The European Business in China Business Confidence Survey 2018
The purpose of the European Chamber’s European Business in China Business Confidence Survey is to take an annual snapshot of European companies’ successes and challenges in China. Launched on 20th June 2018, this year’s survey reports that doing business became more challenging over the past year due to longstanding regulatory barriers, market access restrictions and unequal treatment. European companies must now compete with Chinese firms that are more innovative than ever before. Yet they have remained resilient, delivering strong financial results for the second year running.
After years of decline, 2016 was the year in which European companies’ optimism about growth in China rebounded. Sustained by China’s increasingly sophisticated market, this optimism endured in 2017. However, as its economy matures, the longstanding inefficiencies in China’s business environment are rendered all the more glaring. According to the Business Confidence Survey 2018, half of European Chamber members believe the regulatory environment will worsen over the next five years, making the need to address this issue more pressing than ever before.
Domestic enterprises are evolving to meet greater consumer demand, particularly that of the rising middle class for high- quality goods and services, and European companies see them as increasingly challenging competitors. This year’s survey saw for the first time a majority of respondents (61%) report that they perceive Chinese companies to be equally or more innovative than European firms, an increase of 14 percentage points year-on-year (y-o-y). Most notable is the pronounced increase in domestic firms’ capability for product/service innovation, which is catching up with their capacity for go-to-market and business model innovation.
Despite fiercer competition and other challenges such as rising labour and living costs, European businesses delivered strong financial results in 2017, with y-o-y revenues improving for 66% of respondents. Among them, the medical devices, pharmaceuticals and automotive sectors reported particularly robust sales. However, for some sectors regulatory issues hit them in the pocket. For example, the proportion of companies in the information technology (IT) and telecoms sector reporting an increase in revenue of 5% or more, decreased by 25% y-o-y. Some of the reasons for this decline can be found in certain parts of the Cybersecurity Law, such as unclear requirements for “secure and trustworthy” technology, the Cybersecurity Multi-level Protection Scheme and the Critical Information Infrastructure Protection Scheme.
This year marked the highest percentage of companies reporting positive earnings before interest and tax (EBIT) since 2005. Industries such as automotive, transportation, logistics and distribution, and chemicals and petroleum did particularly well. Some factors that have contributed to these results are members’ ongoing prudence and general efficiency. These practices are set to continue, with 46% of respondents saying they plan to cut costs in China in 2018.
Continued cost cutting is driven in part by a more subdued outlook on future profitability, which is a result of the increasingly difficult business environment and growing competition from domestic firms. Emerging markets in Southeast Asia are increasingly catching investors’ attention, where overheads such as labour costs are now much lower than in China. As China turns its focus towards advanced manufacturing, countries like Malaysia, India, Thailand, Indonesia and Vietnam are becoming more attractive destinations for low-cost operations. However, in general, European businesses remain committed to China, which remains a topthree destination for present and future investment for 59% of member companies.
China has made some visible progress in key areas of concern for European firms such as intellectual property rights (IPR) protection, equal enforcement of environmental laws and support for innovation. Perceptions about the implementation of IPR regulations have steadily improved, with more than double the share of respondents reporting enforcement as adequate or excellent compared with 2013. This can be understood in the context of IPR protection now moving to the top of the Chinese authorities’ agenda, as more domestic enterprises rely on technology innovation to fuel their growth and profitability.
As the domestic environment becomes more innovation driven, overall provisions for research and development (R&D) have also improved. Compared to 2016, European companies are now twice as likely to see China’s R&D environment as more favourable than the worldwide average.
There is an increase in the number of companies that believe environmental regulations are being imposed more stringently – 45% of members now report that environmental protection measures are strong, up 23 percentage points from 2017. Moreover, there has been a gradual evening out of how environmental laws are perceived to be applied to European and Chinese entities, which seems to be part of a general trend towards stricter law enforcement for all. While overall discrimination against foreign-invested enterprises (FIEs) has by no means been resolved, the share of respondents who believe they are treated equally with local firms has increased 11 percentage points since 2016.
However, while European enterprises welcome these positive developments, for people running daily operations on the ground persistent regulatory barriers carry a heavy burden. Half of respondents say that doing business in China has become more difficult over the past year, with challenges particularly pronounced in Beijing, Tianjin and Shanghai. Ambiguous rules and regulations are perceived to be the second greatest challenge in conducting future business in China, ranking as the number one regulatory obstacle (according to 48% of respondents). Other major regulatory hurdles include:
- administrative issues (35%);
- discretionary enforcement of rules and regulations (30%);
- market access barriers and investment restrictions (27%);
- and licensing requirements/registration processes for products (25%).
