China and the EU: the imminent choice between a trade deal and a trade war

“We can bring down energy prices, invest and innovate more, reform our economies. But all this is undermined if our companies do not compete on a level playing field. […] Our trade deficit with China is now €1bn a day. It has reached a tipping point […] it leads to deindustrialisation in the industrial heartlands of Europe. This is unsustainable. And this is why we are engaged in a dialogue with China to rebalance our trade. But this dialogue must now lead to results. […] we will use all the tools to rebalance our relationship.”  — Ursula von der Leyen

European concerns

These words of Commission President von der Leyen in her State of the Union address on 16 September express not only serious concern about the rapidly growing trade deficit of the European Union with its second-largest trading partner, but also readiness to both negotiate and take the necessary measures in case the talks fail.

Indeed, the situation is very serious and demands action, not just words. In 2026, the Chinese global export performance improved impressively, driven notably by rising demand for its high-technology and AI–related products: its total exports reached US $1.2tn, with exports in August being 25% higher on a year-on-year basis.  The EU’s trade deficit in goods with China jumped from €306bn in 2024 to €360bn in 2025 and is expected to reach up to €400bn this year (Eurostat reports a €103bn deficit in the second quarter of 2026).

The Commission is not alone in its concern in the EU, which is shared by the other EU institutions. The fast-rising Chinese trade imbalances were identified as a “strategic challenge” by the EU’s Foreign Affairs Council, in its “Common Understanding of the Threats and Challenges We Face”, a surprisingly clear and unanimously approved assessment of 9 July.

In addition, the European Parliament is expected to adopt a rather critical resolution on EU-China relations on 7 October. When the Foreign Affairs Committee agreed (by a vote of 44 yes to 9 no with 12 abstentions) on the draft resolution on 10 September, it called for “urgent action against the weaponisation of EU economic overreliance on China and a rigorous de-risking strategy focused on critical raw materials, medicines, batteries, electric vehicles, information and communication technology, semiconductors and other strategic sectors.”

But the key decisions on the strategic direction for EU policy on its trade and investment relations on China are scheduled to be taken at the next European Council on 15/16 October. These will be based on its in-depth China-related discussions on 19 June this year, when the Heads of State and Government charged the Commission to address “global macroeconomic imbalances” and gave a mandate to produce tangible results by October on the EU’s steadily growing trade deficit and China’s overcapacity. Discussions will consider the outcome of the meeting between US President Donald Trump and Chinese President Xi Jinping on 24 September 2026 in Washington, DC. It will be beneficial for the EU if there is a continuation of the truce between the US and China as regards tariffs, and notably if a renewal of their understanding on export licensing of critical raw materials can be achieved.

The main task for leaders will, however, be to evaluate the outcome of the European Commission’s intensive talks under the new Trade and Investment Consultations, which had been launched on 29 June by European Commissioner for Trade and Economic Security Maroš Šefčovič and Chinese Minister for Commerce Wang Wentao. Over the summer, both sides engaged in intensive consultations, notably on practical ways to balance trade and investment relations, and address export controls. Both sides will meet again at ministerial level in the second week of October, in Beijing. After weeks of intensive negotiations,there is little time left to demonstrate that they have produced concrete outcomes. If a deal can be reached, it must be substantial to address the concerns of the European side and secure the endorsement of the European Council.

What would a substantive deal with China look like?

What would be sufficiently substantive to avoid agreeing on a ‘second Turnberry deal’, which would favour Chinese commercial interests, keep trade going without any major adjustments and only amount to symbolic concessions? The Commission negotiators are acutely aware of the diverging interests between member states when it comes to trade and investment policy vis-à-vis China, with the PRC using its influence and individual leverage which it has carefully cultivated inside each member state.  These diverging interests also reflect different economic realities.  Member states and economic sectors are affected differently by ever-growing Chinese exports to the EU and declining EU exports to China. Germany and the Czech Republic are particularly exposed, while manufacturing-intensive sectors such as machinery and transport equipment face heightened competitive pressure, according to a recent study of the European Central Bank. 

Taking this into account, the Commission is making every effort to reach a deal with Beijing. It does not pursue these talks pro forma simply to be able to say that it has reached out to the Chinese side before taking unilateral measures, but it does indeed pursue the task of reaching concrete results. It appears that sincere, in-depth talks have led the Chinese side to accept the principle of the need for restraint. But will that be enough? To be meaningful for the EU side, a deal cannot consist of a one-off measure involving only one sector, just for China to demonstrate goodwill.

