- Introduction
Two major powers and traders, China and European Union, have struggled to reach an agreement regarding bilateral investment legal conditions for 7 years. The negotiations have finally came to an end a few days ago. The dialogue between these two political entities was particularly complex. Issues emerged not only from regular trading matters but, rather more significantly, from diversified cultural approach towards multilateral cooperation design and legal system. EU has outlined several drawbacks of the Chinese market, which prevent the agreement from being signed. EU-China 2020 Strategic Agenda for Cooperation points out drawbacks, such as: a lack of transparency; strong government intervention in the economy; more advantageous position of state-owned enterprises (SOE) over privately owned companies (POC) in terms of market competition; poor protection and enforcement of intellectual property rights[1]. From the EU point of view judicial and legal credibility are part and parcel of any BIT-like treaty. It seems that without it, it is impossible to conduct trade on the free market rules. In terms of investments agreements the provisions are not just declaratory. If the agreement is to play its role, there must be a proper enforcement of its provisions. On the other hand, if the negotiations are to reach the outcome, the EU cannot simply make demands. It has to understand and reconcile the differences, as well as make some concessions.
The stakes are high, as both sides are responsible for the future of global trade. It becomes more commonly known that we are entering a new cold war. The Trade War between US and China is long not over, Donald Trump effectively obstructs the WTO dispute settlement system and there is a new economic crisis on the horizon due to COVID-19. The EU is somewhere in between, putting the best effort to maintain a multipolar world with global trade connections, from which it benefits the most, just as well as China does. Strong and mutually beneficial trade connection between both entities could put the progressive global disintegration to an end. Yet, the obstacles have to be overcome first.
- The significance of China-EU CAI
In 2010 China was officially indicated as one of the most prospective partners to establish a bilateral investment treaty with[2]. In fact, there are plenty of existing investment treaties between EU member states and China, but the aim is to replace all of them with one and hence unify the trade policy towards China. Separate BITs consist of a wide range of different investment protection mechanisms, even some of which might be perceived as obsolete. What upsets the EU the most, is that all these BITs cover only the post-entry protection of investment, while lacking pre-entry national treatment[3]. It results in more complications when entering the Chinese market. What is more, differentiated positions of companies established in different EU countries creates an uneven accessibility to Chinese market, while the EU’s aim is to push forward the integration of European market and provide equal chances to all its entrepreneurs.
The value of the EU – China trade has risen more than twice in the last 10 years, from €261 billion in 2009 up to €560 billion in 2019[4]. However, although both parties are important trading partners, the FDI flow between them is moderate and might seem quite insignificant. In 2015, the EU investment in China totaled €6 billion, while Chinese investment in the EU stood at €6.5 billion. It means that Chinese investments amounted to 3.8% of overall inbound FDI in the EU, while merely 1.7% of the overall EU outbound investment directs to China[5]. The FDI flow is unstable, having reached its peak in 2016, when €37.3 billion were invested, and again having fallen to €11.7 billion in 2019[6]. However, having highly developed trade relations that constitute solid foundations for endeavouring FDI, a bilateral investment agreement was perceived as a key factor that could effectively stimulate bilateral investment flows by providing mutual trust, reliable protection and stability.
The project became possible only after the enforcement of the Lisbon Treaty, as foreign trade policy was added to the EU’s competences. Ever since, unified and effective policy toward China has turned out possible. A common policy eliminates the chance of individual EU members competing with each other using tax breaks and incentives, as well as prevents bureaucratic and infrastructural adjustments[7]. Given the scope of EU-China economic relations and already conducted European investments in China, the negotiations were certain to begin and the first round took place in January 2014. The EU indicated that the new BIT should cover all operations accompanying investments, such as transfer of profits, safe payments and protection of intangible assets[8], but also go beyond standard protection and ensure market access. The last factor seems to be the most difficult obstacle to overcome, as China is still, even in WTO, perceived as a non-market economy with strong dependency on the government.
