Protecting Europe

A new Super-Sector Analysis report from Citi Research, penned by a team led by Sebastian Satz, head of European chemicals equity-research coverage, looks at the pressures facing Europe's open economic model and explores potential paths policymakers may take in response. 

Europe’s industrial model is coming under increasing strain as it navigates two powerful external forces at once: a more protectionist U.S. and rapidly expanding Chinese industrial capacity. U.S. tariffs are increasingly linking market access to domestic production, while Chinese producers are increasingly looking beyond the U.S. for export opportunities. Together, these trends are putting stress on Europe’s relatively open market and forcing policymakers to rethink long-standing assumptions about trade and industrial policy.

China’s export growth illustrates the challenge. Between 2019 and 2025, Chinese export volumes rose by more than 40%, while imports were broadly stagnant. In 2025 alone, Chinese exports increased by 6% in value terms. Exports to the U.S. fell 20%, but exports to the euro area rose 8%, exports to ASEAN rose 13%, and exports to Africa rose 26%. While not all of those flows necessarily represent goods redirected away from the U.S., reduced access to the American market makes Europe and other open economies increasingly important destinations for Chinese industrial output.

The resulting trade imbalance has become difficult for Europe to ignore. European Union (EU) imports from China totaled roughly €560 billion in 2025, compared with exports of approximately €199 billion, producing a deficit of €361 billion. The imbalance continued to widen in early 2026, reflecting both growing imports and weakening European exports.

The concern extends beyond bilateral trade. European firms are losing market share inside China as domestic Chinese suppliers replace imports, while Chinese companies are becoming more competitive both in European markets and in third countries. Unlike earlier phases of globalization, China increasingly competes directly with Europe in industries such as automobiles, machinery, chemicals, batteries, and other advanced manufacturing sectors.

A number of structural factors reinforce this competitive pressure. More than a fifth of Chinese industrial companies are currently operating at a loss, while estimates suggest government support measures — including subsidies, tax benefits, favorable financing, and discounted land use — amount to some $800 billion annually, or about 4% of China’s gross domestic product. These policies help sustain production capacity even when profitability is limited, creating continued pressure on global markets.

The consequences are already becoming visible across Europe. Manufacturing investment and capacity utilization are under strain, while factory closures and workforce reductions have increased in several industries. The challenge is not only the loss of individual facilities, but also the potential erosion of broader industrial ecosystems that include suppliers, engineering expertise, infrastructure, and research capabilities. Policymakers increasingly view these issues as strategic concerns rather than temporary economic cycles.

Energy Costs Remain a Major Competitive Challenge

Alongside growing competitive pressure from abroad, Europe faces significantly higher energy costs than many of its global competitors. Electricity prices remain roughly 60% to 110% higher than in the U.S., China, and India.

While the loss of Russian gas contributed to higher costs, a substantially bigger impact has  come from Europe’s carbon-pricing framework and the cost of the energy transition itself. Renewable energy can deliver very low short-term operating costs, but building and maintaining a system capable of meeting demand year-round requires substantial investment in generation, backup capacity, storage, and grid infrastructure, with seasonal demand a particular challenge.

As a result, Europe faces difficult choices balancing climate goals, energy security, industrial competitiveness, and affordability. While investment in renewable energy, grids, and low-carbon technologies will continue, policymakers may increasingly need to address the impact of energy costs on industrial competitiveness.

Europe Is Moving From Diagnosis to Action

In the face of such pressures, the political environment appears to be shifting. European leaders are becoming more willing to intervene to support domestic industry, protect strategic sectors, and reduce economic vulnerabilities.

Recent European Commission statements have described the current trade and investment relationship with China as unsustainable and have called for a more robust response. Policymakers are increasingly discussing broader tools such as safeguards, quotas, tariffs, localization requirements, and diversification measures rather than relying solely on traditional anti-dumping investigations.

At the same time, Europe is placing greater emphasis on industrial competitiveness. Proposed initiatives aim to stimulate demand for products manufactured in Europe, incentivize investment within the region, and ensure that major foreign investments create economic value inside the EU.

An equally important goal is reducing dependence on critical imports. Europe remains highly reliant on China for a range of strategic inputs, including rare-earth processing, permanent magnets, batteries, solar equipment, electronics components, and certain chemicals. Policymakers increasingly view diversification of supply chains as a matter of economic resilience and national security.

The EU is also reconsidering competition policy. Regulators are exploring whether greater scale, investment capability, innovation, and supply-chain resilience should receive more weight when evaluating mergers. The objective is not to create national champions at any cost, but to ensure European firms are able to compete effectively against larger global rivals.

From Open Markets Toward Conditional Access

Rather than moving directly toward broad protectionism, Europe appears to be shifting toward a system of more conditional market access.

One major proposal, the Industrial Accelerator Act, would tie public procurement programs, subsidies, and other forms of public support to local-content requirements or low-carbon production standards. Under such a system, foreign products could still enter the European market, but they might not qualify for government-supported demand programs.

Europe is also expected to continue expanding trade-defense measures where authorities determine that imports are unfairly priced or subsidized. At the same time, supply-chain diversification initiatives could encourage companies in strategic industries to develop multiple sourcing options rather than relying heavily on a single country.

The broader objective is to preserve industrial capacity, strengthen supply-chain resilience, and improve investment incentives without fully abandoning the benefits of open trade.

Retaliation Risks Remain Significant

Stronger European action is likely to trigger a Chinese response. Rather than broad retaliation across all sectors, such measures would likely be selective, targeting politically sensitive industries, companies, or countries.

Potentially exposed sectors include automobiles, luxury goods, agriculture, aerospace, and some chemical products. Restrictions on critical materials could prove particularly disruptive because they could affect European production even when companies have limited direct exposure to Chinese sales.

This risk means that Europe's ability to maintain political unity will be important. The costs and benefits of stronger trade protections are unlikely to be distributed evenly across countries and industries, making burden-sharing mechanisms a key component of any long-term strategy.

Four Possible Policy Paths

With the policy outlook remaining uncertain, we see four scenarios for Europe. The first is incremental action, in which policymakers continue using limited product-by-product trade measures, resulting in only modest industrial effects and little change in market structure. The second, and our base case, is European preference, where public procurement rules, local-content requirements, and supply-chain diversification measures increasingly favor European production. This would likely support industries such as defense, utilities, industrials, selected auto makers, and some chemical firms. A third scenario, strategic-sector protection, would involve broader safeguards, stricter origin requirements, and expanded protections for key industries, providing a larger boost to domestic producers but also raising inflationary pressures. The fourth and most aggressive scenario is trade and technology confrontation, involving broad tariffs, quotas, and technology restrictions. While this could provide significant protection for domestic industries, it would also carry greater risks of supply disruptions, inflation, weaker economic growth, and substantial retaliation from China.