EU-China trade and investment: unbalanced and well below potential

Over the past few years, there has been a shift in how European companies view the China market. Where discussions at company HQs once centred primarily on investment opportunities, the focus is now on mitigating risks and building supply-chain resilience. How did China lose its allure as an investment destination so quickly?

After embarking on a programme of reform and opening in the late 1970s, China’s economy came to be guided by pragmatic principles as its state planners sought to ensure stability. Immense economic returns followed. Reforms facilitated significant inflows of foreign direct investment, with international companies recognising the country’s enormous market potential and increasingly stable business environment.

However, with China now confronting mounting internal and external challenges, policymakers’ attention has been drawn away from the reform agenda, with national security, self-sufficiency and political considerations being prioritised at the expense of sustainable economic growth.

As a result, the predictability, reliability and efficiency of China’s business environment have diminished, making the country less attractive as an investment destination.

China’s predictability has been eroded by the erratic, non-transparent policy shifts of recent years, such as the unexpected disruptions to power supplies that were enforced in 2021, the sudden mass lockdowns as part of the country’s zero-COVID policy, and the crackdowns on the technology and education sectors.

China’s reliability as a sourcing destination has been undermined by rising geopolitical tensions. New and forthcoming legislation pose an additional challenge, putting pressure on companies to demonstrate transparency throughout their supply chains and reconcile their China operations with global corporate sustainability pledges — which is not currently possible due to the inability to conduct independent, third-party audits in China.

The efficiency of China’s market is decreasing as more companies decouple their China operations from their global operations to mitigate risks and ensure they remain compliant in both China and their home markets. At the same time, structural advantages that the country previously capitalised on to great effect, such as its ‘demographic dividend’, are rapidly fading, leading to a loss of productivity.

While the largest European companies continue to invest—four companies alone accounted for more than a third of EU investment into China between 2018 and 2021—most European companies already established in China are merely maintaining their presence, with increasing numbers earmarking future investments for other markets perceived to provide more stable conditions. Furthermore, virtually no new European firms have entered the Chinese market in the past three years.

It is notable that this is against a background of relatively limited EU investments into China, largely due to numerous formal and informal market access and regulatory barriers. At the end of 2022, the cumulative stock of EU investment into China over the past 20 years stood at approximately €160bn – €170bn, which is roughly the same amount EU companies invest in the United States every 12 months.

EU-China trade is also well below its potential. Despite being a huge market in principle, China is a relatively small market for European exports. In 2022, the EU exported just 23% more to China than it did to Switzerland. Trade is also highly unbalanced, with Chinese exports to the EU around two to three times that of exports going in the opposite direction. According to Eurostat data from 2022, Chinese exports to the EU also increased by over 30% year-on-year, while EU exports to China grew by just 3%.

All these issues present a significant and growing cost for China. Increasing numbers of European companies recognise the need to diversify their investments away from China to make their global supply chains more resilient. This is presenting opportunities to other markets that are ready to welcome new investment and jobs, with companies evaluating reshoring, nearshoring or ‘friend-shoring’ – manufacturing in or sourcing from countries with shared values. Meanwhile, China’s push for increased ‘self-reliance’ and the existence of ‘buy China’ policies are only easing the country into deeper isolation at a time when its economy would benefit from a return to reform and opening.

The increasing need to ensure fairness and stability in its single market has resulted in the EU preparing an array of trade defence instruments. Although they have not necessarily been developed specifically for China, they are aimed at protecting against distortions, pushing for reciprocal treatment and increasing market access for EU companies in third countries – all issues the EU has had with China. Russia’s invasion of Ukraine and the position that China has taken has placed further strain on EU-China ties and has pushed European companies to evaluate how susceptible their China operations would be to a similar situation in the Taiwan Strait.

This puts the EU-China relationship in a delicate position. If engagement at the institutional level cannot be strengthened and businesses increasingly shift planned or future investments to other markets, the chances of miscommunication and misunderstanding between the two blocs will only increase. The scope for cooperation will be reduced, including in vital areas of shared interest such as the promotion of sustainable development and the fight against climate change.

With China now in the process of ‘reopening’ to the world and a large number of European CEOs and policymakers set to visit the country in the coming months, China has an opportunity to demonstrate its commitment to further opening its economy. However, it will need to act decisively and take concrete action if it is to convince a European audience that is now immune to mere reform promises.

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