European Business and Investment under China’s Zero-COVID Policy

Whereas EU countries have adjusted to living with COVID-19 and lifted restrictions on masking and social distancing, China’s strict “Zero-COVID” policy has considerably affected European business operations. This has been pushing European companies to re-evaluate their China strategy and reconsider operational alternatives in the medium or long term. In what follows we will assess the latest developments for EU businesses and investment in China, zooming in on a number of specific sectors, forecasting future EU-China trade and investment opportunities and challenges.

European Business and investment in China

On 1 June 2022 Shanghai ended its COVID-19 lockdown after two months. Although normalcy is slowly returning, the recent lockdowns have brought domestic issues and policies in China back to the forefront, waking up EU business leaders and decision makers to EU businesses largely operating in China. Additional lockdowns may not be excluded given the Zero-COVID policy, therefore motivating EU firms and companies to have their contingency plans ready in order to ensure continuity in production and trade. 

On 5 May 2022, the European Chamber of Commerce in China, in partnership with Roland Berger, released a survey on the impact of China’s COVID-19 policy on European business in China. According to the survey, nearly a quarter (23%) of European companies are considering moving planned or current investments to other markets as investors seek more stable and predictable operating conditions. This is more than double the number that were considering doing so at the beginning of 2022, and the highest proportion in a decade. 77% of respondents reported that China’s attractiveness as a destination for investment has decreased because of the country’s stringent and fast-changing COVID-19 policy. The survey captured the deep impact that the Zero-COVID policy had on EU investors’ confidence in doing business in China.

While some European businesses seek alternatives, European firms already operating in China are confronted by the negative impacts of Beijing’s “Zero-COVID” policy. Severe lockdowns in China’s major cities have exacerbated the supply chain problems on top of the disruptions posed by the war in Ukraine, particularly by putting strain on logistics, warehousing and business travel. According to the survey, 85% of European companies operating in China are struggling to obtain raw materials or components for manufacturing. The volume of goods leaving Shanghai’s port dropped by a quarter between mid-March and early April 2022, and China’s road-freight traffic fell by 40% over the same period. This has caused significant delays of finished goods delivery to local customers and the rest of the world. Yet, it is crucial to acknowledge that this is not solely linked to China, as the rest of the world has been grappling with similar difficulties posed by challenging global dynamics. 

While the concerns of the European business community are clear, there may be a disconnect between their perspective and the reality of the Chinese business environment. From the perspective of the Chinese business community, there are indeed challenges to overcome due to the Zero-COVID policy. However, these do not unveil the whole picture. Chinese businesses engage with the Chinese market as a sophisticated and extremely competitive one, whereas certain European businesses seem to retain the same preconceptions of the Chinese market that they did a decade ago: cheap labor, low competition, massive market access, and quick money. In other words, it is quite likely that the reaction of European businesses to COVID-induced challenges reflect not only the impact of the Zero-COVID policy but also a mismatch between their expectations and the reality of the Chinese market.

Doing business in China has never been never easy. Like any business environment, China’s market poses unique challenges. However, while the Chinese market may pose significant challenges to European business, the revenue and profitability for European businesses has remained positive, even during the pandemic. If European businesses want to continue to take advantage of the opportunities the Chinese market offers, they will need to adapt to the latest market dynamics, with a mindset for more long term commitment and investment, but also competition in order to increase the resilience to new challenges such as the Zero-COVID policy.

Despite facing some risks over the increasingly politicized business environment and wide-reaching COVID-19 policy in China, there are still valuable advantages and benefits to operating in China. European companies will remain eager to maintain access to China’s large markets and China still continues to offer competitive operational costs thanks to its highly capable production scale and accessible supply of materials and personnel. For these reasons,  European companies seemingly remain committed to China in the long term and prepared to weather the storm for now. 

