The Strategic Implications of the China-EU Investment Deal

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The Strategic Implications of the China-EU Investment Deal

The EU-China Comprehensive Agreement on Investment is a win for China, and a blow to transatlantic relations.

The Strategic Implications of the China-EU Investment Deal

European Council President Charles Michel arrives for an EU-China Leaders’ meeting video conference at the European Council headquarters in Brussels, Wednesday, Dec. 30, 2020.

Credit: Johanna Geron, Pool Photo via AP

On December 16, 2019, answering a question at an event in Brussels, Chinese Foreign Minister Wang Yi stated that it was unlikely that China could sign an investment agreement with the European Union, because China was a “developing economy.” Fast forward to December 30, 2020. China’s President Xi Jinping held a long-awaited video conference with European Union leaders including Germany’s Chancellor Angela Merkel and French President Emmanuel Macron. After the video call, the European Union announced in a press statement, “The EU and China concluded in principle the negotiations for a Comprehensive Agreement on Investment (CAI).” What happened?

Chinese foreign direct investment (FDI) into the EU has increased exponentially over the last few years, primarily directed to the strategic areas of infrastructure and high technology. According to European Commission data, cumulative flows of Chinese FDI into the EU amounted to almost 120 billion euros. However, EU investment into China was even higher, at more than 140 billion euros. About half of EU FDI in China is in the manufacturing sector, with the German automotive industry as the main investor.

Germany also held the rotating presidency of the EU in the second half of 2020. Merkel had made it a priority to conclude the deal by the end of the German presidency. She was instrumental in persuading the other EU leaders to accept a deal that was so beneficial for German industry. German senior officials within the European Commission drove the negotiations to a successful conclusion. On the Chinese side, Xi unusually stepped in personally and made concessions to clinch the deal. For the EU, this was an opportunity to display its “strategic autonomy” in foreign relations before the new U.S. administration set in. For China, it was a way to drive a wedge between the EU and the United States.

What’s in the CAI for the EU?

All EU member states except Ireland have already concluded bilateral investment treaties with China. These agreements differ markedly from one another, but they all cover only the post-entry protection of investment, not market access. The EU-China “Comprehensive” Agreement on Investment was intended to cover market access as well as investment protection. At the end of the day, the agreed text of the agreement only concerns market access, with investment protection still left to negotiate for a future agreement. Negotiations for the CAI were not easy: they started in 2013 and took 35 rounds of talks.

The European Commission presented the agreement as “the most ambitious agreement that China has ever concluded with a third country.” The agreement binds China’s liberalization of investments and prevents backsliding on conditions of market access for EU companies. In addition, it provides for the elimination of quantitative restrictions, equity caps, or joint venture requirements in a number of sectors. In the automotive sector, China agreed to remove joint venture requirements and to grant market access for new energy vehicles. In the health sector, China promised to eliminate joint venture requirements for private hospitals (of particular interest to France). The CAI will also facilitate EU market access in other sectors including R&D (biological resources), telecommunication/cloud services, computer services, international maritime transport, air transport, and other services. On financial services, market opening provisions match those of the U.S.-China “Phase One” trade deal.

The CAI also seeks to improve the level playing field for EU companies. To ensure that Chinese state-owned enterprises act in accordance with commercial criteria, it establishes the obligation for an enterprise to provide certain information and provides for transparency on subsidies in the services sectors. To prevent the forced transfer of technology, the CAI forbids requirements to transfer technology to a joint venture partner and interference in contractual freedom in technology licensing. Confidential business information collected by administrative bodies (for instance in the process of certification of a good or a service) will be protected from unauthorized disclosure. In addition, China will provide equal access to standard setting bodies for EU investors.

Despite these improvements in market access and a level playing field, however, Chinese treatment of EU FDI in China still falls short of the openness of the EU to Chinese investment. It does not include any investor protection mechanism for individual investors to litigate disputes but only a state-to-state dispute settlement mechanism and a political-level monitoring mechanism at pre-litigation phase.

The agreement also includes references to environmental and labor standards, and to the implementation of the Paris Agreement on climate change.

Labor Rights

Perhaps too optimistically, the EU press statement of December 30 declared that the new agreement “binds the parties into a values-based investment relationship.” In fact, reportedly the last hurdle in the negotiation of the agreement was the treatment of labor rights. Forced labor is well documented in China, including in special camps in its western region of Xinjiang, and there are no independent trade unions.

The European Commission stated that through the CAI China “commits to working towards the ratification of the outstanding ILO [International Labor Organization] fundamental Conventions and takes specific commitments in relation to the two ILO fundamental Conventions on forced labor that it has not ratified yet.” The CAI does not entail any deadline for the ratification of these Conventions.

Political groups inside the European Parliament, including the European Green Party, have pointed out that this commitment is insufficient. Green Party member Reinhard Buetikofer, chair of the European Parliament’s delegation for relations with China, promised to fight against the ratification of the CAI in the European Parliament. European trade union leaders have also opposed the agreement because of the risk of social dumping, which artificially deflates the price of labor.

Before the conclusion of negotiations, on December 16, Merkel was asked in Germany’s national parliament how the EU could sign an investment agreement with a country that does not respect labor rights. She replied, “We take these ILO standards very seriously and will make a good balance.” However, one can wonder how the EU can really balance economic benefits with value losses. How much economic gain justifies condoning human rights abuses?

European Commission President Ursula von der Leyen tweeted that “this Agreement will uphold our interests & promotes our core values. It provides us a lever to eradicate forced labor.” This sounds like wishful thinking. Shi Yinhong, an advisor to China’s State Council, pointed out that China will never agree to change its rules on labor rights. In fact, this would be incompatible with China’s party-state system of governance. “On labor it’s impossible for China to agree,” he told the Financial Times. “Can you imagine China with independent labor unions? Forced labor also relates to Xinjiang, so that’s another ‘no’ for China.”