These barriers come at a real cost, with 46% of respondents saying that they missed out on business opportunities as a result of regulatory barriers and limited market access. The industries most affected were pharmaceuticals, legal services and financial services (including insurance). Again, members located in Beijing, Tianjin and Shanghai were most likely to miss out on opportunities.
China’s restrictive regulatory environment in some ways damages its ambitions to become a global leader in knowledge and innovation. Internet restrictions are a case in point, with a majority of respondents stating they have had a negative impact on their business. For instance, 23% of respondents are unable to properly search for information and engage in research. The Cybersecurity Law has also raised significant doubts among members and may become a barrier to future investment for fear of non-compliance.
Even the popular cause of environmental protection has been accompanied by some negative consequences. For example, as part of the campaign against pollution there were instances where regulations were interpreted and applied with a heavy hand, resulting in forced relocations, disruption and increased costs for perfectly compliant companies. Some businesses that were affected are now exploring the possibility of relocating parts of their supply chains to other countries to meet demand.
Small and medium-sized enterprises (SMEs) are most heavily impacted by inefficiencies in the business environment as they do not have the resources to help them deal with ambiguous regulations and cumbersome administrative processes. Although the government has recognised SMEs’ need for additional support in recent policies, such as the SME Promotion Law, many are either applicable only to domestic firms or are difficult for FIEs to benefit from. These restrictions are preventing many European SMEs from scaling up and fulfilling their potential for contributing more to innovation, tax revenue and employment.
Any progress that has been made in regulatory enforcement does not mask the fact that 51% of respondents still believe FIEs are treated unfavourably, although this perception varies depending on both the industry and location of the company. In 8 out of 14 industries, more than 50% of respondents perceive they are treated unfairly, citing administrative issues and market access as areas where they are most likely to face discrimination. Additionally, despite improvements to China’s R&D environment, FIEs are not always able to access funds for innovation that are available to Chinese enterprises. Furthermore, due to persistent issues, such as unfair technology transfers, the number of members opening R&D centres has stalled since 2017.
It may seem somewhat anomalous that these kind of issues persist while China’s overall IPR environment appears to be strengthening. However, once it is understood that many of the improvements are a result of China’s need to protect the development of its domestic core technologies and expansion overseas, it makes more sense. China’s intentions in this respect were further underlined in early 2018 with the release of the External Transfer of Intellectual Property Rights Measures (For Trial Implementation), which placed increased scrutiny on exports of Chinese IPR.
Significant concerns that industrial policies like China Manufacturing 2025 (CM2025) are tilting the playing field in favour of Chinese players remain, with 43% of respondents stating that they have seen increased discrimination under the plan. That being said, some European Chamber members have seen opportunities in CM2025, particularly in sectors where European firms hold a comparative advantage, such as automobiles and machinery. The onus is now on China to further expand CM2025 opportunities for FIEs to clearly demonstrate that it is not just aimed at achieving domestic dominance in the 10 key industries identified by the plan.
The European Chamber urges China to follow through on its promises of reform and opening up that have been repeatedly stated since President Xi Jinping’s speech to the World Economic Forum in January 2017. While some of these pledges have been written into legislation, European companies have yet to see much real concrete implementation. To illustrate this point, only 6% of respondents reported significant results in market opening y-o-y.
The Chinese Government underwent a recent, large-scale restructuring in March 2018, with the aim of streamlining administrative functions by removing overlapping responsibilities between different ministries. This presents a real opportunity for China to address many of the regulatory problems that continue to plague its business environment. However, this can only be done effectively through deep, structural reform.
Lack of reciprocity in investment relations between the European Union (EU) and China remains a major concern for European businesses. This year’s survey shows 62% of respondents feel that Chinese firms enjoy better market access in Europe than European enterprises do in China. Indeed, China is found to be one of the most restrictive economies in the world, far below that of developed nations and even most emerging markets.
