The EU, China and strategic trade: context and priorities

Pau Ruiz Guix

9 de Enero de 2021, 16:43

Modern world trade has historically been characterized for being based in a set of rules of non-discrimination, transparency and openness, which are embodied by the General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO). This system has been under increasing pressure during the last few years, with trade and investment disputes, technological competition and great power rivalry weakening global economic governance and fueling the rise of strategic trade. Strategic trade, first developed in the late 1980s, theoretically established that states could increase their national economic welfare at the expense of foreign firms, a reality that had not been discussed in trade theory literature before.

With the turn to the 20th century, there has been a decreasing enthusiasm for global trade. This has been mainly driven by the effects of the financial crisis, a misplaced blame to free trade for the effects of global technological change (i.e. job loss due to automation), the contentiousness around free trade agreements and the lack of systems in place to compensate losers. While prior to 2008 trade was mostly referred to as an essential, beneficial tool for promoting economic growth for all, the last decade has seen both a move from multilateralism to bilateralism and a rise in protectionist policies. In a context where economic globalization has created new demands on state governments while essentially reducing their capability to tackle them, global trading relations have been increasingly put under a nationalistic rhetoric and gradually weaponized.

In this context, China has emerged as a leading global power in international affairs, as seen by its formidable growth, domination of new technologies, the Belt and Road Initiative or the South China Sea territorial claims. This has been coupled with increased nationalism, authoritarianism at home and abroad, and a defense of the idea of capitalism with Chinese characteristics. At the same time, the US emerged in 2016 as a unilateral and protectionist power under Donald Trump, which has questioned international organizations (from the EU itself, to NATO and the UN) and abandoned the Joint Comprehensive Plan of Action (JCPOA) and the Paris Agreement, among many others. Putting China at the center of US foreign and trade policy, US policy-makers started a US-China trade war and a process of targeted economic decoupling that will likely continue under the next administration.

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The European Union has therefore been found immersed in a world with a changing global trading landscape, a more assertive China, a more unilateral US and a US-China trade war. At the same time, it has developed a greater consensus on its economic relations with China, the foreign power being perceived as an ally and a systemic rival at once. While member states consider their relationship with China crucial and there is a will of greater economic engagement, there is also growing concern on the risks that overdependence with China might generate and an emerging awareness on the need to develop certain defensive mechanisms. In this context, the EU must ensure a positive sum approach to China, based on the necessity to engage the country and the possibility to reform global economic governance, prevails.

The relationship

The European Union and China have an intense and multifaceted economic relationship. While the EU is today China’s main trading partner, China is set to become EU's largest trading partner, currently only standing behind the United States. Trade between the EU and China has been increasing at an exponential rate since China's WTO accession, but the rise has been mostly fueled by EU imports from China rather than exports to China. At the same time, European FDI to China is highly concentrated in several sectors and has seen an astonishing increase between 2008 and 2017. While Chinese foreign direct investment (FDI) to the EU remains limited, it is increasingly important for Chinese investors and mostly destined to high-value industrial sectors.

The economic relationship between the EU and China has generated great benefits for EU citizens, but it has also been a matter of rising concern. In the context of a more belligerent US that has put China at the center of its trade policy, as well as with influential US voices favoring western decoupling from the country, the EU shares many of the concerns the US has in its economic engagement with China. We can group concerns into (1) level-playing field and (2) strategic and security concerns.

First, the EU has deep and justified level-playing field concerns. China has effectively limited foreign competition while at the same time implementing industrial policy, granting subsidies and providing a favorable regulatory framework to national enterprises, in many cases state owned (SOE) and in critical sectors such as ICT, energy technology or medical equipment. Another reason for concern for the EU has been asymmetry in market access, with China benefiting from open markets while having tariffs, non-tariff barriers and other discriminations for foreign companies in place. This has been particularly relevant in the field of FDI and a main driver behind the negotiations of the EU-China Comprehensive Agreement on Investment (CAI), which was concluded last week.[

Secondly, there are important security and strategic concerns. In the context of a strong role of the state in the Chinese economy, an added reason for concern in the field of FDI has been the increasing Chinese investment directed towards high value added sectors in Europe. Moreover, taking into account EU countries have been decreasingly linked to each other and increasingly linked to China in intermediate goods trade, issues around the control of supply chains, especially in the context of the coronavirus pandemic, are also relevant. Nonetheless, many of the security related frictions between China and the EU are thought to transcend the realm of trade itself, being closely linked to the control of certain services and technologies and the privacy, security and economic risks that this represents.

