SPIEGEL ONLINE

SPIEGEL ONLINE

08/27/2010 03:11 PM

Beijing's High-Tech Ambitions

The Dangers of Germany's Dependence on China

Germany largely has China to thank for its current economic upswing, given the Asian powerhouse's demand for German machine tools and other such products. But many German industrialists are asking themselves how long the symbiotic relationship can go on, given Beijing's ambition to become a high-tech economy itself. By SPIEGEL Staff.

It's a humid Friday afternoon in Beijing, where German Chancellor Angela Merkel is addressing a friendly crowd of 80 students from the Central Party School, the Chinese Communist Party's highest training institution for its officials. A banner on the wall behind her reads: "Welcome, Chancellor Merkel."

But on this day Merkel doesn't have much time for niceties. Of course she admires the country's economic vitality, she says, and is impressed by how quickly China has overcome the financial crisis. But, she adds, it's also important to address the country's deficits -- which she then proceeds to do.

China's protections for intellectual property are not up to Western standards, says Merkel. Besides, she adds, Chinese companies have the bad habit of siphoning off technical expertise from their German partners.

At the end of her speech, the German chancellor hands the future elite of the Chinese Communist Party a few lessons in democracy. There are currently five parties in the German parliament, she says, and although this can be vexing at times, it's also productive, because the multiparty system ensures that every issue and every cause finds a voice. "This is why we ask ourselves: Can one party achieve as much as five parties achieve in our country?"

Merkel's open words in the heart of a one-party dictatorship clearly illustrate how the chancellor -- all diplomatic niceties aside -- feels about Germany's East Asian trading partner. She is well aware of the opportunities in the world's largest market, which is home to 1.3 billion people. But Merkel also knows that business leaders in Germany are starting to feel uneasy about the unstoppable rise of Chinese industry.

Some are already wondering whether the supposedly lucrative China connection will turn out in a few years' time to have been a pact with the devil.

Dependent on Each Other

Germany, more than most other Western industrialized countries, is currently tying its economic well-being to China's recovery. Trade with Beijing is the most important driving force behind the current German upswing. It also explains why economists also foresee a bright future for the German economy in the medium term.

With its luxury cars, machine tools and power plant turbines, German industry offers precisely the products the giant East Asian country desperately wants or needs. But the jubilant mood at German industrial giants like Siemens and BASF has recently been somewhat marred by worried questions. What is the significance of the Chinese starting to compete in more and more high-tech markets? What will be the consequences if the fates of entire industrial sectors are decided in the back rooms of Beijing's party bureaucracy in the future?

And what happens if growth in China proves to be an illusion? The government in Beijing, using the tools of a state-controlled economy, is already trying to prevent the next big bubble from bursting in its real estate market.

"I am aware that a growing portion of the company is dependent on this country," says Dieter Zetsche, the CEO of German automaker Daimler. And that relation of dependency applies both in good times and in bad.

Uninterested in Human Rights

At the end of last week, the human rights organization Südwind revealed that German companies like Aldi, Adidas and Metro, as well as their suppliers in the People's Republic, have some of the worst records when it comes to overtime and exploitation of workers. But the leaders of these and other companies pay little heed to such accusations.

They are also uninterested in the fact that China still imprisons hundreds of thousands of critics of the regime in reeducation camps. But what really keeps German company bosses awake at night is the fear that they themselves could eventually fall victim to Chinese power politics.

Beijing tends to react very sensitively to any form of criticism, as it demonstrated once again last week, when the United States Defense Department issued a report concluding that China is pursuing an expansionist military strategy in Asia. The Chinese state-owned press promptly rejected the report as "aggressive."

Beijing was equally reluctant to accept new statistics indicating that China will surpass Japan this year as the world's second-largest economy. The Chinese leadership announced that the news should not lead anyone to conclude that the country should lose its status as a developing nation -- a status from which Beijing derives financial benefits.