- SOE over POC
The first issue is that Chinese SOE have an advantage over European POC. The European Union relies on the free market rules regarding both internal systems and external economic relations. Major part of European economy is composed of mainly privately-owned companies, which compete with each other on more or less equal rules. Competition law and anti-trust law in the EU is highly developed as well. The important factor is that the government interference is not too extensive. Companies mostly do not receive governmental subsidies and are not binded with government officials. What is more, Brussels is used to the system constructed with the World Trade Organisation, where trade freedoms are well guarded by the Appellate Body. Knowing the scope of prohibited subsidies, the trading parties are able to easily intervene and deter rule breakers. The ICSID convention plays a key role as well, by providing stable rules of international arbitration and ensuring direct enforcement of judgements.
On the other hand, the WTO still perceives the Chinese economy as a non-market. The market is dominated by SOE, which are supposedly connected to the Communist Party of China. When it comes to foreign investments, being subsidized by the government gives the enormous advantage over private companies. It becomes perfectly visible during pandemic times, when many companies struggle to survive, while Chinese enterprises can be easily fueled with money from public income. What is more, these SOEs are a part and parcel of Chinese Socialism system, so they cannot be easily reformed, neither are they desired to be.
That problem has already been raised to discussion on the WTO ground. In the jurisdiction DS437: United States — Countervailing Duty Measures on Certain Products from China, Public Body 21st march 2018 the Appellate Body linked SOE with public bodies, officially hindering the ability to benefit from trade freedoms. One year later, when the judge crisis occurred, the discussion for reform was started. It so happens that it was the EU and China who were the most devoted supporters of multilateralism. It gave the chance to reassess the approach towards SOEs. There were discussed couple of authorization issues determining whether a particular SOE should be perceived as a private or public body. That set consists of e.g. exclusive right to import and export/state pricing; state operation; state equity-based control; personnel exchanges between the government and the leadership of the entity. What is more troublesome, many Chinese companies have a “party organ”, as CCP is allowed to assemble a party organizational unit within certain companies. But that does not mean they are controlled by the party. Very often the entrepreneur who runs the firm can be a party member designated to lead the “party organ” in his own company[9].
Market distorting subsidies are another issue of EU-China trade. These are the subsidies especially contradicted by the EU political interests. They have been commonly conducted in state-controlled economies, such as China among others. Actually it is strictly connected with the SOEs issue. The market distorting subsidies take the form of disguised subsidies, under the cover of commercial activities with non-commercial purposes. The practice is about state-owned bank lending incompatible with a company’s creditworthiness, non-commercial debt-to-equity swaps or government-controlled investment fund equity investment on non-commercial terms[10]. That has been debated and, finally, under the Joint Statement of US, EU and Japan, the list of unconditionally outlawed subsidies has been broadened. What is more, the deal would make it more difficult for member states to justify partially allowed subsidies by reversing the burden of proof. This time the very subsidizing government would have to demonstrate that the financial aid has no serious negative effects on trade[11]. The importance of that has been acknowledged by EU Trade Commissioner Phil Hogan, who said that it “is an important step toward addressing some of the fundamental issues distorting global trade”[12]. In fact, that kind of problems were the key factors obstructing the deals such as China-EU CAI or BITs.
- Fear of extensive Mergers & Acquisition and debt trap
Throughout the last decade, the European Union’s economic position in reference to China has changed. Now, the EU accounts for a lower share of world trade, investment, currency holdings, defence expenditure, and development assistance[13]. Reaching agreement on investment and market access gives prospects for export increase and solving the problem of trade imbalance, as the Chinese market is more closed. In spite of the situation getting worse, the EU has not yet lost in absolute terms. While the overall trade balance is still in a good shape, the economic foundations for high level of welfare and consumption are eroding. Prospects of GDP growth are low, which raises justified concerns. Europe has come to realize that the fundamentals of its socioeconomic system of choice are at stake.
In general, there is a question whether a wide market access and strong legal protection of investment will hinder potentially weaker European companies. Concerns against Chinese investment focus mostly on the fact that Chinese hardly ever conduct greenfield type investments. Mergers & Acquisition (M&A) are the means the Chinese are most attracted to, but its scope frightened EU politics. The most widely known examples are the takeovers of a German robot making company Kuka and Swedish VOLVO. The acquisition of one of the most technologically-advanced enterprises by a Chinese firm caused much controversy, partly due to national security concerns. Certain factions have warned against letting cutting-edge technologies fall into Chinese hands as the world’s second-largest economy ramps up its ambition to be a significant high-end manufacturer[14]. Apart from hostile M&As, China has developed and constructed a strategy called a “debt trap”. First, competitive Chinese infrastructure companies offer to build a large project, under a condition that the government of an inbound country takes a loan in Chinese semi-private banks.. The loan is often too high to be paid off, thus the inbound government has to make further concessions to China. This procedure happens mostly in less developed countries in Africa, but occurred also in Tajikistan and partially in Belarus[15]. However, EU countries are far less threatened by such actions, as they have access to credits of Western capital.
