Contents

Introduction. 1

China’s Mercantilism Is Already Costly to the EU. 2

Diversify EU Needs to Be Explicit About Addressing China’s Trade Aggression. 3

Allied Production Capacity Should Be an Organizing Principle of Diversify EU. 3

Other Considerations: Facilitate Information to Firms’ Supply Chain Diversification. 6

Conclusion. 6

Endnotes 6

Introduction

The Information Technology and Innovation Foundation (ITIF) is pleased to submit the following comments for the European Commission’s consideration as it prepares to present a diversification package, the Diversify EU initiative, to roll out policies that support faster supply chain diversification and reduce dependencies in critical sectors across value chains. ITIF is an independent, nonprofit, nonpartisan research and educational institute focusing on the intersection of technological innovation and public policy.

The European Commission is right to be concerned about supply-chain dependencies, particularly vulnerabilities to the People’s Republic of China’s (PRC) coercion. The Commission’s Diversify EU initiative merits support as a necessary step toward addressing that vulnerability. However, the initiative’s success will depend on identifying which dependencies threaten European security from a geopolitical perspective. That requires a more refined approach than reducing reliance on whichever foreign country supplies the largest share of a determined product.

Europe’s—and Western democracies’—main challenge is the PRC’s pursuit of global market share and dominance in strategic industries.[1] Diversify EU should be explicit about countering China’s trade aggression. The Commission should clearly separate supply chain dependencies on the PRC from the concentration of imports of determined goods from allied countries. Specialization among trusted economies can strengthen competitiveness and security, as most advanced-technology intermediate goods respond to economies of scale.

Thus, dependencies created by Chinese nonmarket policies, especially when Beijing can disrupt essential supplies, require a different response. Treating trade relationships neutrally would waste resources and could weaken the allied industries Europe needs.

ITIF recommends organizing Diversify EU around allied production capacity and a coordinated response to Chinese mercantilism. Drawing on ITIF’s proposed framework for a new class of Strategic Techno-Economic Agreements (STEAs), ITIF recommends stronger rules of origin, development finance for alternative suppliers, joint trade investigations, reciprocal market access, and support for firms’ switching costs.[2]Coordinated export controls and investment screening should protect strategic capabilities. Finally, better supply chain information should guide these measures, helping firms identify upstream vulnerabilities and commercially viable alternatives to Chinese suppliers.

China’s Mercantilism Is Already Costly to the EU

China’s subsidized manufacturing overcapacity threatens the EU’s long-term competitiveness. Subsidized production in Mainland China—and increasingly through outward foreign direct investment from Chinese companies—displaces European suppliers, while technology theft weakens returns on their innovation investments.[3] European investments in China can serve as a bargaining tool, given China’s record of economic coercion. As ITIF has documented, these practices erode the revenues that innovative firms need to finance future research and development.[4] ITIF reports that China’s tightly controlled telecommunications market lets Beijing threaten to exclude European suppliers when their governments challenge Chinese trade practices or restrict Huawei.[5]

Germany illustrates the scale of the challenge. The May 2026 report “China shock 2.0” identifies a cumulative drag from declining net exports equivalent to 3 percent of German GDP since the end of 2023, linking much of the deterioration to China.[6] German manufacturers are being displaced in China, in third-country markets, and increasingly at home—with a subsequent decline in relative competitiveness. Germany went from producing nearly three times as much as China in strategic industries three decades ago to less than one-quarter of China’s output.[7] Indeed, ITIF’s 2026 Hamilton Index shows that Germany’s share of global value-added output across 10 advanced industries fell from 10.4 percent in 1995 to 5.9 percent in 2022, the latest year covered by the analysis.[8] Over the same period, China’s share increased from 3.5 percent to 24.9 percent.

The damage also extends to intellectual property (IP). An ITIF’s 2021 report shows that counterfeiting and piracy cost legitimate producers up to €60 billion in annual sales across 11 EU sectors in 2019, equivalent to 7.4 percent of sales in those sectors.[9] This report also documented pressure on European firms to surrender technology; for example, a 2019 survey found that 28 percent of medical-device respondents and 27 percent of pharmaceutical respondents reported being compelled to transfer technology in China. Furthermore, a 2025 OECD and EUIPO report again identified China and Hong Kong as the leading sources of counterfeit imports into the EU, and the affected sectors included advanced-technology industries such as pharmaceuticals and smartphones.[10]

