Challenges and Solutions for European Businesses in China: Insights From the EU Chamber’s Position Paper 2023/2024

In our overview of the EU Chamber’s European Business in China 2023-2024 Position Paper, we highlight key concerns of European businesses amid the uneven post-pandemic economic recovery, risks emerging from geopolitical issues, and the implementation of policies promising a fair playing field for foreign and domestic firms on one hand, and the public sector and private sector on the other. The Position Paper also makes several recommendations for policymakers to address the challenges identified and possible solutions. Regardless of the shifts in perspectives, European businesses remain invested in the China growth story and are keen to be able to play a role in the evolving market landscape.

The European Union Chamber of Commerce in China (EU Chamber) has unveiled its European Business in China Position Paper 2023/2024 (the “Position Paper”). The Position Paper, which represents the perspectives of the EU Chamber and its extensive network of over 1,700 member companies, outlines 1,058 recommendations for improving the business environment for European companies in China.

Acknowledging China’s historical appeal as a “predictable, reliable, and efficient” market, the Position Paper highlights how this perception has eroded among European companies following the COVID-19 pandemic due to various systemic, economic, and regulatory challenges.

Despite these evolving perceptions of the Chinese business environment, the Position Paper states that European firms remain deeply invested in the China market and China’s success. It also emphasizes the importance of proactive engagement with China and deepening EU-China cooperation in areas of shared interest, such as climate change, sustainable development, and WTO reform.

Below we look at some of the key challenges facing European companies outlined in the Position Paper and the EU Chamber’s key recommendations for improving China’s attractiveness to European investors.

Challenges facing European companies in China

The Position Paper outlines a range of challenges impacting the development of European businesses in China, highlighting the kinds of hidden barriers faced by foreign companies that run counter to the government’s efforts to attract foreign investment.

Among them is the issue of attracting and retaining foreign talent. The Position Paper notes that China’s foreign population remains exceedingly low, accounting for just 0.06 percent of the total population in 2021. In addition, while the overall foreign population has grown since 2010, it has decreased in both absolute numbers and relative size in key cities such as Beijing and Shanghai where foreign companies are concentrated.

According to the Paper, this “outflow of foreign nationals has resulted in reduced transfer of know-how and best practices, as well as increased communication difficulties between headquarters (HQs) and China operations.” It adds that this has in some cases led to the deferral of investment plans or closure of companies’ China operations.

While European companies have welcomed the Chinese government’s decision to extend preferential individual income tax (IIT) policy on foreigners’ fringe benefits for another four years until December 31, 2027, the Position Paper notes that “it is likely that more policies that can attract new talent will still be needed”. Among other issues is a lack of “soft infrastructure” such as foreign hospitals and international schools that senior-level foreign talent from developed countries would expect when relocating to a new country.

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The Position Paper notes that while China has made concerted efforts to increase market access to certain industries for foreign companies, these moves do not always result in a marked increase in investment due to other regulatory hurdles.

The Position Paper notes an example in the automotive industry, where China removed the cap on foreign ownership, leading a large European automotive company to increase its stake in its China joint venture (JV) in a deal that accounted for around half of all FDI from the EU in 2022. However, despite the removal of the ownership cap, the Position Paper states that many foreign automotive companies still face barriers such as unclear approval requirements and processes.

Other examples noted include the aviation sector, where despite measures being released to allow foreign companies to offer certain services, the requirements for sales agencies to carry out long verification processes of foreign suppliers places them at a considerable disadvantage compared to domestic players.

EU-China relations and their impact on European businesses

The bilateral relationship between the EU and China has undergone considerable changes in the last few years, as both parties look to protect their interests in an increasingly polarized and unstable world.

The Position Paper notes the parallels between China’s renewed focus on “self-reliance” and the EU’s “de-risking” strategy to China, in that both strategies “stem from the realization that overexposure to any one source can lead to major challenges if that source suddenly becomes unavailable”.

