36 |
Caroline Meinhardt
1. CRISIS LESSONS: EUROPE NEEDS TO RECALIBRATE ECONOMIC INTERDEPENDENCIES
WITH CHINA
When, in late January of 2020, China’s economy began grinding to a standstill due to the
rapid spread of the novel coronavirus, the ripple effects were quickly felt in the rest of the
world. Before long, sustained factory closures in China meant European manufacturers
faced shortages of crucial products and components from their Chinese suppliers. Europe’s
auto and electronics industries were among the hardest hit, but even more concerning
were disruptions that carried severe public health implications: Europe experienced
shortages in pharmaceutical ingredients and other critical medical supplies imported
from China, ranging from personal protective equipment to ventilators, just as the pandemic
spread across the region.
The supply chain disruptions caused by Covid-19 and the severity of their impact on Europeans’
health and livelihood have heightened existing concerns about Europe’s economic
dependence on China. The pandemic is now widely cited as a real-life case study that has
exposed Europe’s trade vulnerabilities and the need to accelerate existing initiatives to
increase the EU’s strategic and economic autonomy. Meanwhile, fears that Beijing may
exploit European trade dependencies to coerce companies or EU member states to toe the
Communist Party line are also increasing, adding to these concerns.
Part 1: Resilience
2. Safe interdependence: Managing economic
vulnerabilities
KEY FINDINGS
	The supply chain disruptions caused
by Covid-19 and the severity of their
impact on Europeans’ health and livelihood
have heightened existing concerns
about Europe’s economic dependence
on China.
	China has long set its economic policy
on a trajectory of strategically managed
interdependence that does not
converge with OECD norms, requiring a
careful rethink of these interdependencies
in Europe.
	While China remains a long way from
becoming self-sufficient, especially in
high-tech industries, in many sectors
it has managed to move up the value
chain to produce increasingly sophisticated
goods for export.
	Europe faces challenging decisions
when it comes to securing critical supply
chains and assessing the role of Chinese
companies in Europe’s ecosystem for
emerging technologies.
	The EU’s dependence on China for
life-saving pharmaceutical ingredients
and technology-powering batteries are
weaknesses that could be exploited by
China through coercive tactics.
	To handle growing risks of Chinese economic
coercion, the EU should follow the
lead of East Asian nations and better
compartmentalize its relationship from
an “economic security perspective.”
| 37MERICS PAPERS ON CHINA No 9
Patterns of
asymmetry and
dependence
vary across EUChina
economic
relations
The European Commission has long sought to reduce Europe’s dependence on other
countries for critical materials and technologies, as exemplified more recently by its New
Industrial Strategy for Europe, launched in March.1
But the pandemic has created a greater
sense of urgency, causing many prominent voices to call for an immediate reassessment
of the risks of economic dependence on China. EU politicians are now mulling European
production requirements for strategic goods and drawing up proposals for the review
of EU supply chain vulnerabilities and the diversification of import sources for critical
supplies.2
There are widespread calls to strengthen Europe’s “resilience” by diversifying
European supply chains that are predominantly rooted in China.
However, it would be rash to jump to the sweeping conclusion that Europe must reduce
its interdependence with China in all areas of the bilateral economic relationship. As this
chapter’s analysis of three core issues shows, patterns of asymmetry and dependence vary
in scope and risk level across different aspects of EU-China economic relations – from
overall trade and investment relations and the EU’s reliance on China for critical supplies
and products, to Beijing’s attempts to control the value chains of foundational emerging
technologies. While acute vulnerabilities in some areas of the economic relationship
undeniably pose risks to Europe’s strategic autonomy and thus necessitate a rebalancing
of ties with China, Europe’s relative strength in other areas should embolden it to resist
Chinese efforts at economic coercion.
China has long set its economic policy on a trajectory of strategically managed interdependence
that does not converge with OECD norms. Given the long-term competitive
risks this path poses to Europe, as well as the immediate vulnerabilities and potential for
exploitation of dependencies for political gains, a careful rethink of these interdependencies
is needed to strengthen European resilience. The challenge for Europe will be to settle
on a unified and coordinated approach to evaluating and managing EU-China economic
interdependencies at both the EU and member-state level.
2. CHINA’S TRAJECTORY: MANAGING INTERDEPENDENCE TO MINIMIZE
VULNERABILITIES AND CREATE LEVERAGE
China’s global importance as a manufacturer and exporter is the result of decades of
carefully managed integration into global value chains. Since its accession to the World
Trade Organization in 2001, China has rapidly cemented its position as a key producer and
exporter of many manufactured goods, especially intermediate goods. Initially dubbed the
world’s factory due to its abundant supply of low-wage workers, cheap land and relatively
lax environmental regulations, China has since moved up the value chain by manufacturing
and exporting intermediate goods with increasing value added.3
China’s rise to its position as a global manufacturing hub was driven by targeted state measures
that incentivize foreign companies to move their manufacturing (and related knowhow)
into China while supporting China’s domestic industrial upgrading efforts. China’s
industrial policy approach has shifted from prioritizing catching up with foreign manufacturing
and technology capabilities to much more ambitious goals. Localizing global supply
chains within China, upgrading Chinese industrial capabilities and dominating in emerging
technologies from the start are key elements of Beijing’s goal to transform the nation
into a globally competitive manufacturing and technology superpower by 2049.
Part 1: Resilience
38 |
US restrictions
demonstrated
to Beijing the
urgent need
to end its
dependence on
foreign tech
For at least the past 15 years, China’s leaders have focused on indigenous innovation, core
technologies and strategic mega projects to manage China’s future interdependence with
other countries in technologies. With a web of industrial strategies that have targeted strategic
emerging industries and, since 2016, “innovation-driven development,” Beijing has
sought to capitalize on a new technological revolution to improve the country’s relative
strength and competitiveness. Its most well-known centerpiece, the Made in China 2025
initiative, explicitly pushes for substituting foreign manufacturing components and core
technologies in strategic sectors with “indigenously” made alternatives.4
As Beijing actively strengthened the integration of Chinese industry in global value
chains, the government also sought to manage and address the risks of interdependencies
that result from deeper economic ties.5
It made concerted efforts to vertically integrate
Chinese supply chains by reducing the country’s own dependence on foreign manufacturing
inputs and technology.6
The continuing escalation of US-China tech tensions have
further fueled Beijing’s national security concerns. Chinese companies getting cut off from
crucial US-made technology demonstrated to Beijing the urgent need to end its dependence
on foreign tech.
