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An analysis of the economic integrationof China and the European Union: therole of European trade policyRicardo Bustillo a & Andoni Maiza ba University of the Basque Country , Bilbao , Spainb Daughters of Charity of St. Vincent de Paul , San Sebastian ,SpainPublished online: 04 Nov 2011.

To cite this article: Ricardo Bustillo & Andoni Maiza (2012) An analysis of the economic integrationof China and the European Union: the role of European trade policy, Asia Pacific Business Review,18:3, 355-372, DOI: 10.1080/13602381.2011.626990

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An analysis of the economic integration of China and the EuropeanUnion: the role of European trade policy

Ricardo Bustilloa* and Andoni Maizab

aUniversity of the Basque Country, Bilbao, Spain; bDaughters of Charity of St. Vincent de Paul, SanSebastian, Spain

Building a stable industrial relationship with the main emergent countries has become apriority for developed nations. In order to measure the advances that have taken placein the commercial and industrial integration between China and the EU, the presentstudy analyses bilateral processing trade figures. The results reveal a lack of increasedindustrial bilateral cooperation in comparison with other world regions and, therefore,the need for gradual changes in commercial policy to avoid conflict in this bilateralrelationship. The EU considers that China has obtained more benefits from theirbilateral cooperation. Nevertheless, European authorities should understand that Chinais neither the problem of nor the solution to European competitiveness difficulties. Newcooperation channels must be sought in order to arrive at a better mutual understandingin the future.

Keywords: China; EU; international fragmentation of production; processing trade;trade policy; vertical integration

1. Introduction

The recent economic emergence of the BRICS countries (Brazil, Russia, India, China and

South Africa) has raised questions about the nature of the OECD countries’ policy

reactions. Considering the potential benefits of free trade, the United States of America

(US), European Union (EU) and Japan should be interested in favouring a better economic

understanding with BRICS since their markets are large enough to justify a positive

response to their desire to join the international division of labour. Nevertheless, the rise of

BRICS is often viewed by OECD countries as a potential strategic threat (Holslag 2006,

Fukushima 2005) to their leading position in international organizations, which, they feel,

could become obsolete if economic influence became more balanced between the

developed and emergent nations.1

The economic upsurge of BRICS must be situated, following Baldwin and Martin

(1999), inside the second wave of globalization. Baldwin and Martin (1999) point out

that this second wave of globalization (1960 to present times) will end up causing

deindustrialization in developed nations simultaneous to industrialization in the developing

world. Mundell (2000) portrayed the last third of the twentieth century as a time when

flexible exchange rates and supply-side policies were commonly applied. Anyway, this

interpretation of the recent progressive internationalization of manufacturing and service

activities unveils a challenge for individual OECD countries: Each country feels the need to

reorient trade and economic policy in order to create closer industrial links with the

ISSN 1360-2381 print/ISSN 1743-792X online

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*Corresponding author. Email: ricardo.bustillo@ehu.es

Asia Pacific Business Review

Vol. 18, No. 3, July 2012, 355–372

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developing world. The shift of industrial production from the OECD countries to the

emergent nations may end up balancing economic influence and power in the world.

Focusing on China, several authors think that it is about to become one of the most

important agents of international economic regulation (Stiglitz 2004, McKay and Song

2010, Wang and Rosenau 2009, Chan et al. 2008), and recent facts corroborate this

thinking.2 Undoubtedly, China is one of the main global manufacturers and many

developed countries are attempting to build global manufacturing value-added chains in

cooperation with Chinese firms.

The main objective of this paper is to assess the evolution and degree of manufacturing

integration between the EU andChina, assuming that European trade and economic policies

should contribute to higher integration levels and thereby ought to bemodifiedwhen they do

not serve this aim. The EU needs to build a closer economic partnership with China in order

to benefit from future high growth in that country. To this purpose, the remainder of this

paper is organized as follows: Section 2 discusses the effects on trade of the international

fragmentation of industrial production; Section 3 examines recent trends in processing trade

(PT) between China and the EU; Section 4 discusses the determinants of PT between China

and the EU; Section 5 unveils themain features of the European trade policy towards China;

and Section 6 outlines the main conclusions reached through this research.

2. International fragmentation of production and trade flows: literature review and

stylized facts

After the second world war, a new era started in international trade relationships. The

creation of the General Agreement on Tariffs and Trade (GATT) in 1947 removed the

earlier worldwide protectionist strategy. Although the reduction of tariff and non-tariff

barriers to trade did not follow a progressive path and was not commonly shared by

countries and branches of activity, higher levels of trade openness were the key factor in

explaining internationalization up to the 1990s.

