European Business in China: Back in Perilous Waters

The latest Business Confidence Survey and a recently conducted flash survey by the European Chamber of Commerce in China show a marked drop in confidence.

Joerg Wuttke

Throughout 2021, the story of European business in China was one of high risks and high rewards. Revenue and profitability were positive, but doing business also became more difficult for most companies.

As the rest of the world returns to a pre-pandemic level of normality –with few restrictions hampering business operations and travel – the role China played over the last two years in bolstering European companies’ global revenues looks set to diminish, and recent events have led many to question just how many eggs they are willing to keep in their China basket.

In the Business Confidence Survey (BCS) 2021, the European Chamber of Commerce in China predicted that, after navigating the darkness of 2020, more perilous waters lay in wait for European companies in China.

This unfortunately came to pass.

China’s COVID-19 containment strategy throughout 2021 manifested itself in sporadic and highly disruptive measures that had an extremely negative impact on European companies’ operations. The business environment also continued to become increasingly politicised and reform efforts throughout the year were lacklustre, with traditional complaints – such as market access restrictions, an unlevel playing field and regulatory inefficiencies – still present. Despite this, European companies continued to demonstrate their commitment to China by identifying new ways to contribute to its growth story while advocating for deeper reforms.

At the start of 2022, when the new Business Confidence Survey was conducted, more clouds were already forming on the horizon. Conditions rapidly deteriorated and European businesses found themselves in ever-choppier waters due to both the geopolitical fallout of Russia’s invasion of Ukraine on 24th February and the even more stringent approach taken by the Chinese authorities to try and contain Omicron outbreaks, which culminated in mass lockdowns in Jinan, Shanghai, Shenyang and other parts of China.

To better understand the subsequent impact that both these events have had on European business, the European Chamber and Roland Berger conducted a flash survey from 21st – 27th April.

Marked drop in European business confidence

The flash survey found that both events have had a significant destabilising effect on European companies’ China operations and that business uncertainty has increased since the BCS 2022 was conducted.

Three quarters of members report that China’s introduction of more stringent COVID-19 containment measures, starting in late February 2022, has negatively impacted their operations. Supply chains have taken a pounding, with 92% of companies affected by measures such as China’s recent port closures, the decrease in road freight and spiralling sea freight costs.

Such challenges are expected to hit bottom lines, too; 60% of respondents to the flash survey have decreased their revenue projections for the year.

Although European companies remain overall committed to the China market, the current situation has given many pause for thought, and some may vote with their feet should the current wave of uncertainty continue, especially when other markets offer more predictability.

The flash survey shows that 23% of respondents are now considering shifting current or planned investments out of China as a result of its more stringent COVID-19 restrictions, which is more than double the number recorded in the BCS 2022 (11%), and the highest proportion in a decade.

Furthermore, 78% report that the measures have decreased China’s attractiveness as a future investment destination. The war in Ukraine has also hit investor confidence, with 7% now considering moving current or planned investments out of China as a result and 33% viewing the market as having become less attractive as a future investment destination due to geopolitical tensions garnering more attention in boardrooms.

Business Confidence Survey 2022 – results before the storm

Here are the most important takeaways from the BCS 2022 (read the full report here):

Two thirds of European companies reported revenue increases in 2021, up 22 percentage points (pp) year-on-year (y-o-y), as the long COVID-induced shutdowns experienced in some regions during 2020 were largely avoided. Earnings before interest and tax (EBIT) also took a turn for the better, with four out of five companies reporting positive results, a slight improvement from 2020.

However, while 2021 was overall a good year for bottom lines, it was far from plain sailing. The challenges of doing business in China grew, with 60% of respondents reporting it became more difficult than in 2020 – an increase of 13pp – as both internal and external challenges mounted.

Central to this deterioration was the ongoing impact of China’s COVID-19 containment measures. Highlighted as the top issue faced by businesses for the second year running, companies’ operations suffered various setbacks as onerous restrictions brought most business travel to a halt, battered supply chains and prevented some firms from fulfilling orders due to supply shortages and other disruptions.

Employee exodus underway

The ramifications on companies’ workforces have also been significant. Facing a wealth of ever-changing visa and work permit procedures, and extreme limitations on travel in and out of China, 58% of companies (+9pp y-o-y) reported struggling to attract top international and domestic talent, and 42% (+9pp y-o-y) reported struggling to retain the talent they have.

An employee exodus is underway, as sought-after talent look for new opportunities elsewhere due to the uncertainty of living and working in China.

Geopolitical tensions continued to increase, which is reflected by the 60% of respondents (+9pp y-o-y) that reported the business environment became more politicised in 2021, with political pressure coming mainly from Chinese and international media, and the Chinese Government.

Meanwhile, although some incremental progress was seen, long-standing barriers facing European investors in China largely remain:

  • There was just a 1pp y-o-y improvement in the number of companies that saw increased market access, as firms across the board report that market access restrictions continue to prevent them from expanding their investments.
  • Regulatory barriers are still resulting in missed business opportunities, with a 3pp increase in the number of firms reporting this to be the case. China’s ambiguous rules and regulations, unpredictable legislative environment and discretionary enforcement practices continue to be a bane for many.
  • 36% of respondents report experiencing unfavourable treatment compared to Chinese companies, only a 3pp improvement y-o-y, as companies operating in strategic sectors in which Chinese entities are prioritised find themselves handicapped.
  • 14% of respondents were compelled to transfer technology, more than two years after the implementation of the Foreign Investment Law, which should prohibit this practice.

China remains an attractive market

However, the rewards of staying the course and navigating the storm are plain to see. With a market of 1.4 billion consumers, some of the world’s best manufacturing clusters and, in more recent years, a vibrant innovation ecosystem, European companies view it as imperative to be part of China’s growth story. China’s growing and increasingly demanding middle class means that, despite the wealth of challenges, European companies still see a great deal of potential in the market.

Because of this, European businesses have long been willing to bet on China. Prior to both the Omicron outbreak in China, and the geopolitical spillover from the war in Ukraine, eight times as many firms reported plans to onshore as those planning to offshore. Furthermore, 30% of firms were seeking to increase their shares in joint ventures (JVs), and – pending greater market access – more companies were considering increasing their current investments to bolster supply chains and build resilience against external disruptions.

There remains scope for much more too. China has the potential to become a hotbed for research and development (R&D) activities, especially for large multinational corporations – 40% of respondents now view China’s R&D environment as more favourable than the global average.

There is also enormous untapped potential in trade in services, and European businesses are forging ahead in decarbonisation – an area that is ripe for deepening European Union (EU)-China cooperation – with more than half of European businesses operating in China aiming to achieve carbon neutrality by 2030, making them strong potential contributors to China’s carbon neutrality drive.

But realising this potential will require increased collaboration, something that seems a distant prospect as challenges hindering the free flow of data and people in and out of China proliferate.

This is pushing more European companies to increasingly silo their China operations as China continues to build greater self-reliance. The warnings issued in early 2021 in the joint European Chamber / Mercator Institute for China Studies (MERICS) report titled «Decoupling: Severed Ties and Patchwork Globalisation» are ringing true as many companies find themselves having to develop two separate sets of supply chains, information technology (IT) systems and data storage infrastructure – one for China and one for the rest of the world.

Joerg Wuttke

Joerg Wuttke is the president of the EU Chamber of Commerce in China. He’s been living in Beijing for more than thirty years.
Joerg Wuttke is the president of the EU Chamber of Commerce in China. He’s been living in Beijing for more than thirty years.