While China remains a long way from becoming completely self-sufficient, especially
in high-tech industries, in many sectors it has managed to move up the value chain to
produce increasingly sophisticated goods for export – and will continue to do so. China’s
resulting dominance in the production of new technologies such as lithium-ion batteries,
and critical supplies such as rare earths, are increasingly causing concern in Europe.
That is because China’s strengths in these areas are based on an industrial policy approach
that builds on strategically managed interdependence. It fundamentally diverges
from market-oriented principles and practices in the OECD. That includes the principle
of ‘competitive neutrality,’ according to which private and state-owned firms should be
able to compete on a level playing field.7
A major economic policy document, issued by
the CCP Central Committee and the State Council in May this year, is an important and
timely reminder that China’s economic policy-making will continue to pay lip service to
the importance of market forces while in reality championing the state-owned sector and
strategically aligning the private sector through state intervention.8
Even more concerning, China is increasingly leveraging its importance as a supplier of
sought-after goods for economic coercion. There are mounting examples of Beijing threatening
European governments and individual companies that are dependent on its products
with punishment or outright retaliation for acting against its interests.9
With China’s coercive tactics increasing and unforeseen crises such as the Covid-19 outbreak
laying bare the serious risks of economic dependence, Europe will need to systematically
reassess certain areas of its economic dependence on China. The deterioration of
US-China relations and sweeping efforts to decouple from one another add another layer
of urgency: Europe must establish its own position on the risks associated with China’s
strategically managed interdependence.
Part 1: Resilience
| 39MERICS PAPERS ON CHINA No 9
Europe
supplies China
with goods
indispensable
for its industrial
upgrading
ambitions
3. KEY ISSUES: HIGH-STAKES INTERDEPENDENCE IN TRADE, CRITICAL SUPPLIES
AND HIGH-TECH VALUE CHAINS DEFINE EU-CHINA RELATIONS
European decision-makers still hope to conclude an ambitious investment agreement with
China. It is therefore imperative that they weigh the benefits of deeper economic integration
and the offshoring of manufacturing against the associated risks. Doubling down on
an increasingly asymmetric partnership with a state-led and distorted market economy
could have serious negative repercussions for Europe’s long-term competitiveness and
economic security. At a minimum, these efforts need to be accompanied by measures to
minimize the risks. In addition to negotiating a Comprehensive Agreement on Investment
with the necessary guardrails, Europe faces challenging decisions when it comes to
securing critical supply chains and assessing the role of Chinese companies in Europe’s
ecosystem for emerging technologies.
ISSUE 1 – TRADE AND INVESTMENT: MUTUAL DEPENDENCE AND ASYMMETRIES
The coronavirus crisis has given rise to a new narrative that Europe is overly dependent on
trade with China. However, this narrative does not match with official trade data. These
show that, on the whole, the EU single market – not China – is by far the most important
trading partner for all EU member states.10
In 2018, the EU single market, on average,
accounted for nearly two thirds of total exports of EU member states, whereas China
accounted only for an average of 2.4 percent. Of course, trade with China varies across
member states. But even Germany, which is generally seen as most vulnerable to Beijing’s
economic pressures, exported only 7.1 percent of its total exports to China that year, compared
to 59 percent to the EU single market.
Furthermore, this narrative fails to take into account the importance Europe plays for China
economically. Europe is not only a key export market for China, it also supplies China
with goods that are still indispensable given the country’s industrial upgrading ambitions.
From advanced semiconductor manufacturing equipment to specialized machinery
and tools, China needs European technology and know-how as it pursues its goals. Amid
escalating US-China tensions and the continual tightening of US export controls, China
may come to rely even more on its European suppliers and partners, as Chinese tech companies
urgently search for alternative sources for key components and machinery.
The narrative of economic overdependency, then, may stem from the exposure of individual,
large corporates. Germany’s private sector is among the most invested in China, with
an automotive industry that relies heavily on sales to Chinese consumers, but various
major companies headquartered in other European countries – from Dutch semiconductor
equipment company ASM International to British metals and mining corporations BHP
and Rio Tinto – also rely on China for significant shares of their global revenue.11
Such
corporate dependencies open the door to Chinese retaliatory action against European
governments, yet it is worth noting that Beijing has rarely followed through on threats to
cut off European companies from the Chinese market.12
Part 1: Resilience
40 |
In some areas,
China takes
charge of the
value chain from
start to end
ISSUE 2 – CRITICAL SUPPLIES AND PRODUCTS: PHARMACEUTICALS, PPE AND RARE
EARTHS
The coronavirus crisis has also exposed the vulnerabilities of some critical European supply
chains that rely considerably on goods or components imported from China. In these
specific supply chains, Europe is overly dependent on China, which has implications that
go beyond commercial considerations to become a matter of national health or security.
In the medical space, Europe is highly dependent on foreign-sourced active pharmaceutical
ingredients (API). Around 90 percent of APIs needed for the European production of
generic medicines are sourced from China and India, with India itself 70 percent reliant
on Chinese APIs.13
China also provides between 80 and 90 percent of the global supply
of APIs for antibiotics. When it comes to medical equipment, the EU imported half of its
personal protective equipment (PPE) from China in 2018, with an even higher reliance of
71 percent in mouth-nose protection equipment.14
One step further upstream, Europe also depends on China for metals such as cobalt,
platinum and rare earths, many of which are critical materials needed for the production
of high-tech products, medical devices and military equipment. The EU remains entirely
dependent on imports for its rare earth supplies, most of which come from China.15
Already aware of these dependencies in critical areas, the EU had started funding several
initiatives to tackle such dependencies long before the coronavirus crisis.16
However, diversifying
import sources and repatriating the production of such goods is easier said than
done for materials whose production requires large factory sites and causes severe environmental
damage. China remains the most competitive environment to produce such materials
and, for now, Europe remains vulnerable to any disruptions to these supply chains.