More recently, advances in information and communication technologies and the

stagnation of transport costs as compared with labour costs have contributed to a new wave

of internationalization. Rapidly, manufacturing companies (and also services sector

companies), located in developed and developing countries, are becoming aware of these

new business conditions and, consequently, they are preferring to localize each phase of

their production process in the country that holds the comparative advantage in that

individual phase (Jones and Kierzkowski 1990, 2001, Kierzkowski 2011).

There has been a sustained increase in trade that has comparatively surpassed the

growth rates attained in income and production levels. This puzzle can be explained

perfectly by taking into account the fact that fragmented world production requires more

commerce flows than unfragmented production (Jones and Kierzkowski 1997). The

division of the production chain into more units enhances the economies of localization, as

proven by the fact that trade in parts and components has experienced higher growth rates

than has trade in final products (Yeats 2001). That is why several branches of the

manufacturing sector such as textiles, automobiles, computer makers and consumer

electronics have revealed a pattern of high international vertical integration (Kimura 2009,

Kimura and Obashi 2010).

This new scenario demands a relevant change in the OECD countries’ external policies

towards BRICS; the OECD countries need to create closer industrial cooperation with low

labour cost countries if they want to maintain their shares in world industrial output in the

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long run. However, before going further into this discussion, it would be pertinent to study

some relevant changes in world trade flows.

The evolution of total world manufacturing exports shows that China’s exports have

grown at an accumulative average annual rate of 25% since 2000 (Figure 1), in comparison

to 11% in the EU-27,3 and well above the rate of 5% achieved by the US. Thus, even though

in 2009, the EU-27 still held the highest export share in world exports (15% as compared

with almost 13%4 in China and 9.2% in the US), China will overtake the EU-27 in a few

years if the European economy is not able to cope with Chinese export growth.

The EU-27 has been relatively successful in competing with Chinese exports in difficult

circumstances, but this is not the case with some manufacturing activities with high growth

rates. For instance, Chinese exports of electronic data processing, telecommunications and

office equipment have grown at amuch faster pace (Figure 2) as a consequence of the increasing

tendency to localize assembling activities inside China (Barysch et al. 2005, Lardy 2005).

Figure 1. Manufacturing exports, China, EU-27 and the US, 2000–09.Note: In billion dollars.Source: WTO 2011.

Figure 2. Exports of electronic data processing, telecommunications and office equipment fromChina, EU-27 and the US.Note: In thousand dollars.Source: WTO 2011.

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Nevertheless, if only assembly activities were relevant in China, sectors such as

integrated circuits and electronic components would experience some kind of stagnation.

But the analysis of export data reveals a very significant expansion. Moreover, the rise of

China coincides with the decrease of US figures, which could illustrate some degree of

substitution of the American industry by the Chinese one (Figure 3).

Therefore, it is critical for developed countries to perceive thatChina is fostering its ability

to manufacture technologically advanced electronic components through a comprehensive

strategy: policies to attract big inflows of foreign direct investment (FDI), the acquisition of

foreign companies (and their knowhow), and increasing levels of investment in education and

Research, Development and Innovation (R&D+i) (Rodrik 2006, Adams et al. 2006).5

Whenattention is paid to thebilateral trade links betweenChinaand themain industrialized

regions, it is observed that China is increasingly importing from other Asian countries (up to

70% in 2008), which reflects the accelerating economic integration of the East Asian region

(Kimura 2009, Fukao et al. 2003, Hasebe and Shrestha 2006). The EU-27 just aboutmaintains

its share over total Chinese imports, whereas the share of the US over total Chinese imports

decreases by three percentage points. In relation to the destination of Chinese exports, nine

years ago, North America (32%) was the second destination for Chinese exports after Asia

(38%), but now the share of the EU over total exports equals that of the US6 (Figure 4).

A review of previously selected manufacturing activities can be useful in

shedding light on the industrial integration process between the OECD main regions

Figure 3. Exports of integrated circuits and electronic components from China, EU-27 and the US.Note: In million dollars.Source: WTO 2011.

Figure 4. Shares of total Chinese manufacturing imports/exports.Source: WTO 2011.

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(EU-27, the US and Japan) and finding out which countries have become successful

providers of parts and components to the Chinese industry and Chinese markets.

