EUCCC Position Paper 2024/2025

KEY POINTS

The following is Sense China’s extract of the position paper by the European Chamber of Commerce in China. Please find the full paper on Europeanchamber.com.cn

 

Action is needed, not action plans

While doing business in China has always required a high degree of flexibility to adapt to the rapidly changing environment, companies previously viewed the complex challenges they encountered as the ‘growing pains’ of an emerging market. There was a common perception that the difficulties faced were worth bearing in exchange for access to China’s large and dynamic market, world-leading manufacturing clusters, and comparatively cheap labour.

However, with the risks of doing business mounting and the rewards seemingly decreasing, many investors are now confronted with the reality that the problems they are facing in the China market may be permanent features that require a substantial strategic rethink.

 

Growing number of challenges

The central concern for European companies is China’s economic slowdown. However, several other factors are dragging on business confidence, including perennial market access and regulatory barriers; a highly politicized business environment; lackluster domestic consumption; overcapacity; ambiguous rules and regulations; and the government’s continued focus on national security and self-reliance.

 

Third Plenum was a disappointment

The foreign business community had been looking to the Party’s key economic meeting, the Third Plenum, for signals that at least some of their concerns would be addressed. Instead, the focal point of the Third Plenum Decision was to continue promoting investment in manufacturing as China’s key economic driver.

 

Weak efforts to boost domestic consumption

Following the Third Plenum, a new government scheme was announced that sets aside CNY 300 billion (EUR 40 billion) to subsidize the replacement of outdated commercial equipment and certain consumer goods. However, given that the total amount budgeted works out to approximately CNY 210 per capita, only a portion of which will reach household consumers, it is unlikely that this scheme alone will significantly increase domestic consumption.

 

Too much emphasis on state-owned enterprises

The Third Plenum Decision calls for state-owned enterprises (SOEs) to “get stronger, do better and grow bigger”, and notes that state capital “will be steered towards major industries and key fields that are vital to national security […].” This dual mission for SOEs to take the lead in future-orientated industries and to play a central role in maintaining China’s social fabric – while the dynamism of the private sector continues to decline – is one of the main reasons why China’s total factor productivity has stagnated.

 

Too much emphasis on national security

The creation of a section in the Third Plenum Decision dedicated to national security tells its own story. It highlights that maintaining a dynamic business environment should be done in a way that is restrained and proportionate to the perceived risks. The concern among European companies is that China’s prioritization of security could lead to policies that go beyond legitimate concerns and create insurmountable business risks. European companies are already struggling to understand their compliance obligations from recent security-related legislation, including the Law on Guarding State Secrets, the recently amended Anti-espionage Law and the new Foreign Relations Law.

 

SMEs prefer other investment options

The volume of investments into China by European and American firms is now roughly half that of a decade ago, with smaller multinationals and SMEs in particular opting to invest elsewhere. In past years, this shortfall would have at least been partly offset by reinvestments – businesses using profits earned in China to fund new projects. However, this metric is also trending downwards, as is the number of businesses that plan to expand their China operations. There are outliers to the trend, predominantly a few major multinationals that are continuing to make large-scale investments in China.

 

China+1 is important risk mitigator

Similar defensive trends can be seen when it comes to diversification of supply chains. European companies have begun both offshoring and onshoring, often at additional cost and loss of efficiency, as they seek to mitigate risks. These changes do not mean that European companies are running for the exit, but they do represent a strategic shift towards siloing China operations from the rest of the world.

 

“In China, for China” come with high price

In the past, international companies would be able to leverage global operations to spread the costs of their China operations. However, many companies are now pushed to adopt ‘in China for China’ strategies, essentially becoming Chinese companies with foreign shareholders. But not on a level playing field, as foreign businesses face structural disadvantages compared to domestic Chinese competitors.

 

Reforms should be backed by meaningful implementation

At the start of the millennium, reform plans announced by the Chinese government were seen by foreign companies as credible. Now, after more than a decade of largely unfulfilled pledges, doubts over China’s commitment to reform are increasing. Furthermore, with national-security considerations increasingly being balanced against – and sometimes taking precedence over – economic growth, it raises the question of whether Chinese officials have sufficient space to introduce pragmatic, pro-business policies.

 

Slow implementation of new FDI measures

It is against this backdrop that the government’s new FDI measures were introduced in 2023. The European Chamber believed that implementation of the measures would help prevent a further deterioration in business confidence and provide a solid foundation to build on. However, one year on from the document’s publication, momentum has been lost. According to the Chamber’s members, the areas in which progress has been made have been those that will have little material impact on business, or which are too narrow in scope to meaningfully address the challenges faced by foreign companies.

 

Lack of reforms means further FDI decline

The main cost of failing to address business concerns more comprehensively, is that the negative trends can be expected to continue. At the business-level, this would equate to a further loss of investment for China, the continued siloing of supply chains and company operations, and the current fissure between HQs and their China operations expanding to become a chasm. Beijing would also be opening the door wider for other regions to court investment at its expense.

 

Bleaker EU-China prospects

At the intergovernmental level, failure to implement meaningful economic reforms will likely result in an increase in EU-China tensions. The EU has already begun taking a more assertive stance towards China on key areas of concern to European business in China. It will likely set the EU and China on course for reduced engagement, resulting in missed opportunities. 

 

Risks are no longer outweighed by opportunities

As a result of these issues, a sentiment is emerging at company headquarters and among shareholders that the returns on China investments are no longer commensurate with the risks faced. Profit margins in China are equal to or below the global average for approximately two thirds of European Chamber members, and pessimism about future profitability is at an all-time high.

With many other markets offering greater predictability and legal certainty along with the same return on investment, continuing to invest at previous levels in the China market is simply becoming harder to justify. There are indications that FIEs have already begun adjusting their expectations for and approaches to the China market, with foreign direct investment decreasing by 29% year-on-year during the first half of 2024.

 

Recommended actions

The situation could improve if Chinese authorities were to fully implement their stated intentions. It is the European Chamber’s position that responding positively to the following recommendations could turn the tide and begin the process of rebuilding investor confidence in the Chinese market:

  • Reprioritize economic growth.
  • Refocus on reform and opening-up.
  • Allow market forces to play the decisive role in the allocation of resources.
  • Introduce policies to boost domestic demand.
  • Ensure that security-related policies are proportionate to the risk faced.
  • Create a level playing field for all enterprises, regardless of size and ownership structure.
  • Expand the scope of visa-free travel policies to cover passport holders from all EU Member States.
  • Introduce measures to ease challenges on attracting and retaining domestic and foreign talent.
  • Ensure digital and cyber regulations facilitate business operations.
  • Define ‘important data’ and ‘sensitive personal information’ in forthcoming rules and regulations in a narrow and precise manner.
  • Align industry-specific cyber regulations with the revised Provisions on Promoting and Regulating Cross-border Data Flows.
  • Implement comprehensive policies and measures to increase corporate entities’ access to sustainable sources of green energy.
  • Improve the enforcement of IPR in China, including by addressing sectoral-level challenges.
  • Increase ambition and specificity of incentives aimed at attracting investments to China.