On Its Own Terms

China is seeking to engage with the West, but on its own terms. German companies are beginning to feel the effects of this policy. For instance, they note with concern that there is a growing tendency among the Chinese to blatantly demand the divulgence of industrial know-how in return for the right to do business in China. They are vexed by the country's tight control over access to domestic raw materials while it simultaneous seeks to secure exclusive rights to strategic energy reserves in Africa and Asia. And it irritates them that China is treating traditional German industrial domains as strategic business fields.

Some German entrepreneurs and executives consider it a polite understatement when German Economics Minister Rainer Brüderle complains that China is "not always an easy partner." And some Asia experts even predict that Germany's China connection could trigger the long-term demise of many icons of German industry. They warn that German companies that accept China's embrace could quickly find themselves being squeezed too tightly for their own good.

Doing business in China has already brought about deep-seated changes in German companies. Some small and mid-sized companies -- Germany's famous Mittelstand -- already do more than half of their business in East Asia, and the number of German-Chinese joint ventures continues to grow. Chinese executives have already advanced into the ranks of senior management in a number of German companies. There is hardly a company listed on Germany's blue-chip DAX index that hasn't absorbed a part of the People's Republic -- or perhaps it is the other way around.

Risky Symbiosis

The contradictions have even crept into the rhetoric of corporate leaders. When German senior executives are in Beijing or Shanghai, they have nothing but glowing praise for the country. But the minute they return to Munich or Düsseldorf, they complain about industrial espionage and instruct their personnel departments to avoid hiring Chinese interns at all costs.

The relationship between Germany and China is beginning to acquire a dimension that could exert a similar impact on the global economic order as the relationship between the United States and China. The industrial symbiosis between the two countries offers enormous opportunities and carries tremendous risk, so much so that few German companies can escape its pull anymore.

At a time when the US economy is ailing and Europe is launching more and more austerity programs, companies ranging from multinationals to small business face a stark choice: China or death.

'China Was Our Salvation'

Martin Herrenknecht wouldn't put it quite that way, however. He takes a more benevolent view of the situation. "China was our salvation," says Herrenknecht, who owns a company of the same name that builds tunnel-boring machines. "Without China, we would never have made it through the crisis as well as we did."

Herrenknecht is sitting in a conference room at his company's headquarters in Schwanau in southwestern Germany. Photos of gigantic drilling machines designed to drill precisely dimensioned holes into the earth hang on the walls. A shiny brochure containing his company's key figures sits on the table.

According to those figures, the company's total output declined by only 6 percent in 2009, at the height of the crisis. No one was let go at Herrenknecht, nor did the company avail itself of the government-subsidized "short-time working" program which helped prevent job losses at many German firms. It posted €866 million (about $1.1 billion) in sales in 2009, with 25 percent of revenues coming from Asia.

"China, China, China," says the white-haired entrepreneur. "The country is just unbelievably dynamic."

Lightning Pace

The main reason Herrenknecht finds the Chinese so dynamic is that they are constantly digging tunnels -- big tunnels, small tunnels, long tunnels, short tunnels. Herrenknecht received 19 orders for subway tunnels and seven orders for railroad tunnels from China last year alone.

He is in the process of sealing his latest deal. If all goes well, he will fly to Beijing in the next few days. He travels to China about once every two months. His company has nine facilities in the country, with a total of 500 employees. Herrenknecht still produces electronic and hydraulic equipment at its main plant in Schwanau, but domestic sales would not have been sufficient to keep the operation running at full capacity in recent years. "If you want to complete a construction project here, it'll take forever," says the entrepreneur. "In China, on the other hand, it's hard to keep up with the lightning pace of subway construction."

Many German business owners share Herrenknecht's experiences. China's rapidly growing economy seems to have an almost unquenchable thirst for German-made products. Although other European Union countries still account for two-thirds of Germany's more than €800 billion in annual exports, no other segment of German foreign trade is growing as quickly as the Chinese market. Exports to China were up by almost 60 percent this year.