In the case of telecommunications and office equipment, the data show that Japan was

by far the main exporter to China during the 2000–09 period, revealing as well a sharp

upward trend. Meanwhile, the EU-27 maintained its volume of exports and the US

managed to obtain a moderate increase and beat the EU-27 (Figure 5).

Similarly, the data on integrated circuits and electronic components (Figure 6) show

that, in 2009, the level of Japanese exports to China was much higher than that to the

EU-27 and the US. Between 2000 and 2009, Japanese flows experienced an outstanding

increase, whereas the US and EU-27 exports grew at a much lower pace and, in this case,

the EU-27 was overtaken by the US.

Some interesting conclusions can be drawn from this introductory analysis.

First, Japan is more vertically integrated with China than the EU-27 and the US in the

analysed high-income elasticity manufacturing activities. The Japanese results, however,

must be interpreted in the context of the regional integration process of East Asia.

Second, there is no reason to expect sudden progress in EU-China industrial integration

in these key high-growth industries, at least in the short run. Japan and the East Asian

economies and the US pose hard competition (Havik and McMorrow 2006) and European

Figure 5. Chinese imports of electronic data processing, telecommunications and office equipmentfrom selected OECD countries.Note: In million dollars.Source: WTO 2011.

Figure 6. Chinese imports of integrated circuits and electronic components.Note: In million dollars.Source: WTO 2011.

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industries suffer the effects of a poor innovation framework (Van Pottelsberghe 2008).

Undoubtedly, the EUneeds to implement urgentmeasures to reach a competitive position in

these key innovative industries.

Third, it could be rewarding to foster integration in those industries in which Europe

obtains its best trade results, for instance the automotive (Figure 7), machinery and

environmental industries. In addition to the advantages linked to local production,

European producers could have less problematic access to the enormous, growing Chinese

domestic markets (barriers to Chinese markets represent one of the main complaints of

European manufacturers and policy-makers, as will be analysed in Section 5).

3. Analysis of recent trends in PT between China and the EU

PT figures provided by Eurostat constitute an interesting data set with which to examine

the main features of the recent evolution of European economic integration. Every

commercial flow that is included inside Outward Processing Trade (OPT) and Inward

Processing Trade (IPT) data is because of a vertical integration decision of a multinational

company (MNC). This kind of trade flow receives a tariff exemption (or reduction) from

the EU trade policy, which aims to favour European MNCs’ foreign competitiveness.

Under the customs procedure of the OPT, MNCs have to prove that re-imported

goods have been processed abroad employing EU inputs (customs duty is due only for the

value added abroad). Under the procedure of the IPT, tariff exemption is conceded when

foreign inputs employed in European industrial activity are finally re-exported outside the

European Customs Territory (Figure 8). Therefore, both IPT and OPT data include intra-

firm and arms’ length transactions between MNCs.

To examine bilateral PT between China and the EU-15 (we have selected the most

developed countries inside the EU to obtain clearer results), total trade flows against PT flows

are plotted in Figure 9. First, PT flows reach a share of approximately 5% in average values

over total trade flows, with a diminishing relevance throughout 2000–08. There is a growing

trend of PT flows, but the annual rate of increase is much lower than it is in total trade flows,

perhaps because of the administrative difficulties encountered by European firms using these

customs regimes. The progressive reduction in tariff rates because of the accession ofChina to

the World Trade Organization (WTO) can also explain the lower growth of PT flows.

Figure 7. World exports of automotive products from Japan, EU-27 and the US.Note: In million dollars.Source: WTO 2011.

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Second, it is interesting to note that, in contrast to the behaviour of total trade flows, PT

exports (IOPX) reach much higher values than PT imports (IOPM). As a result, we can

conclude that the expected pattern of European firms localizing assembly activities in

China and benefiting from the OPT regime does not seem to be the dominant one, since

processing exports clearly exceed processing imports.

It is noteworthy that the value of Inward Processing Imports (IPM) from China is much

higher than that of Outward Processing Imports (OPM); more precisely, IPM flows are

about eight times higher than OPM flows7 (Figure 10). Once again, this result is to some

extent unexpected since it is assumed that European MNCs are willing to locate assembly

activities in China and benefit from the OPT regime.

These data confirm that European enterprises play aminor role in China’s PT (compared

with other East Asian countries such as Japan, Taiwan, Hong Kong and South Korea)

because of the difficulties in overcoming entry barriers.8 Therefore, European companies

have more incentive to acquire partly processed inputs in China (such as parts and

components, intermediate goods, and rawmaterials) and transform them in the EU under the

IPT regime, which concedes them total exemption in the payment of customs tariffs.9

IPMCHINA EU-15 IPX THIRDCOUNTRY

Inward processing trade

OPXEU-15 CHINA OPM EU-15

Outward processing trade

Figure 8. IPT and OPT.