ISSUE 3 – EMERGING TECHNOLOGY VALUE CHAINS: ESTABLISHING CONTROL
China has been particularly keen in its efforts to dominate the global value chains for
future technologies, from semiconductors to new energy vehicles and 5G. However, these
very technologies have some of the most complex value chains. Fully dominating them
would mean controlling the various points at which value is added, from the mining of
raw materials, to the assembly or production of various components and the manufacturing
of the finished product.
In some areas, China boasts considerable success in taking charge of the value chain from
start to end. A good example is the value chain for the production of lithium-ion batteries,
which power electric vehicles, consumer electronics and new energy storage solutions.
Chinese companies dominate the mining and refining of most of the essential raw materials
needed for battery production, including graphite and cobalt.17
Meanwhile, China produces
the world’s largest volume of midstream battery components, and its leading battery companies,
such as CATL and BYD, produce 61 percent of the world’s finished battery cells.18
Europe,
which has a global battery cell manufacturing share of only around 3 percent, is highly
dependent on importing battery cells as well as the components and raw materials needed
for production.19
Despite EU efforts to scale up Europe’s battery manufacturing capacity,
many of Europe’s upcoming local battery manufacturing facilities are still being built by
Chinese companies.20
To ensure consistent battery supply, European car giants are actively
deepening their partnerships with Chinese battery makers.21
Part 1: Resilience
| 41MERICS | PAPERS ON CHINA No 9
In public debates, China’s dominant global role in foundational emerging technology and
the resulting dependence of other countries on China, is often exemplified by Huawei’s
dominance in 5G network technology. According to Huawei, its equipment is being used in
two-thirds of the commercially launched 5G networks outside of China and it has secured
47 commercial 5G contracts in Europe.22
Yet at the same time, 5G illustrates the significant
weaknesses that remain in China’s drive to control tech value chains. Crucial elements
needed to build 5G base stations include Field Programmable Gate Arrays, for which
Huawei relies on US suppliers Xilinx and Intel. It is also dependent on Taiwan Semiconductor
Manufacturing Company, which fabricates the 5G chips designed by Huawei’s chip
subsidiary using US and Dutch semiconductor manufacturing designs and equipment.
Following the tightening of US export controls, Huawei may struggle to procure or produce
the chips it needs to build 5G base stations – exposing a major weakness in its technology
supply chain.23
Part 1: Resilience
China’s success in dominating entire tech value chains has been mixed
Key strengths and weaknesses along two important value chains
Sources: media reports, MacroPolo, IC Insights
©MERICS
Processed
materials &
product
components
Manufactured
tech product
Raw
materials
Chinese companies increasingly
dominate the mining and refining
of graphite, cobalt, nickel and
lithium. But supply depends
on stable relationship with
resource-rich countries.
Chinese companies produce the
world’s largest volume of anodes,
electrolytes, separators and
cathodes.
China produces around 60 percent
of global battery cells.
Chinese polysilicon production
capacity has grown rapidly. But US,
European and Japanese companies
remain industry leaders.
China relies heavily on silicon
wafer imports from Japanese,
Taiwanese, Korean and German
manufacturers.
Despite significant advances
in chip design, China remains
highly reliant on US, European
and Taiwanese design tools,
production equipment and highend
fabrication capabilities.
Lithium-ion battery
value chain
5G chip
value chain
Exhibit 3
42 |
4. EU-CHINA RELATIONS: EUROPE IS LESS BEHOLDEN TO CHINA THAN MOST THINK
The EU is China’s biggest trading partner – it is China’s most important export market,
and the source of major direct investment and technological know-how. As such, the
EU-China bilateral relationship in trade and investment has long been characterized by
mutual economic dependence, rather than one-sided European dependence on China.
European and Chinese companies trade, compete and cooperate around the world, while
benefiting from investments in each other’s markets.
Certain aspects of the EU-China economic relationship, and certain sectors, reveal imbalances
that point to European weaknesses vis-à-vis China. Supply shortages in the wake
of the Covid-19 pandemic point toward an overdependence on Chinese inputs and imports
in certain critical product value chains that make the EU vulnerable in times of crisis.
Dependence on China for life-saving pharmaceutical ingredients and technologypowering
batteries are weaknesses that could be exploited by China through coercive
tactics.
Part 1: Resilience
Four logics of strategic action under a principles-first approach vis-à-vis China
Exhibit 4
Source: MERICS
©MERICS
Relative power
(Collective) political will,
available resources,
dependence on China
Systemic difference
Chinese behaviour aligned or at least (likely to be)
effectively constrained by OECD norms/principles
high
low
SUPPORT & LEVERAGE
ENGAGE & SHAPE COERCE & CONTAIN
RESIST & LIMIT
Emerging technology
value chains
Critical supplies
and products
Trade and
investment
highlow
Partner Competitor Rival
| 43MERICS PAPERS ON CHINA No 9
To handle
growing risks
of Chinese
economic
coercion, the EU
should follow
the lead of East
Asian nations
However, more broadly speaking, Europe may be less beholden to China in its trade and
investment relationship than recent narratives claim. Its biggest source of economic
growth still comes from trade within the EU single market, while China itself is highly
dependent on European imports of crucial high-tech machinery and chemicals – key European
strengths. When it comes to China’s grasp of technology value chains, specifically,
China has made considerable inroads. However, it still retains its own weaknesses and dependencies,
often to do with the underlying basic research or manufacturing equipment.
The EU therefore should not be overly fearful of economic interdependence with China
and should have greater awareness of the strengths that give it leverage over China.
5. POLICY PRIORITIES: EUROPE NEEDS TO ASSESS VULNERABILITIES AND TAKE
ACTION
The coronavirus crisis has brought to public attention the important risks of Europe’s
economic dependence on China. While the pandemic should indeed be seen as a wake-up
call, it should not lead to sweeping conclusions that economic interdependence with China
is one-sided or harmful in and of itself. While the pandemic has demonstrated the risks
of relying on global supply chains with heavy input from China, it has also showed the
advantages: when it was Europe’s turn to shut down factories as the virus spread beyond
China’s borders, China was able to get back to work and resume production, ensuring a
continued supply of goods.
