi Jinping in Beijing. The high profile meeting was Europe’s attempt to stabilize its tense relationship with China as Chinese exports bolster Russian President Vladimir Putin’s invasion of Ukraine. After the talks, von der Leyen said the landmark EU-China Comprehensive Agreement on Investment, which aims to increase bilateral investment, “did not come up,” indicating the deal is likely dead.
The impasse after the meeting between von der Leyen and Xi is the latest in a series of developments that align Brussels’ China policy with that of the Biden administration. The EU is preparing to adopt export controls on semiconductors, impose restrictions on private sector investment in Chinese tech companies, and enact rules intended to block China from dominating Europe’s renewable energy market. Each of these initiatives follows on an analogous U.S. policy and could significantly hamper China’s technology sector. Although there is significant disagreement across European countries about what the continent’s overall China strategy should be, strenuous European attempts to undermine China’s strategic industries are consistent with U.S. efforts to contain China.
But as a growing group of foreign policy analysts have argued, containing China by hamstringing its tech sector is a dangerous and counterproductive policy. Indeed, containment increases the chance of a kinetic war with China, may preclude cooperation with Beijing on the climate crisis, and will seriously damage the global economy. While still bearing significant risks, a strategy that prioritizes cooperation with China on critical issues like climate mitigation and nuclear nonproliferation is a preferable alternative that would reduce the likelihood of war. Europe is playing with fire by adopting Washington’s bellicose containment strategy.
Collapsing China’s Semiconductor Industry
Last October, the U.S. Commerce Department announced unilateral export controls on China’s semiconductor industry, claiming that advanced semiconductors give China the necessary computational power to build better nuclear weapons and surveillance tools that violate human rights, particularly in Xinjiang. Far more severe than any measures to restrict China adopted under President Trump, semiconductor export controls were widely viewed by analysts as a “declaration of economic war.” The crux of restrictions on non-U.S. companies is a new “advanced computing Foreign Direct Product Rule” that bans foreign firms that use U.S. technology from selling advanced chips or production equipment to China.
This rule put the Netherlands in Washington’s crosshairs. Dutch giant ASML, the largest technology company in Europe, relies on U.S. software to operate its lithography machines and outsources some engineering work to its San Diego-based subsidiary, Cymer. With the threat of significant financial penalties looming, ASML began complying with U.S. export controls just days after they went into effect, even though it depends on China for 15 percent of its revenue. Late last year, ASML CEO Peter Wennink said that the company had “already surrendered” to the U.S. in 2019 when it stopped selling its most advanced lithography machines to Chinese firms. Washington’s latest export controls go a step further by banning the sale of ASML’s second-most advanced lithography machines to China since they can be used to produce cutting-edge chips for training artificial intelligence systems.
The Netherlands announced last month it would enact domestic semiconductor export controls that largely bring it into compliance with U.S. rules. Dutch Prime Minister Mark Rutte felt the need to clarify he was negotiating with Washington “from a position of sovereignty” and that he did not believe the Netherlands had been “put under pressure.” But to outside observers, such as the Belgian Prime Minister, it was obvious that the Dutch fell victim to U.S. “bullying.”
For its part, the EU – which was initially left out of the export control negotiations as there are no other major lithography machine suppliers in Europe – is now likely to adopt semiconductor restrictions of its own. Dutch Trade Minister Liesje Schreinemacher said the Netherlands will submit its export controls to the European Commission (EC) and called for a joint position “to show we are…a geopolitical bloc.” Valdis Dombrovskis, EC Vice President in charge of trade, welcomed the move, agreeing that “EU-level export controls” are needed for advanced semiconductors and other technologies with both civilian and military applications. Continent-wide restrictions would sever China’s supply of essential components for semiconductor production equipment such as extremely high-quality mirrors and precision lasers, made only by the German firms Zeiss and Trumpf respectively. As Bloomberg reported today, Germany has also proposed export controls on the sale of chemicals for semiconductor production to China; the German chemical company Merck has a hand in the production of nearly every chip as a key supplier of chemicals like photoresists that are used to print patterns onto semiconductors.