Million euros

0

50,000

100,000

150,000

200,000

250,000

2000 2001 2002 2003 2004 2005 2006 2007 20080

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Total imports Total exports IOPM IOPX

Figure 9. Total and PT bilateral trade data between China and the EU-15.Source: Eurostat 2011.

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We have selected total PT imports (IOPM) with the purpose of examining the main

member countries involved in bilateral PT with China (Figure 11). The UK seems to be the

main destination for Chinese PT exports (34.3%), well above Germany (21.9%), France

(12.9%) and Italy (6.5%). This list is different from the ranking obtained in the analysis of total

trade imports from China, in which Germany stands in the leading position above the

Netherlands and the UK. Interestingly, these results may reflect that Germany’s industrial

Current thousand euros

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

OPM IPM

Figure 10. OPM against IPM bilateral flows between China and EU-15.Source: Eurostat 2011.

France 12.9%Austria 5.1%

Germany 21.9%

Italy 6.5%UK 34.3%

Others 19.3% France

Austria

Germany

Italy

UK

Others

Figure 11. EU-15 member countries’ shares of PT imports from China.Source: Eurostat 2011.

Thousand euros

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2000–02 2003–05 2006–08

IPM miscellaneousmanufactured goods

IPM machinery, transportequipment

OPM miscellaneousmanufactured goods

OPM machinery, transportequipment

Figure 12. OPM against IPM for China-EU-15 bilateral flows: Main branch distribution.Source: Eurostat 2011.

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integration ambitions have been focused on the Central and Eastern European Countries

(CEEC).

Two main activities form the bulk of the EU-China bilateral PT: manufactured goods

(consumer goods and textiles) and machinery and transport equipment (Figure 12).

The flows of machinery and transport equipment obtain higher values in IPT, which is

consistent with the relative specialization of the EU-15 countries in these capital-intensive

activities. On the other hand, the OPT flows are more relevant in the case of the labour-

intensive miscellaneous manufactured goods industry in which China specializes.

The differences between these two broad industrial activities diminish throughout the

period of analysis. Moreover, PT shows a strong downward trend that can be explained by

the reduction in tariff barriers after Chinese accession to the WTO. This is the usual time

evolution of PT flows in periods in which commercial integration processes take place, as

occurred between the EU-15 countries and the CEEC in the second half of the 1990s

(Baldone et al. 2001).

4. Determinants of PT between China and the EU: proposed hypotheses,

methodology and data analysis

The aim of this section is to shed light on the determinants of PT flows between China and

the EU member states.10 To this purpose, two main hypotheses have been set: First, taking

into account that PT flows can be favoured or hindered by bilateral differences in unit

labour costs (ULCs), we expect that the higher the ULC corresponding to individual EU

member countries, the lower would be their processing exports to China and the higher

their processing imports.11

A higher labour cost gap would mean that there is greater probability of the location of

industrial activities in China, favouring imports and reducing processing exports.

Hypothesis 1: There is a positive (negative) relationship between ULC and processing

imports (exports).

Second, we assume that FDI is negatively related to processing export volumes, since,

under this situation, European firms would tend to substitute export flows with the foreign

location of industrial activities. Even if FDI in China could lead to the creation of additional

vertical links among European companies and new subsidiaries in China, it is expected that

its main impact would be the substitution of semi-elaborated goods dispatched from the EU

to China (to be re-imported into the EU) with goods manufactured in China (to be imported

by the EU). There would not be a clear relationship between European FDI in China and

processing imports, since the latter would depend on Chinese FDI.

Hypothesis 2: There is a negative relationship between FDI and processing exports.

