China Shock 2.O is also Europe Shock 2.0

How an external shock becomes a domestic crisis for the European Union

In a matter of months, these economies lost a substantial fraction of their GDP and were forced to make painful adjustments. After an initial reluctance from Europe’s largest lender and current account surplus country – Germany, joined by the "frugal" member states -the ECB under Mario Draghi ushered in its famous new policy: quantitative easing and lowered interest rates to save the debtor member states, a "whatever it takes policy" that restored confidence. 

It was a success, but at a great cost: the money thrown at debt repurchases and overall credit facilitation created another era of cheap, undirected money flow without a strategic purpose. Some countries did use the reprieve to retool and regain competitiveness. Others – starting with France which had itself avoided the debt crisis – largely piled on spending without any clear strategic direction. It threw money at various targets – income redistribution, greening, early retirement. Overall, the loss in overall competitivity – the difference in GDP growth between the Europe and the United States – started from that moment and has kept increasing since. Internal devaluation – ultra-low interest rates and ultra-low inflation – cushioned the shock to consumers. Private indebtedness – including of firms – filled the gap between lower incomes and investment needs.

Thus, Europe Shock 1.0 was digested and largely forgotten, except with ritual calls to cap public indebtedness.

This time, it is not a credit crunch and rising rates that hit Europe, but a price and cost deflation originated in China. 

The phenomenon isn’t entirely new. China’s world factory has shrunk the price of every product it has taken on for decades. But the trend has both accelerated and widened in scope. Almost all types of goods including sophisticated high-end products are involved, the scale of production dwarfs anything the world has seen (one number only: 40 million cars…). China hasn’t renounced previously low-tech industries. It aims for a full set industry and exports on a scale that Japan in its heyday could only dream of.

Global trade logistics also favor China: reports that global trade is shrinking and fragmenting are entirely wrong. It is still increasing but entirely driven from China. China makes 90 % of the world’s containers, and out of more than four containers shipped full to Europe, only one comes back with any content. 

This is what is now commonly described as China Shock 2.0. Half-jokingly, Prime Minister Li Qiang recently renamed it China Opportunity 2.0. Indeed, for international shoppers, it is now "every day low price" (Walmart’s former motto…)  in China. And of course, Li Qiang predictably denies the manipulated part that has led to this situation, and which in international comments can be summed up with just one word: subsidies.

Yet it is too easy for Europeans to find solace in accusations against a partner tougher than steel – authoritarian China – and to delude ourselves with the belief that protective and defensive solutions alone are the way to resolve the issue of what is also described as a global imbalance. 

The balance sheet of European responses so far

Yes, defense and pushback against Chinese trade inflexibility are necessary. Since its global export drive is also an outcome of a deep domestic impasse, it knows no boundary other than what may be set in stone by its trade partners. China may not want to "rule the world" as some have wrongly asserted, because this is simply too costly. But it has not set or recognized in any way a limit to its global manufacturing share. This sits currently at 35%, and could easily reach 40% by 2030, given the current trend. Whatever we think of the successive Trump administration’s trade moves, the United States is the only economy that reduced since 2019 its overall direct trade dependence on China. This was done by using a heavy hammer – outsized customs duties bringing China to the negotiation table. 

Critics will counter that more of the trade deficit, whether by substitution or through re-export of Chinese components, now originates elsewhere – notably, from Japan, Korea and Taiwan, Vietnam, Mexico, as well as from some European member states. Ultimately, given China’s regime and geopolitical strategy, is it indifferent to have an influx of goods from other Asian countries or from a China? with most of Asia, there is room for talk and respect for agreements. By contrast, China has already put its trade leverage to coercive use on several occasions, including against Europe. 

We should therefore support the mandate given by the European Council to come up quickly within a new solidarity instrument against Chinese trade threats and countermoves. We should also speed up and broaden existing or planned trade countermeasures, from cars to steel and chemicals. It is only with credible deterrence against exports that we will reach any deal with China on direct investment in Europe as an alternative to exports. The European Commission has a mandate to come up with new safeguards - instruments more akin to the United States’ Section 232 or 301 tariffs that can be used when there are sudden import surges and trends detrimental to economic security. Commendably, the EU is setting in motion additional duties on steel while talking with China.We should also draw red lines on national security ("public security" in proper EU parlance…) and economic security: we cannot grant China an open bar in its quest for the technologies that is may still miss. 

After the recent EU Council and the meeting between Maros Sefcovic, EU Commissioner for Trade and Economic Security and Wang Wentao, China’s Minister of Commerce, there are signs that the European Union is moving seriously in this direction. It is also attempting to get China to accept a genuine negotiation, which implies compromises. Importantly, the nice words written into a joint communiqué do not stop the EU from enacting some of its early decisions and moving on the process that will finalize the Industrial Accelerator Act (IAA). This is the pilot or demonstrator piece of legislation that will allow for more industrial policy and a foreign investment regime on terms that are acceptable to Europe: something that China, of course, has itself enacted…since the late 1970s! 