Chinese companies and consumers are helping to ensure that the German economy grows at a rate almost rivaling economies in East Asia. In the second quarter, Germany's gross domestic product grew by an amount corresponding to an annual gain of 4 percent, almost half as much as in China. But the Germans didn't just benefit from a weak euro. They have also been more adept at adjusting to conditions in global markets than other European countries. The chief executives of companies in cities like Düsseldorf, Frankfurt and Stuttgart streamlined their organizations to become more flexible and constantly came up with new products, while the unions played their part by agreeing to only modest wage increases.

This led to a decline in unit labor costs, an important indicator of an economy's competitiveness. German products kept their high quality but became less expensive, which did not hurt their already strong reputation in global markets.

Everything a Growing Economy Needs

The German economy also offers a broad range of products. Its companies can provide almost anything a growing economy needs to get ahead, from machine tools to chemical products to turnkey industrial plants.

German companies also benefited more than most from a €400 billion infrastructure program that the government of Chinese Prime Minister Wen Jiabao launched to help stimulate the economy. Unlike other Western countries like Britain, for example, Germany had never allowed its industrial base to deteriorate -- a strategy that is now paying off.

Another advantage German companies have is that they became internationalized early on. Most owners of small- and mid-sized companies were already looking abroad one or two decades ago to sell their products or produce parts to supply their plants at home.

"For those who have been active in Central and Eastern Europe in the last 20 years, the step to China isn't all that big anymore," says Axel Nitschke, foreign business chief of the Association of German Chambers of Industry and Commerce (DIHK).

Growing Demand for German Consumer Goods

Nowadays, Germany isn't just supplying capital goods for the development of Chinese industry. As the Chinese upper class becomes more affluent, there is growing demand for consumer goods, including luxury cars made by the likes of Mercedes, BMW and Audi, high-end kitchens and expensive shoes. Even German stuffed animals are finding their way east. The Chinese, the world's largest toy exporters, have a yen for teddy bears and stuffed rabbits made by the legendary German toymaker Steiff. Ironically, for quality reasons Steiff is shifting some of its Chinese production back to Europe.

If the Germans have their way, this symbiotic relationship could go on indefinitely. On the one hand, the Chinese export T-shirts and athletic shoes, flat-screen TVs and CD players to Germany. In return, German industry sells its high-tech products -- cars, aircraft, railroads and machines -- to China.

And because the country is so big and so much of its land is still underdeveloped, especially in the rural western provinces, this mutually beneficial division of labor could continue for years, generating consistently high growth rates and benefiting German industry.

It sounds nice, but it won't happen. China has been booming for the last three decades, often growing at double-digit rates. But the laws of capitalism also apply to the state-controlled variety. The longer the upturn, the more likely it is that the economy will experience a setback.

Signs of a Crunch Ahead

Although the Chinese economy is still expected to add 10 percent this year, there are growing signs that the rapid upturn is losing momentum.

The Chinese central bank drastically cut back lending months ago. In many factories, workers have achieved significant wage hikes after staging strikes and protests in recent months. Experts also note that the real estate market is dangerously overheated. In recent years, increases in property prices in big cities have significantly outpaced income growth.

A few weeks ago, US economist Kenneth Rogoff warned of the beginnings of a "collapse in property," which could lead to bank failures, a credit crunch and a sharp decline in growth. This would have fatal consequences for Germany.

Volkswagen, for example, now sells almost one in four of its cars in China. If Chinese growth declines sharply, the Wolfsburg-based automaker would suffer losses worldwide.

Surging Ahead

The Germans also fear that as the Chinese become more affluent, they will no longer be satisfied with their role of low-wage producer. China is already developing an automobile and aviation industry, manufacturing high-speed trains and building chemical factories that could easily contest the global status of German manufacturers.

But Beijing isn't just interested in catching up with companies in Germany, which are still superior to their Chinese competitors. Instead, its goal is to surpass Germany technologically.

