European Business in China Position Paper 2020/2021

09/10/2020

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European Union Chamber of Commerce in China

Six centuries ago, in 1420, the Yongle Emperor became the first ruler of China to occupy the newly-built Forbidden City. The third monarch of the Ming Dynasty, Yongle would prove to be an altogether different kind of emperor than both his predecessors and successors. After founding the Ming, his father, the Hongwu Emperor, began closing off the country’s maritime trade routes in 1371, in part to protect his reign from outside influences. When Yongle took the throne, he brought a different viewpoint. To him, engagement with foreign nations was an opportunity to project and advance China’s greatness and increase trade, as a means to enforce the Chinese tributary system, thereby legitimising his reign.

Throughout his reign, Yongle sent his close friend, Admiral Zheng He, on seven voyages with the recently-built Ming treasure fleet to establish relations with civilisations as far west as Mogadishu and as far south as Surabaya. The admiral did indeed return with foreign dignitaries, who sealed new diplomatic connections between these distant lands, and with them came agreements for tributes and trade. China had opened to the world, and both sides enjoyed the economic benefits of the ensuing exchange of goods, technology and people.

After Yongle’s death, the voyages of the treasure fleet came to an end. Resuming the policy of the Ming’s founder, subsequent occupants of the Forbidden City imposed the haijin, a prohibition on Chinese maritime ventures. This persisted well into the Qing, China’s final imperial dynasty. By then, what maritime trade existed was almost exclusively conducted by foreign vessels limited to the port island of Shamian, a spit of land in Guangzhou. The reason was rather infamously expressed by the Qing Emperor Qianlong in a letter to Britain’s King George III, saying, “Our Celestial Empire possesses all things in prolific abundance… [and has] no need to import the manufactures of outside barbarians.”

The China of 2020 has a far less restrictive economy than anything found in the imperial era. Yet, echoes of the contrasting viewpoints of Yongle and Qianlong persist. For much of the last four decades, European business has been confident that China’s leaders were leaning heavily towards continued opening up after having emerged from an era of seclusion. Unfortunately, the last several years have challenged this confidence, with an increasing number of voices asking if China is leaning more towards Qianlong’s belief that the Middle Kingdom has no need, or desire, for what foreigners have to offer.

The reality on the ground is not so black and white. European business sees China moving in multiple directions at the same time.

For example, as noted in the European Union Chamber of Commerce in China’s European Business in China Business Confidence Survey 2020, a ‘one economy, two systems’ model has emerged. One half of China’s economy continues to open, is increasingly fair and well regulated, and very much wants European investment. For instance, while late in the game, the lifting of equity caps in the automotive sector has led to meaningful opportunities for European manufacturers and their suppliers, several of which have either increased their shareholdings or are aiming to take full control of their long-held joint ventures.

However, this more market-driven half of the economy also includes saturated sectors that China seems to have finally unlocked purely to perpetuate its now familiar narrative that it will open its doors wider and wider to foreign investors. The lifting of equity caps for foreign investment in the financial services sectors serves as a key example in this respect. China’s closed-off banking sector allowed domestic financiers to fully saturate the entire market without the challenge of outside competition. The eventual removal of the direct barriers to foreign banks was then hailed in Chinese state media as a monumental step towards China opening its economy. However, the fact that the reform took place so late in the game made it more akin to letting foreign investors onto a railway platform only after the train had long since departed.

In a market already dominated by state-run banks—four of which are the largest in the world—only a few remaining niches, like cross-border services, still have space for European banks. After entering those niches, European banks are then confronted by secondary barriers, like restricted access to licences and complex administrative approvals, meaning that most cannot even catch the crumbs from the table. European bankers project that the already pitiful foreign share of less than two per cent of the market will shrink. Meanwhile, Chinese banks are feasting on Europe’s open banking market.

The other, state-driven half of the economy sees China still nursing its national champions and stateowned enterprises (SOEs) that have largely uncontested access to a fifth of the world’s consumers, producers, depositors and innovators. China’s leaders reaffirmed its plan to enhance the role of its SOEs as recently as July 2020. China currently has 97 behemoths run at the central level by the State-owned Assets Supervision and Administration Commission (SASAC), and another 130,000 SOEs run at the provincial and local levels.