What is required to succeed is agreement on a method of rebalancing trade, with a series of first steps. Such a substantive outcome needs to cover concrete product areas. A key requirement for success might be the inclusion of concrete commitments involving hybrid car exports, which could help gather support in the Council in favour of such a deal.

The dilemma: deal or trade war?

The alternative to a deal is a trade dispute. This might then easily escalate into a trade war, creating a ‘lose-lose’ situation for both sides. The EU could see itself forced to use the Anti-Coercion Instrument for the first time, which would allow it to use hard-hitting measures to stem the flood of cheap Chinese goods, including substantial tariff increases and quantitative restrictions. Chinese retaliatory measures are certain in such a case, with each side calculating which ‘chokepoints’ would be the most effective to use. At this stage, both the EU and the Chinese side want to avoid such a scenario unfolding.

But to avoid such an outcome, both sides must deal with their very own policy dilemmas:

• The EU has to weigh the choice between (a) accepting the potentially minor positive effects of reduced market pressure on EU industries resulting from a limited Chinese acceptance of voluntary self-restraint regarding exports of certain goods and (b) a much stronger protective impact as a result of unilateral measures to stem the glut of cheap Chinese products and favour domestic producers, while facing the negative effect of significant Chinese retaliation.
• China in turn has to weigh the choice between (a) making concessions in order for its largest export market to remain open at a time of sluggish domestic demand and steadily slowing growth at home alongside a volatile US market, and (b) the prospect of the EU imposing a series of trade-restricting unilateral measures in the absence of any Chinese concessions, which would then prompt Chinese retaliatory actions and lead to a potentially significant reduction in

China’s domestic economic pressures and the role of exports as a driver for growth

EU negotiators must keep in mind the increasingly difficult internal economic situation of China, which is often overlooked in view of its stellar export performance. At the same time, EU decision–makers need to be clear-eyed about the political and ideological drivers of China’s aggressive export-led growth.

Protective measures that result in a partial closure of the EU market could further undermine Chinese economic growth prospects, given its very high savings rate and low domestic consumption. Latest Chinese economic data show that in the first eight months of 2026, consumption in China remained sluggish, while investment fell, including in construction and infrastructure by -7.2%. Property investments fell by 19.9% and unemployment in cities reached 5.3%. At the same time, industrial production increased by 5.2%, surpassing expectations and reinforcing the need for export orientation, in view of low domestic demand.

China’s extraordinary export performance is largely attributed to extensive subsidies estimated at some 5% of GDP, mainly in the form of grants and below-market-rate borrowings from state banks (see US Undersecretary of the Treasury Shambaugh, in July 2024). The most recent OECD MAGIC Database of Industrial Subsidiesconcludes that Chinese firms receive three to eight times more subsidies than companies in OECD countries (2005-2024), and that almost 60% of their global market share gains can be explained by the subsidies they received. A recent study by the Rhodium Group concludes that distortions in China’s financial system are at the root of today’s global trade imbalances. According to the study, Beijing has not only not delivered on its promised market reforms to its banking system as agreed in its WTO accession, but has “tightened controlover banks, moulding them into policy tools, and imposing consequences on both China’s economy and trading partners. Chinese banks are saddled with perpetually rolled-over debt piles that foist de–industrialisation on others”.

When considering the possibility of agreeing to any substantial form of voluntary self-restraint with the EU on exports, Chinese negotiators will therefore have to raise the difficult question with their political leadership of whether China’s massive export performance, one of the most dynamic of its economic drivers, is in its own long-term national interest.

This question can of course not be openly raised by EU negotiators with their Chinese counterparts. Chinese negotiators will remain eager to explain the advantages for the entire world of relying increasingly on efficient, low–cost and steadily higher–technology–based Chinese products. And Chinese officials and journalists challenge the narrative that Europe’s declining economic competitiveness is also due to unfair Chinese state subsidies and assert that Europe is “scapegoating” China to delay its own overdue domestic reforms, to increase its competitiveness. It is indicative that a recent articleby Xinhua journalists based in Europe making this argument was officially endorsed by China’s Trade Ministry (MOFCOM) on its website.

But the scale of the imbalances is massive:  

• China has the highest saving rates in the world with savings of 45-50% of GDP over the past 20 years, accounting for some 28% of global savings,
• China represents some 16.5% of world GDP (EU: 18.2%) according to the IMF’s World Economic Outlook,
• but it is home to nearly 30% of global manufacturing with the stated goal of reaching 35% by 2030.

