Europe’s crusade to fend off Chinese interference falls short

After trumpeting victory over an agreement reached between Europe and China for a Comprehensive Agreement on Investment (CAI) only a few months ago, Chinese leaders are probably stunned at the much harsher narrative now coming from European institutions.

Beyond the Xinjiang-related sanctions, which could have been read as political and mainly symbolic, the European Commission has just announced two types of defensive measures, first against foreign subsidies hampering the good functioning of the European single market and, second, actions to ensure the resilience of the European supply chain.

In both cases, the hidden target is China.

The anti-subsidy legislation is the outcome of a white paper released by the European Commission in May last year that creates instruments to redress the distortions that foreign subsidies might create in the single market.

In more practical terms, foreign companies acquiring European targets or involved in public procurement in Europe will be subject to the scrutiny by the Commission, which will also have the right to prohibit deals, fine companies, or force them to repay subsidies with interest.

The second set of measures aims at increasing the resilience of the European supply chain but reducing excessive dependency on strategically sensitive products from China.

To reduce such dependency, the European Commission will create incentives to stockpile, pool resources, and possibly set standards in six sectors that have been identified as key: batteries, cloud and edge technologies, hydrogen, pharmaceutical ingredients, raw materials, and semiconductors.

If we add to the above two issues the much cloudier outlook for ratification of the CAI after China’s counter-sanctions on members of the European Parliament and institutions, it becomes quite clear that EU-China economic relations have deteriorated in the last few months.

How much is related to pressure from the administration of US President Joe Biden or the EU’s own interests is hard to tell. In fact, while strategic autonomy has so far been the buzzword to justify support for the CAI, it could also justify measures to protect the single market from foreign-related distortions or excessive dependence of Europe’s supply chain on China.

The reality is that neither of the two measures (anti-subsidy moves and supply-chain resilience) will probably be enough to achieve their ultimate goal of improving the level playing field in the single market.

The reason is that the origin of such distortions is not really in the EU but in China, and is related to the lack of market access by foreign companies, and most important, the uneven playing field for foreign, but also Chinese, private companies in the Chinese market.

In fact, the dominance of state-owned (or, more loosely, government-related) enterprises in that market gives them a clear advantage when expanding abroad, including in the EU single market, as they can use the rents they have extracted in China to subsidise operations elsewhere and grow their market share. This means that the EU’s intention to chase explicit foreign subsidies might not be enough to solve the problem.

Secondly, implicit subsidies can be very hard to measure, as they may stem from lower interest payments per unit of debt and/or a lower tax burden versus competitors in a huge market like China. Such extra rents can help Chinese government-supported companies to finance acquisitions or participate in public procurement in Europe, but also to outcompete local players through greenfield investment.

While one could argue that European consumers benefit from cheaper goods and services, this is only true for sectors under perfect competition and much less so for those with large network externalities and/or economies of scale and scope.

All in all, having preferential access to the European single market through cheaper funding and/or subsidies etc can have lock-in effects, damaging competition. Unless full reciprocity is established and European firms can compete on par in the Chinese market, the lack of competition in China can put European companies at a disadvantage in their own market.

In sum, the two problems that the European Commission is trying to address, namely potential distortions from foreign subsidies but also enhancing the resilience of the global value chain, are related, but their solution lies in China and not so much in Europe.

By being able to access the Chinese market on equal footing, European companies could be free to decide where and how to reshuffle their supply chains without fear of being cut off from what will soon be the largest market in the world.

It is in everybody’s interest for China to level the playing field among state-owned, private and foreign companies so that no new distortionary measures need to be taken elsewhere. The recent announcements by the European Commission are clearly a second-best.