As a means of reducing exposure to potential risks and ensuring business continuity, European businesses are increasingly adopting two separate systems for their China and global operations, “including for supply chains, data and information technology (IT) systems, and staffing”. For China operations, this means localizing more and more of their operations. This may involve moving more of the production to China, encouraging their existing suppliers to enter the China market, or replacing overseas suppliers with local ones “that are more likely to be in line with relevant Chinese regulations and guidelines”.

The Position Paper notes that this strategy carries certain risks and that it is not feasible for all companies, in particular small companies with fewer resources.

Key recommendations

The Position Paper outlines key recommendations tackling broader systemic and economic issues in order to improve the environment for foreign investors. The paper notes that while some of these recommendations can be implemented easily through targeted policies, others will require “a systemic approach”.

Boosting the private sector

With regard to the first recommendation, the Position Paper posits that “the prioritisation of the public sector is hindering competition and undermining productivity in China”.

The disparity between China’s private and public sector has grown over the last decade, an issue that has been further exacerbated by the pandemic. According to China’s H1 2023 economic data, the value-add of state-owned enterprises (SOEs) grew by 4.4 percent year-on-year, compared to just 1.9 percent for private companies. In addition, fixed asset investment (FAI) in the first half of 2023 grew by 8.1 percent year-on-year for SOEs but fell by 0.2 percent year-on-year for private companies, showcasing unequal post-pandemic recovery. This is despite small and medium-sized enterprises (SMEs) making up the bulk of corporate entities in China.

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The Position Paper outlines unequal market access for SOEs and private businesses and SOEs’ advantageous positions in access to financing, licensing, public procurement, and influence over policymaking, as key causes of this disparity.

The issues facing the private sector have been acknowledged by Chinese officials, as noted in the Position Paper. The Chinese government has also taken several steps in recent months to improve the environment for the private sector, having released measures to boost the private sector in July 2023 and measures to boost foreign direct investment in August 2023.

The EU Chamber welcomed the measures to boost FDI at the time of their release, stating that they “could go a long way to improving business confidence if they are implemented in a timely, coordinated and consistent manner”.

In light of these issues, the EU Chamber provides a range of recommendations surrounding refocus on reform and opening, SOE reforms, leveling the playing field between Chinese and foreign companies, addressing barriers to attracting and retaining foreign talent, and providing administrative and financing support for SMEs. In addition, the Position Paper urges China to steer away from excessive self-reliance and self-sufficiency, develop nuanced strategies for strengthening supply chains, and remain committed to globalization.

Clarity and consistency in legislation

Secondly, the Position Paper tackles what it describes as the “politicisation of business” and ambiguous laws and regulations that make it difficult for companies to conduct due diligence.

It points to the introduction of new and amended legislation aimed at protecting China’s national security and development interests, such as the amended Anti-Espionage Law and the new Foreign Relations Law. Given the lack of guidelines on what is considered to be “national security” or “national secret” in these pieces of legislation with regard to prohibited information disclosure, “businesses tend to err on the side of caution” which can “deter new investments”.

The Position Paper also notes European companies find themselves caught in the crosshairs of competing EU and Chinese legislation. Specifically, it raises the issue that the EU’s Corporate Sustainability Reporting Directive (CSRD), which entered into force on January 5, 2023, “obliges all large and all listed companies operating in the EU to ‘disclose information on what they see as the risks and opportunities arising from social and environmental issues, and on the impact of their activities on people and the environment’”. These requirements could directly contradict Chinese legislation on information disclosure if no clarity on specific definitions and parameters is given.

The Position Paper also notes that the ambiguity of the definition of “important data” in China’s data and personal information protection legislation creates similar difficulties for foreign companies.

To address these issues, the Position Paper proposes that the government engage in dialogue with other governments and key stakeholders to “depoliticise the business environment”.

In addition, it calls for improving the predictability and reliability of China’s regulatory environment by ensuring laws and regulations are specific and clearly defined, enabling companies to undergo independent audits to be certified compliant with global legislation.

Finally, the government should ensure that administrative processes are transparent, consistent and predictable, and local authorities should be provided with proper guidance and training on how to consistently implement laws.