Potential Solutions: Enhancing Trade and Investment in Eastern Europe and Southeast Asia

Moreover, in response to the intensified geopolitical rivalry between the US and China, a debate has emerged in EU business and policy circles around reshoring production and shifting supply chain routes. However, this debate can easily fail to consider industry-specific contexts. It is important for the EU to consider that reshoring is not a one-size-fits-all solution. Instead, reshoring should be primarily focused on critical sectors and products with pronounced supply bottlenecks. Feasible alternatives to reshoring should be industry and location specific to facilitate transitions.

Challenges in moving back to Europe

Central and Eastern European countries (CEEC) are favorable reshoring options within the EU due to their geographical proximity and cultural similarity. Although the labor costs are higher than in China, the shortened delivery time and the advantages of being within the EU single market could offset the additional labor cost, according to data collected by the European Reshoring Monitor Project. The more difficult challenge would be that CEECs lack supplier capability in the region and need to source raw materials from other parts of the world. An additional barrier would be the lack of large-scale manufacturing facilities in CEECs compared with the comprehensive manufacturing infrastructure China has developed over the past few decades.

Even when there is a lack of financial incentive, the arguments for nearshoring, particularly in strategic sectors such as electric car manufacturing and pharmaceutical industry, are largely political. Government initiatives are likely to be the main driving force and might push forward with this approach with EU firms. 

Diversifying in Southeast Asia

Southeast Asian countries have always been the preferred alternative options for reshoring out of China for low-tech sectors, and particularly the textile and clothing (T&C) sector. This can be attributed to three main competitive factors: geographic vicinity to China, openness to foreign investment, and low labor costs. The EU has been paving the way towards further cooperation in the region, and already has a Free Trade Agreement (FTA) with Vietnam and Singapore. However, Vietnam, like other ASEAN countries, faces the disadvantage of heavy reliance on China for raw and intermediate materials supply. Notably, China was the largest T&C supplier to Vietnam in 2019, accounting for 50% of Vietnam’s total T&C import, mostly cotton and fiber. Unfortunately it will require some time for ASEAN countries to catch up with Chinese supply chain scale and capacity. Nevertheless, Southeast Asia can be a satisfactory relocation destination for low-tech EU companies, as could South Asia be.

Trade and Investment Future Outlooks in China

China’s strict COVID policy gives a fresh impetus for EU business and investment groups to re-evaluate the future outlook in China and reconsider their China strategy. Unavoidably, geopolitics will need to be taken into consideration. The Comprehensive Agreement and Investment (CAI) stagnation is a vivid and ongoing demonstration that business and trade policies between the EU and China are strongly intertwined with political positions. 

For European business and investment in China, a positive outlook still remains, As there are other solutions worth endeavoring for European companies. European businesses will need to rethink how to do business with China in the future. One solution is to diversify their logistics to a combination of distinct methods to transporting goods, rather than solely rely on ocean shipping. Another emerging potential would be digitalization, as large digitized platforms and widespread digital payments like in China have the potential to make business more transparent.

On the other hand, for sectors which have higher prospects for reshoring, it would be realistic for EU companies to take China’s role as a major raw materials supplier and enormous market into consideration. This implies that bluntly cutting ties and putting operations in China to an end would place many EU businesses in a disadvantageous position and to miss out on great opportunities. Instead, to address these challenges and mitigate the situation, the European business community should advocate stronger and more integrating economic relationships between the EU and China, whilst engaging with China constructively, which will also reinforce EU’s competitiveness in the long run. With the objective in mind, dialogues and exchanges between the EU and China need to be reinforced and continued to ensure an optimistic outlook in China, particularly in advancing diverse dialogues including a combination of business and policy communities. 

Ultimately, European businesses are presented with diversifying considerations to continue business operations and investment in China; to grow and prosper by building trust and transparent relations; diversifying their logistics; and exploring digitalization. Essentially, COVID-19 will fade away and associated challenges are likely to be temporary. While for some industries and particular companies there may be viable options for relocating, in the long run, China still remains a top destination for European business and investment, despite the current drop. In general, EU business and investment need to be reminded that China has developed itself into a mature and sophisticated market and will continue to be so.

Author: Shasha Pogon, EIAS Junior Researcher

Photo credits: Unsplash