To check these hypotheses, we built a regression model, which, in addition to the

aforementioned basic variables (ULC and FDI), includes two control variables whose effects

over trade flows have been proven to be relevant in gravitymodels (Baldone et al. 2001, Clark

2007), namely gross domestic product (GDP) and population. The population level has been

introduced to reflect the companies’ decision to select big dimension markets in order to gain

scale economies. In addition, the nominal exchange rate was introduced to assess the direct

impact of exchange rate changes over the purchasing power of importers, without deflating it

to avoid the bias that inflation differences would cause in our analysis. Finally, a fixed effects

estimation was chosen, selecting the branches of economic activity (k) and the years (t) as the

fixed effects ‘a’ and ‘d’. The proposed model takes the following form (Table 1):

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Table 1. PT model.

ln PTikt 5 b1ln GDPit 1 b2ln ULCit 1 b3ln FDIikt 1 b4ln ExchangeRateit1 b5ln Populationit 1 ak 1 dt 1 mikt (i)

ln PT - real PT data in logs, deflected by the unit value indexes (OPM, IPM, OPX and IPX areregressed separately)ln GDP - real GDP in logsln ULC - ULC in logsln FDI – estimated sectoral FDI in logs (total FDI in China has been multiplied by the percentage ofeach selected branch of activity over total FDI stock in each EU member state)ln Exchange Rate – Exchange Rate in logsln Population –Population in logsSubscripts:‘i’ stands for EU member states‘k’ stands for branches of economic activity‘t’ stands for years. Time period: 1999–08 (Go to the Appendix for more details)

Table 2. China–EU processing trade: Main determinants.

Model 1: OPM Model 2: OPX Model 3: IPM Model 4: IPX

Ln GDPi 6.842** 2.317*** 3.325*** 1.382***Ln ULC_i 6.138** 24.835*** 3.208*** 213.370***Ln FDI_Branch_i .103 2 .278*** 2 .036 2 .157***Ln Exchange Rate_i 1.011 2 .151*** 2 .049*** 2 .038Ln Population_i 23.155** 21.146*** 22.054*** 2 .440[Branch ¼ Chemicals] 2530.076** 6.552** 236.852*** 56.489***[Branch ¼ Crude materials] 2531.650** 6.324 240.331*** 54.278***[Branch ¼ Food] 2530.155** 7.267* 238.792*** 54.017***[Branch ¼ Machinery transport] 2528.202** 8.032 236.506*** 57.569***[Branch ¼ Manufactures] 2529.873* 9.484* 237.335*** 56.034***[Branch ¼ Metal products] 2530.172** 7.067* 238.118*** 55.798***[Branch ¼ Miscellaneousmanuf. articles]

2526.539** 7.722** 237.541*** 54.969***

[Branch ¼ Rubber plastic] 2530.749** 6.535 239.766*** 54.230***[Branch ¼ Textiles] 2526.360* 8.325 238.228*** 52.833***[Branch ¼ Wood and paper] 2531.770** 4.014 242.283*** 52.875***[Year ¼ 1999] 3.763** 24.000*** 21.174*** 25.832***[Year ¼ 2000] 263.865** 23.126*** 21.081*** 24.894***[Year ¼ 2001] 16.279* 23.378*** 21.176*** 23.916***[Year ¼ 2002] 243.143 22.666*** 21.384*** 23.484***[Year ¼ 2003] 13.405 22.471*** 21.351*** 22.571***[Year ¼ 2004] 257.483 21.482*** 2 .943*** 22.149***[Year ¼ 2005] 257.982** 21.081*** 2 .643*** 21.750***[Year ¼ 2006] 26.023** 21.043*** 2 .330*** 21.473***[Year ¼ 2007] 23.077* 2 .527*** 2 .049*** 2 .638***Adjusted R2 .92 .88 .952 .91F-test 250.295*** 28,297*** 742.87*** 52,119.8***Levene test 4.335*** 1.216** 1.37*** 1.235**Durbin-Watson 1,2** 1,29** 1,43*** 1,42***N 764 1,041 1,211 1,141

Note: * significant at 10%; ** significant at 5%; *** significant at 1%.

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The results of the model are detailed in Table 2. The following findings must be

underlined:

. The positive and significant coefficients of ULC reveal that high-ULC EU

member states are prone to import more (for both OPM and IPM) and export less

(OPX and IPX) from/to China. This means that European countries with higher

ULC have less incentive to export parts and pieces and try to obtain the maximum

benefits from Chinese low labour costs through increasing PT import flows. Hence,

we would accept Hypothesis 1.

. The impact of FDI in China is negative and statistically significant in the case of PT

exports (OPX and IPX), whereas it seems to have no influence over processing

imports. As it refers to OPX, this result confirms that companies that set up new FDI

locations in China do not need to continue exporting semi-elaborated goods to

China (FDI discourages OPX). Similarly, in the case of IPX, new ventures in China

are used as export platforms to the rest of the world in substitution of the inward PT

regime in the EU. As a consequence, we would confirm Hypothesis 2.

. The results generated by the gravity model variables are consistent. Higher GDP

and population, that is to say, higher production and consumption levels, correspond

to higher volumes of OPT and IPT flows.