European lawmakers are quick to point out that EU export controls would apply to all countries, not just China. But the reality is that Chinese firms are the only major purchasers of machines to make advanced semiconductors whose applications for EU export licenses will be denied. Export controls have already caused Chinese imports of chipmaking equipment to fall by 15 percent in 2022, helping to reduce semiconductor output in China by 15 percent year-over-year in the first quarter of 2023 since two-thirds of Chinese semiconductor factories use only foreign equipment. Consequently, China’s top three semiconductor firms have had to delay production at new factories, leading firms like memory chip giant YMTC to lay off 10 percent of its staff. This could have a significant impact on China’s economy – semiconductors are the most essential input for electronic devices, powering every refrigerator, car, and smartphone. China’s Semiconductor Industry Association said export controls are “destroying the existing global semiconductor industry” and constitute an “act of tearing apart the global industrial system [that] will cause immeasurable harm.”
Export controls have caused a significant shift in how China views its relationship with Europe and the United States, legitimizing a containment narrative that has become the prevailing Chinese interpretation of U.S. intentions since the 2016 election of President Trump. At China’s most important annual political gathering last month, President Xi said “Western countries led by the United States have implemented all-around containment, encirclement and suppression of China, which has brought unprecedented severe challenges to our country’s development.” In this case, “suppression” has a specific connotation: foreign sanctions on China’s technology sector.
Economic warfare of this variety can all too easily escalate into outright conflict. A U.S. embargo on oil sales to Japan in August 1941 was the catalyst for Japan’s attack on Pearl Harbor four months later. Today, semiconductors are the most critical input for warfighting just as oil was in the 20th century. The embargo on advanced semiconductor sales to China could lead to a similar outcome in which Beijing feels surrounded and lashes out in a moment of crisis.
European Council President Charles Michel has stated that Europe does not want “systematic confrontation” with China. But as historian Stephen Kotkin has pointed out, “technology export controls were one of the great successes…of the Cold War” – it’s incoherent to be “in favor of technology export controls but…against a Cold War with China.”
Curbing Investment in Chinese Technology
Along with its restrictions on semiconductor-related exports, Europe is pursuing new rules that will limit foreign direct investment in Chinese tech companies. In a major speech on China before her trip to Beijing, von der Leyen said she would include restrictions on outbound investment in “sensitive technologies” in the EC’s forthcoming Economic Security Strategy.
Dombrovskis, the EC Vice President in charge of trade, explained the rationale for such restrictions last month:
Outbound investment controls are the other side of the coin of export controls…Because you can effectively ban exports of so-called dual use technologies, which we have done for instance to prevent feeding Russia’s war machine, but that still leaves room for the leakage of sensitive technologies through investments on the ground.
As with semiconductor export controls, EU regulations on foreign investment in China will likely mirror similar U.S. policies. President Biden is poised to issue an executive order banning investments in Chinese firms focused on advanced semiconductors and making it more cumbersome to invest in Chinese AI, biotechnology, and green technology companies. These rules are widely referred to as “Outbound CFIUS,” creating an external complement to the Committee on Foreign Investment in the United States, which screens inbound investments.
Europe’s specific rules on outbound investment have yet to be hashed out – and unlike trade policy, investment policy on the continent is governed at the country level. Germany, which accounts for more than half of EU foreign direct investment in China, has spearheaded the effort to restrict EU investment. Berlin’s draft China strategy proposes the creation of a legal mechanism to allow “security-critical” investments to be vetoed by either Brussels or Berlin.
A significant portion of European foreign direct investment in China could be subject to additional scrutiny under outbound investment rules targeting China’s tech sector. Automotive investment represents 30 percent of European investment in China, reflecting a rush by automakers to spend lavishly on electric vehicle plants in partnership with world-leading Chinese suppliers. Biotechnology, another sector where investment is likely to be subject to further review, represents 10 percent of European investment in China along with pharmaceuticals.
