The Flanders-China Chamber of Commerce, with the support of Flanders Investment & Trade, organized a webinar on the topic of “Making sense of a changing China – recalibrating for the future”. This webinar took place on 6 July 2023.
Ms. Gwenn Sonck, Executive Director, Flanders-China Chamber of Commerce / EU-China Business Association, welcomed the participants to the webinar and introduced the speaker. Mr. David Hoffman, Senior Advisor, The Conference Board Asia & China Center, has been a guest speaker for more than 10 years and has been a resident analyst and business developer in China for more than 30 years. He is a strategy advisor and top management consultant on a wide range of China and Asia business developments. Prior to joining The Conference Board, David led the technology and entertainment advisory practice at PricewaterhouseCoopers (PwC) in China for 21 years. He is a life-long student of contemporary Chinese political science and economics and a graduate in Chinese studies from the University of California San Diego.
China is changing and doing business has become more complex in a slowing market and with local competitors scaling. With geopolitization running hot, it is a very challenging business environment. This demands of European companies to rethink China and recalibrate appropriately for a possibly very different business environment. A new China playbook for European companies in China is required. Despite this, many of our companies view it as imperative to maintain a footprint in China because of its market size, dynamism and industrial clusters, which are not replicated anywhere else in the world.
In 2022 Europe invested USD12.1 billion in China, which is a significant increase of 70% compared to the previous year with the automotive industry continuing to be the largest hotspot. Chinese investment in Europe increased by 21% to USD11.1 billion during the same period. Battery investments are now the mainstay of Chinese FDI in Europe. The EU and China have a daily trade volume exceeding €2 billion, making the two sides each other's second biggest trading partner. Taking into account the size of the market and the opportunities for cooperation in several sectors, more European companies should be able to participate in this growing market. According to a recent survey of European companies in China, the top three challenges for European companies based in China are the slowing down of the Chinese economy, the global economic slowdown and the geopolitical situation. The attractiveness of China as an investment destination varies by sector, 60% of European companies currently consider China a top three investment destination. Many of our companies are in China for its innovation power. To keep up with the technology of the future, they must continue to invest in China. The speed of innovation in China is very fast and keeps our companies sharp.
Mr. David Hoffman, Senior Advisor, The Conference Board Asia & China Center, explained that the title of his presentation – Making sense of a changing China, recalibrating for the future – emanates from his interactions with Conference Board members over many months and a recent trip to China. Executives of western companies in China really spend a lot of time trying to figure out what is happening in China, wondering who started the trade war, who is to blame and who needs to do what to resolve it. This is very pervasive and unhelpful. I prefer to explain the dynamics because if companies can understand what is going on and why, they have a better chance figuring out where it is leading. It is not surprising that western businesses are confused by the current goings on. There is America with its political dysfunction, behaving in very unpredictable ways; Europe, with war on the continent and a wake-up call about Russia and its relationship with China; China undertaking a pivot with a lot of ideology difficult to interpret from a western perspective; major technological changes with AI; and all of this coming around Taiwan as a global flashpoint of crucial consequence given its role in the global semiconductor value chain. The situation is daunting.
Mr. Hoffman structured his presentation around 3 key trends; 2 vicious cycles; 4 narrowing apertures; and 2 calls-to-action. Putting aside how this began or who started it and who's to blame, there are today three interrelated and mutually reinforcing key trends, amplifying one another. The most important trend is political reversion, relating to how Xi Jinping and the Party have reoriented since 2012 when Xi Jinping came to power based on a platform of fixing China. His assessment was that China was on the brink of collapse and the Party was on the brink of losing control. The situation was likened to the collapse of the Communist Party of the Soviet Union in the late 80s and the eventual dissolution of the Soviet Union. The response to this situation was to fix the Party. The assessment was that China lacked strong leadership and the Party was undisciplined and corrupt. The platform was expressly non-western according to Document 9 in 2013. Universal values were deemed to be subversive and needed to be stamped out. The political reversion began with a strong effort to align and discipline the Party with the long-lasting anti-corruption campaign and national security rising in prominence with the introduction in 2015 of the national security framework. Military reform became a big focus, reorganizing the PLA in unprecedented ways. The 19th Party Congress in 2017 was very significant when Xi and his platform were elevated to a new level. We saw the ideology of socialism for the 21st century emerge. The market has been dropped from “socialism with Chinese characteristics”. The Party is under threat from capitalism and its response is stronger control.