. Finally, the exchange rate variable presents the expected results. In the case of

outward processing, a negative relationship with OPX is obtained as is a positive

(not significant) influence over OPM. As it refers to inward processing, currency

appreciation against the yuan probably means more difficulties exporting to the rest

of the world (IPX) and, consequently, less incentive to import semi-elaborated

goods to be exported (IPM).

5. Discussion of the implications of European trade policy towards China

European attitudes towards China have experienced a change since the start of the new

millennium. During the past decade, the EU has progressively adopted a less friendly

stance because the European Commission has interpreted China as not having cooperated

enough in further developing the EU-China economic partnership (European Commission

2006).

The EU considers that China has benefited unfairly from their economic relationship

and it desires a more balanced partnership. In this sense, the growing commercial deficit

borne by the EU has become a central aspect of EU-China relations, allegedly not so much

because of the quantity of this deficit, but because of its nature, since the Commission

thinks that has been provoked by unfair practices.

The optimism of European public policymakers about the potential benefits of the

Sino-European relationship reached its highest level at the end of the 1990s. EU support

became a key factor in the Chinese accession to the WTO in 2001. In exchange for this

support, European companies obtained better conditions to access the Chinese market.

Moreover, the EU expected that China’s membership in the WTO would contribute to a

faster adoption of market practices by Chinese stakeholders.

However, reality has turned out to be substantially different from those expectations.

China has made progress in some specific fields, especially in the reduction of tariff

barriers, but overall progress has not been so relevant. According to the Commission,

Chinese public authorities have adopted a wide set of new initiatives to replace tariff

barriers with non-tariff barriers. Barriers to trade and investment in China are estimated to

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cost European companies e21,400 million in lost trade opportunities every year (European

Commission 2007).

The difficulties experienced by European companies trying to do business in China are

clearly delineated in the last Position Paper of the European Chamber of Commerce in

China, which calls ‘for an end to the industrial policy interventions and foreign investment

restrictions that threaten to stifle a new generation of reforms’ (European Chamber of

Commerce in China 2010).

The EU stresses three main problems in bilateral economic relations. First, the lack of

protection of intellectual property rights (IPR): In 2008, China was the main source country

for IPR infringing articles (100 million articles, 55.9% of the total amount). Second,

the creation and development of new entry barriers to foreign competitors and to FDI:

compulsory technology transfers in public procurement procedures, unusual technical

standards, and complex registration and certification requirements in manufacturing

industries. Third, inadequate intervention by public authorities in order to foster exports.

It is significant that between 2002 and 2006, the EU started twice as many antidumping

cases per billion euros of EU imports against China than against the rest of the world

(Messerlin and Wang 2008).

The EU has started negotiations to reach a new partnership and cooperation agreement

(Lingliang 2009, Leal-Arcas 2010). Officially, the EU is committed to building a stronger

relationship with China and gives priority to dialogue and negotiation. Notwithstanding

this, the EU also warns China that it is ready to use the WTO dispute settlement system to

resolve trade issues and confirms that trade defence instruments will be used ‘carefully but

rigorously’. Moreover, some European leaders have already said that the EU is prepared

to use protectionist policies if necessary (Ferrero-Waldner and Mandelson 2006; Van

Rompuy 2011). EU authorities have not managed to understand the nature of Chinese

market reforms, specially that it is not going to be complete, but adapted to Chinese

economic and political idiosyncrasy (Liew 2005).

There are signals that may arouse some doubts about the EU’s real commitment to the

implementation of open and fair markets. For instance, several researchers have suggested

that the EU is using antidumping measures excessively (Liu and Vandebussche 2002,

Eeckhout 1997, Hindley 2007). Similarly, the initiatives adopted by the EU during the

textile conflict (in 2005) were not according to market laws (Heron 2007).

It is true that China represents the main individual challenge to the globalization

paradigm. It is also true that the degree of economic complementariness between China

and the EU will probably decrease as China advances upwards in the value-added chain

(Andreosso-O’Callaghan and Nicolas 2007). And it is certain that the inadequate practices

of the Chinese authorities provide a valuable rationale to those supporting a more intensive

use of protectionist policies in Europe (European Commission 2011). Nevertheless, the

EU should be cautious and not blame China for its own weaknesses.

The new aggressive approach to China should not be used to hide the competitiveness

problems of the European economy. It is obvious that the Lisbon Strategy has not met

its original ambitious objectives; Europe has made little progress towards the aimed

knowledge and innovation economy and there is urgent need to implement deep reforms in

labour markets, education, innovation and so on.

