How Should the EU Deal With China?

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When Obama sat down with Hu this week, he faced the quandary raised last year, according to WikiLeaks, by Hillary Clinton: how a nation talks tough with its banker.

The euro crisis and resultant Chinese investment in European sovereign debt, partly in a bid to help shore up the single currency, means that several EU countries now have something else in common with Washington: China is their banker too.

Those who worry that China has ‘bought Europe' with its recent investment should remember the above chronology. Its investment in the USA is larger and longer-standing, yet nobody would argue that American foreign policy is run from the Middle Kingdom. Even in this economic counter-current, the EU is trying out a more reciprocal and hard-nosed engagement with China than has gone before.

Yet Chinese attitudes to the US and Europe are of course different. The latter is seen by Beijing more as a source of potential opportunities for investment and high-tech acquisitions than as a global player. China's Vice Premier Li Keqiang, the up-coming man in the Chinese post-2012 power team, made headlines during his recent trip to Europe when he went on a January sales shopping spree, with a number of contracts inked in Germany, Spain and the UK. Add to that the announcement that China will buy a solid amount - reportedly six billion euro - of Spanish bonds. That follows earlier bond buy-ups throughout 2010 in debt-ridden European countries such as Spain and Greece.

China has constructed an image - assisted by clever public diplomacy and the fixation of the European media - as the saviour of the euro. ‘Cold Europe is feeling the warmth of the Chinese breeze,' as Liu Xiaoming, China's ambassador to the UK has poetically described it. What does China want in return for spending its money in Europe?

Rather than engaging in too many conspiracy theories, we have to take Chinese behaviour at face value to a large degree. China does not want to see the euro break up, or the European economy go completely downhill. The reason is not pure altruism; Europe is China's largest trading partner and a stable European economy is in China's national interest. A continued weakening of the euro, which the Chinese currency is not pegged to like the dollar, makes European exports more competitive. Germany is already making good inroads into the Chinese market at the moment. Volkswagen that sold more than 1.9 million cars in China last year.

Another straight-forward reason for going shopping in Europe is that China has money to spend, holding as it does the world's largest foreign exchange reserves. It is at saturation point with the dollar, and the next debt crisis might well unfold in the US. Its interest in the euro is therefore understandably heightened, notwithstanding market jitters.

China also needs access to high-end technology and distribution networks for the next phase of its economic development, which will be based on innovation and internal consumption. Europe has the high-tech, and fewer restrictions than the US on Chinese investment. Compare the US block in 2005 on Chinese company CNOOC's bid to buy up UNOCAL with the official British blessings given to recent deals by both CNPC and CNOOC, through which China bought into UK oil refineries. The EU's Industry Commissioner, Antonio Tajani, was a lone and little-heeded voice in calling for a supervisory body in the EU, like in the US, to oversee investments.

The equation is simple. Europe really needs money and investment coming in. China has it. That is a positive story for both sides. So what are the broader implications of this happy economic relationship? Can China also buy political influence in Europe through national deals? Newspapers and commentators were quick to link the last Chinese visit to a possible lifting of the arms embargo, high on China's wish list in relations with the EU.

Yet just as Beijng does not run the State Department, China cannot simply buy a lifting of the arms embargo. Spain was already pushing for a lifting of the embargo before China's buy up and the UK was still resisting after the new trade deals were signed and 700 jobs secured in the UK. Unlike with the US, however, China can and does use a divide-and-rule policy to exploit differences between member states within the EU. China knows that southern European countries will dilute EU human rights policy, and that free-traders in the North, spearheaded by the UK, Netherlands, Denmark and Sweden, will work to block strong retaliatory moves on trade that smack of protectionism. The EU's policy continuously ends up in a lowest common denominator comfortable for China. Recent economic deals will reinforce the bilateral tendencies of European countries, and thus aid Beijing's continued dividing and ruling.

For China, the most important political concession to secure from debt-ridden PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) in which it invests is reduced insistence on trade protectionism. The recent moves by the EU towards removing anti-dumping tariffs on Chinese shoes, which have been in place since 2006, might represent the first fruits of this. That would show that investment in European bonds is a well-placed insurance policy against trade protectionism, something that China fears from both the EU and the US.

But in the wings, as the euro crisis absorbs the limelight, Europe has been adopting a new approach to China directed by Catherine Ashton, the EU's new foreign policy head. The script for this new strategy is right, with a central focus on the need for "reciprocity" - giving to China only when the EU gets something back. Enacting this will not be easy in a time when the EU is getting weaker financially, but there are signs of real movement; the EU is, for example, considering the possibility of closing off the European public procurement market to Chinese firms if China does not give similar access.

Ashton's new strategy also specifies an urgent need for the EU to define clear priorities and stick to them in negotiations, in order to match China's consistent demands and so-called ‘core interests'. That is easier to write in a strategy paper than put into practice. Dealings with China by individual member states show that short-term benefits for national capitals are often preferred to joint European priorities. China will work actively to continue that division in 2011. For example, there was no official Chinese announcement on investment in the eurobonds issued by the new EU emergency fund to sustain Ireland. The auctioning of those bonds coincided with China's bilateral move into Spain, and Beijing knows that dealing bilaterally with the political dwarfs of Europe leads to larger pay-offs than bolstering multilateral European initiatives.

The new EU diplomatic force, called the External Action Service, is starting to function and will work to implement Ashton's new approach. Yet that is not enough for a genuine turnaround in relations with China. Member states must make strategic choices that do not favour short-term national rewards at the expense of Europe's strength, and which recognise the new realities of what is really in their national interest in the longer term. The big players in Europe have been bypassed economically in the last decade by China. They still have traction individually, but much less than their national egos would like to think - this is true even for Germany, which is currently accelerating its large-scale exports to China. Bilateral state visits must be employed to amplify European priorities. Germany could find a new role here as a natural leader and the primus inter pares among the big three European players, amplified by its own burgeoning trade relationship with China that gives it traction in Beijing and bolstered by flattering remarks from China about the quality of German goods.

If the EU's new strategy actually gets off the ground, the US also has to be prepared for the fact that independent European decisions will be taken on the basis of what can be secured in the European interest. That will mostly mean trade and market access. But an EU decision to lift the arms embargo on China - since stringent measures on arms sales that would limit the potential sale to China already are in place - could also be a legitimate part of Europe's new approach of trade-offs with China. The issue still remains internally divisive for the EU - something which both China and the US knows how to exploit - and a continued stalemate is still the most likely outcome also in 2011. Yet Washington must accept that the strong, united European stance on China that it wants and calls for might mean some decisions in Brussels that it doesn't actually like.

Chinese New Year is fast approaching. Caution and sound judgement should be the EU's resolutions, but the likelihood is that member states will oscillate between their ambitions of leveraging Europe-wide power in their dealings with China and moments of bilateral weakness prompted by the urgent need to meet the next debt payment. Chinese help with the latter does not have to make the former impossible but, like the US, Europe must work out how to talk tough to the banker.

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