Originally, the foundational and primary sectors of the economy, as well as anything that could be deemed ‘strategic’ in the government’s broad definition of the term, were off limits, including energy, utilities, resource extraction, refining, steel production and rail. Worryingly, there now seems to be a growing list of sectors that either restrict foreign investment, or in which support is provided to China’s national champions to the extent that it squeezes out any potential European competition.

This is particularly apparent in the industries promoted in the China Manufacturing 2025 plan and similar national goals. Renewables, telecommunications, internet and high technology industries, along with other key sectors projected to drive the most growth over the coming decades, are tightening up to foreign investors. European companies have found themselves only being permitted into these areas to perform specialist roles and provide inputs where Chinese expertise is lacking.

The enduring and growing challenges facing European companies in this half of the economy are depleting business sentiment. Meanwhile, as China’s indigenous companies catch up to and even surpass European firms in some areas, many European business leaders are starting to wonder if Jeffrey Immhelt, former CEO of General Electric, was right a decade ago when he said, “I am not sure that in the end [China] wants any of us to win, or any of us to be successful.”

In the wake of the COVID-19 outbreak, new obstacles have emerged that have left Europeans feeling decreasingly welcome in China. While Chinese nationals have been able to get to Europe for essential business travel and work/residency, a large portion of China’s European business community—many of them long-time, tax-paying residents—have been largely prevented from returning, even from places within China’s borders like Hong Kong. Furthermore, instances of discrimination directed at foreigners in China went ignored by Chinese officials at best, and were outright denied at worst.

European Chamber members cannot help wondering if these actions and inactions are indicative of a broader mindset that while foreign capital and technology are desired in China, foreigners themselves are not.

These various directions that China is moving in indicate a huge difference in how the concept of ‘openness’ is understood. As an open economy, the EU has embraced the idea that market access is taken as granted through multilateral institutions like the World Trade Organization (WTO), and bilateral ones like investment agreements. Since EU-China negotiations on the Comprehensive Agreement on Investment (CAI) began in 2013, the EU has completed trade and investment agreements with several dozen other markets. But the China of 2020 seems to buy into a different way of thinking: market access is not seen as a right, but instead a privilege that is either extended to or removed from certain areas, depending on whichever part of the economy China’s leaders want foreign investment to flow to at any given time.

Not only does this understanding clash with the rules-based economic order to which China voluntarily acceded, it also drags down business sentiment.

This is to China’s detriment, as the potential of the market remains huge – China’s development trajectory has been comparable to that of Japan and South Korea in the decades following their market reforms. As opposed to the growing narrative of foreign companies voluntarily ‘decoupling’ from China, European firms are actually eager to deepen their positions and compete for market share.

The European Chamber is frequently asked by the European Commission and member-state governments if Europe should seek deeper engagement with China, with the ultimate goal of China establishing a truly open and competitive market economy; or if it should accept that the state-driven half of the economy will eventually prevail. The answer is increasingly clear: build a toolkit that will work either way.

EU investment screening mechanisms directed at state-backed capital will not need to be employed if China truly liberalises its economy, but will be in place to protect against market distortions caused by SOEs if China chooses not to. Similarly, the International Procurement Instrument will have no effect on China if the country opens its procurement market, while protecting against anti-competitive bids from China’s national champions if it does not. Leveraging trade and investment deals with third-market partners to counter market distortions resulting from competition from China’s artificially-boosted national champions will be unnecessary if Beijing aligns with the rules-based economic system, but such steps would be needed to counter damage to European players in those markets should nothing change.

Meanwhile, both sides must commit to concluding a binding and robust CAI that brings the EU and China as close to a reciprocal trade and investment environment as possible, and provides investor protection on both sides. This would not only bear clear tangible benefits, but also demonstrate that deeper engagement is still the best way forward, countering the growing international narrative that playing hardball in a world of zero-sum games is the only viable option.

Realising its stated reform agenda and bilateral and multilateral commitments would also resolve many of the contradictions that see China’s economy perpetually pulled in different directions: the tensions of one economy, two systems; the mismatch between market potential and market access; the conflict between business and politics; and the gulf between rhetoric and reality.

To download the full report, please click here.

EU China Chamber doc