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EU-China trade deal is a Trojan Horse sellout

Australian Financial Review | 30 March 2021

EU-China trade deal is a Trojan Horse sellout

by Adrian Blundell-Wignall

Article 21 of the Lisbon Treaty states: “The Union’s action on the international scene ... seeks to advance in the wider world: democracy, the rule of law, the universality and indivisibility of human rights and fundamental freedoms, respect for human dignity, the principles of equality and solidarity…”

Yet right at the end of Angela Merkel’s tenure, with unseemly haste, we have the sudden conclusion of the EU-China Comprehensive Agreement on Investment (CAI), just at the time when these very things are being taken away from China’s Muslim minorities and the people of Hong Kong.

Helmut Kohl broke the ice for Germany with China following Tiananmen Square. Since then, the two countries have always “understood” each other.

You don’t criticise China and the deals follow. The middle ground can be walked between China and the West with the line: “dialogue and personal relationships are more constructive”.

That certainly has worked for Germany. China is already its largest trade partner.

Four factors underpinned the speedy signing. First, with diplomatic relations deteriorating with the West it is a win for China. Second, both countries see potential economic benefits: German technology will help fill the gap as the West toughens the rules on China; and German trade and investment will grow even further.

Third, Brexit. Britain would side more with the US on the China question. It has a greater respect for the role of markets compared to the much more dirigiste Europe – where the interference of the state has always played a large role. With Brexit, there is now no serious counterweight to Germany’s self-interest in Europe (France generally plays along with its much-larger neighbour). The UK’s strong views on Hong Kong too would have put a brake on things.

Germany will pay lip service to the China issues while dealing for itself.

The fourth factor was that Joe Biden was elected President of the United States and flagged a desire to work with Europe on dealing with China trade issues through the Trans-Pacific Partnership (TPP), a multilateral approach that deals with state-owned enterprises (SOEs) and subsidies. Locking in the German path for trade and investment with China before Biden became a constraint avoids delays to the perceived benefits for Germany.

China’s import penetration of the West is no accident. With SOEs and subsidies in operation, US companies would have to cut prices by 25 per cent-30 per cent to match China (and the US is the highest productivity country in the world). But being a “strategic partner” helps. US imports from China have risen to some 20 per cent of its total imports, but its exports are only a quarter of this. The picture is similar for Britain. Germany, by contrast, has rising foreign investment and (related) imports while its exports to China are also buoyant (see the chart).

The rapid agreement with China is short-sighted and damages the European project.

China’s aim in allowing inward investment first from the US and now from Germany is to absorb technology – a lesson the US has learned. The welcome to Germany as the US clamps down is something of a Trojan Horse. But even if Germany believes it can protect itself, it can’t protect the south of Europe from competition from SOE China. Opening further avenues for Chinese entry to Europe before SOEs and subsidies are dealt is something of a nightmare for less technologically advanced countries in the south of Europe hemmed in by the euro.

The trends in the chart illustrate some of the substitution effects underway when a currency union is imposed on the vast structural differences between countries as Europe turns towards SOE China.

Britain has been an early casualty.

Europe (especially the north) has a comparative advantage in producing goods whereas for Britain it is services (finance, the City, consulting and the professions). The single market was never going to be much help for Britain because its rules are well-harmonised for goods but not for services.

The services directive stipulates non-discrimination, but national residence, language and tertiary qualification requirements are permitted, and key sectors (eg financial services, electronic communication, transport, healthcare) are singled out for sector-specific legislation. Here country regulations may be applied where the public interest, security, health and consumer protection issues are flagged. The resulting complex patchwork of regulations fragments the market for services. Hence Britain has always run a tiny services surplus with Europe alongside a large goods deficit.

At least Britain had its exchange rate as a buffer, which helped it to match German GDP following the 2008 crisis. Others, such as Italy and France also shown in the chart, are not so lucky. They have to contend with China on an unlevel playing field with no exchange rate buffer. That Mario Draghi – the saver of the euro – has taken on saving Italy is ironic. Imagine Montagu Norman invited to run the US economy in 1933 instead of FDR—the Gold Standard scold versus the President who recognised the need to devalue.

Germany will deal for itself

The CAI is is not unlike the Australian free trade agreement with China, in that SOE issues are not dealt with. Subsidies are touched on but with plenty of escape clauses like: “… the requested Party shall use its best endeavours to find a solution with the requesting Party. Any solution must be considered feasible and acceptable by both Parties”. Australia has also seen what these agreements mean for China – if you criticise they will be ignored.

So, the Western world is left with a Europe-China economic and political problem. Britain is no longer in the EU as a balancing force. Germany will pay lip service to the China issues while dealing for itself.

It will therefore be more difficult to bring pressure on China to change its approach to trade. The south of Europe will be urged to carry out more reform, forcing them towards further internal devaluation (downward pressure on already-low wages and living standards).

In essence, Germany and like-thinking northern countries seem to be saying to the south: “it is you that needs to reform more and not China. You had better hurry as we are opening the door further”.

The US and other western countries are going to have to push harder for a TPP-like solution including (but not watered-down by) Europe.

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 source: Australian Financial Review