A Joint Report by Bruegel, Chatham House,China Center for International Economic Exchangesand The Chinese University of Hong KongAlicia García-Herrero, K.C. Kwok, Liu Xiangdong, Tim Summers and Zhang YanshengEU–China EconomicRelations to 2025Building a Common Future#EUChina2025

A Joint Report by Bruegel, Chatham House,China Center for International Economic Exchangesand The Chinese University of Hong KongAlicia García-Herrero, K.C. Kwok, Liu Xiangdong, Tim Summers and Zhang YanshengEU–China EconomicRelations to 2025Building a Common FutureSeptember 2017

The EU–China 2025 project has drawn upon funding from the partnerinstitutes. In addition, the authors and directors would like to thankGlaxoSmithKline and Huawei for their generous support for ChathamHouse during the project, and Mr Chen Zhuolin for his generousresearch grant to The Chinese University of Hong Kong. The StateGrid Corporation of China also provided funding for CCIEE tocarry out this project.The Royal Institute of International AffairsChatham House10 St James’s SquareLondon SW1Y 4LET: 44 (0) 20 7957 5700F: 44 (0) 20 7957 5710www.chathamhouse.orgCharity Registration No. 208223Copyright The Royal Institute of International Affairs, 2017Chatham House, the Royal Institute of International Affairs, does not express opinions of its own.The opinions expressed in this publication are the responsibility of the author(s).All rights reserved. No part of this publication may be reproduced or transmitted in any form or byany means, electronic or mechanical including photocopying, recording or any information storage orretrieval system, without the prior written permission of the copyright holder. Please direct all enquiriesto the publishers.ISBN 978 1 78413 241 5A catalogue record for this title is available from the British Library.Typeset by Soapbox, image: The European Union (EU)–China Summit plenary session atthe Great Hall of the People in Beijing on 12 July 2016. Copyright HOWHWEE YOUNG/AFP/Getty Images.ii

Contentsiii Directors’ StatementivSenior Advisory GroupvExecutive Summaryvi1Introduction12Trade Relations83Investment Relations164Infrastructure Investment and Connectivity255Energy and Climate Change306Innovation: Science, Technology and Industrial Cooperation357Financial Services and Financial Cooperation418People-to-People Ties499Conclusion54Acknowledgments57About the Authors58Appendix A: EU–China 2025: Project Background59Appendix B: EU–China Background62Appendix C: Economic Growth Projections67

Directors’ StatementIn the four decades since China and the European Economic Community (EEC) established bilateral relations in 1975, both have changed enormously. China has risen tobecome the world’s largest economy in purchasing power parity terms, and the EEChas been transformed into the European Union, the world’s largest single market,with a common currency and free movement of goods, capital, services and labour.Given this process, it was perhaps inevitable that the EU has become China’s largesttrading partner, and that China is the EU’s second-largest export market and mainsource of imports.Nonetheless, there is a general sense on both sides that decision-makers in Beijingand Brussels, as well as in other EU capitals, are yet to bring to fruition the full potential of their relationship, be it in trade and investment, industrial cooperation or globalgovernance, and in respect of climate change in particular. Against a backgroundin which the United States is increasingly drawing into question its commitments tofree trade and the global commons, and with the uncertainty resulting from Brexit,there clearly exists a need for China and the EU not only to increase the breadth anddepth of their cooperation, but also to act more strategically in the way they relateto each other.Strengthening EU–China relations will not be easy. In fact, this report documents thehurdles and differences in views that exist as well as the opportunities. The continueddifference in economic systems poses challenges for further collaboration, and policymakers need to be frank about this if they wish to harvest the huge potential of deepertrade and investment linkages. Perhaps the best starting point where broad agreementcould be found is in the area of climate policies. Both China and the EU are concernedby the issue. The topic is of such importance that it cuts across many other aspects ofthe relationship. For example, increasing connectivity through China’s Belt and RoadInitiative (BRI) and the EU’s Juncker plan for strategic investments offers the opportunity to immediately build infrastructure in a climate-friendly way. Greater cooperationin science and innovation, as well as exchanges of people, also holds promise as anarea in which progress can be made relatively easily.Over the past 18 months, staff from each of the four institutions we lead haveassessed relations between the EU and China from a variety of different angles,from the broad to the specific. This report synthesizes the main insights and conclusions from the collective workshops in Beijing, Brussels, Hong Kong and London, andfrom the various papers produced by the individual researchers. It offers a series ofrecommendations on ways to maximize opportunities and minimize the risks facingthis bilateral relationship that is crucial to the health of the global economy.We are delighted, therefore, to present this report to policymakers and the public, andhope that it might provide a useful point of departure for both sides to think creativelyabout how to bring their indispensable relationship to the next level.We would like to thank the staff of our four institutes for all their hard work on theEU–China 2025 project. We are also very grateful for the support of the membersof our Senior Advisory Group, chaired by Romano Prodi, President of the EuropeanCommission (1999–2004) and Zeng Peiyan, Vice Premier of the People’s Republicof China (2003–08), who provided invaluable input and are listed overleaf.Professor Lawrence J. Lau, The Chinese University of Hong KongDr Robin Niblett, Chatham HouseDr Guntram Wolff, BruegelMr Zhang Xiaoqiang, China Center for International Economic Exchanges (CCIEE)iv

