European businesses are concerned about China’s business environment but remain optimistic about the country’s long-term prospects, according to the EU Chamber’s annual position paper for 2022/2023. Among others, the Chamber urges that China should make more pragmatic efforts to rebuild investor confidence and continue its reform and opening up. It also calls both parties to proactively engage with each other and steer away from excessive self-efficiency.
On September 21, 2022, the European Union Chamber of Commerce in China (EU Chamber) released its annual European Business in China Position Paper for 2022/2023 (position paper).
The position paper raises a number of concerns about doing business in China, ranging from criticism of the “dynamic zero-COVID policy” to an opaque policy development process. Despite these concerns, European businesses note that China’s unparalleled consumer base and manufacturing capacity make the country a core part of their business plans going forward.
Overall, the position paper presents 967 recommendations based on consultations with members of the EU Chamber of Commerce in China. Here, we look at the position paper’s main points and their implications for EU-China trade and investment.
The risk of two separate systems
The position paper is critical of policies that risk creating “two separate systems”. This refers to the need for many companies to create distinct policies and procedures when dealing with China compared to the rest of the world, such as developing separate supply chains to navigate the COVID policy.
The paper argues that China’s COVID policy is inflexible and inconsistently implemented and that they threaten economic growth. In a survey conducted by the Chamber in April 2022, 75 percent of respondents said that the COVID policy had a negative impact on overall operations. Respondents reported that the uncertainty the policy creates is its most significant challenge.
The paper suggests a way forward for the government to reopen its borders. It argues that the Chinese government should focus on fully vaccinating the population and providing boosters, and predicts that China will not fully open its borders until at least the second half of 2023.
Beyond logistical challenges, the paper argues that some of China’s policies that promote self-reliance and “buy China” are pushing the country towards isolation. This refers to policies such as “Made in China 2025” and “dual circulation”, which many foreign investors and governments worry will reduce opportunities for foreign businesses. Further, China and the US are increasingly instituting trade restrictions that limit the export or import of some products and components made in the respective countries.
In addition to the economic impacts of such policies, the paper says that China’s increasing isolation is leading to less understanding of the country. It states, “Europe misses the deep level of engagement in hand with China in areas such as arts and culture, sport and tourism”.
With COVID policies in place, it is difficult for European executives to visit China and attract European talent. The Chamber estimates that the total number of Europeans living in China has halved since the start of the pandemic.
Because of issues such as these, the paper argues that China is “unable to showcase its potential to foreign investors”. As such, the opportunities presented by the Chinese market – such as its consumer base and manufacturing capabilities – are less visible to European businesses than they otherwise would be.
Inadequate policy predictability
The paper says that the Chinese government’s policymaking has become less predictable and more ad hoc. It notes that many areas of the economy are better regulated than ever, but that some strategic industries are only fully open to state-owned enterprises.
Further, the paper observes that, in recent years, policies are increasingly implemented in a blanket manner with limited transparency and prior consultation. The paper cites regulatory crackdowns on the tech and tutoring sectors as well as inconsistent energy reduction policies as among the policy developments that have caught large segments of the business community off guard.
According to the paper, the growing politicization of business is a factor contributing to a less transparent and predictable environment. The paper recommends that the Chinese government provide conditions to allow companies to conduct trusted third-party audits in order to ensure compliance with global legislation.
More broadly, the paper states that providing a transparent and predictable environment as well as reaffirming a commitment to reform and opening up would reassure European businesses.
Businesses aren’t leaving – but they are diversifying
The paper suggests that European businesses are not leaving China, but that they are diverting some investments to other markets to mitigate risks, whether they relate to policy shifts or trade disputes. However, it warns that potential new entrants to the Chinese market may not take the plunge due to market obstacles.
The paper notes that between 2006 and 2015, EU FDI into China was relatively evenly distributed between the top 10 investors and the rest. However, over the last four years, the top 10 investors have contributed over 70 percent of total FDI.
This suggests that European FDI is increasingly concentrated among larger businesses, while small and medium-sized enterprises (SMEs) are investing comparatively less. In light of this trend, the paper says there is an “increasing discrepancy between market potential and the actual market share of European companies.” In other words, European SMEs are not capturing all of the potential of the Chinese market because of access barriers.
Due to China’s unpredictable policymaking environment, the paper states “while those already established in China are not looking to leave, they are increasingly weighing up the possibility of shifting planned or future investments to other markets that are perceived to provide greater reliability and predictability.”
This sentiment represents the popular “China+1” strategy, where businesses supplement their China operations with investments in other Asian countries such as Vietnam and Indonesia. Such a strategy allows businesses to mitigate the risks of being overly dependent on one country while capturing opportunities presented by fast-growing emerging markets. The paper says that some companies are looking into “China+1+2+3” strategies to further diversify their risk exposure.
Increased trade and investment encouraged
While the paper includes a variety of critiques of Chinese government policy, it recommends that the EU continue to proactively engage with China and reject calls for disengagement. Rather than pull back, the paper says that the EU should remain deeply integrated with the global economy and steer away from excessive self-sufficiency. This position acknowledges the size and importance of the EU-China economic relationship.
The EU is the third largest source of foreign direct investment (FDI) into China, following Hong Kong and Singapore, though the latter two often act as intermediaries for investment from other countries. In 2021, EU-based entities invested US$5.1 billion in China, about 3.5 percent of the total, slightly down from 3.8 percent in 2020.
In 2021, the EU exported EUR 223 billion (US$215.25 billion) worth of goods to China and imported EUR 472 billion (US$455.61 billion). Through the first seven months of 2022, China’s exports to the EU grew by close to 20 percent, while EU exports to China declined by 7.5 percent.
For European companies, the paper recommends maintaining strong communications between headquarters and China operations to stay informed and to continue to integrate foreign staff into China operations and Chinese staff into global operations. It further emphasizes the need for European companies to conduct supply chain and global systems analysis, while recommending that businesses monitor political risks on an ongoing basis.
Source: China Briefing