The EU-China Economic Relationship

China's Growth

The EU has been the largest importer of Chinese goods for many years while China represents the EU's second largest export market after the US. Trade and investment have dominated the EU-China relationship since China's accession to the World Trade Organisation (WTO) in 2001. Nevertheless, in its ten years of WTO membership, China's position in the world economy has changed dramatically.

Between 2001 and 2010, China's GDP, measured in nominal US dollars, rose from $1.3 trillion to $6.1 trillion, overtaking Japan as the second largest economy in the world. In the same period, its share of world GDP more than doubled from 4.3% to 9.1% and is set to double again by 2020. Should this occur, China will overtake the US to become the world's largest economy.

China's rapid resurgence is not just about its sheer economic size, but also its accumulation of foreign exchange reserves, which are currently the world's largest, standing at $3.2 trillion in 2010. It also holds top position as the world's largest exporter and manufacturer.

Despite these successes, China's growth model has revealed some fundamental weaknesses. Although its GDP share is still less than 10% of the world total, its CO2 emissions account for more than one-quarter of global figures. And this trend will continue if China is to maintain its almost double-digit level of economic expansion.

Despite the global financial crisis, China continues to grow fast, to increase its absorption of foreign capital and to maintain high growth in international trade. One interesting development over the last decade is that China has not only become one of the largest recipients of foreign direct investments (FDI), but has also emerged as one of the largest overseas investors. By 2015, it is expected that FDI outflows from China will be equal to its FDI inflows.

The EU and China

The fast pace of development in China and its rising influence in world business, politics and international relations present challenges as well as opportunities for the EU.

The EU is under enormous pressure to recover from the financial crisis – particularly in the debt-ridden economies of Portugal, Ireland, Italy, Greece and Spain (PIIGS, or the 'five pigs', as they are referred to in China) – so it is important that it maintains and enhances its economic ties with China.

As a whole, the EU forms the world's largest economic entity, significantly bigger than both the US and China. However, the size of each EU Member State is relatively small. The GDP of Germany (the EU's largest economy) is only half the size of China's and one-fifth the size of US GDP. Consequently, in order to engage effectively with China, the EU needs to act as a 'single' economic entity, rather than 27 individual Member States. However, the matter of how to achieve this is a long-standing internal issue within the EU.

The current European debt crisis has revealed fundamental weaknesses within the EU and, together with the potential Eurozone and Euro crises, has rendered China reluctant to bailout the EU to its maximum ability.

China has signed good deals with individual states such as Hungary, Greece, Italy and Portugal because they have a history of working with China on a bilateral basis. In contrast, the EU's efforts to encourage China to invest in the European Financial Stability Facility (EFSF) have achieved little result. This has happened for two reasons. First, China has not seen Germany and France demonstrate full willingness to bail out the PIIGS. Second, China sees little purpose in cooperating with the EU as a whole, because it cannot necessarily persuade each of its Member States to satisfy China's bargains.

The EU-China relationship has also been affected by the EU's focus on several political issues. From China's point of view, matters such as human rights, the arms embargo, and failure to recognise China's market economy status have stood in the way of building a meaningful strategic partnership.

But how can Europe and China gain from economic engagement with one another? Bilateral relations, be they economic or political, must be based on mutual benefits and complementarities that allow both parties to exploit their own comparative advantages.

China's comparative advantages over the EU are still cheap and abundant labour, low to mid-level manufacturing, as well as its huge market potential for European business. The EU's advantages over China include its superior technologies, managerial skills and social structure.

For example, there is much scope for EU-China economic cooperation in the field of energy efficiency. China's economic sustainability depends on its ability to improve its energy efficiency and harness alternative energy sources to fossil fuels. Rising oil and other commodity prices mean that China will be unable to sustain its fast growth if it remains dependent on its current economic structure, heavily dominated by manufacturing – in particular, the production of highly polluting products such as cement, steel, coal and chemical fertilizers. The EU has huge technological advantages and regulatory experience with regard to energy efficiency, carbon capture and pricing policies compared with China. These can be used to China's advantage and could open up many business opportunities between both parties in the future.

The potential for EU-China cooperation is huge and there are many other areas that the EU and China can work together for mutual benefit. These might include higher education, bio-medicine, pharmacy, food security and safety, environmental control and fighting poverty and corruption.

Shujie Yao, ECRAN Key Expert in Economics
December 2011