The European Union is concerned about the future of its industrial might as the structure of global supply chains changes. If Europe does not want to be left behind, it needs to actively focus on finding and creating safe shores rather than continue to rely on a changing China or the impossible dream of friend-shoring.
Key takeaways:
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Beijing’s national agenda and economic statecraft coincide with the growing tech industry in the rest of Asia to produce supply chain shifts that Europe cannot miss.
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“Re-shoring” and “friend-shoring” vital technologies are necessary but impossible for all production. The EU should focus on “safe-shoring” instead.
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The EU and its member states should respond to shifting supply chains by creating and keeping shores safe through sensitive diplomacy, improving Global Gateway, coordination with like-minded partners, and leveraging their diversity.
The EU faces an economic Zeitenwende. Beijing’s increasingly nationalist agenda has made China’s economic statecraft more threatening to European security as a crisis of competitiveness hits the continent with full might, with Chinese dominance in the solar panel and electric vehicle sectors threatening some of Europe’s largest companies. Furthermore, the rest of Asia is emerging as a crucial hub for tech manufacturing, adding yet another challenge for Europe.
In response, industrial policy has regained importance, symbolized by the European Chips Act. The developing semiconductor cluster around Dresden illustrates the trend of reshoring—though whether one can indeed call it “reshoring” is debatable since European manufacturers had never previously reached this production level. While these policies have merit, it would be neither economically sensible nor diplomatically wise for the EU to attempt to replicate every supply chain domestically.
The EU needs a cooperative framework to address economic security. Many advocate for partnering with like-minded democratic countries, but being overly selective in so-called “friend-shoring” limits options and excludes important growth regions. A smarter approach is “safe-shoring,” where the most sensitive technologies are kept in friendly nations, but most products are sourced from any country adhering to the rules-based international order.
Southeast Asia presents a particularly promising opportunity. The EU already collaborates closely with ASEAN, which originally began forming an economic community in response to demand from Japanese automakers. Southeast Asian countries like Indonesia, Malaysia, Thailand, and Vietnam have become destinations for supply chains shifting away from China. However, European companies are disadvantaged as free trade agreements (FTAs) in the region link these countries with China, Japan, and South Korea, while the EU has trade pacts only with Singapore and Vietnam.
ASEAN’s evolving role
EU-based manufacturers in China face two reinforcing challenges. As China climbs the value chain, wages rise, prompting natural supply chain shifts to nearby lower-wage countries. Political developments compound this trend. Domestically, Xi Jinping’s emphasis on political security has created more uncertainty and reduced economic dynamism. Internationally, Western nations are increasingly concerned about the geopolitical risks of relying on Chinese production.
Foreign investment in China has sharply declined. While diversification away from China is underway, 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 leaves the country. These geo-economic trends are already reshaping parts of Asia, with ASEAN and South Asian countries benefiting from the so-called “China + 1” strategy, where companies hedge by maintaining Chinese operations for its vast domestic market while moving global export production to other countries, such as India, Vietnam, or Thailand.
Even though imports from China may decline in favor of Southeast Asian imports over time, the Chinese content in supply chains for now often remains—disguised by the shift of final assembly to Southeast Asia. On top of that, many companies relocating to Southeast Asia for world exports are Chinese.
US-ASEAN and China-ASEAN trade surged between 2012 and 2021, growing by 80% and 100%, respectively. In contrast, the EU’s trade with ASEAN grew only from $210 billion to $270 billion, reflecting Europe’s stable yet declining relative importance in the region. Chinese and US trade growth may indicate a diversion through Southeast Asia in response to Washington’s barriers, but over time, a newly created manufacturing presence in the region can serve as a platform for global expansion as well.
Chinese manufacturers and suppliers benefit from free trade agreements and new Belt and Road infrastructure. However, this has also enabled lower-end Chinese producers to overwhelm Southeast Asian companies. As their capacity grows while Chinese consumer sentiment remains depressed, they flood cost-sensitive Southeast Asian markets with impossibly cheap products, driving local companies out of the market.
Thus, the picture is mixed. The latest State of Southeast Asia survey by the Singapore-based ISEAS-Yusof Ishak Institute shows that elites still regard the EU as the most desirable “third party” to hedge against the China-US strategic rivalry. However, this perception is declining compared to previous years, as is trust in the EU to act appropriately. In meetings and dialogues, Southeast Asian partners indicate they are waiting for Europe to deliver economically.
Missing out on FTAs
The EU has long supported ASEAN, working closely with the regional organization and helping fund its Secretariat. However, on economic issues, Europe has consistently struggled to deliver. The ongoing disputes over palm oil with Malaysia and Indonesia are prime examples of this challenge. The EU has only two FTAs with Southeast Asian countries. Despite its historical closeness to ASEAN, it is not among the six development partners with FTAs with ASEAN nor part of the Regional Comprehensive Economic Partnership (RCEP) grouping.