What is needed is a thorough assessment of the risks as well as the benefits of economic
interdependencies with China. Europe should adopt a more systematic approach and
recalibrate interdependence in a way that addresses European vulnerabilities while building
on its strengths. This includes the need for concrete and unanimously accepted definitions
of which traded goods and technologies are considered “critical.” It also requires the
creation of EU-level mechanisms to support policy responses from an economic security
perspective. There can be no blanket approach to building “resilient” or “robust” global
supply chains, given their complexities. Different types of interdependencies – across different
sectors, among specific value chains and individual corporations – require different
policy solutions.
When it comes to the overall trade and investment relationship, the EU will have to
change course to rebalance trade and investment relations with Beijing towards greater
fairness and reciprocity, as negotiated first best options are likely to fail. While the EU
should not overestimate China’s lackluster dedication to market reform or Europe’s own
relative power, given certain member states’ or sectors’ relatively larger dependence on
China, it should not underestimate the power of collective political action.
Based on a comprehensive audit of national and corporate-level dependencies on China,
the EU should pinpoint its strengths and weaknesses and identify areas for coalition-building.
Should a unified EU stance fail to advance European interests, it should
look to its allies beyond Europe to exert pressure in areas where competitive risks from
China’s managed interdependence are unbearable. To handle growing risks of Chinese
economic coercion, the EU should follow the lead of East Asian nations and better compartmentalize
its relationship from an “economic security perspective.” This would allow
it to resist political pressure from Beijing while maintaining a stable trading relationship.
Part 1: Resilience
44 |
The EU should
strengthen
support for
its European
ecosystems for
technologies
such as 5G
Based on EU-level and national-level reviews of strategic industries and specific goods
that are critical to national security, the EU should limit its exposure to China through a
strategy that prioritizes diversification – and in some cases relocation – of critical supply
chains. This will require serious resource commitments to enable the building of manufacturing
capacity outside of China. In doing so, the EU should not aim for complete self-sufficiency
through reshoring production – this is an unrealistic goal given the complexity of
supply chains and China’s considerable manufacturing strengths.
Emphasis should instead be placed on rebalancing away from reliance on a single supplier.
In addition to existing plans to stockpile emergency equipment and shore up investment
in Europe’s domestic pharmaceutical and rare earth capabilities, the EU should review
its other existing trading relationships with allies to identify opportunities for closer
cooperation with the aim of reducing dependencies on China in critical, strategic goods.
There is also a need for nuanced terminology and strategies so that efforts to strengthen
Europe’s supply chain resilience do not slide into trade protectionism.24
To tackle dependencies on China for foundational emerging technologies, new institutional
mechanisms fulfilling the functions of an “economic security council” would
enable member states and the EU to devise policy responses specifically for issues that lie
at the nexus of technology, trade and security. Such mechanisms should be an essential
part of the EU’s efforts to constrain the reach of China’s distortive economic and industrial
policies; only in this way can the EU ensure that its policies are based on nuanced
assessments of both Chinese and European strengths and weaknesses in technology value
chains, and that member states are unified in their interpretation of political and economic
risk.
To be digitally sovereign, the EU should strengthen support for its European ecosystems
for technologies such as 5G, semiconductors, and cloud technologies. At the same time,
the EU must upgrade its safeguards to mitigate the potential risks stemming from the
inevitable involvement of Chinese companies in European development of future technol-
ogies.
Finally, any European strategies to recalibrate global supply chains must be developed in
close consultation with European firms, given the difficulties of adjusting complex value
chains. Thus far, political rhetoric on the need for supply chain relocations has not yet
translated into major corporate action. European companies are expressing concerns over
the financial and logistical challenges of adjusting operations – all of which could take
years. Continually growing market demand in China also means that many European companies
will continue to pursue an “in China for China” manufacturing strategy. The EU
must take into account industry representatives’ perspectives in order to conduct realistic
scenario-planning and ensure the effectiveness of policy support measures.
Part 1: Resilience
| 45MERICS PAPERS ON CHINA No 9
Part 2: Competitive liberalism
| 47MERICS PAPERS ON CHINA No 9
Part 2: Competitive liberalism
Rebecca Arcesati
1. CRISIS LESSONS: COVID-19 HAS GIVEN CHINA’S DIGITAL TRANSFORMATION TOPLEVEL
ATTENTION
Chinese leaders’ response to Covid-19 has underscored their longstanding ambition to
turn China into a high-tech superpower, with digital technologies spurring innovation and
transforming the economy.1
As the crisis unfolded, the government worked closely with
technology companies to tackle the emergency.2
However, the pandemic also accelerated
a broader trend: Much like the EU, China has identified the coronavirus as an opportunitiy
to rebuild its economy by putting digitalization first.3
There is work to be done – while the lockdown boosted China´s consumer-facing digital
economy, digitalization in traditional industries like manufacturing is still lagging.4
Xi Jinping’s leadership wants this to change, and therefore gave digital transformation
top-level attention during the outbreak.5
As the country was hit by the virus, 5G network
construction was ramped up. The technology, which is set to power the industrial Internet
of Things (IIoT) along with intelligent vehicles, smart health systems and other disruptive
applications, is a strategic priority of the Chinese Communist Party (CCP). The Ministry of
Industry and Information Technology (MIIT) instructed telecom carriers and local governments
to “forcefully advance 5G network construction”.6
By the end of this year, Beijing
wants to have over 600,000 base stations.7
For Europe, economic competition with China is increasingly playing out in the digital domain
and new technologies. The EU has begun to address China’s state-driven technology
ambitions in the context of two major policy challenges – strategic acquisitions of European
technologies and the presence of high-risk vendors Huawei and ZTE in the continent’s
3. Competing with China in the digital age
KEY FINDINGS
	China sees the Covid-19 pandemic as an
opportunitiy to rebuild its economy by
putting digitalization first, in line with
existing goals and plans.
	The crisis has not altered China’s
state-driven industrial and technology
poli­cymaking. The pandemic and decoupling
from the US have added urgency
to Beijing´s indigenous innovation drive.
	 For Europe, economic competition with
China is increasingly playing out in the
digital domain and new technologies.
policymakers will be forced to integrate
previously marginal policy issues into
their China strategies.
