Blog post

The dragon sneezes, Europe catches a cold

European stock prices, financial contagion and the trade exposure to China. How the turmoil in China’s stock market is affecting European stock market

Publishing date: 26 August 2015
Authors: Guntram B. Wolff Thomas Walsh

Should we be worried about the turmoil in China’s stock market, and the spill-overs to markets in other countries? Two competing hypotheses currently exist:

The first is that Chinese stocks had grown at unsustainable rates leading up to the crash, and this is simply a market correction back towards fundamentals, and not a warning of deeper weakness in the Chinese economy.

This view would align with that of the ECB’s vice-president Vitor Constâncio:

"Indications are that ... the (Chinese) economy is not decelerating so much to justify the rout in the stock market. (…) The problems in China are not affecting ... the concerns of German firms,"

Stock market declines around the world would in this view only represent some short-term financial contagion without a connection to real economic activity.

The second hypothesis is that the collapsing stock prices are linked to a slowdown in economic activity in China. Such a slowdown will then be passed on through trade linkages to China’s trading partners.

We want to investigate whether the stock market falls in Europe are primarily a financial contagion problem or whether they are linked to trade exposure to China. We look at the decline since the start of August until now, compared to the extent to which the respective OECD economy is linked to China, measured in gross exports to China as a share of GDP.

Contrary to the first hypothesis that this episode is just a matter of turbulence in financial markets, we can see that in Europe those countries with stronger trade connections to China have generally suffered bigger losses in their stock markets. We take this as an indication that there is a disruption in the real economy in China, leading to less demand for European exports to China that is passed on to European stock markets through trade channels.

For example, if we look at Germany, we can see that the DAX has fallen by around 12% (second highest in the sample), and also has the highest exports to China as a share of GDP at 2.66%.

Overall, we would warn European policy makers not to take the Chinese crisis lightly. The health of the Chinese economy is of essence to the global economy and there are reasons to believe that this could turn out to be a more fundamental cooling of China than previously thought.

Figure 1: Decline in European Stock Markets and Trade Exposure to China

Source: UN COMTRADE, 2013. GDP from OECD. Stock indices not available for Portugal and Slovakia.

About the authors

Guntram B. Wolff

Guntram Wolff is a Senior fellow at Bruegel. He is also a Professor of Public Policy and Economics at the Willy Brandt School of Public Policy. From 2022-2024, he was the Director and CEO of the German Council on Foreign Relations (DGAP) and from 2013-22 the director of Bruegel. Over his career, he has contributed to research on European political economy, climate policy, geoeconomics, macroeconomics and foreign affairs. His work was published in academic journals such as Nature, Science, Research Policy, Energy Policy, Climate Policy, Journal of European Public Policy, Journal of Banking and Finance. His co-authored book “The macroeconomics of decarbonization” is published in Cambridge University Press.

An experienced public adviser, he has been testifying twice a year since 2013 to the informal European finance ministers’ and central bank governors’ ECOFIN Council meeting on a large variety of topics. He also regularly testifies to the European Parliament, the Bundestag and speaks to corporate boards. In 2020, Business Insider ranked him one of the 28 most influential “power players” in Europe. From 2012-16, he was a member of the French prime minister’s Conseil d’Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed member and co-director to the G20 High level independent panel on pandemic prevention, preparedness and response under the co-chairs Tharman Shanmugaratnam, Lawrence H. Summers and Ngozi Okonjo-Iweala. From 2013-22, he was an advisor to the Mastercard Centre for Inclusive Growth. He is a member of the Bulgarian Council of Economic Analysis, the European Council on Foreign Affairs and advisory board of Elcano.

Guntram joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he worked in the research department at the Bundesbank, which he joined after completing his PhD in economics at the University of Bonn. He also worked as an external adviser to the International Monetary Fund. He is fluent in German, English, and French. His work is regularly published and cited in leading media.
Thomas Walsh

Thomas Walsh, a British citizen, worked as a Research Assistant at Bruegel in the area of macroeconomics from August 2014 to August 2015.

He holds a Master’s degree in Economics from the Barcelona Graduate School of Economics with a thesis entitled “The Credit Channel of Monetary Policy at the Zero Lower Bound: A FAVAR Approach”.

He also holds a Bachelor’s degree in Economics and Econometrics from the University of Bristol.

Previously, Thomas worked at the European Central Bank as a Trainee in the Statistics Development and Coordination division, working primarily with the ECB’s SME access to finance survey, SAFE.

He has also held positions as Research Assistant at the Social and Public Health Sciences Unit, University of Glasgow and as Intern at the Centre for Market and Public Organisation, University of Bristol.

His research interests cover macroeconomics and finance, particularly monetary policy transmission and central bank decision making. Thomas speaks English, conversational Spanish, and basic German.