Finding the middle ground: EU-China relations

Relations between the European Union and China have had better days. Gone is the era when Angela Merkel, former chancellor of the EU’s largest state, used to frequently visit Beijing with large business delegations in tow.

These days, skepticism toward China is in fertile ground, spurring increasingly hostile attitudes toward Beijing’s policies. Yet the answer to the questions that China is posing to the maintenance of the global trade system lies perhaps counterintuitively in more, not less, globalization. Germany’s predominantly materialistic approach toward China has long caused frustration[1] among those in the EU who believe engagement should focus more on issues such as human rights. The outsize role of the Chinese market for European exports and investments as well as imports including of critical commodities are increasingly causing concern across Europe.[2]

Flying in storm clouds

Germany is seeking to renew economic ties with China even as Europe-China relations have been deteriorating for years.

The disputes include EU complaints at the World Trade Organization over Chinese trade policies in intellectual property, technology, and other sectors, Beijing’s human rights record, and economic coercion against EU members. China earlier this year sanctioned Lithuania after Vilnius permitted a Taiwan representative office.[9]

China’s indirect support for Russia in the invasion of Ukraine, which exposed Europe’s dependence on Russian gas, is deepening concerns on the continent over the Middle Kingdom’s foreign policy.

Handling an increasingly assertive, totalitarian, and powerful China will therefore likely be the primary question of international relations for the remainder of this decade and beyond.

A missed opportunity

For the EU, the CAI would have improved investment conditions in China. Although implementation[13] might have fallen short of expectations, the CAI almost certainly would have helped to level the playing field for EU firms vis-à-vis Chinese state-owned companies. The agreement also prohibits forced technology transfers, removes joint-venture requirements, and lowers equity caps for EU investments. It could have provided Europeans with a modicum of influence over labor and environmental standards in China.

More, not less, globalization

The rising tide of decoupling among the world’s largest economies, most visible under slogans such as re-, near-, and friend-shoring[15], is not the answer. Scaling back globalization would incur immense economic costs and very substantial welfare losses. It would further increase inflation and international political polarization. It is in the West’s interest to retain a modicum of dialogue, exchange, and influence, especially in times of crises.

The economic imperative for cooperation with China remains as relevant as ever. China is the world’s second-largest economy, larger in gross domestic product (GDP) than the EU-27 combined. China is the EU’s second-largest trade partner[16] and Germany’s largest[17]. And while still lagging other partners, mutual inbound and outbound foreign direct investment (FDI) is sizable, too.

How can Europeans find a balance between these factors? Somewhat counterintuitively, the answer is more, not less, globalization.

A new agenda for EU-Asia policy

For Europe, the key is to diversify toward developing more partners. Scholz’s visit sends the right message at the right time, despite the criticism from those who believe Germany should not engage, or at least have limited engagement with, non-democratic partners. The visit signaled both Germany’s keen interest, indeed imperative, to have a sound working relationship with Beijing as well as Berlin’s keen intent to diversify beyond China. Importantly, in the same month, Scholz visited Singapore and Vietnam. The theme of his visits was the same: Germany needs and wants to trade with China, but is looking much more actively for new partners in the region.

The case for doubling down on Indo-Pacific engagement could hardly be clearer: the region accounts for 60% of global GDP and is home to four of the EU’s top 10 trade partners (China, Japan, South Korea, and India). Together, the EU single market and the Indo-Pacific represent 70% of global trade in goods and services and 60% of FDI; the EU is the biggest investor in the region and in 2019, annual inter-regional trade stood at 1.5 trillion euros. The EU has four bilateral trade agreements in place with the Indo-Pacific (Japan, Vietnam, South Korea, and Singapore) and a range of strategic and connectivity partnerships.

Despite the WTO’s problems, plurilateral trade frameworks – smaller groups of negotiating economies within the WTO – are still at work. The EU should work hard to lay the groundwork for deepening trade ties with Indo-Pacific economies such as India, Vietnam, and Indonesia to better position themselves in the EU’s supply and value chains.

Further, the EU should seek accession to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) – a fairly open agreement creating a rules-based trade environment. The CPTPP could become the core element of the EU’s Indo-Pacific strategy, positioning the single market deep into the regional trade agenda. As a recent European Parliament resolution[18] agreed, CPTPP accession would not only be economically beneficial, but it would also diversify supply and value chains, reduce dependencies, and enhance the EU’s capacity to shape standards in the region. This is a daunting task. But the EU already has in place bilateral trade agreements with all CPTPP economies except Brunei.

Lastly, in terms of redressing asymmetric dependencies, relative percentages matter. European economies should never again be as dependent on a third party for 40% or more of their needs of a critical resource, as was the case with Europe’s reliance on Russian gas or rare earth imports from China. To prevent this, the European Commission should launch a monitoring system that can issue early warnings to member states. Instead of pressuring companies to then exit certain markets, EU governments should jointly create financial incentives to increase diversity and resilience of value and supply chains across the Indo-Pacific region.

This would pave the way for a broader regional approach rather than obsessions with economies of scale in large markets such as China. Likewise, the EU should produce critical infrastructure legislation. Instead of making arbitrary case-by-case decisions, legislators should designate certain sectors, such as 5G or public transport infrastructure, as “critical” and prohibit all international third-party (except EU) investments in these sectors.

In short, the idea is to diversify more toward the Indo-Pacific region, by enacting new rules at home and reaching out to new partners abroad. Instead of becoming increasingly isolated, the EU should become independent and engaged.

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[1] EU-China Sanctions Tussle: Winners and Losers, RSIS.
[2] Cutting Germany’s risky trade dependence on China, Financial Times.
[3] How German leader Olaf Scholz walked a fine line in China, SCMP.
[4] Germany’s Solo Trip to Beijing Exposes Europe’s Dilemma on China, Bloomberg.
[5] Germany will pay the price for its bizarre love affair with dictatorships, The Telegraph.
[6] Germany’s dependence on China is ‘overblown,’ but critical goods diversification needs to improve: EU Chamber of Commerce, CNBC.
[7] Cutting Germany’s risky trade dependence on China, Financial Times.
[8] Chinese subsidiary in Sweden wants to take over Dortmund chip manufacturer, WDR.
[9] Lithuania Opens Trade Office in Taiwan as Ties With China Sour, Bloomberg.
[10] EU imposes further sanctions over serious violations of human rights around the world, Council of the European Union.
[11] Ministry of Foreign Affairs, China.
[12] Key Facts and Figures, EU-China Comprehensive Agreement on Investment.
[13] Assessing the pros and cons of the EU-China comprehensive agreement on investment: an introduction to the special issue, Springer.
[14] Globalization and Its Discontents, W. W. Norton & Company (2003).
[15] Just Say No to “Friend-Shoring”, Project Syndicate.
[16] Euro area international trade in goods deficit €32.4 bn, Eurostat.
[17] Ranking of Germany’s trading partners in foreign trade (final results), Statistisches Bundesamt.
[18] European Parliament resolution of 5 July 2022 on the Indo-Pacific strategy in the area of trade and investment, European Parliament.

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