In addition, the steady appreciation of the euro in the currency markets is seldom

considered by the European authorities when lack of competitiveness is mentioned. The

recent financial problems suffered by many economies inside the eurozone do not permit

the EU to maintain a strong negotiating position, once Europe has needed help to overcome

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recent financial difficulties. The European authorities should understand that China is

neither the problem of nor the solution to European competitiveness difficulties.

If attention is paid to bilateral trade volumes and their respective shares in both

economies, it can be concluded that the EU is a more important market for China than vice

versa, and it can be argued that China has more to lose than the EU if both partners do

not maintain a satisfactory relationship (Cameron 2011). However, this is a short-term

conclusion, which ignores the long-run negative consequences for the European economy.

Certainly, the EU can use the European market as a key asset during bilateral negotiations,

but at the same time, it must be fully aware of the high opportunity costs derived from a

new wave of protectionism on the EU-China agenda.12

Recent events provide reason to maintain some hope. Both partners have agreed on

some initiatives in order to moderate the increasingly hostile rhetoric and to prevent a

more indiscriminate use of protectionist practices. The new agreement between the EU

and China on an Action Plan on IPR Customs Enforcement (signed on 30 January 2009)

represents a positive step. More important still is the launching of the EU-China High

Level Economic and Trade Dialogue in 2008. Of course, it is difficult to expect major

outcomes from this dialogue in the short term; in fact, few meetings were held in 2008,

2009 and 2010 and much of the dialogue was about ‘agreeing to agree’. But, at least, the

dialogue has contributed to halting the rising confrontationist stance and maintaining a

friendlier atmosphere (Dreyer and Erixon 2008, Cameron 2008, Crossick 2009).

6. Implications for theory and practice/policy

Analysis of the Chinese-EU trade integration through the last few years seems to confirm a

scarce improvement in bilateral cooperation as well as to reveal the logical difficulties that

many countries suffer when deeper economic integration does not render equally

distributed benefits to both parties. This kind of trouble has been observed frequently; it

appears whenever there is an increase of trade deficit after a period of greater commercial

openness, and the deficit is not offset by the appreciation of the currency of the favoured

country. Therefore, the Chinese fixed exchange rate policy can be viewed as an obstacle

for bilateral understanding. Anyway, the EU must first consider that the euro’s rate is not

influenced by only the Chinese bilateral trade imbalance, but by many other factors as

well, such as interest rate levels, capital flows and economic growth prospects.

Therefore, the EU must first worry about the competitiveness challenge it faces

from emerging countries. Once this need for improved competitiveness is taken into

consideration (similar to designing real policy measures to accomplish the Treaty of

Lisbon’s objectives), the EU could try to convince the Chinese authorities that they should

modify some of their policies, especially those hindering fair trade (IPR measures, for

instance), and remove obstacles to European firms’ expansion in China (FDI requirements).

The EU should make the Chinese authorities understand that the EU market is relevant for

Chinese export expansion and some policy changes could ease bilateral tensions.

Nevertheless, the present financial turmoil has weakened the EU’s position in future

trade negotiations and, perhaps, recently made demands ought to be softened to arrive at

mutual understanding.

7. Conclusion

The analysis of trade flows and PT data reveals that trade integration between the EU and

China in some key manufacturing activities has not developed as expected according to

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mutual complementariness, which means that the EU is not obtaining the relevant gains of

China having accessed the WTO fully. The regression model shows that in contrast to the

expectations from a vertical integration process, companies located in Europe, which have

decided to invest in China, are using their new subsidiaries in the substitution of previous

outward processing flows after a process of delocalization. Influenced by a rapidly

growing commercial deficit, the EU remains convinced that China has obtained more

benefits from EU-China economic cooperation than it has, and it is stressing the need to

remove non-trade barriers to European companies in China and promote a level playing

field. The European authorities should understand that China is neither the problem of nor

the solution to European competitiveness difficulties. Reaching a new PCA would be a

positive step in avoiding confrontation and promoting new advances through closer

cooperation.

Notes

1. In less than 40 years, the BRICS (Brazil, Russia, India, China and South Africa) economiestogether could be larger than the G7 (France, Germany, Italy, Japan, the UK, the US andCanada) in US dollar terms, according to Wilson and Purushothaman (2003).