This hinders Europe, as diversification follows the paths of least friction, where regulatory and customs barriers are minimal. Other countries are addressing this effectively. Japan is deepening its already impressive economic integration with the region, leading with nine FTAs with ASEAN and Southeast Asian countries. China is currently negotiating to upgrade its existing FTA with ASEAN with a focus on tech, while the US is developing its Indo-Pacific Economic Framework (IPEF). Meanwhile, the EU is struggling to make progress on an FTA with Indonesia.
As a result, Europe risks missing out on an important economic shift. As a manufacturing powerhouse, Germany has long had a substantial and profitable presence in China. Now, new supply chains are forming around emerging technologies as manufacturing moves to Southeast Asia. Europe will be squeezed out if it does not ensure its continued involvement.
Shifting assembly to countries such as Vietnam often maintains the China content of supply chains as Chinese suppliers relocate as well. However, in the long term, Chinese dominance in the supply chain remains at risk. In the 1980s and 1990s, Taiwanese companies moved entire supply chains from Taiwan to China, gradually incorporating more Chinese suppliers. As these Chinese companies learned through exposure to Taiwanese firms, they slowly moved up the value chain. What happened to Taiwanese companies may again happen to China in Southeast Asia.
There already is a strong European high-tech presence in ASEAN countries when it comes to advanced semiconductors. For example, Singapore and Malaysia host significant chip manufacturing, mostly within the supply chains of Western and Japanese-Taiwanese-South Korean companies. This is a promising location, as a Malaysia-Singapore-Indonesia manufacturing triangle appears to be forming. However, as Chinese companies move in and US measures might challenge Singapore’s role as a portal for China to access Western technology, the EU cannot be sleeping at the wheel.
A greater Chinese role does not necessarily mean Southeast Asian countries will become more politically subservient. Taiwan’s economic power gained strength from moving up in the global supply chain by outsourcing work to China. Its close economic integration with China did not automatically produce political integration. However, that required other options and placing limits on Chinese investment in Taiwan.
Taiwan grew by accessing markets beyond China. One reason Southeast Asian countries overwhelmingly see China as unavoidable is its economic size and proximity, but the lack of alternative options exacerbates this perception. Europe alone is too distant to directly compete with China’s heft. However, its Common Market is robust enough to help expand options and demonstrate the benefits of a free and open trading system.
Reshoring, friend-shoring, or safe-shoring?
China’s slowing economy is impacting emerging Southeast Asian economies. The countries in the region—except for Cambodia—are more than average dependent on China for exports, but this dependence has remained stable and is no longer growing. Southeast Asia receives many parts from China, which it assembles and sells globally. Most Southeast Asian countries run trade deficits with China. Southeast Asia is not gaining as much from the shift of supply chains due to China’s immense capacity and the rising Chinese share of value-added in ASEAN exports. The region holds significant opportunities, especially as China falters, presenting chances for Europe.
The EU has its own interests in the game and must take action domestically. One strategy is onshoring. The European Chips Act reflects Brussels’ recognition of this need. Other countries also recognize Europe’s potential and the importance of engaging it. Taiwanese supply chains are extending to Europe, with a new Dresden-Czechia semiconductor hub appearing as TSMC plans a joint venture fab in Dresden and Taipei sets up chip centers in Central Europe.
Perhaps paradoxically, another aspect of the evolving European strategy involves attracting Chinese investment. The EU still has much to catch up on in the most advanced industries. Just as companies in China advanced through foreign supply chains, European suppliers can learn from Chinese manufacturers. However, national and economic security risks must be carefully monitored. Chinese EV investment has promise only if its European factories will do more than just assembling parts from China.
Nevertheless, Europe cannot rely solely on itself and like-minded partners. Brussels needs to more explicitly advocate that safe shores are sufficient in its effort to bolster its position in global supply chains. This approach makes economic and political sense. Southeast Asia offers many opportunities, but action is required to create the right conditions.
Firstly, the EU must maintain safe shores. Ensuring that ASEAN member states remain economically open to Europe requires sensitive diplomacy and showing respect. The EU must also demonstrate its value in ASEAN economic upgrading. The influx of Chinese products in Southeast Asia is partly due to displacement as developed markets close to China. Europe can help by providing alternatives and support.
Secondly, the EU must make shores safer. The EU’s Global Gateway is gaining momentum after a slow start, but much can be done to improve it and target the right areas. The EU could help bridge Southeast Asia’s productivity gap through targeted development and investment under Global Gateway. Brussels should not hesitate to work with supply chain partners and coordinate with Taiwan’s New Southbound Policy or Japan’s initiatives.
Thirdly, the EU should strengthen its ties with safe shores. This could involve minilateral agreements between European and Southeast Asian states focused on specific sectors. If a full-scale FTA is not feasible, smart agreements targeting supply chain resiliency and specific sectors are viable alternatives. The EU should leverage its member states’ diversity, taking advantage of varying proximities to the US and recent experience with adopting the acquis communautaire.
The European Union faces an epochal challenge as the structure of the world economy changes in response to rising countries. The growing welfare of millions is not just a joyous occasion but also offers opportunities and creates risks for existing producers. To gain rather than lose out, Europe needs to meet the moment with a recognition of the new reality and act accordingly.