A Win for China

For China, the EU market is already open to investment with very few restrictions. The CAI will improve access to some manufacturing sectors and to the energy sector, including renewables, but will fall short of facilitating investment in nuclear energy. As the European Commission stated, “EU sensitivities, such as in the field of energy, agriculture, fisheries, audio-visual, public services, etc. are all preserved in CAI.” In addition, the EU FDI screening mechanism and the 5G toolbox are still standing.

Since the benefits of the Comprehensive Agreement for Investment for Chinese FDI to the EU are so limited, the advantages of the deal for China must lay elsewhere. In my opinion, they include three gains. First, the deal will preserve and encourage EU investment in China, to fuel China’s economy and technological development.

Second, it will legitimize the regime in the eyes of domestic and international public opinion (despite recent behavior in Hong Kong, Taiwan, Xinjiang and elsewhere). Finally, and perhaps most important of all, the CAI could pre-empt policy coordination on China between the EU and the United States under the new Biden administration. Such coordination could result in a united front against China and would be more difficult to handle than dealing with each separately.

The deal was sufficiently important for Xi to intervene personally. Clearly, he considered this a strategic issue and sensed that the deal needed to be struck within the window of opportunity before the end of the German presidency of the EU Council and during the lull between the Trump and the Biden administrations in the U.S.

China and the EU announced the deal on December 30, but they have not yet signed the agreement. Even if the CAI is never signed – for instance due to U.S. pressure resulting in EU member states withdrawing their backing – or if it is never implemented, China has already scored a win. It has stirred controversy in the EU between backers and opponents of the agreement, both in the European Parliament and among member states. Poland and Italy have complained publicly that Germany and France pushed the deal through before the end of year over the heads of the other member states. In addition, the CAI has also poisoned relations between the EU and the U.S. even before the start of the Biden administration.

Impact on Trans-Atlantic Relations

President-elect Joe Biden has declared his desire to work more closely with U.S. allies and partners in order to coordinate a stronger response to China. There are legal limits to what the incoming Biden administration can do before taking office. In a tweet on December 22, Jake Sullivan, Biden’s pick for national security adviser, obliquely cautioned European capitals about dashing to conclude the CAl. He posted a link to a report on the negotiations and declared that the incoming administration “would welcome early consultations with our European partners on our common concerns about China’s economic practices.”

The CAI could weaken the Biden administration’s efforts for closer EU-U.S. cooperation on China as they no longer trust the EU’s offers of cooperation.  Many involved in European trade negotiations recognized Europe’s frustration with the U.S. “Phase One” negotiations and feel that CAI brings them closer to parity with the United States.  The strategic autonomy camp in Europe favored completing the agreement with China as soon as possible, rather than waiting the few weeks until the Biden administration came to power. Although the new Biden administration will have a full inbox after Biden takes the oath of office, the new president will need to prioritize relations with the EU and other allies in order to help build a coalition of like-minded partners. Beijing has cleverly used both CAI and the Regional Comprehensive Economic Partnership to discourage a potential balancing coalition. However, the United States must be patient as the benefits of CAI may prove short-lived if Beijing does not deliver on their promises. In addition, Merkel’s mandate ends in September 2021 and her successor may take a harder position on China. Other EU member states are also increasingly skeptical toward China.

The new administration needs to keep things in perspective and understand that the long-awaited EU deal with China, seven years in the making, will not necessarily prevent future U.S.-EU cooperation on China. The bipartisan shock in the United States at the EU’s timing of this agreement needs to be followed by clear messaging on the proposed U.S.-EU partnership on China. Working together, both could focus on extracting real commitments from Beijing on increased market access, subsidies to state-owned enterprises, and respect for intellectual property. The U.S. and EU could spearhead a new multilateral coalition to balance China on the world stage.

What’s Next?

The agreement now needs to undergo “legal scrubbing” and to be signed by the two sides, before it is ratified and enters into force. On the EU side, it will have to be ratified by the European Parliament (there is no need for ratification by the national parliaments of the EU member states). This process is estimated to take around one year. In addition, China and the EU set themselves a two-year deadline for the conclusion of negotiations on an additional investment protection agreement.

This means that the EU will still need to be on its best behavior toward China for several months if it wants to sign the agreement, and China may use this as leverage in other policy areas. For one, the EU may be less inclined to condemn vocally any human rights abuses in China or any reckless behavior by China in the Taiwan Strait or elsewhere.

According to the EU press statement on the CAI, “The EU will continue to conduct its policy towards China in line with the multi-faceted approach endorsed at the European Council on 1-2 October.” There are three facets to this approach: China as a partner, China as a competitor, and China as a systemic rival, depending on the policy area in question. However, can these policy areas be held neatly separate? In practice, it seems difficult to de-link trade and investment, where China is considered as a partner, from security and values, where China is a systemic rival. Will the EU ever be able to address China not through three different facets but through one single, consistent lens?

In the future, the EU will need to reflect further on its China policy. It will also be well advised to coordinate its approach with the United States. Such coordination may have been more challenging under the unilateralist Trump administration, which also initiated the “Phase One” trade deal with China but should be easier and more effective with the Biden administration. An EU-U.S. unified front will have more leverage vis-à-vis China and can be a catalyst for a broader multilateral coalition of like-minded countries to promote the rule of law and to blunt Beijing’s efforts at economic coercion.

Theresa Fallon is the founder and director of the Centre for Russia Europe Asia Studies (CREAS) in Brussels and a nonresident senior fellow of the Chicago Council on Global Affairs. Her current research is on EU-Asia relations and great power competition.