Finally, while concerns might be shared, unilateral US policy and the US-China war have negatively contributed to the EU-China trading relationship due to trade diversion and decoupling. For example, $120 of the $200 billion in increased Chinese imports from the US negotiated in the framework of the Phase One deal directly compete with EU manufactured goods. At the same time, the increasing trend of technological decoupling between the United States and China puts EU companies competitiveness at risk, having to abide by two different ecosystems that they do not control, while risking EU's capability to become a standard setter in the technological domain, hampering its efforts to define global norms according to its interests.

The priorities

The EU has the objective to maintain a rules-based, liberal and multilateral trading order while at the same time defending itself from the potential challenges and risks that emanate from its economic relationship with China. In view of the inherent interest the EU has in preserving good economic relations with China, EU policy-makers should continue to maintain a long term view, investing in first term solutions, while establishing a set of instruments and policies that might help alleviate short-term concerns. Taking into account the current strategic trade context; the benefits and challenges of the EU-China economic relationship; and the strengths, weaknesses, opportunities and threats of EU's ability to develop and consequences of implementing a strategic trade and decoupling strategy, the EU should focus (and is already focusing) in four wide priorities.

First, in terms of internal issues to consider, EU member states should ensure unity and coherence, address perceived dominances of EU China policy and strengthen and develop new instruments. Albeit growing consensus on EU China policy, there are still cohesion and coordination issues. With a foreign policy system that requires unanimous votes by all member states, there are still hundreds of dialogues and visits from the EU Commission, Parliament, member states and cities to China, which are not often coordinated or even shared to one another. There are still differences on whether to prioritize economic engagement or political and security concerns, and there is growing concern on the perceived dominance of the EU-China agenda by Germany and France, which may hamper efforts to develop coherent and effective EU strategies and instruments. Moreover, there is diverging economic dependence on China that the country can exploit to bring EU member states against one another. China has referred to the EU as weak and politically divided, and has most notably exploited divisions by establishing the 17+1 negotiations, which bring together central-eastern European countries (13 EU member states) together with Chinese leadership. If the EU decides to implement measures that China sees as potentially harmful, a threat is that China can apply similar tactics, together with already common disinformation campaigns, to hurt a common EU position on China and the EU project itself.

Therefore, key to Europe’s ability to pave a path of sustainable economic engagement with China is to strengthen its negotiating position by clearly developing a unified trade and investment position towards China with smaller divisions to exploit. Without internal, coherent strength, little external power can be projected. In such a process, we should make an effort to address the Franco-German perceived dominance of EU-China policy by making sure all country representatives feel heard while expressing their concerns and sharing their policies in discussing pressing issues around EU-China relations. Moreover, the EU should strengthen current and develop new internal mechanisms. While the new EU investment screening mechanism is a good development in terms of EU's capabilities to react, it is based on coordination and information sharing, and decisions are still under member states control. Because of the consistency problems that this can generate, negotiations could continue and consider to establish an EU-wide, centralized screening mechanism under the control of the Commission and the community method. EU policy-makers should also establish a mandatory information-sharing mechanism under the European External Action Service (EEAS) that brings together all bilateral engagements with China.

Second, in terms of engagement and global governance reform, the EU should ensure sustained engagement and capitalize on current negotiations to deliver results. As opposed to the US, the EU is currently in a non-confrontational context with China. The recent EU-China summit (2019) emphasized economic cooperation, dialogue and multilateralism as building blocks of their relationship, and generated Chinese commitments on procurement, intellectual property and technology transfers, among others. There are other important progresses such as the CAI, cooperation in WTO legislation (particularly in the field of industrial subsidies) and cooperation in WTO reform proposals concerning the Appellate Body.

In terms of engagement, the first and foremost priority for the EU was the negotiation of the CAI, which was announced just a few days ago. While the deal is a political success and sends a clear signal in favor of economic engagement and European strategic autonomy in front of the US, it has been argued that it adds too little economically, and the main issues of market access and level playing field remain. It should be celebrated, but sustained and strategic economic engagement must and will continue. For example, in terms of the EU-China summit, the EU must invest in the monitoring and implementation of the agreed commitments. As per global governance, we need to continue pushing for WTO reform. In the framework of the WTO the EU has a respected common position that has been instrumental for issues at heart of EU-China tensions. The EU should develop plurilateral agreements on issues ranging from subsidies to intellectual property protection before next WTO Ministerial Conference and propose an interim dispute settlement mechanism, even if voluntary, until the Appellate Body crisis is solved.

