The EU-China Investment Relationship: From a One-Way to a Two-Way Streetby Thilo Hanemann | January 28, 2013
Over the past decade China has become one of Europe’s most important economic partners. In 2011 bilateral trade flows totaled €430 billion, four times higher than just ten years ago. In addition to growing exports, European firms have also expanded their physical presence in China. The stock of foreign direct investment (FDI) by European firms in China amounted to more than €100 billion in 2011. Investment flows into the other direction, from China to Europe, were negligible in the past. However, the past patterns of one-way investment flows are changing as investment from China has grown rapidly in recent years, taking EU-China economic relations to the next level.
For one, China has increased its holdings of European securities, including small equity shares in listed European companies and sovereign debt issued by European governments. Growing portfolio investment into Europe has come on the back of China’s enormous foreign exchange reserves, which state-controlled agencies need to re-invest abroad, mostly in government debt or lower-risk equities. Efforts to diversify China’s reserve holdings away from the US dollar into other major currencies like the euro or the Japanese yen should have increased the holdings of European assets, but there are no reliable statistics available on the extent of those purchases.
The second major trend is a structural increase of outward FDI by Chinese firms in the European Union. There are similar data problems with capturing FDI from China, as official statistics have a huge time lag and often fail to capture flows through offshore financial centers. However, there are alternative data sources that allow a real-time assessment of those flows. According to Rhodium Group estimates, annual Chinese OFDI flows to Europe grew from less than €1 billion per year from 2004 to 2008 to €1.9 billion in 2009 and €2.7 billion 2010 (Figure 1). In 2011, flows tripled again to €7.6 billion, a surge not captured in official statistics. In 2012, Chinese firms invested another €7.8 billion in the 27 countries of the European Union, driven by large-scale acquisitions in utilities (Energias de Portugal), consumer products (Weetabix), industrial machinery (Putzmeister) and infrastructure (Heathrow Airport).
This surge in Chinese investment is mostly driven by commercial motives, not a grand government strategy. China’s growth model is changing rapidly, and for an increasing number of Chinese firms continued growth and prosperity is becoming inexorably tied to overseas investment in developed economies. Investments in Europe help firms to conquer new markets, move up the value chain, remain competitive in the domestic market and gain regulatory experience. Looking ahead, the ongoing structural adjustments in China will likely sustain future growth of outward FDI. China’s global OFDI can be expected to grow by €750 billion to €1.5 trillion by 2020 and developed economies will receive a substantial share of this investment.
Given the urgent need for investment in many European economies and the drop in global FDI flows to Europe in recent years, the emergence of China as direct investor is a great opportunity for Europe. Chinese investment can help to create jobs, increase competition, maximize consumer welfare and allow European companies a better access to the fast-growing Chinese market. At the same time there are legitimate concerns related to investment from China, rooted in the exceptional size and velocity of China’s growth, its residual non-market elements, and the revival of interest in state capitalism and nationalism as alternatives to Western consumer-centric models. Securing the right policy response is crucial at this point in time to maximize the benefits from these new capital flows while addressing legitimate concerns related to the special character of China’s state and economy.
Most importantly, Europe must not risk losing its hard-earned reputation for openness by tuning up protectionist rhetoric or imposing additional barriers to capital inflows. Rising investment from China has already bred anxiety in Europe, demonstrated for example by the reactions to Tianjin Xinmao’s announced takeover of Dutch cable maker Draka in 2010. Europe must avoid such kneejerk reactions, as they will damage the perception of Europe as an investment destination in China. Fixing Europe’s structural problems and assisting firms with investment promotion frameworks are other elements of a successful model for sustaining the inflow of investment from China.
At the same time, Europe must address several concerns about the economic and national security implications of Chinese investment. Europeans will only continue to embrace foreign investment if they know a thorough, EU-wide process to address valid concerns is in place. Brussels must ensure that policies are in place to protect EU economic interests via legislative frameworks such as competition policy reviews, labor regulations and transparency requirements. Europe also needs a common concept and supranational framework for screening foreign investment for security threats. The current fragmented approach fails to address pan-European national security risks and at the same time offers room for protectionist abuse. Its new FDI policy competencies under the Lisbon Treaty also allow Brussels to pursue its goals on the bilateral level, for example through an investment treaty with China that improves the access for European firms to the Chinese market.
China’s emergence as a global investor also opens a window of opportunity for the European Union to explore new multilateral approaches to global investment governance. As China and other emerging economies move from outright investment controls toward more sophisticated regimes — including national security and competition reviews — the problem of regime balkanization is becoming global. New efforts to converge international norms in these areas will be needed to prevent tensions. Never before in history were the interests of the European Union, the United States and China – the three largest economies on the planet — so closely aligned when it comes to safeguarding an open, fair and mutually beneficial global investment environment.
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