A push to limit economic interdependence with China poses serious risks for European economies. Since 2000, annual EU-China trade volume has grown twelvefold to $850 billion and European consumers have come to rely on cheap Chinese products as their income growth slows. Today, China is Europe’s largest goods trading partner, the supplier of over half of EU imports of mobile phones, laptops, and textiles, and Europe’s most important market for exports such as cars, planes, and machinery. The International Monetary Fund projected this month that decoupling in foreign direct investment would reduce global economic growth by two percent, or $2 trillion using 2022 as a baseline; growth in the EU and China would shrink three times more than in the U.S.
Should Beijing choose to retaliate over increasingly hawkish EU restrictions on its technology sector, China could inflict significant pain on European companies. For instance, Chinese regulators are angling to block the British semiconductor design company Arm from exiting its Chinese joint venture with SoftBank, preventing it from fundraising through an IPO. An anonymous Chinese official told the Financial Times “China does not want to lose Arm at this juncture… The chip war between the US and China continues to escalate and Arm is a must-have ally for China’s chip industry.”
Nevertheless, European policymakers are charging ahead with further restrictions. Limits on investment in Chinese technology come after the European Parliament refused to approve the Comprehensive Agreement on Investment with China, which would have increased market access, banned forced technology transfer, and reduced China’s ability to discriminate against foreign firms. Progress on that Agreement stalled in 2021 after Europe imposed sanctions on Chinese officials over genocide in Xinjiang and China responded by sanctioning several European lawmakers. As European Central Bank President Christine Lagarde underscored in a speech in New York last week, due to “growing rivalry between the United States and China…we are witnessing a fragmentation of the global economy into competing blocs.”
Though new investment screening rules may not be adopted until after the 2024 European elections, they are gaining momentum. Margrethe Vestager, EC Vice President in charge of technology, recently compared the risks of Europe’s dependence on Chinese technology to “how the dependency on Russian gas affected Europe. We should only need to learn this once, now we need to act upon it…including also [by] looking at outbound investment.”
Comparisons to Russia lay bare the reality of European efforts to contain China – they anticipate a future in which NATO will back the United States in a war over Taiwan and the EU will impose punishing economic sanctions on China as it has on Russia. However, the best strategy to avoid war over Taiwan is not to torpedo China’s technology sector but to cooperate with China such that high-level channels of communication remain open and available to diffuse a crisis.
Taking Chinese Renewable Energy Down a Peg
The EU’s climate strategy centers on the goal of becoming carbon neutral by 2050, but this could require deepening its substantial dependence on China for renewable energy. With the introduction of the Net-Zero Industry Act last month, Brussels is making a concerted effort to reduce the market share of Chinese renewable energy suppliers in Europe. The benchmark it lays out is for the EU to meet 40 percent of demand for solar, wind, batteries, and other net-zero technologies domestically by 2030, more than double current levels.
The only country of concern named in the Net-Zero Industry Act is China. The legislation underscores that “for solar photovoltaic technologies and their components, [EU] dependency [on China] exceeds 90%,” while “China accounts for 90% of investments in manufacturing facilities” for net-zero technologies. In 2007, Europe was the world’s largest solar manufacturer with 30 percent of the global market; today, Europe produces less than 1 percent of the world’s solar cells, while China produces 85 percent.
The EU hopes to change this by reducing government procurement of Chinese technology. The Net-Zero Industry Act deprioritizes bids for public contracts from companies based in countries that supply 65 percent or more of a specific green technology to the EU, which applies only to China, and potentially Turkey. Under current rules, EU countries are required to give public support to renewable energy projects based almost entirely on which firm offers the lowest price; but the Act relaxes nondiscrimination rules to allow governments to reject Chinese proposals.