China's Communist Party leaders want to become the world's preeminent producers of the cars of the future: hybrid and electric vehicles. They want to manufacture aircraft that consume less kerosene than comparable models made by Airbus, and power plants with lower CO2 emissions than those of their Western rivals. In one future-oriented sector, the solar industry, the country has already managed to unseat the leading producer, a German company.

Generous Subsidies

A few years ago, companies like Siemens and Sharp were still far ahead in terms of solar cell production. Germany, in particular, was making every effort to secure a top spot in the production of photovoltaic systems. The consensus, both among the general public and among politicians, was that solar energy was an important industry for the future.

This led to generous subsidies for solar energy in Germany. Germans who mount solar panels on their roof are paid guaranteed rates for the electricity they produce and feed in to the grid. Experts estimate that German consumers will be paying at least €14 billion ($17.6 billion) over the next 20 years for the solar modules installed in 2009 alone.

The domestic solar industry supposedly benefits from this bonanza. But that's not even half the truth, because a significant portion of the money now goes directly to China. Even leading German solar system manufacturers are already quietly installing Chinese-made solar cells.

Beijing has promoted the development of this future-oriented industry more than any other country on earth. The government subsidized research into solar technology, and companies built large production plans for solar modules. Today four of the world's 10 largest producers are from China, while not a single German company is among these top 10. And while the large German solar providers' share of exports continues to decline, the Chinese are constantly expanding their position. This is partly because the Chinese-made products are cheaper. German solar cell manufacturers now charge an average of €1.60 per watt, while the Chinese sell their silicone components for about €1.30 per watt. Experts expect the price to fall below €1 this year.

Warning Signs for German Industry

But the Chinese solar cells are by no means of poorer quality. Only a few years ago, Chinese modules had the reputation of being more prone to failure and more harmful to the environment, but now the quality has improved dramatically. In fact, a recent study by the Stuttgart-based bank Landesbank Baden-Württemberg (LBBW) concluded that the productivity of Chinese producers is now higher than that of their German competitors. And according to TÜV Rheinland, a technical inspection agency, Chinese solar cells are of high quality.

China owes its rapid rise in the solar industry partly to German energy policy. About 70 percent of its total production is exported, and about half of that goes to Germany, a country known for its generous subsidies for solar electricity.

At Risk

What's happening in the solar industry should be a warning sign for Germany's most important sector, the automobile industry. Even strong sectors are at risk when China goes on the offensive.

The country is pursuing a dual strategy. On the one hand, China gains access to state-of-the-art technology through joint ventures. On the other, it is developing the technology of the future: electric cars. Chinese companies are already world leaders in battery technology, which could give the newcomer a decisive competitive edge over established European and Japanese carmakers.

VW, Daimler and the like are still benefiting from the China boom more than companies in most other industries. In fact, German carmakers are having trouble producing enough cars to meet Chinese demand. The most popular German cars in China are the large luxury sedans, like the Mercedes S Class and BMW's 7 Series, for which China is now the biggest market worldwide.

VW, Daimler and BMW are building new plants and intend to at least double their production in China. However, these new plants are not VW, Daimler and BMW plants, but joint venture operations between the German manufacturers and Chinese companies.

The Concubine Economy

This form of cooperation has been dubbed the "concubine economy." Just as the Chinese emperors once selected their concubines, China's current leadership selects foreign companies and grants them the right to produce goods locally in cooperation with a domestic partner.

The People's Republic compels the German carmakers to enter into these joint ventures. By imposing high import duties, the government prevents the Germans from simply exporting German-made cars to China. Any company interested in selling large numbers of its products is required to build factories in China with a Chinese partner, thereby giving the country access to their technology.

Beijing began upping the pressure on Western companies to transfer technology to the Chinese partners about five years ago. At the time, the business magazine Zhongguo Caifu published a story titled "Germany as Role Model." According to the article, cooperation with the Germans in the coming 20 years would be the "ultimate weapon" for the "rebirth of China's manufacturing industry."