On the other hand, the acquisition type of investment is definitely much easier when a company enters a complex market and has no relevant knowledge of it. The company simply takes over an already functioning “mechanism”, omitting the fundamental steps of the establishment. Takeovers do not necessarily mean that they are hostile. Difficult market, complex legal regulations and cultural differences might be the factors that sufficiently obstruct a mutually beneficial exchange. Taking the COVEC case in Poland as a reference, that hypothesis seems to have validity. It is a real, well-functioning example of a greenfield investment conducted by Chinese. The Liu Gong company re-established the prosperity of a steel plant in Stalowa Wola. It was a time-consuming process, but eventually it turned out to be one of the best functioning Chinese investments in Poland.
- Overall market issues
Another barrier for signing China-EU CAI was a restricted accessibility to the Chinese market. While Chinese companies value an open European market with stable rules, the European counterparts face multiple legal obstacles when entering the Chinese market. Certain industry sectors are prohibited from foreign investments, while other branches are set to attract FDI. The protectionist approach gives China a significant advantage, especially in terms of technological slipovers. However, that does concern the EU as it urges for fair competition. Regarding automotive or heavy industry branches, it is impossible to enter the market without special admission of the government, which include enforcing establishment of Joint Venture (JV) with domestic companies.
Chinese Law is troublesome as well. European companies often complain about opaque regulations, inconsistency regarding implementation of the law at national, provincial and municipal level, constant modifications of regulations with immediate effect, and also lack of official English translations of the legal acts. Licensing and procedures create serious obstacles for incoming investments. There are certain cases where discriminatory treatment of foreign investors was recorded. Inferior treatment reveals itself in foreign ownership limitations, JV requirements and in taxation, as well as in protracted investment procedures if not conducted with a domestic partner.
There also exist constantly problematic issues with court jurisdiction and implementation of foreign adjudications. The Chinese court system has been questioned by the west for its unprofessional workforce, lack of objectivity and the fact that judges can, and often are, communist party members. To obtain the position of the lowest ranked, yet fully operational judge, 3 years of work experience is enough[16]. However, one can decide to choose an arbitration court of different origin than China. This choice generates problems as well. China is not a member of ICSID convention and has no legal obligation to implement foreign judgements. Implementation of foreign courts adjudications is also doubtful. That is why Comprehensive Investment Agreement is so needed. For instance, an umbrella clause could be extremely useful in ensuring legal claims enforcement.
- Theft of IP
When investing in some sectors of industry in China, the investment must be conducted through JV. That means transfer of technology, at least up to some point. Those restrictions can be of concern to the EU investors since giving away the control over their intellectual property to domestic firms might not be a sustainable business practice. Apart from that, there were multiple cases where the technology was simply stolen, copied and manufactured, especially in regions where courts are more favorable toward domestic companies. IP theft is also a case of trademark scam. It happens that irrelevant Chinese entrepreneurs register popular trademarks of western corporations, hence making it difficult to be regained by the actual holder. However, the episode of IP theft is slowly becoming a thing of the past. China has developed its own technological companies, thanks to what they have already learned from the inbound in the last decade. Professor Jeffrey Towson tends to call it “the brainpower behemoth”, as 7.5 million students graduated from college in 2015, which outlines the scope of potential R&D workers[17]. That is why the FTT policies are in decline. Only 8% of respondents to a foreign industry association survey in the lead up to the China-US trade war reported that expectations of technology transfer in China were a top IP challenge for them, while cyber-hacking constitutes only 8-13%[18]. Nevertheless FTT practices have been further limited in the CAI.