The harsh truth remains that Chinese companies manufacture green technologies at a fraction of the cost of their European competitors. Chinese solar panels are 30 percent cheaper than European alternatives. Chinese wind turbines cost 50 percent less than average global prices, and Chinese prices will likely fall a further 20 percent in 2023 while European competitors hike prices by 30 percent to stem losses. Chinese electrolyzers, which generate energy in the form of “green hydrogen” by splitting water molecules, are 70 percent cheaper than European electrolyzers.
China’s cost advantage, manufacturing prowess, and unrestrained spending have made it the global leader in every green technology. In 2022, China had three times more domestic and foreign green tech investment than Europe and 40 times more spending on factories for renewables. As a result, Chinese firms control half of the global market for wind, electric vehicles, and batteries. Much of this clean energy production is backstopped by fossil fuels – in 2022, China approved six times more coal plants than the rest of the world combined.
Reducing reliance on Chinese firms will slow the EU’s progress toward reaching its goal of net-zero emissions by 2050. Simply put, euros spent on more expensive European renewables will not go as far as those that purchase cheaper Chinese alternatives. This is arguably an unacceptably high price to pay for containing China as the climate crisis is the paramount threat to European ecosystems, economies, and citizens. But Europe, like the United States, is willing to balance its climate goals against its perceived interest in undercutting Chinese tech companies.
Moving Towards Containment
Semiconductor export controls, outbound investment screening, and the Net-Zero Industry Act are just a few of Europe’s most prominent new tools to tackle China. The EU has also proposed the Critical Raw Materials Act to decrease dependence on Chinese suppliers of raw materials; reached consensus on the Anti-Coercion Instrument to impose trade penalties on China if it retaliates against an EU Member State; and adopted the Foreign Subsidies Regulation to increase EU authority to investigate Chinese subsidies.
Von der Leyen said last month, with respect to key technology inputs, “this is an area where we [the EU] rely on one single supplier – China – for 98% of our rare earth supply, 93% of our magnesium and 97% of our lithium – just to name a few,” adding “this is all part of a deliberate use of dependencies and economic leverage to ensure that China gets what it wants from smaller countries.”
When viewed together, these new initiatives make clear that the EU has joined the U.S. effort to contain China by undermining its technology sector. China has not taken kindly to Europe’s policy shift. Advocating for cooperation between Europe and China, Beijing’s EU ambassador Fu Cong said last month:
We do hope that the European governments and the European politicians can see where their interests lie and then resist the unwarranted pressure from the US.…Who in their right mind would abandon such a thriving market as big as China?…It will only be at their own peril.
Cooperation with China is not without risks, to be sure. Procuring Chinese renewables often entails engaging with organizations tied to genocide in Xinjiang. Investing in Chinese technology companies strengthens the surveillance state in China and abroad. And boosting China’s semiconductor production capacity could help it produce more weapons in the event of a World War III-style confrontation over Taiwan.
However, these strategic considerations are not so vital that they justify increasing the risk of war with China. The mainstream view among foreign policy analysts is that cooperation with China is doomed from the start, but a policy of containment excludes any possibility of cooperation. In the words of China’s top diplomat Wang Yi, “the United States should not pursue dialogue and cooperation while containing and stabbing China in the back. This is not reasonable competition, but unreasonable suppression.” Just as Nancy Pelosi’s visit to Taiwan last summer led China to cancel dialogues with the United States related to climate and the military, coordinated measures to halt China’s technological development will erode diplomacy on critical transnational issues.
Not every leader in Europe wants to ditch the Chinese market as Fu suggests, however. French President Emmanuel Macron visited China alongside von der Leyen this month, but he articulated a much more cooperative position. After a meeting between Xi and Macron, China and France released a joint communique that pledges to increase market access for businesses and to promote nondiscrimination in investment. On his return trip, Macron told reporters “we don’t want to enter into a bloc-to-bloc logic,” warning that if European countries become “America’s followers” on China they will be little more than “vassals.”
Nonetheless, France will be obligated to abide by EU-level restrictions on Chinese technology companies. The political wind in Europe is blowing towards von der Leyen’s hawkishness, not Macron’s dovishness; towards containment, not cooperation.