Senior Advisory GroupChairsRomano Prodi, President, EuropeanCommission (1999–2004)ZENG Peiyan, Chairman, CCIEE;Vice-Premier, State Council, People’sRepublic of China (2003–08)MembersCHEN Dawei, Vice President, China–EUAssociation; former Vice Minister,Ministry of Housing and Urban-RuralDevelopment (2008–15)CHEN Deming, former Minister ofCommerce (2007–13); President,Association for Relations Acrossthe Taiwan StraitsVictor CHU, Chairman, First EasternInvestment GroupIan Davis, Chairman, Rolls-Royce plcTom Enders, CEO, Airbus GroupMario Monti, Prime Ministerof Italy (2011–13)NING Gaoning, Chairman of theBoard, Sinochem GroupFrances O’Grady, General Secretary,Trades Union CongressGordon Orr, Senior Adviser, McKinsey;Board Member, Lenovo;Board Member, Swire PacificUrs Rohner, Chairman of the Boardof Directors, Credit SuisseSHU Yinbiao, Chairman, State GridCorporation of ChinaMichael Spence, Recipient of the 2001Nobel Memorial Prizein Economic SciencesVictor FUNG, Group Chairman,Fung GroupSUN Yongfu, former Director-General,Department of European Affairs,Ministry of CommerceDame Clara Furse DBE, Chairman,HSBC UK; Chief Executive,London Stock Exchange (2001–09)György Szapáry, Deputy Governor,Hungarian National Bank(1993–99; 2001–07)HE Yu, Chairman, China GeneralNuclear Power GroupPhil Thomson, President of Global Affairs,GlaxoSmithKlineHUANG Min, Vice President,China RailwayTIAN Guoli, CEO, Bank of China LtdHUANG Ping, Director-General, Instituteof European Studies, Chinese Academyof Social SciencesAnatole Kaletsky, Columnist, ReutersGerard Kleisterlee, Chairman, VodafoneCaio Koch-Weser, Secretary of State,Ministry of Finance, Germany (1999–2005)Pascal Lamy, Director-General (2005–13),World Trade Organizationv Peter Mandelson, First Secretaryof State, UK (2009–10);European Commissioner forTrade (2004–08)Jean-Claude Trichet, President, EuropeanCentral Bank (2003–11)TUNG Chee-hwa, Vice Chairman, 12thNational Committee, Chinese People’sPolitical Consultative Conference,People’s Republic of China; FirstChief Executive, Hong Kong SpecialAdministrative Region (1997–2005)Axel Weber, Chairman, UBSLI Shufu, Chairman, Zhejiang GeelyHolding Group Co., LtdZHAO Jinjun, Vice Chairman, CCIEE;Ambassador Extraordinary andPlenipotentiary of China to the Republicof France and Monaco (2003–08)MA Yun (Jack), Founder and ExecutiveChairman, Alibaba GroupZHAO Xianming, Executive Directorand President, ZTE Corporation