	 When it comes to collaboration with
China in research and innovation, a riskbased
approach is needed to prevent
unwanted tech transfers.
	 China’s need for European technology
and know-how, for instance in intelligent
manufacturing and the industrial
internet, could be leveraged to advance
EU interests by making access and
partnerships conditional.
	The EU will need to join forces with
partners around the world if it wants to
attain digital and technological sover­
eignty.
48 |
digital infrastructure. This year has seen the implementation of the defensive strategy
Brussels crafted in response, with EU investment screening rules and cybersecurity measures
for 5G now in the adoption phase.8
However, this is merely the beginning of work on
a necessarily more strategic EU response to China’s technology and digital policies – and
member states are far from united on the matter.
Post-pandemic China will remain the formidable “economic competitor in the pursuit of
technological leadership” the previous European Commission (EC) described in its March
2019 Strategic Outlook.9
Despite government calls for marketization and encouraging
openings to foreign investors, Beijing will not abandon state capitalism and techno-nationalist
policies any time soon.10
With economic recovery plans forcing both Europe
and China to look inward, and negotiations for a bilateral investment agreement moving
slowly, it looks increasingly unlikely that there will be progress on rebalancing economic
relations within the year.11
Against this backdrop, policymakers will be forced to recalibrate their strategies in ways
that reflect China’s policy direction and will have to integrate previously marginal policy
issues. This chapter focuses on three specific dimensions:
(1) If member states want to prevent unwanted tech transfers to China, they need to look
beyond Chinese Foreign Direct Investment (FDI) and come to terms with the way Beijing
utilizes foreign research collaboration as an industrial policy tool.
(2) A realistic assessment of China’s standardization strategy for ICT and emerging
technologies would help European actors better understand where their competitor is
headed.
(3) Distortions in the digital economy caused by state interference should feature more
prominently in ongoing debates on reciprocity and fair competition.
2. CHINA'S TRAJECTORY: COVID-19 AND DECOUPLING FROM THE US ADD URGENCY
TO INDIGENOUS INNOVATION DRIVE
The coronavirus crisis has not altered China’s state-driven industrial and technology policymaking.
The latest business confidence survey conducted by the European Chamber of
Commerce in China shows that Covid-19 has, rather, exacerbated existing trends: European
businesses are experiencing an increasingly politicized environment and persistent market
barriers in critical sectors, like ICT, and they expect state-owned enterprises to gain more
opportunities at the expense of the private sector.12
The rollout of 5G illustrates the contradictions
of China’s economic strategy, with selective opening in some sectors and protectionist
industrial policy elsewhere. As of April, domestic vendors had secured 90 percent of the
multibillion 5G contracts already awarded by state-owned telecoms operators.13
But the issues around 5G are not only about market access: 5G is where the Chinese
government’s technology policies and national security priorities converge. The CCP’s top
priority is to reduce reliance on foreign technology, which it sees as an existential threat.
Mounting tensions with Washington have only accelerated China’s quest for indigenous
innovation, as decoupling in hardware, software, and even science and talent exchanges
becomes a reality.14
The upcoming five-year plan (2021 – 2026) is expected to place a heavy
focus on homegrown technological innovation to further ease China’s dependence on the
United States.15
The coronavirus
crisis has not
altered China’s
state-driven
industrial and
technology
policymaking
Part 2: Competitive liberalism
| 49MERICS PAPERS ON CHINA No 9
Part 2: Competitive liberalism
Exhibit 5
Sources: CCID think tank; media reports; central and local government documents; industry associations; company websites
©MERICS
From EV chargers to 5G networks: Beijng boosts technology deployment under
"new infrastructure" banner
Illustration of key targets and relevant example projects
Type Main goal Key domestic players Example of related local
government or corporate
initiative
5G network
infrastructure
Triple the number of 5G
base stations across the
country to 600,000 by
the end of 2020 and have
5 to 5.5 million by 2025
to achieve nation-wide
coverage
Ministry of Industry and
Information Technology
(MIIT); China Broadcast
Network; China Telecom;
China Unicom; China Mobile;
Huawei; ZTE
Shenzhen: 45,000 base
stations by end of August,
part of RMB 411.9 billion
(EUR 49.4 billion) planned
investment in new
infrastructure until 2025
Industrial internet
platforms
Build three to five internationally
competitive industrial
internet platforms
by 2025, with 300,000
participating companies
by 2020, to support the
digital transformation of
enterprises
Ministry of Industry and
Information Technology
(MIIT); Alibaba; Inspur;
Huawei; CASIC; XCMG;
Yonyou; Haier; Shanghai
Baosight; Xiaomi; JD; other
companies
Jiangsu: One national,
cross-sectoral plaftorm
and 70 provincial-level
platforms. Close partnership
with Huawei for
industrial internet and
Internet of Vehicles
AI innovation
zones
Build 20 "AI Innovation
and Development Pilot
Zones" across the country
by 2023
Ministry of Science and
Technology (MOST); Baidu;
Tencent; Alibaba; SenseTime;
Hikvision; Megvii;
Yitu; Huawei; CloudWalk;
iFlyTech; other companies;
research institutes
Beijing: first AI pilot
zone launched in China
(February 2019). Ten
further zones announced
across the country as of
August 2020
Big data centers Accelerate the construction
of big data centers
across the country by
2025, sharpening the focus
on industrial big data
and intelligent computing
Tencent; Alibaba; Baidu;
Huawei; Lenovo; Sugon:
other companies
Alibaba: three new hyperscale
data centers opened
in Nantong, Hangzhou
and Ulanqab; one million
servers over next three
years as part of RMB 200
(EUR 23 billion) investment
plan to expand cloud
infrastructure
Electric vehicle
charging stations
Add 12,000 additional
EV charging stations and
have 4.5 million charging
points by 2020
State Grid Corporation
of China; Qingdao Teld
New Energy; Star Charge;
Potevio; Jiangsu YKC; EV
Power; Huawei; Alibaba;
other companies
Shanghai: 100,000 new
EV charging stations by
2022; construction of the
country´s leading Internet
of Vehicles infrastructure
including 50 kilometres of
autonomous vehicles test
roads
50 |
Part 2: Competitive liberalism
Technology
and the digital
realm have
become terrains
of great power
competition
