China and the EU: It’s the Economy That Matters

Urgent neighborhood crises crowd on Europe, and the very benefits from European integration are increasingly doubted by voters. In this context, it comes as no surprise that the China-EU relations tend to focus on basics – its trade and economic core. Europe has had little success over its human rights policies towards China, in part because short-term economic interest often divides member states. Its hard power is not really felt in Asia, except indirectly via arms sales. The European Union has made a meritorious effort to weigh in after the ruling by the court of arbitration against most Chinese claims in the South China Sea, coming up with a unanimous resolution. Even there, the economic interests of several member states precluded very concrete language.

Economic interests, on the other hand, are powerful for both Europeans and Chinese. They are not limited to the trade balance – although for both this is either the first or the second overall trading relation, with an all-weather trade surplus in favor of China. China’s going-out strategy has led to a surge in overseas investment – and Europe is at the forefront of that strategy, after the downgrading of energy and raw material investments that previously went to primary producers elsewhere. This is doubled by a strategy of financial acquisitions, part of which in fact is under the radar as China’s sovereign funds adopt a classic strategy of investment diversification for their portfolio. While there is a Chinese economic slow-down and talk of increased debt risks, China’s current account remains in the black. The country is therefore a prime source of loans at low rates, a trend that is increased by lower returns in China and a lower renminbi relative to the euro. Hot money flowing out of China (which can include some developments by state firms themselves), the surge of real estate acquisition by Chinese candidates to residence permits, and a huge increase in the number of tourists from China add a grey zone in the relationship, less easily caught by official statistics.

Paradoxically, the EU remains less dependent on China than the United States. Its public debt problem is only sub-regional. Its overall current account surplus implies it is less in need of outside money. Behind this large picture, the EU’s small overall budget, the fatigue about structural transfers to the Eastern Europe member states, and the competition for new infrastructures all indicate that China can be a much soughtafter partner for investment or lending by some member states in need.

To this picture, one should add one looming deadline. By December 2016, the temporary provisions of China’s admission to the WTO expire. Although on the surface it is a debate about granting China the so-called “market economy status,” in reality this is about the future of anti-dumping. The deadline could not have come at more awkward time for China, currently riddled with overcapacities and industries trying to export their way out of trouble, and with a huge need for the European Union to demonstrate to the public its economic and social usefulness. This happens in a global climate where a switch to protectionism is happening. It is apparent in the emerging economies facing competition against China, it is visible in the American presidential campaign. In Europe this has been compounded by China’s long neglect of key discussion channels with the EU, focusing instead on bilateral lobbying with some member states. It has gone to the trouble of creating a summit format with 16 Central and Eastern European states that spans over the issue of EU membership.

Finally, the prospect of Brexit is creating new negotiating stakes in what could become a triangle between China, the EU, and the UK. China has been uniquely talented to play on existing divisions within the EU – it hardly needs to foster new ones. The UK has also used many divisive tactics inside the EU. For the UK to cushion what is increasingly looking like a hard Brexit, or perhaps to gain a better hand in negotiating with the EU the terms of exit, a credible strategy for a global UK is needed. China, with its surge in industry and financial investment abroad, would be the jewel in the crown, and in fact the previous UK government has already pulled out most stops in its race for Chinese capital.

Europe’s potential for fragmentation and weakness cannot be underestimated. Yet there is also a new sense of realism in many member states and in the EU institutions, brought on by previous difficult experiences in negotiating with China. It is by far not the immediate geopolitical threat that most consider Russia to be, but illusions about a convergence via economic transformation to common values has dissipated, in part thanks to official Chinese policy declarations themselves. China’s need of Europe is less easy to assess, partly because China is a very skilled actor at denying path dependence where it would seem to exist. For example, once it has understood after 2005 that lifting the EU arms embargo was very unlikely, this took a second seat in China’s approach to the EU. On market economy status, China turned around in early 2016 and declared this a symbol devoid of substance, putting all of its emphasis on the legal issues around anti-dumping that are perhaps implied by its accession treaty to the WTO. Yet there is no doubt that China is heavily dependent on the European markets, for structural and conjunctural reasons. Regarding consumer goods, it matches the US market in size. The downturn in energy and raw material producing countries means that the prospects of large infrastructure projects are less obvious there, and that outcries about China’s trade surplus become more likely. Financially, China’s growing capital outflow requires safe harbor and safe returns, which are more readily offered by Europe’s public and private actors. Going upscale in technology for Chinese firms and acquiring brand name prestige which favorably influences Chinese consumers also points in the direction of Europe.

The one threat that is currently receding for China is that of the so-called mega-trade deals that would “encircle” China and impose higher standards and norms than its economy can sustain. Not only the TTIP, but also the TPP look increasingly unlikely to happen. Europe’s trade strategy with Japan and India has not made great progress. In fact, China is making more advances in the removal of at last some trading obstacles with Central Asian states and Russia. The attraction of the Silk Road may be greatly overestimated by observers who do not see its risks and the small scale compared to Western markets, but it is a sign that in a climate where trade liberalization sours, China has a chance to push its pragmatic, bilateral, and mercantilism- based strategies.

The next steps in the China-EU economic relations are quite easy to discern. After a false start, EU institutions have actually been able to coordinate and support each other as almost never previously on the issue of Market economy status, and also on adopting a public China strategy that focuses on reciprocity. At the end of the year, this will face several reality tests. One is a legal action by China with the WTO and the European Court of Justice as, likely, the EU steps over the deadline for ending the transitory anti-dumping measures set by WTO. Another will be in getting its act together to adopt new trade defense instruments, essentially a revamp of Europe’s overall anti-dumping laws that would avoid singling out China, and yet provide reliable tools. In the recent past, this has proven very difficult, so great is the division between the so-called protectionists and the so-called liberals among Europeans – constituencies with different economic interests that in fact show up in almost every member state. Finally, Brexit offers a wild card to China, and will be watched carefully to assess whether in the end, the single market matters more to Chinese interest than the more political views on taming partners.

François Godement

Director of China & Asia program, European Council on Foreign Relations

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