Dangerous Liaisons

Jacques Chirac played the perfect guest. Touring Beijing with 30 French executives in October, the French president called for an end to Europe's arms embargo on China. He labeled Taiwan's moves toward independence as "irresponsible" and argued that Chinese human-rights violations should be discussed "discreetly" or not at all. China, he proclaimed, is "taking its full place--which is immense--on the global scene." Clearly appreciating the unctuous affirmations, Chinese officials showered the French with a record-setting 4 billion euros worth of business contracts.

Europe, these days, is besotted with Sino-euphoria. Its diplomats dream of a newly multipolar world--with China as an indispensable pole. German Chancellor Gerhard Schroder, who embarks on his sixth visit to China this week, enthuses over the new "strategic partnership." The burgeoning China trade, he hopes, will help Germany to trade its way out of economic stagnation--and himself into a third term as chancellor in 2006. This week's summit of European Union and Chinese leaders in The Hague will bring yet another lovefest, with new agreements ranging from research cooperation to tourism. Europe and China, business leaders agreed at a conference in Hamburg last week, are "a marriage made in heaven."

Hmm. That's not quite how the European Commission sees it in its recent 2004 Competitiveness Report. It devotes a whole chapter to the emerging China threat. Just as America's China craze a decade ago set the stage for wrenching industrial changes, so now will Europe's. It, too, will soon face massive competition from ever more powerful Chinese "national champions," the report warns, undermining entire industries and requiring a large-scale transformation of European economies. A study by the Boston Consulting Group predicts that Germany stands to lose a quarter of its 8 million manufacturing jobs during the next decade, many of them to China. Yes, economic opportunity beckons. But if not properly managed, Europe's embrace of China could hasten rather than arrest its own economic decline.

That would be a cruel twist. After all, it was Europe that originally opened the door to Beijing. French President Georges Pompidou, not Richard Nixon, was in 1973 the first Western head of state to visit Red China. Long before outsourcing became a dirty word, European companies were pioneers. Volkswagen entered the market as early as 1983; today the German automaker sells more cars in China than at home. But most European companies slept through the China frenzy of the 1990s, leaving the field to American, Japanese and Korean competitors who flooded in to cut costs and seize new markets. Thus Europe largely missed out on the consumer boom sparked by cheaper Chinese wares--one reason, say economists, for Europe's feeble growth.

Now Europe seems to be making up for lost time. From German machine makers that equip Chinese factories to French couturiers who dress the growing middle class, European companies have doubled their sales to China during the last four years. The European Union will soar past Japan and the United States this year to become China's biggest trading partner, creating or saving tens of thousands of European jobs. When Schroder inaugurates a new 1 billion euro Volkswagen plant in Changchun on Dec. 7, his advisers would do well to remind him that VW is not the only struggling German blue chip whose 2004 corporate profits would look dismal if it weren't for China. Chirac in October secured a $1.5 billion order for the French engineering giant Alstom, a huge relief for a company recently on the verge of bankruptcy.

Geopolitics figures in this shift. Since assuming full power earlier this year, Chinese President Hu Jintao has been more pro-Europe than pro-America. Beijing is eager to break its reliance on investment from America, which it sees as a potential strategic adversary, not only over Taiwan but farther afield. Hence China and the EU signed a 200 million euro deal this year to jointly develop Europe's Galileo satellite navigation system. Also this year Chinese airlines will for the first time be ordering more new planes from Airbus than from Boeing. Indeed, Schroder is expected to wrap up an order from Air China for 24 more Airbus planes worth 1 billion euros this week.

Such deals will make Europeans a lot of money. Yet Europe should beware: this love affair is double-edged. China makes no secret of its ambition to build so-called national champions--powerful companies that can compete on a global scale. For that it needs technology, which the Europeans have been more willing to share than has America. Airbus, for example, won its recent contracts chiefly because it agreed to outsource a good chunk of the manufacturing to Chinese aircraft companies, along with invaluable know-how.

Chinese companies aren't just building champions at home. They have also begun buying up brands in Europe, taking over factories and setting up production. Last month Shanghai Automotive Industry Corp.--which grew big as Volkswagen's partner--announced it would take over troubled British carmaker Rover for 1.5 billion euros. Chinese electronics giant TCL has bought insolvent German TV brands Grundig, Dual and Schneider, as well as France's mobile-handset maker Thomson. In a sudden reversal of roles, TCL now ships parts and modules from China while expensive European workers do nothing but final assembly. If that begins to happen broadly, says Bain & Company partner Uwe Reinert, other European companies will be undercut. Perhaps Chinese owners will decide that Europe's expensive social model--with its high labor costs, unions and pension systems--isn't for them. They could move production out, leaving nothing but an empty distribution system. "The Chinese are fast, cold capitalists without any of our social romanticism," says Reinert. Sinophoria could quickly turn to Sinophobia.

Perhaps the good news is that Europe's leaders are awake to the threat. For all his rapture over China, Schroder is hard-eyed about the potential downside: one reason he's sticking with welfare reform, despite massive protests, is that he knows German companies have to be able to cut costs if they're to compete in a world increasingly dominated by China. Andreas Kreimeyer, Asia chief for chemicals giant BASF, says he takes his German union negotiators to Asia each year, where they meet with their Chinese, Indian and Malaysian counterparts. That's one of the reasons, perhaps, that Germany's chemical workers' union has been more flexible in its wage and benefit demands. It's one thing, though, for individual companies to adapt to a changing climate. It's another for whole societies. Whether Europeans at large are ready for the radical changes of the China era is an open question. For now, let them enjoy the euphoria.