Towards this end, China’s innovation policy relies heavily on central planning. Recent
calls to liberalize the allocation of production factors, including technology and data,
are therefore not likely to lead to structural shifts.16
It is reasonable to expect continued
reliance on interventionist industrial policies designed to nurture indigenous innovation,
especially for the development of ’strategic emerging industries’ (SEI) – sectors that Beijing
has decided to bet on in order to transform the economy and climb up value chains.17
In February, the MIIT identified nine SEI as policy priorities in restarting the pandemic-battered
economy.18
The fact that the national memory chip champion YMTC and US
EV company Tesla were given preferential treatment, so that they could operate amid the
lockdown, is evidence of Beijing´s determination.19
The Covid-19 crisis has catalyzed the push for digital transformation and hi-tech develop-
ment.20
The term ‘new infrastructure ’ (新基建) – from 5G and industrial internet platforms
to data centers and artificial intelligence (AI) – emerged as a major policy focus in
post-pandemic stimulus measures.21
The goal is to speed up the adoption of digital and
emerging technologies and their integration with traditional industries, in order to stimulate
new growth drivers and boost China’s future competitiveness.22
Although the bulk
of Beijing’s infrastructure stimulus will go to traditional projects, a think tank under the
MIIT expects total investment in new to reach 10 trillion yuan (1.3 trillion euros) by 2025.23
3. KEY ISSUES: FILLING GAPS IN EUROPE'S TOOLBOX TO ADDRESS CHINA'S
STRATEGY FOR TECH SELF-RELIANCE
With Beijing accelerating its bid for self-reliance and global leadership in key technologies,
Europe must brace for challenges. Europeans may not be used to seeing technology
and the digital realm as terrains of great power competition, but shifting global trends
force a rethink. The pandemic and an ever-fiercer contest for technology dominance
between Washington and Beijing provide opportunities for Europe – even though it was a
net loser in the first waves of the digital revolution – to revise policies around a number of
critical issues set to influence technological and industrial competitiveness in the years to
come.
ISSUE 1 – RESEARCH AND INNOVATION (R&I) COOPERATION: DOUBLE-EDGED
SWORD
China already matches the EU-28 in R&D intensity, while Chinese companies have been
increasing their investments in research much faster than their European competitors.24
Despite pandemic-induced budget constraints R&D remains a priority, especially in basic
research and core technologies.25
China’s vibrant innovation system offers tremendous opportunities
for European firms, and Covid-19 has brought the importance of cross-border
innovation into the spotlight. Europe could also benefit from attracting more talent flows
as Chinese STEM researchers face growing barriers in the US.26
Despite these opportunities, the lack of reciprocity in bilateral R&I ties is still a problem,
particularly in terms of funding, data-sharing, and IP protection.27
Even more importantly,
collaboration with China requires substantial investment in risk assessment and due diligence.
China’s foreign research collaboration strategy poses long-term risks for Europe’s
competitiveness, security, and values. China’s government seeks to leverage collaboration
for industrial policy goals.
| 51MERICS PAPERS ON CHINA No 9
Part 2: Competitive liberalism
Exhibit 6
Sources: media reports; ASPI; Human Rights Watch
©MERICS
Europe needs to brace itself against unwanted tech transfers
Selected cases involving Chinese actors
Vector Description Country
Investments and
acquisitions
Acquisitions of advanced semiconductor technology are instrumental
for the Chinese government´s pursuit of technological
independence. UK semiconductor company Imagination Tech was
acquired by Chinese private equity group Canyon Bridge, which is
backed by a state-owned investor. The Chinese owner recently
tried to seek control of the company, prompting an investigation.
UK
R&D collaboration
(academia)
Researchers at Aalborg University collaborated with Hikvision
to create an algorithm that tracks how online sentiments change,
which could also be used for social repression. The researchers
ignored that Hikvision, a leading manufacturer of surveillance
equipment, is heavily implicated in human rights abuses in
China´s Xinjiang region.
Denmark
R&D collaboration
(government)
Part of the know-how needed to build China´s dual-use satellite
navigation system, Beidou, reportedly came from the Galileo
technology partnership between the Chinese government and
the EU, which was dissolved due to controversies between the
two sides.
Belgium
R&D collaboration
(corporate)
Siemens has a strategic cooperation agreement with CETC aimed
at testing and developing intelligent manufacturing solutions
in electronic information. The state-owned military contractor is
behind a computer platform used by the Chinese police for the
surveillance and internment of ethnic minorities in Xinjiang.
Germany
Exports Germany-based MTU supplied state-of-the-art diesel engines for
PLA submarines.
Germany
Industrial
espionage
Employees of Dutch chip machine maker ASML reportedly stole
trade secrets and passed the information to competitor XTAL,
which is owned by a Chinese company with ties to the Chinese
Ministry of Science and Technology. ASML denied finding proof
of Chinese government involvement in the theft.
The Netherlands
Academic
espionage
A Chinese doctorate student and his supervisor were expelled
from Norway after it was found that their research could be used
by the Chinese military to develop hypersonic cruise missiles.
The scientist had deliberately concealed his affiliation with the
institution training the PLA´s strategic missile forces.
Norway
Cyber theft Chinese spies hacked Britain´s largest defense company BAE,
stealing sensitive data related to the multinational F-35 Joint
Strike Fighter (JSF) project. Experts have warned that the PLA
may have used the stolen data to build its own stealth fighters.
Information was also stolen from US companies involved in
the JSF program.
UK
52 |
China is
attempting to
blend digital
connectivity and
standardization
Transferring foreign talent and technology is a strategic priority, accomplished through a
sophisticated web of legal, extra-legal and illicit channels.28
These range from setting up
science parks and tech transfer centers and attracting European R&D to China, to sending
military scientists to universities and engaging in industrial espionage.29
In some cases,
Sino-European partnerships have contributed to China’s military technology R&D, or
efforts to perfect mass surveillance.30
Against this backdrop, a shift to a more clear-eyed
approach to R&I collaborations with Chinese actors is overdue.