Although the EU is China’s largest trading partner, and China is the EU’s second largest, the lack of investment reciprocity is leading to noticeable imbalances in EU-China foreign direct investment (FDI) flows. Annual Chinese FDI in Europe was euro (EUR) 30 billion in 2017, the second highest year on record, while FDI from the EU to China stagnated at around EUR 10 billion between 2010 and 2015, and further declined in 2016 and 2017 to EUR 8 billion. This contrasts with Europe investing approximately EUR 149 billion in the United States in 2017.[13&14]
Broader and more tangible market opening would go a long way to unleashing the investment potential of European businesses, with 57% of respondents likely to increase investment in China if greater market access were to be granted. A successfully negotiated EU-China Comprehensive Agreement on Investment would directly address a number of market access issues and other key concerns, while also helping to diffuse rising political tensions. Both the EU and China should therefore now take the opportunity to move forward with meaningful dialogue to reach a deeper, more mutually beneficial understanding.
- The China Effect on Global Innovation, McKinsey Global Institute, October 2015, p. 54, viewed 9th May 2016, <https://www.mckinsey.com/~/media/McKinsey/Global%20Themes/Innovatio/Gauging%20the%20strength%20of%20Chinese%20innovation/MGI%20China%20Effect_Full%20report_October_2015.ashx>
- Cybersecurity Law, National People’s Congress, 7th November 2016, viewed 29th May 2018, <http://www.npc.gov.cn/npc/xinwen/2016-11/07/content_2001605.htm>
- Lomas, Matthias, Which Asian Country Will Replace China as the ‘World’s Factory’? ,The Diplomat, 18th February 2017, viewed 15th May 2018, <https://thediplomat.com/2017/02/which-asian-country-will-replace-china-as-theworlds-factory/>
- Cybersecurity Law, Related Regulations: Unpacking the Second Draft for Public Comment of the Assessment Guidelines for Cross-Border Data Transfers, Zhonglun, 22nd September 2017, viewed 16th May 2018, <http://www.zhonglun.com/Content/2017/09-22/1521375229.html>
- China’s Pollution Curbs May Start Slowing Growth Within Months, Bloomberg, 2nd October 2017, viewed 21st May 2018, <https://www.bloomberg.com/news/articles/2017-10-02/china-s-pollution-curbs-to-slow-growth-liftprices-socgen-says>
- Law of the People’s Republic of China on the Promotion of Small and Medium-sized Enterprises, National People’s Congress, 2017, viewed on 18th April 2018 <http://www.npc.gov.cn/npc/xinwen/2017-0/01/content_2027929.htm>
- Carson, John and Schwaab, Andrew, China applying for more patents than ever before as companies push to = innovate, protect brands, South China Morning Post, 16th June 2017, viewed 21st May 2018, <http://www.scmp.com/business/companies/article/2098724/china-applying-more-patents-evercompanies-push-innovate-protect>
- China issues new rules tightening up on overseas transfers of intellectual property rights, Hogan Lovells, April 2018, viewed 22nd May 2018, <https://www.limegreenipnews.com/files/2018/04/CN-overseas-IPR-transfers.pdf>
- President Xi’s speech to Davos in full, World Economic Forum, 17th January 2017, viewed 14th April 2017, <https://www.weforum.org/agenda/2017/01/fulltext-of-xi-jinping-keynoteat-the-world-economic-forum>
State Council Institutional Reform Plan, State Council, 17th March 2018, viewed 16th May 2018, <http://www.gov.cn/guowuyuan/2018-03/17/content_5275116.htm>
- FDI Regulatory Restrictiveness Index, OECD, 2016, viewed 20th April 2018, <http://www.oecd.org/investment/fdiindex.htm>
- Hanemann, Thilo and Huotari, Mikko, EU-China FDI: Working towards reciprocity in investment relations, Rhodium Group (RHG) and the Mercator Institute for China Studies (MERICS), 17th April 2018, viewed 22nd May 2018, <https://www.merics.org/en/papers-on-china/reciprocity>
- Hamilton, David and Quinlan, Joseph, The Transatlantic Economy 2018: Annual Survey of Jobs, Trade and Investment Between the United States and Europe, Center for Transatlantic Relations at Johns Hopkins University and the American Chamber of Commerce to the European Union, 2017, viewed 22nd May 2018, p. viii, <https://transatlanticrelations.org/wp-content/uploads/2018/03/TA2018_FullStudy.pdf>
- The average exchange rate of USD 1.1293 per EUR was used based on: Average Foreign Exchange Rates, Credit Suisse, December 2017, viewed 22nd May 2018, <https://www.credit-suisse.com/media/assets/private-banking/docs/ch/unternehmen/kmugrossunternehmen/devisendurchschnittskurse-2017.pdf>