A campaign by the Chinese company Shanghai Automotive Industry Corporation (SAIC) illustrates what this means in practice. SAIC is involved in joint ventures with both VW and General Motors. When the US carmaker was fighting for its survival last year, SAIC took advantage of its partner's weakness. It gained a controlling interest by increasing its share of the joint venture to 51 percent. The business publication Jingji Cankao Bao wrote triumphantly: "A new model of cooperation between Chinese and foreign automakers has been established."

Self-Confident

The Chinese have also become far more self-confident lately in their joint venture with VW, reports a senior employee. In the long term, says the employee, Beijing will hardly tolerate one of the country's most successful companies being run by managers in Wolfsburg.

VW CEO Martin Winterkorn is convinced that the Chinese will remain dependent on German technology for vehicles with classic gasoline and diesel engines. But Beijing intends to extricate itself from this dependency by focusing on new technologies.

The company that is expected to make a key contribution to this effort is called BYD, or "Build Your Dreams." BYD has only been making cars since 2003, but it is the world's second-largest manufacturer of batteries for mobile phones. Its research division has 10,000 employees and has just developed a new type of electric cell designed to power electric cars.

Whether the BYD dream will come true is still up in the air. Daimler, at any rate, is intrigued. The Stuttgart-based company, where the automobile was invented more than 100 years ago, is developing an electric car together with BYD. In doing so, it is testing a new form of cooperation, in which the Chinese partner is responsible for a substantial portion of the innovative technology.

Optimizing Imported Technology

China is pursuing the same strategy in the construction of power plants as it does in the automobile industry. At first, Beijing invited Western companies, mainly from Germany, to build power plants jointly with domestic companies. Now the Chinese are upgrading the plants with their own technology. The Waigaoqiao coal plant in Shanghai is a case in point.

Director Feng Weizhong is wearing a beige uniform with a shiny red party badge on his chest. But the impression that he is a party official is deceptive. Feng is China's most creative expert in environmentally friendly power generation using coal. The Waigaoqiao plant still looks shiny and new, as if Feng had just connected the plant to the grid. Against the skies over Shanghai, the smoke coming from the newest of the three tall chimneys looks almost as clean as a freshly laundered sheet. Feng, who has patented the technology for the filtration system, says proudly that it filters out a large percentage of pollutants

Waigaoqiao is almost overwhelmed with visitors. The plant, which is in the 1,000-megawatt class, is seen as a model project for other provinces that plan to build their own new coal-fired power stations or replace outdated plants.

Feng makes no secret of the fact that most of the technology used in his efficient power plant comes from Siemens and the French power generation conglomerate Alstom. Waigaoqiao is also an example of "indigenous innovation," he points out. "First we import foreign technology, and then we optimize it."

Close Cooperation

Thanks to his innovations, says Feng, he has been able to consistently reduce energy use. In this way, his efforts are in keeping with the "spirit" of the 17th Communist Party Congress in 2007, namely to turn China into a high-tech nation. At the time, the Chinese government also published a list of industrial projects with which the People's Republic plans to reach its goal by no later than 2020. The projects range from water purification plants to jumbo jets to biotechnology.

This is why Feng wants to continue his close cooperation with Siemens in the future, and he can count on the Germans to remain on board. Indeed, they have no other choice. If they hope to continue doing business in China, they have to share their own technology with their Chinese partners.

Western manufacturers no longer have access to contracts for smaller power plants in China, however. It is only with plants in the 1,000-megawatt category, like Waigaoqiao, that they are still permitted to compete for contracts.

The Germans are playing for time in China. Hence it's somewhat symbolic that Siemens has appointed a Chinese executive to run its business in the People's Republic.

Admittedly Mei-Wei Cheng, 60, is originally from Taiwan and has also lived in the United States. It's also true that other multinational companies have always installed local managers in the regions where they do business -- but their first obligation was always to the company and its shareholders. Beijing, on the other hand, sees the Siemens executive, who is believed to have close ties to the government, as one of its own.