- Conclusions
Negotiations on China-EU Comprehensive Investment Agreement have a long-term importance in regard to the future of EU-China relations as well as the world market. It is not only about increasing the amounts in companies’ accounts or just keeping the indicators in a good shape. It is rather a civilisational challenge, whose accomplishment can be described as a milestone in the globalization process. Trade flow does not require direct contact between a sender and recipient. While investment is much more complicated, especially greenfield investments which constitutes the most beneficial type of FDI and the most desired. When it comes to execution of a foreign investment, there are multiple challenges regarding the working culture, business strategy and trust. There is still plenty of work to be done, mostly beyond law matters. Nevertheless, the Agreement could strengthen relations and normalize mistrust. It is also a reliable platform to promote the Belt and Road Initiative, which have slowed down due to rising concerns towards China. In the forthcoming future it might turn out that China is the one who needs the agreement more urgently. A fast growth of China is near its end. The coronavirus outbreak has only worsened the situation. What is more, the topic of the great exodus of western companies from China has made its way to the headlines. Such a transition needs time to develop. The process will last for at least a decade. However, it has not been caused only by political distress. It happened due to the natural economic tendency. These days even the Chinese producers tend to transfer production to poorer countries, as costs of manufacturing in China are rising. It creates a new reality in which the level of Chinese competitiveness is set to rise, diminishing the need to play unfairly.
[1] EU-China 2020 Strategic Agenda for Cooperation
[2] EC communication Towards a Comprehensive European International Investment Policy
[3] EU-China Comprehensive Agreement on Investment (EU-China CAI), europarl.europa.eu, access 28.08.2020
https://www.europarl.europa.eu/legislative-train/theme-a-balanced-and-progressive-trade-policy-to-harness-globalisation/file-eu-china-investment-agreement
[4] European Union, Trade in goods with China, European Commission 29.08.2020
https://webgate.ec.europa.eu/isdb_results/factsheets/country/details_china_en.pdf
[5] FDI flows, OECD, access 29.08.2020 https://data.oecd.org/fdi/fdi-flows.htm
[6] Chinese FDI in Europe: 2019 Update, Rhodium Group 30.08.2020
[7] Sophie Meunier, Divide and Conquer? China and the Cacophony of Foreign Investment Rules in the EU, Journal of European Public Policy 21.7 (2014) 996–1016; see also Martin H. Thelle, Eva R. Sunesen and Joseph Francois, EU China Investment Study (Commissioned by the EU Commission, DG Trade, 2012
[8] Rocky Road to a Level Playing Field in EU–China Investment and Trade Relations, PISM Policy Paper nr 8 (91), 2014
[9] Exclusive: In China, the Party’s push for influence inside foreign firms stirs fears, Reuters, access 01.09.2020 https://www.reuters.com/article/us-china-congress-companies/exclusive-in-china-the-partys-push-for-influence-inside-foreign-firms-stirs-fears-idUSKCN1B40JU
[10] Trade Trilateral Targets China’s Industrial Subsidies, Center for Strategic & International Studies, access 01.09.2020 https://www.csis.org/analysis/trade-trilateral-targets-chinas-industrial-subsidies
[11] China Faces Stepped-Up Calls to Slash Trade-Distorting Subsidies, Bloomberg, access 02.09.2020 https://news.bloomberglaw.com/international-trade/china-faces-stepped-up-calls-to-slash-trade-distorting-subsidies
[12] Bloomberg ibid.
[13] Gustaaf Geeraerts, Europe and China’s Belt and Road Initiative: Growing Concerns, More Strategy, Security Policy Brief, No. 118, November, 2019
[14] German robot maker Kuka’s CEO to be replaced by Chinese owners, Deutsche Welle, access 02.09.2020 https://www.dw.com/en/german-robot-maker-kukas-ceo-to-be-replaced-by-chinese-owners/a-46440242
[15] Jarosław Turłukowski (red.), Rozpad ZSRR i jego skutki prawne – zarys problematyki, Warsaw, 2020
[16] Who Can Serve as Judges in China?, China Justice Observer, access 02.09.2020 https://www.chinajusticeobserver.com/a/who-can-serve-as-judges-in-china
[17] The 1 Hour China Book, Jeffrey Towson, 2017
[18] 3 Myths About China’s IP Regime, Harvard Business Review, access 02.09.2020 https://hbr.org/2019/10/3-myths-about-chinas-ip-regime
Anatol Jaśkowiec – student in Faculty of Law and Administration at University of Warsaw. Graduate of School of Law and Economy of China. His research interest concern on international trade law and international arbitration.