Executive SummaryBackgroundThe European Union (EU) and China have much in common. Their GDPs( 14.72 trillion and 9.75 trillion, respectively, in 2015) rank number two andnumber three in the world, behind the United States ( 16.64 trillion). They are twoof the most externally-integrated economies in the world, with annual internationaltrade in goods and services of 15 trillion ( 5 trillion if only trade external to the EUis considered) and 4.75 trillion, respectively, in 2015. Their annual bilateral trade ingoods and services stood at 580 billion in 2015, with each being the other’s largestsource of imports and second-largest export destination. Both EU and Chinese leadersbelieve that effective rules-based multilateralism should form the core of globalgovernance. The two are also not security competitors.At the same time, the United States is stepping back from playing a leadership rolein support of more open global markets and there are profound concerns across theworld about the negative impacts of globalization on income inequality. This overallshift makes it an especially important moment for the EU and China to consider howto deepen the full range of their bilateral economic relationship – by increasing tradeand investment, promoting cooperation in the areas of climate change, energy andthe environment, and global governance, collaborating in science, technology andinnovation, infrastructure, and financial services, and engaging in people-to-peopleexchanges. These efforts can be mutually beneficial – they help to sustain economicgrowth, create jobs and improve levels of social welfare not only within their ownsocieties but also globally.Trade in goods has been the driving force in the EU–China economic relationship.Bilateral trade in goods grew by an average of 14.4 per cent each year between 2001and 2011, and, although the growth rate declined to 3.6 per cent between 2011 and2016, trade in goods has rebounded since the beginning of 2017. With the EU recovering well from a protracted financial crisis, and China committed to sustaining annualGDP growth above 6 per cent as its economy undertakes further reform and opening,there are significant opportunities for the two sides to further deepen their economicrelationship in the future.However, beyond trade in goods, many areas of economic interaction remainunder-developed, including trade in services, levels of foreign investment, cooperation on industrial and technological innovation, and financial market integration.Chinese imports of services grew at an average annual rate of more than 25 per centbetween 2010 and 2015, and the EU’s trade surplus in services with China has beengrowing at an average annual rate of 37 per cent since 2010, reaching 11 billion in2015. Current stocks of the cumulative direct investments of the EU and China in eachother do not reflect their overall weight in the global economy or the extent of theirtrade. In 2015, the stock of EU foreign direct investment (FDI) in mainland China(not including Hong Kong) amounted to 168 billion, and investment stock frommainland China in the EU was only 35 billion ( 115 billion including Hong Kong),even though Chinese investment flows into the EU have grown substantially in recentyears. This contrasts with the stock of EU FDI in the US of 2.6 trillion and US FDIstock in the EU of 2.4 trillion. The low stocks to date show that there is scope for anenormous increase in the coming years and decades in investment in both directions.Growing Chinese consumption, especially of services, has the potential to createnew markets for European businesses, while rising Chinese investment in the EU,in addition to increasing EU GDP and employment, also provides Chinese companieswith a platform to improve their global