Boosting consumption and addressing socioeconomic challenges

The Position Paper addresses the need to boost consumption and demand to fuel China’s economic recovery.

Consumption in China recovered considerably in the first half of 2023 following the lifting of COVID-19 restrictions, but has stagnated in recent months as confidence waivers. In response, policymakers have released a series of measures to boost consumption across various sectors, such as household appliances.

However, the Position Paper notes that many of the measures that have been released “predominantly target the supply side, and fail to address the issues on the demand side that are inducing Chinese consumers to keep their wallets closed”.

These issues include a weak property market, which holds much of China’s household wealth, rising costs of living in particular in eastern regions, and a lack of support for households in areas such as affordable housing and welfare programs.

To address these demand-side issues, the Position Paper recommends developing and implementing demand-side policies that can boost domestic consumption and “providing a more predictable policy landscape in order to reassure consumers that they do not need to accumulate large amounts of savings in anticipation of sudden policy shifts”.

Align economic recovery with low carbon transition

The Position Paper raises a concern that the focus on economic recovery and ensuring energy security is potentially decelerating its low-carbon transition.

China has set two major carbon reduction goals: reaching peak carbon emissions by 2030 and carbon neutrality by 2060.

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However, the Position Paper notes that since reopening after the COVID-19 pandemic, economic recovery has focused on energy-intensive exports and investments, and coal features heavily as a means of ensuring energy security. Meanwhile, European companies that have made global carbon pledges face challenges such as “limited access to renewable energy, a lack of clear policy guidance, a scarcity of necessary technology and issues related to China’s emissions trading system (ETS)”.

In order to align China’s post-pandemic recovery with its climate goals, the Position Paper suggests deepening collaboration between the EU and China on sustainable development and increasing cooperation in environmental policymaking. In addition, it calls for addressing challenges to companies’ green energy transitions. This would include measures such as increasing access to reliable sources of renewable energy and enabling European companies’ participation in China’s green transition.

Finally, it calls on removing market access and regulatory barriers that prevent foreign companies from investing in renewable energy and green technologies from entering the Chinese market.

Recommendations for the EU and European companies

The Position Paper makes a clear case for the EU to adopt a proactive approach in its engagement with China. It advocates for a united European approach and for deepening EU-China cooperation in areas of shared interests. Furthermore, it underscores the significance of continued engagement with chambers of commerce, think tanks, and industry organizations, which is essential for informed policy formulation.

This position largely aligns with that of the European Commission, which in its June 30 decision on its official strategy towards China also called for continued collaboration with China: “The European Union will continue to engage with China to tackle global challenges and encourages China to take more ambitious action on climate change and biodiversity, health and pandemic preparedness, food security, disaster reduction, debt relief, and humanitarian assistance.”

It is important to note that many of the issues and recommended solutions proposed in the Position Paper are already priority areas for the Chinese government. Long-term challenges, such as sluggish domestic demand, disparity between the private and public sectors, inconsistent policy and regulatory implementation, and industry participation in standard setting, are frequently the targets of new policy directives and guidelines from the government. This means that many of these issues raised are actively being addressed.

However, some of the issues raised require longer-term solutions that may take many years to see results, such as tackling socioeconomic issues that hinder domestic demand and expanding the mix of renewables in the electricity supply. In addition, issues such as supply chain instability and trade and investment barriers arising from political disputes may be unpredictable and difficult to manage, given the many stakeholders involved.

While not all risks can be completely mitigated, the Position Paper provides a list of recommendations for European companies in handling their China operations. These include maintaining strong communication between their headquarters and China operations, integrating foreign and Chinese staff to maintain diverse teams, and establishing “decoupling teams” to evaluate costs related to localization and disconnection from global systems.

Companies are also advised to monitor potential political risks, public backlash, and market conditions, and prepare for emerging global regulations on supply chains and determine levels of exposure to current and potential sanctions. Finally, companies are encouraged to invest in government advocacy efforts through chambers of commerce, industry associations, and standard-setting bodies.

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