The Need for Visions

China is not overly squeamish in its choice of methods to capture its spot in the global economy. That's something German engineering giant ThyssenKrupp learned when it became involved in a project that was long seen as a showcase of German innovation: the Transrapid magnetic levitation train.

The Düsseldorf-based steel conglomerate had spent a long time searching for a project that could serve as a showcase route for its magnetic levitation train. It finally found one in China. On New Year's Eve 2002, then-Chancellor Gerhard Schröder and then-Chinese Prime Minister Zhu Rongji inaugurated the first, 31-kilometer (19-mile) commercial test route, which now connects Pudong airport with Shanghai's financial district.

No one in Germany wanted the train, which travels at speeds of more than 400 kilometers per hour (250 mph), and it doesn't make much sense in Shanghai from the standpoint of transportation policy. But China's planners take a different approach. They know that visions are also important to an economy. The Eiffel Tower in Paris was just such a vision for the old world, and the giant Burj al-Arab Hotel in Dubai is one for the new.

The Chinese see the Transrapid as a collective inducement for its 1.3 billion people to eventually overtake their Western role models.

War of Nerves

Beijing had promised that once the test route had been built, a consortium would be formed, with Chinese participation, to install the revolutionary technology on other routes in China. But the promised contracts, which would have been worth billions, have not been awarded to this day. Instead, a war of nerves erupted between the Chinese and German partners that continues to rage today. The conflict revolves around the Germans' suspicion that the Chinese were merely interested in copying their technology.

Videotapes show how Chinese engineers went into the assembly buildings at night to secretly examine parts of the Transrapid. Nevertheless, the Germans still have no clear proof of the supposed technology theft.

Three years ago, the Chinese unveiled their own maglev train on the grounds of Tongji University in Shanghai, and they have unveiled other, more sophisticated trains since then. Some are said to be capable of traveling at speeds of more than 500 kilometers per hour (311 mph) and be more than 30 percent cheaper than the German technology. So far, the new trains are only prototypes.

Last year, the Germans negotiated an agreement under which the Chinese could be granted licenses to operate the Transrapid on Chinese routes. But the memorandum of understanding has yet to come into effect.

ThyssenKrupp executives in Düsseldorf are not ruling out the possibility that the Chinese are still speculating that they will ultimately be able to acquire the entire Transrapid technology at a bargain. The war of nerves continues.

Feeling of Déjà Vu

Many German companies have had similar experiences. At the auto shows in Shanghai and Beijing, visitors are routinely confronted with a feeling of déjà vu when they see Chinese imitations of German products -- or at least parts of them. The Lifan 320, a tiny Chinese city car, is the spitting image of BMW's Mini. The Chinese have also cloned Daimler's Smart, calling it the Noble and giving it two seats more than the German original.

Daimler once tried unsuccessfully to obtain an injunction against Chinese carmaker Shuanghuan and thereby prevent it from exporting its Smart copy to Europe. CEO Zetsche has even tried to approach Chinese plagiarism with humor, saying that stealing car designs is ultimately "a way of paying homage." Seen in this light, the Chinese must also have tremendous respect for Germany's capital goods industry.

Chinese competitors copy German machines and their components and then sell them at low prices in other markets, like India, the United States and Russia. According to the German Engineering Federation (VDMA), two out of three German machine-building companies are victims of product or trademark piracy, which translates into €6.4 billion in annual lost revenues. China, which is responsible for 80 percent of these losses, is the "uncontested world-champion plagiarizer," says the VDMA.

German companies often hesitate to take the East Asian plagiarizers to court. They have little confidence in the Chinese legal system and fear reprisals.