EU–China Economic Relations to 2025: Building a Common FutureExecutive SummaryHowever, elevating the EU–China economic relationship into the genuine strategicpartnership envisaged by EU and Chinese leaders will require greater effort from bothsides. On the one hand, many EU business leaders perceive Chinese companies assources of unfair competition, in both the EU and Chinese markets. On the other hand,Chinese companies worry that the EU can impose policy measures against them, suchas anti-dumping and countervailing duties, which are perceived in China as unfair.Moreover, EU leaders are distracted by a full policy agenda, ranging from eurozonereform to negotiating Brexit.China is also in the midst of a complex economic transition. Structural changesunder way in its economy and slower rates of growth are creating new challengesfor European and Chinese businesses operating there. The impact of new technologiesand innovation is likely to intensify disruption to existing business models as muchas provide new economic opportunities. In these circumstances, differences over therole of the state in their respective economies mean that the European and Chineseeconomic models are unlikely to converge in the foreseeable future. Significant differences between the political and economic systems of the EU and China add to the challenges of deepening their bilateral economic ties.RecommendationsGiven this mix of challenges and opportunities, it is important that EU and Chineseleaders pay more attention to their bilateral strategy and consider how deepeningtheir economic relationship between now and 2025 could bring mutual benefits.This means building on the existing EU–China 2020 Strategic Agenda for Cooperation,re-stating their common interests in the new global context, while also recognizingmore candidly their differences, and prioritizing progress where it is achievable andwhere relations are currently under-developed. The over-arching goal should be topromote sustainable, balanced and inclusive growth of both economies.Specifically, the EU and China should:1. Conclude an investment agreement as soon as feasibleThe ongoing EU–China negotiations for an investment agreement can be usedas a platform for addressing differences and facilitating further investment, witha view to concluding an investment agreement between the EU and China that worksfor both sides as soon as feasible. The investment agreement will replace existingbilateral agreements between China and EU member states. The aim of such an agreement is to create a more open, transparent and secure environment for greater futureflows of investment.Market access is currently the most challenging issue in these negotiations.Potential Chinese investors in the EU perceive growing scrutiny from EU national regulators, on grounds of national security and unfair competition. Conversely, Europeancompanies perceive major limitations to access the Chinese market on grounds ofdomestic development strategy and protectionism of certain sectors. In pursuing theinvestment agreement, therefore, the objective should be to create fair, stable, transparent and predictable business climates in China and the EU, so that companies fromboth sides enjoy equal treatment regardless of their country of origin. This will requireboth the EU and China to update their respective strategies and institutional frameworks, including possibly the passage of new legislation, to ensure such business climates and to strengthen protection for intellectual property rights.vii

EU–China Economic Relations to 2025: Building a Common FutureExecutive SummarySome EU concerns could be partly addressed by Chinese companies adopting prevailing international principles of corporate governance. China would expect theEU to acknowledge that Chinese companies are starting from a different point andoperating in a different economic system. Nevertheless, the Chinese government hasstated that it is committed to opening up its markets further to foreign investment andletting the market play a decisive role in the allocation of resources. An important steptowards reaching an agreement, therefore, would be for China to begin implementingthe application of its ‘negative list’ on investment to its whole national territory ratherthan solely in the free trade zones (FTZs), after which, shorter, coordinated ‘negativelists’ for investment could be agreed between the EU and China.Meanwhile, the EU–China investment agenda should focus more on opening upeach other’s service sector. An EU–China investment agreement has the potentialto spur a new round of economic reform, including in the SOEs, and market liberalization in China.2. Open negotiations on establishing an EU–China free trade agreement (FTA)Such negotiations can be initiated upon the successful conclusion of the investmentagreement between the EU and China. China’s relative importance to the EU as a tradepartner will continue to grow in the coming years, even as the EU’s relative importanceto China is likely to decline slightly (by 2020, the EU may no longer be China’s largesttrading partner, partly as a result of Brexit). This means that the extent to which Chinaand the EU further open up their markets and improve trade and investment liberalization and facilitation with each other will be a crucial factor shaping EU–Chinaeconomic relations to 2025.As China’s economy continues to develop and urbanize, leading to a shift tohigher-quality consumption and higher value-added activities, expanding marketaccess and coordinating regulation between the EU and China will become moreimportant and potentially easier to achieve. Trade in services should be actively promoted in both directions. Healthcare products and services are good examples of areasthat can benefit both sides. Driven by the changing demographics of China’s ageingpopulation and the capacity gap in healthcare provision between the EU and China,it should become a major area for market opening.As an example of an FTA’s potential impact, Chinese research estimates that an FTA in2020 could increase the EU’s exports to China by one-third over the five years to 2025,while China’s exports to the EU would be 20 per cent higher. Although an FTA wouldhelp improve the EU–China trade balance, eliminating the EU’s trade deficit withChina will require additional joint efforts beyond an FTA.In the meantime, the two sides should encourage pragmatic cooperation and marketliberalization across a number of related areas, while conducting further researchand engaging in dialogue on how an FTA could help deliver mutually beneficial economic development.3. Use China’s Belt and Road Initiative (BRI) as a platform for further expandingbilateral trade and economic cooperationThe BRI offers the opportunity for complementary benefits to the EU and China.The EU has the potential to become the western ‘anchor’ of the BRI, which aims tocreate new land and sea connections between the fast growing markets of East Asiaand the mature, developed markets of Europe, enhancing trade between them asviii