The longer-term key question can and should be put to the Chinese side, even though there is clearly no answer at this stage: how long does China intend to benefit from ever higher export figures while its production capacities steadily replace more and more national capacities in importing countries, leading to job losses and deindustrialisation? It is this unsustainable de–industrialisation that President von der Leyen also raised so clearly in her State of the Union address.

However, nothing points to China’s willingness to change its overall approach, which is seen as a means of making the country a global economic and technology leader. Quite the contrary, as was argued recently in a landmark speech by former Australian Prime Minister Kevin Rudd. He pointed out that China’s decent growth rates are due to its net exports and to state investments, which are fulfilling Xi Jinping’s ideological ambitions with his technology-driven industrial vision for China’s future. New high technology products, driven notably by AI, will allow China not only to catch up with the US, but also to “leapfrog” the West, resulting in a paradigm shift against Western economic models. In this thinking, high technology would provide an alternative to the free market for achieving an efficient allocation of resources.

This will only work as long as the world does not build tariff walls in response to China’s subsidised high–technology industries. And it also depends on the Chinese consumers’ readiness to maintain their massive savings in low-interest deposits in the Chinese banking system, thus allowing banks to provide their massive subsidisation of loans.

Can China be persuaded to accept a substantive deal with the EU?

From the above analysis, it appears obvious that China has an interest in maintaining the status quo. The success of the Commission negotiators’ efforts in China will thus depend on whether their Chinese counterparts can concede that they must moderate their exports to keep the EU market open, and, if so,whether they are prepared to do so in a substantial way and for a variety of products.

French President Emmanuel Macron had urged China and fellow EU leaders already in December 2025, upon his return from a visit to China: “We urgently need to rebalance EU-China relations […] these imbalances are the result of weak EU productivity and China’s policy of export-driven growth.” He called for Europe to strengthen the Single Market and unleash European savings to spur innovation and growth, while urging China to address its internal imbalances and level the playing field for investment across both regions through a cooperative investment framework generating employment, innovation and technology sharing. He clearly favoured a cooperative effort and opposed entering into a “dire trade dispute”.

But Chinese negotiators are anxious not to agree to a deal, which would set a precedent for many other partners around the globe to demand similar self-restraint commitments from the PRC.

It will thus be critical to convince Chinese counterparts that it is not in the PRC’s own long-term interest to become the dominant global producer and exporter of the majority of key export products, encompassing not only critical raw materials and rare earth elements, but also high-technology products and, increasingly, products that have traditionally been strengths of European producers, including machinery and chemicals.

Once China has realised all its ambitions, such as those set out in “Made in China 2025”, it will have contributed to the impoverishment of its main export markets through deindustrialisation, gradually reducing demand for Chinese products and contributing to ever more protectionist measures. In fact, such measures tend to be favoured by populist far–right and far–left political forces in Europe, similar to positions taken by US President Donald Trump at the outset of his second presidential mandate.

This would then run counter to China’s own interests. In fact, the PRC’s economic success, and thus its economic and political stability, depends on its ability to adjust to the capacity of the global economic system to absorb its output. China must adapt to the absorption capacities and limits of its economic partners, or there will be a major economic adjustment shock based on a wave of protectionist measures and related financial repercussions. Former Deputy USTR Michael Froman argues that there is an urgent need to manage the global impact of the imbalances caused by China with an international adjustment effort like the Plaza Accord of 1985, warning that a global economic crisis would unfold soon if this is not tackled in time.

But the likelihood of Beijing entering such a deal appears to be very limited when looking at the political orientations adopted at the Fourth Plenum of the 20th Central Committee of the Chinese Communist Party, where the recommendations for the 15^th Five-Year Plan were adopted. This Five-Year Plan focuses on the domestic market and welfare, scientific and technological self-reliance, moving up the production ladder, and national security. It prioritises “technological autonomy” – particularly in AI, advanced manufacturing and strategic industries. No references are made to global imbalances.

Only if such long-term reasoning were to emerge in Beijing, would I see the possibility of reaching agreement with China on a set of trade–restricting steps, which would include a voluntary reduction of export quantities of critical goods, possibly together with the understanding that when such quantitative restrictions are reached, higher tariffs would take effect. The model for such understandings could be the Voluntary Restraint Agreements reached first by individual member states and later “Europeanised”, which were concluded in the 1970s and 1980s with Japan and in the 1980s and 1990s with South Korea. These also led later to significant industrial investments of key Japanese and Korean companies in the EU, including genuine technology transfer.