As a result, some business owners are so frustrated that they withdraw from the Chinese market. Manfred Wittenstein is CEO of the engineering company Wittenstein, as well as being president of the VDMA. His company planned to build a plant for precision transmissions in China five years ago. But when Chinese officials demanded that he disclose technical plans and product details, Wittenstein abandoned the project. "The Chinese market has many hidden snares, which shouldn't be underestimated," says Wittenstein.

Misunderstandings and Mutual Incomprehension

The incident shows how disparate the two cultures still are today. The shared history of the Germans and the Chinese is filled with misunderstandings and mutual incomprehension.

The image many Germans have of China is still shaped by the horrific pictures of Mao Zedong's Cultural Revolution. But those days are long gone, and besides, the Cultural Revolution was never in keeping with the country's great traditions. Throughout the Middle Ages, the Chinese empire was technologically superior to the European powers. As recently as 1820, the country's economic output was well above that of the old continent.

But there was little trade and communication between Europe and China, and when there was contact, it was often ill-fated. The German astronomer Johann Adam Schall von Bell (1592-1666) was a case in point. He was made a court official and director of the imperial observatory in Beijing, but after the death of his patron, the emperor Shunzhi, Schall was sentenced to death.

German interest in China was only revived in the 19th century, when the German Reich established its "model colony" at Qingdao. The Boxer movement arose in part from local resistance to the German colonial masters and, in 1900, led to an attack on the diplomatic district in Beijing and the death of the German envoy. In a famous speech known as the Hunnenrede ("Hun speech"), Kaiser Wilhelm II said that the Chinese should "never again" be permitted to dare "to even look askance at a German."

Reviving Relations

But despite this animosity, the Chinese to this day admire imperial latecomer Germany for having caught up with Britain and France. After World War I, German officers and representatives of heavy industry came to the aid of the Chinese nationalist general Chiang Kai-shek.

Economic relations were eagerly revived in the 1980s. In 1984, VW signed a joint venture agreement with the state-owned Shanghai automaker. Even after the bloody suppression of student protests on Tiananmen Square in 1989, German industry was unwilling to spoil its cozy relationship with Beijing's leaders. Only three months after the massacre, Otto Wolff von Amerongen, chairman of the German East-West Trade Committee, became the first foreign official to pay a visit to then-Prime Minister Li Peng. During the administrations of former Chancellors Helmut Kohl and Gerhard Schröder, the Germans were viewed in Beijing as docile partners who were more interested in their business deals than in questions of human rights.

The first major rift happened in 2007, when Merkel received the Dalai Lama, the spiritual leader of Chinese-occupied Tibet, in Berlin. The furious Chinese cancelled scheduled diplomatic meetings and threatened to suspend contracts. German business leaders, like BASF CEO Jürgen Hambrecht, argued that it would be preferable to settle differences with China on the quiet.

But Merkel was unimpressed at first, noting that as German chancellor, she would decide with whom she was to meet. It's debatable whether Merkel would get away with such a gesture today. China has become stronger and more powerful since then, and unnecessarily provoking the country is probably not a good idea.

Cultivating a Difficult Relationship

During her most recent visit to Beijing, the chancellor handed her hosts a list of dissidents in Chinese prisons. She addressed the subject of human rights, but she did it quietly enough so as not to embarrass the Communist Party leadership.

Merkel is convinced that China wants to become a superpower at all costs. The financial crisis has only accelerated this process. The chancellor senses the new self-confidence of Beijing's leaders, and she wants to ensure that Germany will not be left in the dust when the world's political center of gravity shifts.

Hence, she is interested in a good relationship with the Chinese. But how does one build close relations with a country when one is simultaneously criticizing it for its human rights violations and contempt for international rules?

This is the big question that currently shapes Germany's China policy. Merkel's challenge is to cultivate the relationship without creating the impression that she doesn't care about democracy, civil rights or protecting German economic interests.