EU–China Economic Relations to 2025: Building a Common FutureExecutive Summarywell as markets along the planned rail and sea routes. Related Chinese investment,alongside the EU’s ‘Juncker Plan’, can help address some EU infrastructure bottlenecks, especially in port and rail facilities in Central and Eastern Europe, and throughnew rail freight routes between China and Europe. The EU’s global trade couldincrease by some 6 per cent as a result, once all related projects are completed, principally due to a reduction in transport costs. EU companies could use these new routesto increase the amounts of their exports to a growing Chinese consumer market,even as Chinese companies improve the price competitiveness of their exports inthe other direction.For their part, EU financial institutions can bring expertise in the long-term financialmanagement of complex infrastructure investment projects, while European investment could help BRI projects meet the necessary global standards for environmentaland other forms of sustainability. Moreover, new BRI-related investment, trade andindustrial cooperation can help invigorate growth in the EU and its neighbourhood.The EU and China should ensure that these investments contribute to balanced, sustainable and inclusive development for both and for the world economy as a whole.4. Deepen EU–China cooperation on energy security and climate changeThe EU and China share many common objectives in relation to energy and climate policy. In 2016, the EU and China signed an energy cooperation roadmap, promoting bilateral cooperation in energy security, infrastructure building, and markettransparency. Future objectives include strengthening bilateral cooperation in design,low-carbon energy systems, energy legislation and policy, standard setting, and pricingmodes and governance mechanisms, especially in nuclear and renewable energy.The EU and China have also reiterated their strong support for the 2015 ParisAgreement on climate change, after US President Donald Trump announced in June2017 that the US would withdraw from the accord. In order to help sustain domestic and international progress towards the Paris goals, the EU and China could takea number of steps together, in accordance with the principle of common but differentiated responsibilities, as stated in the United Nations Framework Conventionon Climate Change. These include pursuing their Intended Nationally DeterminedContributions, securing financing for programmes in the least developed countries,and deepening their cooperation on data sharing and transparency in multilateralforums. Climate finance, including green development finance, should be anotherkey area for deeper cooperation.5. Focus on the opportunities offered by new breakthroughs in science,technology and innovation (STI)Breakthroughs in STI will be key factors in shaping economic development in the EU,China and across the world in the coming years. They will also be necessary to manageglobal challenges such as climate change, energy efficiency and active and healthyageing. The EU and China both have major initiatives under way to leverage theseopportunities, and should facilitate cross-border collaboration as necessary.What makes this a promising area for EU–China cooperation is that STI is a field drivenless by questions of market access and more by the capacity of those engaged in innovation to create networks across borders. Companies involved in STI already link togetherresearch and development (R&D), collaboration with universities and production valuechains across multiple locations. EU firms are estimated to conduct over 40 per centix