Such steps by the Chinese side could be facilitated by the future rules on foreign investment in the Industrial Accelerator Act, which cover not only public procurement (“Made in/with Europe”), but also foreign investment, including from countries dominating supply chains. Former EU trade negotiator John Clarke provides a more thorough examination of such a “managed trade” solution “to save the EU-China relationship” in his recent analysis.

But the likelihood that China would agree to more than symbolic steps restricting its own export performance is small.

• First, because this would amount to nothing less than the beginning of a departure from China’s “Dual Circulation Strategy”, its official industrial policy since 2020, aiming at reducing its own dependency on imports while increasing its exports, thereby making its partners more dependent on Chinese products.
• Second, because any meaningful deal with the EU would set a precedent for other trade partners seeking the same concessions.
• And third, because China would resent any such singling out.

Preparing for unilateral EU measures

Therefore, EU leaders, including the more reluctant ones, will have to prepare for the need to take EU unilateral measures. The political pressure on them to do so is likely to grow incrementally in the coming weeks, due to the steadily growing number of layoff announcements in qualified industry jobs. The linchpin country is Germany with its large industrial base, the many companies which are heavily invested in China and the steadily increasing pressure from China exports, not only on the domestic market, but also on third-country markets. Not only German Chancellor Friedrich Merz, but notably also the CEO of Volkswagen and IG Metall, the largest trade union, have called for more robust trade measures against China, all of them under mounting public pressure to save jobs. The German mood has swung, and it is now widely perceived that “The cost of inaction is now judged to be higher than the cost of action.”

Such unilateral EU measures are likely to be:

• Product–specific anti-dumping and anti-subsidy duties, which have so far been the main trade defence instruments used. They are product- and company–specific and require a long and detailed investigation to prove government subsidies causing injury before they can be adopted. These measures have been used and are likely to be used much less often in future, in view of the massive sector-wide impactof Chinese
• Sectoral safeguards are more likely to become the trade defence instrument of choice in the current situation, as they are based on the injury caused by a sudden surge of exports in a sector and can be adopted within a matter of months. Their adoption can be prevented only with a reverse qualified majority of members. This instrument has so far been rarely used (except for steel products). It could be notably applicable to protect against the massive sudden recent surge of hybrid car exports, as well as certain chemical and machinery industries and possibly cover more steel products.
• It is also likely that EU leaders will charge the Commission to develop, as soon as possible, a legislative proposal for some form of a diversification instrument, which would render the EU’s economy more resilient and reduce critical vulnerabilities. Such an instrument would most likely be based on economic security considerations and may foresee an easier adoption rule, such as for sectoral safeguards. While establishing diversification requirements on EU companies, it might also impose tariffs and quotas in cases of excessive dependencies on external partners. Such an instrument may have to be accompanied by flanking financial measures to support industries in reducing the cost of diversification, since most companies continue to rely on their established supplier relationships, for cost reasons. Diversification is thus a widely shared policy goal but is largely not implemented by individual companies, unless incentives for doing so are provided.

As former European Commissioner for Trade and WTO Director General Pascal Lamy said in an interview with the South China Morning Post on 21 September, the Chinese authorities’ lack of interest in addressing the structural macroeconomic imbalance is a “huge problem” for the EU, which has to “get a rebalance, or go protectionist”.

Where does this leave the EU and China?

China will not react positively to the adoption of any such unilateral EU trade-restricting measures. The likelihood of retaliatory measures and the danger of entering an escalatory spiral is significant – just as the PRC did in response to the EU’s anti-subsidy duties against electric vehicles. But this should not prevent EU leaders from taking unilateral measures.

The systemic competition between the EU and China is reaching a turning point with substantial stakes for both sides. For the EU, the stakes concern deindustrialisation and potentially massive job losses, which it needs to bring to a halt now. For China, they concern its need to adjust its economic model and reduce its dependency on export performance to avoid its export markets closing and the risk of entering a global economic crisis.

Negotiations will ultimately only succeed if the EU shows not only its general political resolve but also adopts specific measures and instruments and has the political will to implement them to safeguard its interests. Only this will command the respect of the leadership of the People’s Republic of China and create an incentive for it to pursue a substantial deal with the EU to avoid the imposition of such measures, and to achieve potentially lasting positive effects for both sides with a substantial trade deal.

The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.