German Impotence

Speaking recently to a small group of confidants, she mused that it doesn't help to vehemently parade one's own impotence on the issue of human rights. Instead, during her recent visit to Beijing in July, she encouraged German business leaders to air their frustrations over trademark piracy and mandatory discounts -- and she was successful. Siemens CEO Peter Löscher complained about the poor prospects for Western companies in bidding for government contracts in China. BASF CEO Jürgen Hambrecht criticized Beijing's policy of forcing Western companies to disclose their know-how, noting that it "doesn't quite correspond to our notion of a partnership." Officials at the German Economics Ministry say that "there was a completely new tone" at the meeting.

The effort shows that, 30 years after the beginning of Chinese reform policies, Germany's involvement in China has reached a turning point. Until now, it was considered de rigueur for anyone doing business in China to conform to local norms, sometimes to the point of self-denial. Those who managed to sidle up to Beijing's functionaries -- derisively referred to as "panda huggers" -- were most likely to garner the best contracts. In the future, Germans will face a completely new challenge in China. They'll have to learn that sometimes it's in their best interest to say no.

For politicians, this means defending Western values of democracy and the rule of law, even in the face of Chinese opposition. All around the world, from Africa to Asia to South America, Beijing is trying to tout its model of authoritarian state capitalism as the better alternative. If the West hopes to preserve its influence in these regions, it will have to prove that it is not prepared to abandon its basic principles. After all, credibility is also a value.

No Choice

It is no less important for the rivals of East Asia's rising industrial power to do their homework. For example, the United States, by long pursuing a policy of paying for its consumption with borrowed funds, has become dangerously dependent on Beijing. China has been the US's biggest creditor for years. With its trillions in foreign currency reserves, Beijing could manipulate the value of the dollar almost at will.

If the United States hopes to liberate itself from this dependency, it has no choice but to find its way back to the type of economy that was long held in high regard in the US. The government in Washington should finally clean up its deficit, and US consumers need to save more.

For Europe, too, much depends on whether it manages to solve the financial problems in the euro zone. As long as countries like Greece, Ireland and Spain are threatened by bankruptcy, the euro remains acutely at risk. But if the monetary union collapsed, the Germans would also suffer. Their currency would most likely become much stronger, thereby significantly curbing exports.

The challenges for European politicians are obvious. Merkel, French President Nicolas Sarkozy and others must avert national bankruptcies in the euro zone and reestablish a sustainable basis for the monetary union in the long term.

Defending Germany's Edge

Germany's business elite must defend their technological edge against Beijing's aggressive advances more vehemently than in the past. Until now, no one cared much whether Chinese companies were flooding world markets with their counterfeit, mass-produced goods. In fact, it enabled the Germans to sell even more of their high-tech equipment in China. But today, as the country encroaches on Germany's traditional industrial sectors, the protection of intellectual property becomes a question of survival.

More is at stake than a few copied blueprints or the small print on licensing agreements. The underlying issue is whether the German business model is still viable in the 21st century, an era that will be strongly influenced by the Chinese.

If German companies manage to maintain their technological edge over the increasingly powerful Asian competition, doing business in East Asia will still prove to be a blessing for German industry in the future. But if they relinquish their unique position, they will sooner or later be steamrollered by China's industrial power. And if they do, German industrial giants like Siemens and Daimler could end up with little more than a few niche markets in northern Europe.

The leading position of German universities and research institutions also has to be defended. The German economy still benefits from the fact that the average engineer in Germany is better trained than his or her counterparts in Beijing or Guangdong. In the future, making sure that this remains the case will be a key issue in German industrial policy.

The German economy faces an enormous challenge, and yet sometimes it seems as if its business leaders are still reluctant to take on the Chinese. "We can either do without this huge growth market, or we submit to the Chinese conditions," says one German auto executive. "There is nothing in between."

FRANK DOHMEN, KATRIN ELGER, DIETMAR HAWRANEK, RALF NEUKIRCH, RENÉ PFISTER, CHRISTIAN REIERMANN, MICHAEL SAUGA, WIELAND WAGNER

Translated from the German by Christopher Sultan

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