Diversify EU Needs to Be Explicit About Addressing China’s Trade Aggression

The European Commission’s new trade measures should target Chinese trade aggression. The proposed country-agnostic approach does not explicitly distinguish between dependencies on trusted trade partners and those on nonmarket economies such as China. In an October 16, 2026 statement, President Ursula von der Leyen announced Diversify EU as part of the EU’s “substantial rebalancing” in its trade relations with China—which could implicitly position the initiative as a way to address China’s mercantilism.[11] However, the same statement outlines that Diversify EU “will be country-agnostic.”[12]

The concern is that a country-agnostic approach could apply similar diversification requirements to fundamentally different trade relationships. Once Diversify EU’s expanded trade-retaliation measures are available to EU policymakers, there is no assurance they will be effectively used against China. More concerningly, there is also no assurance they won’t be used to retaliate, for example, against U.S. unilateral tariffs, risking a potential tariff escalation with transatlantic partners.

The EU needs a way to explicitly assign risk to different non-EU players, or to deploy proxies (e.g., alignment with legal frameworks, democratic values) that serve the same purpose. That differentiation would strengthen the relationships with allied trade partners and drastically reduce the short-term downside impact listed in the call for evidence for this Diversify EU initiative.

Allied Production Capacity Should Be an Organizing Principle of Diversify EU

Diversification requires a larger economic strategy than a set of new trade measures. Conventional free trade agreements can improve market access, but they were not designed to coordinate a collective response to Chinese aggression. Uncoordinated restrictions, by contrast, can backfire: they can raise barriers without building the productive capabilities needed to sustain them.

Strategic Techno-Economic Agreements (STEAs): A Useful Framework for Diversify EU to Counter Chinese Mercantilism

ITIF’s Strategic Techno-Economic Agreements (STEAs) framework offers a way to organize China retaliation tools—and, importantly, align them with allies’ so their effect is amplified.[13]

The STEA framework provides an organizing principle: strengthen allied strategic industries and coordinate action against Chinese mercantilism. In other words, they are minimum conditions that enable strategic industries to lead globally while also slowing rivals. STEA’s framework rests on two mutually reinforcing pillars: increasing strategic industries’ competitiveness and countering Chinese mercantilism. Applied to Europe, this requires binding commitments that give reliable suppliers access to a larger market and make investment in alternative capacity commercially viable.

The following recommendations would support Diversify EU’s objectives and deepen cooperation with the EU’s closest partners, including the United States. Some concerns relate to Diversify EU’s design and implementation; others should be pursued through complementary trade, investment, and economic security instruments. Together, they would strengthen allied production capabilities and coordinate responses to Chinese mercantilism. A broader STEA agenda would also encompass allied defense and dual-use production, essential infrastructure, joint research and development (R&D), and commitments governing trade agreements with nonmarket economies.

Proposed Measures to Advance Allied Competitiveness

Rules of Origin Should Reflect the Stages of Production That Create Dependence

Preferential access will contribute little to diversification if Chinese products qualify after minor processing in a partner country. Instead, the EU should establish product-specific origin requirements that reward substantial production within participating economies and permit producers to combine qualifying inputs from those economies.[14]

For strategic products, the stages of production should determine whether supply can withstand a Chinese cutoff. A battery assembled abroad may still depend on Chinese cathode or anode materials. A magnet manufactured outside China may rely on Chinese separation of rare earths. Ordinary customs origin and resilience assessments answer different questions; customs declarations alone cannot establish that a supply chain has diversified.

The EU should pair preferential origin rules with targeted disclosure of critical inputs for products receiving diversification support. Customs authorities should share verification results with trade partners, investigate suspicious changes in trade routes, and recover benefits obtained through false declarations.

Transparency matters for implementation. Companies should have access to advance rulings and a common reporting format, and these compliance standards should align with those used in other economic blocs, such as the United States-Mexico-Canada Agreement (USMCA).[15]

Use Development Finance to Build Alternative Supply Chains

Europe’s exposure is particularly acute in several key inputs. In 2025, China supplied 92 percent of the value of EU magnesium imports, 77 percent of gallium imports, and 68 percent of ferro-tungsten imports from outside the bloc.[16] Reducing these concentrations requires investment in the specific production stages that alternative suppliers lack. The Commission’s Raw Materials Diplomacy could be used as a starting point.[17] Each agreement signed under this initiative should specify how mining, separation, refining, recycling, and transport will be developed. If processing depends on China (or Chinese companies), funding will achieve little unless its output can reach a processor outside China.

The EU should combine development finance, guarantees, and private capital with long-term purchase commitments from European users. Project selection should assess ownership, operational control, and where production goes. A nominally diversified project offers little security if it has already committed all its output to a Chinese buyer.