2. The G20 sealed an agreement branded as ‘historic’ on 24 October 2010 to reform theInternational Monetary Fund. Europe will give up two seats on the Fund’s Executive Board inreturn for greater responsibility from emerging economies on currency valuations. China willovertake traditional powerhouses Germany, France and Britain to become the third mostpowerful member of the IMF, up from sixth spot. India, Russia and Brazil will also wield morepower in the Fund, with greater voting powers as well as financial obligations and access to IMFfunds.

3. This figure must be taken as a positive result, since the EU-27’s main currency has seen a steadyappreciation throughout this period.

4. It must be mentioned that the Chinese figure (as does Mexico’s) includes a significant volume ofshipments through processing zones.

5. The Chinese educational system has enough human capital accumulation to permit at least insome regions a progressive improvement of innovation activities (Chi and Qian 2010).

6. Europe has become a priority for Chinese commercial expansion, although it must be pointedout that this growth has taken place while the Euro was maintaining a high exchange rate againstthe US dollar.

7. In other studies such as Egger and Egger (2005), total EU OPT flows were measured as twice thevalue of IPT flows. In Gorg (2000), OPT flows were related to delocalizing lower-skilled,labour-intensive activities, whereas IPT was used to promote higher-skilled, labour-intensiveactivities.

8. Processing trade between China and the US also reaches a higher level in comparison with theEU (Xing 2011).

9. The OPT regime only permits a partial exemption of the payment of tariffs, since the foreignvalue-added result of the offshore transformation is taxed by the corresponding tariff.

10. Annual bilateral PT flows between 14 EU countries (see Appendix) and China have been used asexogenous variables from 1999 to 2008. Bilateral flows are divided into 10 branches of activity(see Appendix) and, therefore, there could be a maximum of 14,000 possible data, but due tomissing data or the absence of some figures, the number of cases, ‘N’, is much smaller, as shownin Table 2. In the database, only PT flows and FDI figures vary throughout the different branchesof activity; the rest remain the same. In this case, some authors suggest the random effects modelshould be used (Maddala 2001), but random estimation was also calculated with similar results.

11. Exports are considered trade flows from the EU to China and imports trade flows from China tothe EU.

12. The 2010–11 European ‘debt crisis’ constitutes a good example of the relevance of China in thewelfare of European society.

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Notes on contributors

Ricardo Bustillo is Lecturer in the University of the Basque Country. He has also taken partin public projects for training experts in internationalization of firms financed by publicinstitutions, as well as having developed academic research in the fields of export promotion,the Spanish and the Basque economy or Emergent economies.

Andoni Maiza is Financial Manager in a network of schools of Daughters of Charity of Saint Vincentde Paul. He has also been Senior Consultant in Ikei Research & Consultancy for 10 years, where heparticipated in researches financed by many institutions. He is specialized in the analysis of EU-China trade and policy issues.

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Appendix 1

Appendix 2

Basic information on all the variables included in the models.

Abbreviation DefinitionSourceof data

Expectedsign Units

IPM Outward processing imports Eurostat Thousands eOPM Outward processing exports Eurostat Thousands eIPX Inward processing imports Eurostat Thousands eOPX Inward processing exports Eurostat Thousands eFDI_branch Bilateral FDI from EU member

states to ChinaOECD þ /2 Thousands e

GDPi Gross domestic product of EUmember state

Eurostat þ Thousands e

ULCi Unit labour cost of EU member state Eurostat þ /2 Thousands ePopulation Population of EU member state Eurostat 2 Number of people

List of EU countries for 1999–2008: Austria, Belgium, Denmark, France, Finland, Germany, Greece, Ireland,Italy, the Netherlands, Portugal, Spain, Sweden, the UK.List of branches of activity in the models: 1. Foods and processed beverages and foods; 2. Minerals, oils and fuels;3. Chemicals, plastic and rubber; 4. Furs, leather, wood, paper, textiles and footwear; 5. Material for construction;6. Metals; 7. Machinery; 8. Transport material; 9. Diverse manufactures

Descriptive statistics.

Minimum Maximum Average Standard deviation

IPM .0 753030.5 14969.721 47752.7886OPM .0 318050.0 6271.785 17751.8433IPX .0 2838780.7 33675.386 164174.5154OPX .0 327163.8 3362.815 15920.5020FDI branch .0 92094539.80 279973.0882 3650973GDPi 87173400.00 2410838258 695,210,000 624682398ULCi 92.90 162.90 115.3300 13.57022Population 3732201 82536680 27425639.64 26229983Exchange rate .80 15.22 8.2850 3.33885

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