Bank of Lithuania
2020-09-04
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In recent years, the European Union’s (EU) position towards China has gone through a significant transformation. The European policy makers have shifted their focus from the opportunities created by closer cooperation to the risks associated with China’s growing economic power. Last year, the European Commission (EC) for the first time referred to China not only as a partner, but also as an “economic competitor” and a “systemic rival”. An increasingly cautious EU political stance towards China confirms that the EU is set to take a more coordinated action to protect Europe’s economic and political interests.

Comment by Linas Mickus, Senior Economist at the Economic Policy Analysis Division of the International Relations Department of the Bank of Lithuania

What is driving the EU to change its attitude towards China?
EU-China relations are very complex, with strong economic and political dimensions, thus there are a number of reasons prompting the EU to change its position towards China. However, the key reason behind it is the lack of a level playing field in economic relations, which makes it difficult for EU businesses to compete on an equal footing with Chinese companies.

First, China provides various forms of state subsidies to local businesses, which may include preferential financing, tax incentives, credit guarantees and other measures. The state-led model of China’s economy poses risks to the effective functioning of the EU single market. Subsidised companies operating in the EU single market can distort the competitive environment and gain an unfair advantage over the European corporate sector. State aid can create artificial conditions for China’s firms to offer lower prices for goods or services in public procurement tenders as well as to help mobilise more resources in competing for acquisition of EU undertakings.

Secondly, China enjoys much better access to the EU internal market than vice versa. According to the foreign direct investment restrictiveness index compiled by the Organisation for Economic Co operation and Development (OECD), China remains one of the most conservative countries with regard to foreign investment. Its market access restrictions protect local businesses from foreign competition and, together with the aforementioned state support, create the conditions for particularly large companies – so called “National Champions” – to emerge, which naturally have a competitive advantage when entering foreign markets. The best example of this strategy is the information and communications technology (ICT) sector, which is largely closed to foreign investors in China. 

Thirdly, the EU is unsatisfied with the uneven conditions for participation in public procurement tenders. In the EU, the public procurement market is open and transparent for third-country companies that can tender on an equal footing with local undertakings. However, this market in China is largely closed. The problem has been exacerbated by China’s Belt and Road Initiative (BRI), which is an ambitious strategy to develop transport, energy and telecommunications infrastructure in Asia, Europe and Africa. The total financing needs of the BRI projects are expected to reach $1 trillion by 2027. Despite their high value, the economic benefits for EU companies will be negligible due to their limited participation in project development as a result of a low transparency level and administrative barriers for foreign firms to bid tenders. According to the data of 2018, as many as 89% of construction work of BRI-related infrastructure projects is undertaken by Chinese companies.

With regard to the development of EU-China relations, it is important to underscore the fact that the EU has already been emphasising the asymmetry of economic relations for many years. Back in 2013, negotiations have been launched on the EU-China Comprehensive Agreement on Investment (CAI), aimed at addressing at least some of the identified issues. Although last year the EU and China committed politically to finalise the agreement by the end of 2020, there are reasonable doubts that the negotiations will be completed in time. According to EU officials, China needs to step up its ambition in order to overcome the main issue of rebalancing market access.

The EU is pursuing a defence strategy
With China’s economic power growing, the EU feels an increasing need to ensure a level playing field in trade and investment. Since all efforts to do so through negotiations have not yet yielded any substantial results, the EC has made a number of proposals in recent years to correct the existing asymmetries.

In 2019, the EU adopted a regulation establishing a framework for screening foreign direct investment inflows into the strategically important EU sectors. The ongoing transition period is intended to provide a time gap for national authorities to establish an investment screening mechanism. At the end of the transition period in October 2020, every EU Member State must have established or harmonised national assessment mechanisms in accordance with the EU rules. 

Foreign investment screening has become particularly relevant in the wake of the COVID-19 pandemic. The EC called on Member States to implement the regulation as soon as possible in order to protect strategically important companies from hostile foreign takeovers in the face of the crisis which has put asset prices under pressure. However, in case of Lithuania, the EU-level regulation will not bring any significant changes, as the country established an investment screening mechanism already in 2002, before joining the EU.

Another significant step was taken by the EC in June 2020, when it presented a white paper and launched a public consultation on measures dealing with the negative impact of subsidies granted to companies by non-EU governments. Up until now, the EU competition rules strictly regulated the provision of state aid within the EU, yet they did not cover third-country subsidies. The proposed document does not explicitly point to any country, however, wider context makes it obvious that the EC is targeting Chinese government subsidy practices, against which it so far had no real remedies.

The white paper sets out measures for countering subsidies which may have a negative impact on the functioning of the EU single market. This includes rules on restricting acquisition of EU undertakings by subsidised non-EU companies where the EU antitrust rules are breached. Furthermore, the EC proposal suggests restricting participation of subsidised companies in public procurement tenders when subsidies may distort fair competition. If Member States support the EC proposals laid out in the white paper, the EU will develop a comprehensive set of instruments to help protect European businesses from unfair foreign competition.

Last year, the EC brought discussions about the proposed International Procurement Instrument (IPI) back to the political agenda. The purpose of the IPI would be to make third countries open up their public procurement markets where access for EU companies is restricted. According to the proposed procedure, if the EC finds that EU companies are being discriminated in the procurement market of a third country, it would encourage the concerned country to start negotiations in order to remedy the current situation. If no agreement is reached, the EC will have the right to take corrective action by artificially inflating the price of the bid by 20%, thus making it more difficult to win the tender.

Finally, the need to reform the EU competition rules is gaining traction in the EU policy debate. In recent years, a number of EU countries, led by Germany and France, have tried to initiate a review of the competition rules to enable creation of large European companies. Member States are pushing for an update of the EU merger guidelines in order to take greater account of competition at the global rather than the European level.

The EC has so far treated such proposals with caution, in particular due to potential competition distortions within the internal market. However, fast-growing Chinese companies benefiting from state support are changing the global competitive environment. The EU must therefore respond accordingly, so that European undertakings could withstand competition from large foreign firms, especially in strategically important sectors such as energy, transport, IT or telecommunications.

The EU aims for a level playing field
As stated by EU foreign policy chief Josep Borrell in March 2020, the EU has been a little naive in its relationship with China, but this position is gradually changing and European countries are taking a more pragmatic approach regarding such relations. Although in the recent past the prevailing narrative in the EU was that closer cooperation with China needed to be strengthened and this would encourage China to liberalise its economy, now the sentiment has changed – increasingly more voices are calling for defence measures against China’s economic model.

It is important to ensure that the initiatives proposed by the EC evolve into effective instruments that have the capacity to offset the negative effects resulting from the lack of a level playing field in economic relations. At the same time, the EU must remain open and actively engage in the negotiations in order to finalise the EU-China CAI as soon as possible. It needs to be assured that the EU’s defensive measures do not encourage protectionist tendencies, but act as a catalyst in accelerating the opening up of China’s economy.

The presented assessment is the author’s personal opinion and does not necessarily correspond to the official position of the Bank of Lithuania.