As it is, the draft for this legislation has flexibilities for member states, and at least one major olive branch to China: it is a non-signatory of the International Procurement Act, yet its companies will nonetheless be able to bid for public tenders in Europe if their price comes in 25% under competition. On infrastructures and many other public goods, this is easily achievable by Chinese firms with lower costs. In any case, the IAA at this point covers only 2% of the European market. 

Yet even this commendable stand taken by the European Union must be qualified and watched. The IAA‘s final form is not expected before October (the official deadline is the end of this year). Parliamentary and Council approval will take up more time. At the speed that Chinese exports are going, this gives ample room for China to smother many European companies – and to lure European customers to the promise of ultra-cheap goods. The platform for talks that has just been created between China and the EU has an October 2026 deadline, if one follows European communications. That deadline appears nowhere in Chinese readouts. 

It seems obvious to this writer that China has no incentive to make important concessions to Europe before the American midterm elections in early November. Until that date, it risks more reprisals than rewards from the US for reaching deals with the European Union. The trade truce reached between Donald Trump and Xi Jinping extends precisely to the coming month of October. And whatever the outcome, time gained by China is also more relief for its exporters and companies undermined by domestic price dumping.

There is an unavoidable conclusion: the course taken by the European Commission and the fairly wide mandate apparently granted by member states are commendable. 

Dealing with Europe Shock 2.0

Just like dealing with Europe Shock 1.0 required urgent measures, the China Shock 2.0 requires a change of gears in all defensive measures briefly outlined above. But we must also recognize the reality of Europe Shock 2.0 and put our own house in order. China’s export drive may be a tsunami, but it hits Europe harder than the other regions of the world except Africa. According to China’s customs statistics, China’s exports to the EU rose 18% YoY in Q1 2026, ahead of exports to ASEAN and the UK and well above overall Chinese foreign-trade growth. EU imports from China reached €145.3bn in Q1 2026, up roughly 20% from Q1 2024, while total extra-EU imports were down 3.3% YoY. China’s growth in exports also far exceeds global merchandise trade increase, which the WTO put at 4.6% in 2025, with slower growth expected in 2026. And Europe is its first destination.

Painful adjustments cannot be delayed. Certainly, China’s energy and land costs cannot be matched, and its large savings and low household consumption are now complemented by a huge monetary creation, currently 50% YoY, more than its East Asian neighbors who also have a policy of letting their currency slide. But what did we do in the decade when European interest rates were cheap, at 1% or even negative for some? With national interests battling one another, we have weakened and delayed the deepening of a European capital market, and even if the EU is now doing better than usually reported on implementing the Draghi report, there is only so much you can do with an EU budget standing at 1% of Europe’s GDP. There certainly are some gap fillers – such as common insurance schemes to encourage lenders – but they cannot replace a major reorientation of capital. 

As believers in the virtue of a market economy and competition, we cannot think that it will go along Chinese lines – e.g. a massive shift of resources to centralized and largely public or quasi-public financing. Much of the shift from public expenditures to capital market will have to come from a reduction of the former’s share of GDP if we still have only low growth, and a stabilization if that growth should accelerate. We leave aside here the other recommendations from the Draghi report, starting with the streamlining of rules and the speeding up of decision processes. At the moment, almost all analyses converge on China as a problem, yet there is a tangle of unclear processes – member states, the Commission, EU parliament – and an even worse spaghetti bowl of public administrations and agencies across the EU. The US has much clearer rules for access to its market and investment base. 

Ideally, rebalancing the global economy, the stated objective of this year’s G7, should help. That requires getting the support of East Asian countries other than China – Japan, Korea, which along with Taiwan have large current account surpluses matched with cheaper currencies. To woo them, we would need to shift our new defensive trade and investment tools from agnostic policies to measures explicitly targeting China. By doctrine or for fear of frontally antagonizing China, the EU is not ready for this. The United States pursues more than ever its own course in monetary and capital market policies, and it is unlikely that we can effectively team up in the short term. A collective bargaining for a realignment of currencies – what some call a new Plaza agreement – is therefore unlikely. 

There is another avenue: lowering the price of the European currency, what is in effect a competitive devaluation. The US has considered it, East Asia practices it, and many emerging economies threatened by China’s export drive must resort to this. There is not enough space here to discuss its possible consequences, but let’s just make two concluding observations. First, if devaluation along with money creation, and accompanied by strong reforms, increases the growth potential of the single market, this will also stimulate outside investment into our economies. Second, just as you cannot stay multilateral in a world where few others are doing so, you cannot keep being a guardian of your currency when nearly everybody else is engaging into competitive devaluation.

The main risk of this choice would be political, rather than economic: that this gives another mandate, under pseudo-Keynesian justifications, for profligate public spending on populist claims, industry lobbying or on every “do good” policy one might think of. 

A most urgent task is reaching a better definition and arrangements across 27 member states of the European Union for public support to what must largely remain private investment. 

Chinese Premier Li Qiang at the opening ceremony of the World Economic Forum (WEF) in Dalian, China's Liaoning province on June 24, 2026.

Copyright: WANG Zhao / AFP