Learning from China’s success? Europe in the 21st century global economy

Gerhard Stahl - Professor at the Peking University HSBC Business School, and the College of Europe

The G7 summit was followed by controversy at the EU summit on June 23rd concerning the French-German proposal for tougher screening of foreign investment. The debate about trade and openness is not only between the EU and the US but is also a discussion amongst European countries. The Nordic, Benelux and Baltic countries, supported by Portugal, Greece, Ireland and Spain watered down a proposal for a European mechanism to analyze and restrict unwanted foreign takeovers.

To understand this debate between the so-called ‘free traders’ and ‘protectionists’ it is necessary to study all aspects of international competition. References to trade theories of the past and standard economic textbooks are not sufficient to understand the reality of the globalized economy of the twenty-first century, with its three main actors: the United States, China and the European Union.

The starting point of the globalization process in the second part of the twentieth century is well known. After the Second World War decades of closer economic integration led to an increase in international trade and allowed companies to ‘delocalize’. Companies could achieve efficient and cheap production by outsourcing to, or producing, in developing countries. This provided cheaper goods and services for consumers and new economic opportunities for developing countries. The period after WW2 also saw the creation of an international financial market with – in principle – free flow of capital, based on the US dollar as the dominant international reserve currencies. International financial institutions (the IMF, World-bank) were founded in 1944 with the task to supervise and to assist the international economy. The dominant policy was the ‘Washington’ consensus, based on neoclassical thinking, underlining the role of private business, supply side reforms and limited public interventions.

As we saw in 2016 in the Brexit vote in the UK and in the US presidential vote an increasing number of people in western democracies question whether this globalization process is still beneficial for them. Unemployment and inequality are perceived as a consequence of international exchanges and international competition. Contrary to these fears, more and more developing countries – and especially China as its big economic success story – defend globalization and an open international economy. The Silk Road Summit organized by the Chinese government in Peking in May 2017, which gathered together 44 heads of states, confirmed its commitment for open free trade and promised a new golden age of globalization.

China is a very good example to understand how integration into the international economy can be achieved, and to learn how states can be successful in international competition. The Chinese case (but also US policy) shows that in the twenty-first century it will not only be companies that compete with each other on the world stage. We are confronted with competition between political and regulatory systems.

China’s integration into the international economy is built on a socialist market economy with Chinese characteristics. The main elements of the Chinese governance system are strong political leadership, intensive consultation of different parts of the society, fact based policy choices and a ‘step by step’ approach. Since the opening up of China by Deng Xiaoping in 1979, the successive five-year plans gave guidance and monitored the careful opening of parts of the Chinese economy.

The accession of China to the World Trade Organisation in 2001 has not put into question the dominance of the political leadership, but has supported further liberalization steps and the choice of market based instruments for the implementation of policy objectives. Specific economic zones were created, attracting international investors and building up an export industry, without exposing the whole country to international competition. International investors who want to benefit from the huge Chinese market have to follow the industrial policy objectives of the political leadership. One prominent example is the automotive industry where international investors are only allowed to establish joint ventures with Chinese partners and no majority share holding for foreign investors is possible. This arrangement helps to achieve technology transfers to Chinese partners, contributing to the increasing number of internationally competitive Chinese car companies.

The Chinese banking sector is also still highly protected, ongoing liberalization of the financial sector is very prudent and the market share of international banks is only around 2%. This helps to maintain the strong position of Chinese state banks, allowing them to finance strategic long-term investments even for projects with higher insecurity and risks. In the digital and data economy, market access for foreign companies like Google is limited. This helps national companies like Baidu (a Chinese search engine) to progress and to obtain the necessary network size. Furthermore, social media companies are obliged to store data obtained from Chinese clients on servers located on Chinese territory.

But China’s economic policy is not only protective: to succeed in its modernization programme ‘China 2025’, companies, experts and researchers are invited from all over the world to invest and to work in China. Start-up companies and top-researchers obtain tax exoneration, subsidies and high salaries.

Nor is China’s success only focused on attracting high-value activities to China, state policy is also highly focused on increasing China’s role in the global economy. With the support of the state’s ‘going out strategy’ Chinese companies are helped and financially supported to invest in foreign markets, to create subsidiaries, to take over foreign companies. As a result China has become the world’s biggest foreign investor after the United States. In addition there is also the Silk Road or ‘One Road One Belt’ initiative presented by the Chinese President in 2013. This is a multibillion cooperation and investment programme, inviting partners from Asia, Africa, Latin America and Europe to cooperate with China. The planned cross-country infrastructure projects will provide new business opportunities for Chinese and other companies.

What lessons can be learned from China?

1. A well-prepared comprehensive long-term industrial policy strategy is needed to decide between conflicting priorities and to use public expenditures and regulatory power in a coordinated way.

2. Close cooperation between state actors and private actors is needed for the implementation of policies. With pilot projects and specific economic zones a trial and error process can be established. Different approaches can take into consideration specific local conditions. In this way flexibility and subsidiarity can be assured in the policy implementation. Successful experiences can be up-scaled to the national level.

3. The size of the national market is essential. A big country like China, with economic development potential for decades to come, can condition the access to its market on the acceptance of its regulatory environment and policy objectives.

How should European policy makers and European business react?

European economies belong to the most open market in the world. The establishment of a common European internal market – the Single Market – has reduced national market entry barriers for foreign business and investors. To follow the Trump temptation and to go back to a policy of national preferences is incompatible with the European treaty and its objective to create an integrated internal market. But to simply continue a policy of opening up national markets for foreign business without insisting on equal treatment for European companies in foreign markets puts Europe in a disadvantaged position.

Taking into account the Chinese experience the European Union should revise its Europe 2020 strategy and prepare a European industrial policy plan. It should use the right to access the big European internal market as the leverage to insist on equal treatment for its businesses in non-European markets. Regulation especially for the digital and data economy and the financial industry should be further developed to favour the creation and competitiveness of European companies. Public research and public tendering should support innovation by European companies. Governments of EU member states should allow the EU institutions to scrutinize foreign investments and to represent an agreed European position in international trade and investment negotiations. The difficulties to find common agreement at the recent EU summit for the French-German proposal to control foreign investments shows that a proper consultation of all EU member states and economic actors is needed. It is understandable that countries like Greece, Portugal and Ireland which have been forced in the European Stability Mechanism assistance programmes to open up their economies to more foreign direct investments are reluctant to suddenly change their policy orientation on this issue.

In this sense it was a first positive sign that the representatives of different European countries present at the Silk Road summit in Peking could agree on a common position demanding more transparency and access for European companies in tendering procedures. But in order to achieve an agreement for a European policy on international competition and foreign direct investments the benefits for everybody of the common strategy must be shown clearly.