ISSUE 2 – STANDARDIZATION: TECHNOLOGY SPECIFICATIONS MEET CONNECTIVITY
ALONG THE DIGITAL SILKROAD TRAIL
Europe must also come to terms with China’s strategic approach to technology standardization,
starting with a realistic assessment.31
Chinese companies’ growing participation
in standard-setting bodies and the standardization of emerging technologies (AI, 5G and
IoT in particular) is entirely normal and critical for ensuring safety and interoperability;
their market shares will depend on the quality of their technology and their success at
commercializing it.32
At the same time, Beijing sees standardization as a tool for strengthening
indigenous innovation.33
To that end, it actively promotes and sponsors Chinese
companies’ participation in international standard-setting bodies.34
Cases of firms forming
coalitions to support domestic industrial policy goals have already emerged.35
Beijing also pushes the internationalization of Chinese technical standards in a range of
industries through the BRI, with a strong focus on ICT, emerging technologies and the integration
of these with industrial production.36
By building fiber-optic cables, smart cities,
data centers and digital service platforms, while encouraging developing and emerging
economies to adopt Chinese standards as part of the Digital Silk Road (数字丝绸之路, DSR),
China is attempting to blend digital connectivity and standardization and to leverage the
lower cost of Chinese standards compared to Western alternatives.37
While the content
of most DSR memoranda of understanding (MoUs) is undisclosed, evidence points to an
increased emphasis on standardization cooperation.38
By 2019, China had signed 85 standards
cooperation agreements with 49 countries and regions along the BRI.39
This year, China will release a national standardization strategy incorporating the results
of the ʻChina Standards 2035’ project (中国标准2035项目), a major research effort aimed
at streamlining the national standardization system and promoting Chinese standards
globally.40
Next-generation technologies like IoT, cloud computing, big data, 5G and AI are
a focal point of this strategy.41
European businesses have long been concerned about the closed nature of Chinese standardization
committees.42
If they were excluded from the 'China Standards 2035' process,
while Beijing succeeded at exporting its preferred standards through the DSR, the playing
field in the digital economy could be tilted in favor of Chinese competitors. Meanwhile,
Chinese firms’ first-mover advantage in the standardization of applications like facial
recognition means China could acquire a greater say in emerging technology governance,
thereby promoting interests that are not necessarily aligned with European ones.43
ISSUE 3 – DIGITAL ECONOMY: EXPANDING THE REMITS OF UNFAIR COMPETITION
As EU Commissioner Thierry Breton put it, we are witnessing a “global battle for industrial
data”.44
Like Brussels, the Chinese government is also upping its game to unleash the
untapped potential of data in upgrading industry and transforming the economy through
Part 2: Competitive liberalism
| 53MERICS PAPERS ON CHINA No 9
Data security
is a top priority
for Chinese
regulators and
a matter of
national and
regime security
platform business models and technologies like IoT, AI and cloud computing. Unlike
internet users’ data, data from production plants and machines in China is not yet shared
and used to create value. The government wants this to change. While these efforts date
back to the 2015 ʻInternet Plus’ action plan, there is now a stronger focus on the industrial
internet and the creation of an industrial big data system by 2025.45
Data security is a top priority for Chinese regulators and a matter of national and regime
security. This encourages them to place sweeping restrictions on the collection, processing,
and cross-border transfer of personal and ‘important’ data. On July 1, the draft ʻData
Security Law’ was released for public comment.46
By introducing a system for grading and
regulating data, including industrial data, based on its importance for national security,
the law could heavily impact foreign business. The law also codifies China’s ability to
retaliate against any country imposing trade and investment restrictions towards the PRC
related to data and technology. These developments could further politicize the treatment
of foreign technology in China and exacerbate competition distortions in the digital econ-
omy.
Lastly, the EU and members states should also pay more attention to the DSR since Beijing
is leveraging it to promote and finance the global expansion of domestic technology
companies.47
Despite the growing backlash against Huawei in developed countries, the
unmet needs for digital connectivity in developing and emerging economies will continue
to provide fertile ground for Chinese ICT and digital projects. These often consist of
integrated hardware and software packages provided by state-backed companies, with the
potential outcome of creating China-centered digital ecosystems in which European companies
cannot participate.48
Already dominant in China’s closed digital market, Chinese
tech giants could control increasing amounts of data and create entrenched monopolies
in third markets.
4. EU-CHINA RELATIONS: LEVERAGING CHINA’S TECH DEPENDENCE BECOMES A
PRIORITY FOR THE EU
Europe plays a central role in Beijing’s high-tech ambitions. Despite increased scrutiny,
most Chinese transactions in the then EU-28 in 2019 were in the ICT sector.49
This is consistent
with the trend of Europe being both target (through acquisitions) and willing partner
(through R&D collaborations) of Beijing’s MIC2025 strategy.50
Additionally, European firms
have experienced an increase in forced tech transfers in recent years.51
As China finds its
access to US technology increasingly curtailed, it is likely that it will turn to Europe for
alternatives. This is already happening in the semiconductor value chain, for example.52
It was the appreciation that Europe’s competitiveness and economic security were at risk
that already led to a significant change in EU China policy. Following Brussels’ call, more
member states are adopting or upgrading investment screening tools and reconsidering
the role of Chinese vendors in their digital infrastructure. Moreover, as part of an ambitious
work program launched by the previous EC to fill gaps in the EU’s defensive toolbox,
reform proposals have been advanced in competition, trade and public procurement
policy.53
Despite these achievements, the EU and member states cannot effectively compete in the
Fourth Industrial Revolution by only playing defense. To preserve the continent's digital
and technological ‘sovereignty’, in February the EC therefore unveiled new industrial,
Part 2: Competitive liberalism
54 |
The EU has
many cards to
play
Part 2: Competitive liberalism
digital and data strategies aimed at strengthening EU competitiveness, making sure that
the bloc masters critical technologies, especially AI.54
Although the European concept of
digital sovereignty is sometimes conflated with China’s approach to the governance of
cyberspace, its rationales differ fundamentally from China’s, where state control over data
and the digital economy is first and foremost a tool of information control.