EU–China Economic Relations to 2025: Building a Common FutureExecutive Summaryof their R&D overseas, and their investments in research and development centres inChina make up a significant part of the Chinese innovation system. Similarly, Chineseenterprises are building more R&D, design and information centres in Europe.Although Chinese STI expertise lags behind the EU in many manufacturing and service sectors, some Chinese companies are already world leaders in communicationsinfrastructure and applications, and e-commerce. As China’s domestic market growsin scale, its companies will increasingly work alongside EU companies and others indriving globally-networked innovation, potentially leap-frogging current technologyin areas such as modern agriculture, advanced manufacturing, and services. Theemergence of these sectors demonstrates the way in which opportunities for EU–Chinabusiness-to-business collaboration continues to shift from traditional manufacturingto advanced manufacturing as well as new information technology, internet security,biopharmaceutical, renewable energy and ‘new energy’ automobile industries.Still, more proactive efforts from both sides will be needed to secure ‘win-win’ cooperation. Chinese enterprises consider the current EU bans and restrictions on exportsof high-technology products discriminatory and unfair. For their part, European businesses consider that their intellectual property is not sufficiently protected and thattechnology transfer tends to be uni-directional. Furthermore, they are increasinglyconcerned about Chinese government support for domestic high-technology sectors.Both the EU and China will therefore need to promote specific opportunities for technical cooperation wherever possible. Concerns over cybersecurity will also need to bemanaged sensitively and consistently. However, growing Chinese focus on protectingintellectual property and working more closely with the EU in setting global standards for future technologies could help the two sides overcome current obstaclesto cooperation. Ultimately, what European and Chinese companies build and designtogether will be as important as what they sell to each other.Investing more in STI cooperation under a networked approach will depend to a greatextent on easing the capacity for individuals to travel to and work in each other’s markets. At a basic level, the growth of the Chinese middle class and levels of consumptionmakes it more likely that there will be significant expansion in the number of Chinesetourists and students in Europe. According to Chinese research, in 2015, consumptionper capita of Chinese visitors to the EU reached 2,200, contributing 0.3 per cent to EUGDP and raising EU employment by 0.6 percentage points. All of the areas describedhere – from trade and investment to deepening people-to-people exchanges – wouldbenefit greatly from targeted, reciprocal, multi-year and multiple-entry visas.6. Support further EU–China cooperation in the financial sectorIncreasing levels of EU–China trade and investment, driven in part by the increasedpresence of Chinese enterprises in the EU as they continue to ‘go global’, will requiremore financial support from institutions in the EU and China. The early involvement of EU member states in the Asian Infrastructure Investment Bank and Chineseinvolvement in the European Bank for Reconstruction and Development have shownthat the EU and China are willing to deepen cooperation in multilateral financialinstitutions. The massive demand for infrastructure financing in Asia and under theBRI will offer new opportunities for financial cooperation, especially if the two sideswork together to use these opportunities to champion green financing mechanisms and products.x

EU–China Economic Relations to 2025: Building a Common FutureExecutive SummaryThe EU and Chinese economies are both dominated by bank financing and are experiencing a rapid expansion of their capital markets, though they are starting fromvery different initial conditions. Liberalizing the entry requirements for EU financialinstitutions into the Chinese market would enable them to support China’s reform anddevelopment of its financial services industry, including helping to improve regulatorystandards and technical financial oversight, thereby enhancing the allocative efficiencyof capital in China and promoting stable and sustainable development. Similarly, moreChinese financial institutions should be encouraged to operate in the EU. In addition,enterprises of both the EU and China should be permitted as well as encouraged tolist their shares and to issue debt in each other’s capital markets, thus facilitatingthe development of direct finance.Even though most of China’s capital account categories are already either convertible,basically convertible, or partially convertible, the foreign currency assets of China’sprivate sector are still relatively small, as are global investors’ portfolio assets in China.However, a global portfolio rebalancing process will begin when Chinese capital controls are further relaxed, with portfolio investments flowing in both directions. Therewill then be new opportunities for the EU and China to deepen their financial cooperation to ensure a smooth, orderly and stable transition in the Chinese (including HongKong’s) international capital and foreign exchange markets.Working together, the EU and China could promote the use of the euro and the renminbi in global transactions. The internationalization of the renminbi is proceedingwith a high level of involvement from EU financial institutions. In the longer term,when China’s financial markets are sufficiently mature and open, there will be moreopportunities for the EU and China to cooperate to maintain the integrity of globalfinancial markets and to strengthen the global financial architecture.7. Contribute to strengthening mechanisms of good global governanceBoth the EU and China should continue to promote an open world economy and contribute to the improvement of the global economic order. Deepening EU–China economicties will not only bring potential benefits to both the EU and China, but also go some waytowards strengthening the global economy and more broadly enhancing global governance, given the importance of both economies in the world. However, the beneficialeffects of working more closely together will depend on certain pre-conditions.First, it should be recognized that EU–China cooperation should not disadvantagethe US, given its paramount importance to both the EU and China as well as to theglobal economy. Finding ways to connect the US to aspects of EU–China regulatory,financial, research and development

trading partner, and that China is the EU’s second-largest export market and main . (1999–2004) and Zeng Peiyan, Vice Premier of the People’s Republic of China (2003–08), who provided invaluable input and are listed overleaf. . Professor Lawrence J. Lau, The Chinese University of