Proposed Measures to Counter Chinese Mercantilism

Coordinate Trade Investigations and Remedies Against Chinese Mercantilism

As the PRC repeats its playbook across many economic zones, the EU would benefit from coordinating trade investigations with allies. A formal joint investigation would improve information exchange and strengthen each economy’s defenses against unfair practices. Otherwise, alternative suppliers will struggle to attract capital if Chinese state support allows competing producers to expand capacity regardless of commercial returns.

Thus, the EU should establish standing investigative cooperation with trade partners, including shared evidence on preferential credit, subsidized inputs, state-directed investment, and concealed ownership. Trade partners should coordinate investigations and the timing of justified remedies while retaining responsibility for their own legal findings.

Diversify EU should include an authority for coordinated investigations of such practices and specify the evidentiary standards, response options, and review procedures. This would adapt STEA’s proposal for joint investigations modeled on Section 301 of the U.S. Trade Act to the EU institutional context. Any additional restrictions would require an identified legal basis and an assessment of their compatibility with the EU’s international obligations.[18]

Condition Market Access on Reciprocity and Lawful Competition

The EU should respond systematically when China excludes European suppliers from strategic procurement while seeking unrestricted access to the European market. The 2025 International Procurement Instrument for Chinese medical devices provides a concrete precedent: it excludes Chinese companies from covered tenders above €5 million and limits Chinese-origin devices in relevant contracts.[19]

The EU should also strengthen border enforcement against goods that infringe intellectual property rights. For firms with a sustained, legally established record of technology theft, the Commission should propose targeted exclusion powers, with transparent criteria, rights of appeal, and coordination with partners. Repeated misconduct should carry consequences for future market access.

Subsidize Switching Costs to Decrease Chinese Dependency

Companies need economic incentives to eliminate sensitive dependencies on China while maintaining competitiveness. A firm can recognize a supply risk and still find switching commercially prohibitive.

In this context, the Commission should coordinate with like-minded trade partners to establish a jointly financed fund to help firms cover transition costs in designated strategic technologies. Any support should be time-limited and contingent on a verified reduction in exposure. The fund should distinguish the one-time cost of switching from a continuing operating subsidy. For the most consequential chokepoints, financial incentives may need to be accompanied by binding diversification plans.

Align Export Controls and Investment Screening With Partners

Europe should protect the technologies that make its firms valuable participants in diversified supply chains. Through agreements on export controls and investment screening, the Commission and member states should identify critical technologies that require coordinated export controls, share end-user intelligence, and align licensing decisions sufficiently to prevent substitution among allied suppliers.[20]

Other Considerations: Facilitate Information to Firms’ Supply Chain Diversification

The most useful starting point for Diversify EU is better market information. Policymakers should help firms identify where disruption would occur, which alternatives are available, and what it would cost to use them. Requiring a different supplier before answering those questions can produce compliance without resilience.

For example, a recent ITIF report shows how the China-Plus-One or China-Plus-Many strategy—a private-led risk-management strategy to reduce dependence on China—shifted or expanded production outside China by shifting production to other jurisdictions.[21] Yet many internal value chains in these diversification strategies remained anchored in China, giving the PRC significant leverage. Diversification can therefore look successful in bilateral trade statistics while leaving the relevant chokepoint untouched.

A non-interventionist approach is to give European firms better data to make informed decisions about shifting their supply chains. In this context, the Commission should collect and publish detailed information on upstream suppliers that can serve as alternatives to Chinese ones, including processing locations. Comparable data on supply concentration and substitution costs would help firms assess their exposure and identify commercially viable options to diversify their supply chains.

Conclusion

ITIF urges the Commission to focus Diversify EU on dependencies that give the PRC leverage over European strategic industries. In addition, the STEA framework can guide efforts to expand market access for industrial investment and coordinate action against Chinese mercantilism. In other words, the Diversify EU should provide trade measures to expand the EU’s competitiveness by creating market scale with allies and to counter PRC’s trade aggression.

This document therefore recommends a series of trade measures for Diversify EU. First, design product-specific rules of origin to prevent third-country processing from granting Chinese goods preferential access, and provide development finance for alternative suppliers and temporary support to cover firms’ switching costs. To counter China’s mercantilism, the EU should conduct joint trade investigations with allies and coordinate justified trade remedies. It should also condition access to public procurement on reciprocity, strengthen border enforcement against IP-infringing goods, and establish targeted exclusion powers for companies with a legally established record of technology theft. Finally, aligning export controls and investment screening with trusted partners would help protect the strategic capabilities these measures support.

Thank you for your consideration.

Endnotes