We see two threats emerging: geopolitical competition and economic downturn. The system is trying to respond to economic downturn with more and more control, which is undermining economic growth, and to geopolitical competition with higher degrees of security, causing counterparties to feel insecure and in response step up their own national security measures.
The future world state is the unanswerable question. The U.S. is taking measures to compete more effectively with China. There are many things we don't know: how stable policy will be on the U.S. side? How aligned allies will remain with the U.S. China policy? The U.S. policy is shrouded in much political noise. Business is despondent about the insistence of policy makers to secure supply chains and that China dependencies be reduced. China has taken U.S. policies as an economic act of war, but sanctions could have been much broader. Europe and Japan refused to go along with a U.S. protectionist regime. We don't know how patient China will be with regard to Taiwan. Chinese leaders have always said the issue needed to be resolved sooner than later. At this stage it is very hard to know how things will work out and relations are very tense. The world could go anywhere from war to hostile cold war to some sort of pragmatic accommodation. Selective decoupling will eventually reach an equilibrium. The U.S. and Europe will impose controls on certain technologies with dual use capability and leaving most commercial lanes open. For China the risks of invading Taiwan would be much too high. The allied efforts in the region will serve to establish a stalemate with some degree of stability from a military perspective. This is a pragmatic view based on the best mutual interests. Something more irrational could happen, but for planning purposes, this is the scenario that makes the most sense.
The Marxist-Leninist line of travel that China is on is significant. How the market could perform in this setting is an open question. From Deng onwards, capitalist development was seen as temporary and China would eventually revert to a more socialist state-centered planned economic model. The communist ideals raise many questions. Frugality is embraced as a very important norm; Party above all; nation and mission first. We see this in campaigns like common prosperity, where business is expected to channel portions of its profits to social infrastructure and remedy wealth inequality. This is a very significant shift from market oriented development. Xi is a believer. Foreign companies in China will need to accommodate to this divergence from operations elsewhere in the world.
A course correction is possible. Political preferences always run into societal, economic and external constraints. Xi leads a very conservative group within the leadership which is aligned, making it easier to change. There could be a swing towards liberalization without opposition or recrimination, which is underscored by the zero-Covid pivot.
The estimated market opportunity is being downsized as a result of lower growth and intensified competition. Many of these competitors are state sponsored. Many companies are facing national security discrimination and those in sensitive sectors impacted by geopolitical factors see their opportunities shrink even further. China was a strongly growing market where foreign companies expanded capacity to meet the growing demand. Now demand is slowing down and the game of gaining market share is harder. But China remains a very important market even in the downsized scenario. The headroom for growth is very significant for most companies.
There are two calls to action: recalibration and reset. Pressing tasks include revising assumptions for market access, regulatory engagement and competitive conditions. A changing China requires a “reset” from the status quo of the last three decades. A realignment between headquarters and China operations is also needed. A China CEO Council poll on needed recalibrations over the next five years showed recalibration to stiffer competition first, followed by geopolitical factors, growth expectations and reduced market access. The reset measures that warrant the highest consideration were localizing operations, becoming more or fully Sinicized, and partnering more with local partners. About 26% of members mentioned descaling but nobody preferred exiting China. It is all about recalibrating and resetting for a future establishing optionality, insisting on profitability in the near term, and postponing strategic investments until the outlook is clearer.
Over the next five years the success factors in China will be the competitiveness of products and services (74%); alignment with China policy goals (70%); and strong alignment with HQ in China strategy, planning and risk management (48%).
A Q&A session concluded the webinar. Q.: What will be the implications for European companies of the restrictions on rare earth metals? Mr. Hoffman: We don't know how it will be implemented, so it is difficult to assess the impact. This is a signal from the Chinese government for western export controls not to go any further. There is much discussion in the U.S. on making it broader. Rare earth controls are firing a shot across the bow and saying enough is enough. The semiconductor controls target a very narrow sliver of the semiconductor sector, leaving almost every other commercial lane open. China understandably doesn't like it. Rare earth export control may be disruptive but will be temporary.
Q.: What about restrictions on cross-border data flows? Mr. Hoffman: They are a facet of the security and control dilemma, making business much harder for multinationals, and deeper levels of localization are going to be required to participate in the Chinese market. A ground will be found and like most Chinese regulations will be workable and not require foreign companies to provide open access to their sensitive data in China. However, cross-border data flows will be heavily scrutinized.
