By Veronica Burgstaller
On 30 December 2020, the Comprehensive Agreement on Investments (CAI) was concluded in principle between the EU and China, marking the most ambitious agreement China has ever concluded with a third country and replacing the bilateral treaties it had previously with 26 EU member states (except Ireland). The agreement, after 7 years of negotiations, is a milestone in the bilateral relationship between the EU and China but clearly is unbalanced in the sense that it brings more benefits for the EU than for China. In essence, the CAI is an investment market access agreement that will expand market access and ensure competitiveness. It will provide a level-playing field for EU entities in China in addition to easing such restrictions as the condition of joint ventures activities with Chinese partners or the compulsory transfer of sensitive technology. On the other hand, the EU’s investment environment has long been relatively open. Although under CAI China will gain access to additional markets, that will help promote technological development, the main reasons for Beijing to push forward with the agreement are generally understood as being of geopolitical nature. For instance, the agreement will serve to legitimize the Chinese Communist Party (CCP) and pre-empt policy coordination between the EU and the U.S.
Though these points are not wrong, the CAI should be seen as a brick-stone of a broader and long-term Chinese policy strategy to achieve middle income status by 2035 and resolve the country’s internal domestic problems. Since its accession to WTO in 2001, China’s high growth has been driven predominantly by high levels of investment, mainly through domestic financing. Due to high export rates, followed by high domestic savings levels, China faced a problem of twin surpluses on both capital and current account. With an underdeveloped financial market, it cannot channel domestic savings into areas of investment. Also, its large foreign exchange reserves have led to protectionism and trade frictions with the EU and US. In order to overcome ‘a middle-income trap’, China has to implement reforms in the demand and supply side of the economy, meaning it has to encourage consumption, while at the same time increasing outward investment. The Belt-and-Road Initiative (BRI) for example enables China to redirect investment into infrastructure development projects. But inward investment is equally important because China can benefit from the expertise and know-how of foreign firms. Innovation would increase labor productivity and ultimately China wants to encourage the creation of its own original domestic products that are consumed by its citizens.
In addition, high-level agreements may enable China to lock in domestic economic reforms. A recent study showed that trade agreements with strong political and economic partners put more pressure on domestic firms to comply with international standards and provide incentives for regulatory reform. The EU is currently the biggest global investor. Although the CAI may not be a trade agreement it is binding and ratcheting and also goes beyond investment-related provisions like clauses on sustainability and labor protection.
Finally, the COVID-19 crisis, since the beginning of last year, had some unexpected and profound effects on global trade and investment flows. In the first quarter of 2020, China’s economy contracted with a growth rate of -6,8% and fixed-asset investment sank by 16%. Although most major firms in China returned to 90% of their working capacity within a period of two months, small firms are still lagging behind and consumption remains low. Inward foreign direct investment from the US and the EU continues to decline. More than ever, it is crucial for China to provide a more liberal and transparent investment environment. In line with such developments, China has issued a revision of its negative lists for foreign investors on June 23, 2020, that reduced the number of sectors in which domestic firms have preferential treatment from 151 in 2018 to now 123. Equally, the Foreign Investment Law promulgated in March 2019 had come into effect on January 1, 2020, unifying investment regulations and indicating further opening up of market access. The EU should understand that China’s foreign policy is mainly motivated by domestic concerns. From the 5th to 11th March, during the holding of the 4th session of the 13th National People’s Congress, Premier Li Keqiang outlined the 14th Five Year Plan that emphasises high-quality development with a focus on innovation, high-tech technology and the promotion of foreign trade and investments. Market liberalisation in China may have taken place incrementally, first in special economic zones that function as testing grounds, as seen in the case of negative lists for foreign investors before being finally adopted nation-wide. In short, China has to balance policies that maintain the legitimacy of the party and has to retain its centralised grip, while also acting to liberalise its trade and investment environment. The CAI is an opportunity for China to achieve the objectives it set itself to become an innovative, middle-income country.