The European Union is facing an economic shift due to Beijing’s growing nationalist agenda, which has made the Chinese economy increasingly threatening to European security and undermined the continent’s competitiveness. Chinese dominance in the solar panel and electric vehicle sectors poses a significant threat to Europe’s largest companies. In response, industrial policy has regained its significance, the European Chips Act has been enacted, and taxes have been imposed on Chinese electric cars. While these policies are justifiable, it would not be economically or diplomatically wise for the EU to attempt to protect all products or to localize all supply chains.
Manufacturers based in the EU are encountering two challenges in China. As China rises in the value chain, wages are increasing, prompting a natural shift in supply chains to nearby countries with lower wages. Political developments further complicate this trend. Locally, Xi Jinping’s emphasis on political security has created greater uncertainty and reduced economic dynamism. Internationally, Western nations are increasingly concerned about the geopolitical risks associated with reliance on Chinese production.
Foreign investment in China has sharply declined. While diversifying away from China is ongoing, it will not happen overnight. China’s manufacturing strength and proximity to Southeast Asia ensure its continued involvement in supply chains, even if final assembly moves out of the country. These geopolitical trends are already reshaping parts of Asia, where ASEAN and South Asian countries benefit from the so-called “China + 1” strategy, allowing companies to hedge by maintaining their Chinese operations for their vast local markets while shifting global export production to other countries like India, Vietnam, and Thailand.
Although imports from China may decline in favor of imports from Southeast Asia over time, the Chinese content in supply chains currently remains dominant. Additionally, many companies relocating to Southeast Asia for global export are Chinese firms. Trade between the U.S. and ASEAN, as well as with China, grew significantly from 2012 to 2021, with an increase of 80% and 100%, respectively. In contrast, EU trade with ASEAN grew only from 210billionto210billionto270 billion, reflecting Europe’s relatively stable yet declining significance in the region. While the growth in Chinese and American trade may indicate a shift across Southeast Asia in response to U.S. barriers, over time, the newly established industrial presence in the region could serve as a platform for global expansion.
The EU has long supported ASEAN, working closely with the regional organization and helping to fund its secretariat. Nevertheless, in economic matters, Europe has consistently struggled to achieve success, with ongoing disputes over palm oil with Malaysia and Indonesia serving as prime examples of this challenge. The EU has only two free trade agreements with Southeast Asian countries. Despite its historical closeness to ASEAN, it is not among the six development partners that have free trade agreements with the organization and is not part of the Regional Comprehensive Economic Partnership, which hampers Europe’s ability to confront China.
Japan is deepening its already impressive economic integration with the region, having signed nine free trade agreements with ASEAN countries. China is currently negotiating an upgrade to its existing free trade agreement with ASEAN, focusing on technology, while the U.S. is developing its economic framework for the Indo-Pacific region. Meanwhile, the EU struggles to make progress on a free trade agreement with Indonesia.
As a result, Europe risks missing a significant economic transformation opportunity. As a manufacturing powerhouse, Germany has long enjoyed a substantial and profitable presence in China, but new supply chains concerning emerging technologies are forming as manufacturing shifts to Southeast Asia, and Europe will be sidelined if it does not ensure its continued participation. Moving assembly to countries like Vietnam often retains Chinese content in supply chains, as Chinese suppliers also shift. However, in the long run, Chinese dominance in the supply chain remains vulnerable.
In the 1980s and 1990s, Taiwanese companies moved entire supply chains from Taiwan to China, gradually incorporating more Chinese suppliers. As these Chinese firms learned from their exposure to Taiwanese companies, they slowly moved up the value chain. What happened to Taiwanese firms may happen again with China in Southeast Asia. There is already a strong European presence in high-tech sectors in ASEAN countries concerning advanced semiconductors. For instance, Singapore and Malaysia host significant chip manufacturing, much of which is within the supply chains of Western, Japanese, Taiwanese, and South Korean companies. A manufacturing triangle of Malaysia, Singapore, and Indonesia appears to be forming, but with the transition of Chinese companies and U.S. measures that may challenge Singapore’s role as a gateway for China to access Western technology, the EU cannot find its place.
China’s growing role does not necessarily mean that Southeast Asian countries will become more politically submissive. Taiwan has gained economic strength by ascending the global supply chain through outsourcing work in China, yet its close economic integration with China did not lead to automatic political integration. However, this required other options and imposed restrictions on Chinese investment in Taiwan. Taiwan thrived by accessing markets outside of China. One reason Southeast Asian nations perceive China as an inescapable force is its economic size and proximity, but the lack of alternative options exacerbates this perception. Europe, standing alone, is too far from direct competition with China’s weight. However, its single market is strong enough to help expand options and demonstrate the benefits of a free and open trading system.
The slowdown in the Chinese economy is impacting Southeast Asia’s emerging economies, with the region—excluding Cambodia—being more reliant on China for its exports than the average. However, this reliance has remained stable and is no longer growing. Southeast Asian countries receive many parts from China, which they assemble and sell globally. Most Southeast Asian countries run trade deficits with China. They do not benefit significantly from the supply chain shifts due to China’s vast capacity and its increasing share of added value in ASEAN exports. The region has considerable opportunities, especially with China’s stagnation, which represents openings for Europe.