Third, and critically, in terms of cooperation, most member states believe that the EU can address some of the risks found in the EU-China relationship by partnering with allies, and most see the US as a primary partner in such efforts. Taking into account the effects that a US deal with China may have for the EU, the new Administration under President-Elect Biden and the EU proposal for a new transatlantic partnership, which includes issues from supply chain security to a joint EU-US tech agenda, EU cooperation with the US marks a huge opportunity in this realm. At the same time, there are ample opportunities to cooperate on reforming global economic governance and rebalancing China with other partners. While France is looking at increased cooperation with Asia-Pacific and Spain with Latin America, the EU is in a good position to convey to emerging countries the need to protect a free, open, fair and multilateral trading system in front of increased Chinese assertiveness.

Therefore, the EU should heavily invest in the transatlantic cooperation of China policy. Despite the troubled times, and the potential continuation of some US-China policies under the new Administration, the EU and the US share concerns and interests in addressing China. A new administration will surely abandon isolationism, and the recently proposed EU strategy is a first essential, well-thought step to tap into such change. Recently there has been lengthily discussion about how the Biden administration might perceive the CAI when it would have preferred the EU to coordinate with the US. The CAI is the result of Europe's approach to China, engagement, which has radically differed from recent US approaches. It is an example of strategic autonomy in action, and serves to bring European companies closer to US companies in terms of market access, providing a more equal footing for the transatlantic coordination of China policy. Biden will continue to make cooperation with the EU a priority if it truly believes in the benefits of global economic governance and engagement with China. Similarly, the EU should work with other partners. The EU should work to expand the EU-Japan-US commission on industrial subsidies to partners that rightly share the same concerns (such as Canada, Singapore, Mexico or South Korea) and strengthen EU-Japan cooperation, taking into account both countries alignment in a number of topics, especially under US isolationism. Moreover, EU leaders should incorporate China issues on EU’s engagement with Latino America.

Finally, in terms of risk reduction, in a period marked by its disillusionment with global trade, the EU has signed and enforced historical trade agreements with South Korea, Japan, Singapore, Canada and Vietnam. This has allowed the EU to expand its norms while creating a free trade network that can help protect EU consumers to some degree in front of potential Chinese retaliatory action. Nonetheless, and depending on the assertiveness EU measures, which for now seems unlikely to push for an aggressive decoupling strategy, China can respond with reciprocity, implementing measures designed to harm EU businesses and consumers. For example, and while the Belt and Road Initiative can create gains for the EU in terms of greater Eurasian connectivity and infrastructure in EU's neighborhood, China could undermine those gains by creating a free trade area with Belt and Road Initiative countries, diverting trade from the EU.

Thus, the EU should continue to expand its Free Trade Arrangements (FTA) network. Expanding EU’s FTAs and making sure a greater share of EU global trade is covered under bilateral free trade agreements (currently 75% of EU trade is) is a good way to expand EU's interests and while protecting it from both potential China initiatives and a dysfunctional multilateral system. Efforts to conclude more FTAs with Southeast Asia, with the possibility of signing a region-to-region FTA with Asean, should be pursued. Finally, the EU should invest heavily in the southern neighborhood strategy and throw weight behind the EU-Asia connectivity strategy. To counter the potential threat of China diverting trade from EU's Southern Neighborhood and Eurasia, the EU should redefine the priorities of the Southern Neighborhood strategy and make greater funds available for the EU-Asia connectivity strategy. The latter is a particularly useful framework to exercise power and expand EU norms in Asia, but it needs both funds and greater political attention to be realized.

With a renewed sense and necessity of strategic autonomy fueled by US isolationism, the EU increasingly feels it needs to use diplomatic and geoeconomic means to influence change in Chinese policies, engage the country and protect itself from potential sources of risk found in the EU-China economic relationship. In the process, the EU must ensure than non-populist, positive sum relations to China prevail, while again convincing the world (and the US) that engagement is necessary and WTO reform possible. The recently signed EU-China investment treaty (CAI) is a step in the right direction.

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