Having rightly identified the nexus between industrial, competition and digital policymaking,
the EU now needs to implement its offensive agenda. Momentum is building
across the bloc and in the UK, a key partner in the technology and innovation contest with
China. In a major shift, London decided to fully exclude Huawei from its 5G networks, and
major EU economies like Italy are also placing restrictions on the company´s involvement
in network rollouts.55
Meanwhile, Paris and Berlin are elevating the importance of digital
and industrial policies as pillars of the post-pandemic recovery.56
The EU has many cards to play, starting from a world-leading science and innovation
base, talent, and lots of cutting-edge technology; the challenge is to overcome longstanding
weaknesses in terms of digital market fragmentation, regulatory hurdles, and underinvestment
in scalable tech businesses.57
China, by contrast, is very good at funding and
commercial adoption of digital and emerging technologies. It has large digital businesses
that adopt technology quickly and foster dynamic ecosystems – both domestically and
increasingly also overseas – taking advantage of a favorable regulatory regime at home.
That said, the EU has some relative strength vis-à-vis China. For one, investing in internal
capabilities and enforcing EU rules in the Single Market is unlikely to provoke substantial
backlash on the Chinese side. Meanwhile, China’s need for European technology and
know-how, for instance in intelligent manufacturing and the industrial internet, could be
leveraged to advance EU interests by making access and partnerships conditional. The
bloc’s relative power is high when it comes to R&I and standardization, both areas where
Beijing is eager to partner with European institutions and industry. However, the EU is
quickly losing ground as an innovation and standards power while China is doubling
down on investment in these fields.
5. POLICY PRIORITIES: EUROPE NEEDS TO TRANSLATE INDUSTRIAL AND DIGITAL
STRATEGIES INTO ACTION
The new EC’s offensive agenda, which considers technology and the digital sphere to be
critical elements in today’s geopolitical competition, is Europe’s best chance to respond
to China’s bold plans for high-tech leadership. Planned investments in 5G, AI, cloud, cybersecurity,
and green technologies as part of the EUR 750 billion post-pandemic recovery
package are steps in the right direction.58
A challenge for Europe will be to position itself strategically as the US-China tech conflict
heats up. Fully applying defensive tools to protect technology and critical infrastructure
will be key, as restricted access to American technology forces Chinese firms to look elsewhere.
Additionally, companies will need to adjust their scenario planning constantly to
navigate the partial decoupling of American and Chinese tech ecosystems. Policymakers
will face increased pressure to think even more strategically across policy domains and
competences, which requires setting up new structures to tackle risks associated with
emerging technology ties with China.59
| 55MERICS PAPERS ON CHINA No 9
Part 2: Competitive liberalism
When it comes to R&I, a risk-based approach is needed to prevent unwanted tech transfers.
This means shifting to a logic of coercing and containing with regard to those aspects
of China’s cooperation strategy that threaten Europe’s competitiveness, security and
values. It will be necessary to raise awareness among member states, universities and
businesses and draft guidelines for R&I partnerships with Chinese entities, including red
lines for partners and technologies that are off-limits. Aside from curbing unwanted tech
transfers, increasing the Horizon Europe Program budget to EUR 120 billion, as recommended
by the European Parliament, would boost the EU’s ability to compete on the
global stage.60
On standardization, EU actors need to coordinate their lobbying efforts in China, especially
in the context of China Standards 2035, as it is in the EU interest to engage and shape
and promote emerging market-oriented forces.61
More resources should also be invested
to help companies understand the standardization dimension of the DSR, while member
states’ standards cooperation format with China – such as the Sino-German Industry 4.0
Cooperation – should be leveraged whenever possible to achieve European regulatory
objectives in the Chinese market.62
Four logics of strategic action under a principles-first approach vis-à-vis China
Exhibit 7
Source: MERICS
©MERICS
Relative power
(Collective) political will,
available resources,
dependence on China
Systemic difference
Chinese behaviour aligned or at least (likely to be)
effectively constrained by OECD norms/principles
high
low
SUPPORT & LEVERAGE
ENGAGE & SHAPE COERCE & CONTAIN
RESIST & LIMIT
Research and
innovation cooperation
StandardizationDigital
economy
highlow
Partner Competitor Rival
56 |
The EU will need
to join forces
with partners
around the
world
Part 2: Competitive liberalism
In international standard-setting bodies, Europe does not need to copy China’s stateled
strategy to invest more resources and ensure continued relevance of its businesses.
Beijing and Washington see standardization as terrain for geo-economic competition.
If it wants to retain its industrial competitiveness in the digital age, the EU should shift
from an overly technical to a more strategic approach.63
Breton’s recent call for greater
EU engagement in the standardization of lithium for EV batteries in response to China’s
proposal to set up a new committee was timely.64
The EU should also be prepared, in
consultation with industry and like-minded countries, to coerce and contain China when
it manipulates standard-setting processes.
As China seeks access to Europe’s technology and digital market, Brussels and member
states should insist on digital reciprocity as a new principle in bilateral relations. China’s
protected digital market, discriminatory standards and data regulations hurt the competitiveness
of European businesses, and they are now being exported through the DSR. As it
works on creating a unified data market, the EU should explore ways for making Chinese
companies’ access conditional.
Navigating China’s emerging data regulations will be challenging, as the government will
not change its approach to data security. Europe can only resist and limit. As it sets out to
measure cross-border data flows and address unjustified obstacles as part of its European
Strategy for Data, the EU should monitor competition distortions arising from unequal
access to data in the Chinese market. The monitoring should include third markets where
Chinese ICT and Internet players are creating new digital ecosystems, as data-driven market
power or anticompetitive practices may arise.
Lastly, the EU will need to join forces with partners around the world if it wants to attain
digital and technological sovereignty.65
Many aspects of the China challenge, from forced
technology transfers to digital protectionism, cannot be confronted alone. The UK’s recent
proposal to set up a group of like-minded democracies to fund secure 5G solutions is
worth exploring.66
For example, such grouping could invest in secure, sustainable and
affordable digital connectivity in the developing world, thereby providing alternatives to
China’s DSR. At stake is not just Europe’s competitiveness, but also its strategic autonomy
and the very democratic values and fundamental rights it wishes to promote in the digital
transformation.