Introduction

In 2013, the European Council instructed the European Commission to negotiate an investment agreement with China to improve legal certainty, reduce investment barriers, and increase bilateral investment flows. The aim was to correct asymmetries in market access and protections, with negotiations expected to conclude within two and a half years. Instead, talks stretched over seven years and 35 negotiating rounds, culminating in an “in principle” Comprehensive Agreement on Investment (CAI), with annexes published in March 2021.

The CAI is not a trade agreement. It is a narrowly focused investment deal designed to address a deeply asymmetric relationship in which Chinese companies enjoy far greater freedom to invest in Europe than European companies do in China. This imbalance shaped both the slow pace of negotiations and the muted incentives for China to compromise. The ratification process, now resting with the European Parliament, has become a focal point for broader debates about the European Union’s (EU) economic engagement with China, its liberal values, and its geopolitical alignment particularly with the United States. In this sense, the existence of the CAI has become as significant as its contents.

A changing landscape

The CAI was conceived in a markedly different geopolitical environment. In 2012, EU-China summit communiqués spoke of “shared interests” and “deepening economic integration,” reflecting optimism about China’s role as a driver of global growth and a vital export market for Europe. At that time, there was little discussion of systemic rivalry or clashing values.

That context has shifted dramatically. China’s territorial assertiveness in the South China Sea, the Himalayan plateau, and the East China Sea has intensified. Economic relationships have increasingly been weaponized to achieve political goals, with Australia and global apparel brands linked to Xinjiang cotton among the most prominent targets. Public campaigns against foreign firms have shown how quickly commercial access can become contingent on political compliance. Against this backdrop, the CAI appears to have been designed in an era of relative naivety about China’s trajectory.

The economic balance between the EU and China also changed profoundly during the negotiation period. In 2012, the EU economy stood at US$14.5 trillion, or around 70% larger than China’s US$8.5 trillion. By 2020, China’s economy had grown by more than US$6 trillion, compounding at 7.2% annually, and reaching parity with the EU in nominal terms. Over the same period, the EU economy stagnated in US dollar terms, while Brexit reduced its size by US$2.8 trillion.

This dramatic shift in relative economic power inevitably influenced the negotiations, weakening Europe’s leverage as China’s confidence increased.

A widening gap

Despite China’s rapid growth, the trade relationship did not rebalance as economic theory would suggest. Between 2012 and 2020, China increased exports to the EU by 35%, from US$323 billion to US$436 billion. EU exports to China also rose by 35%, but from a much lower base at US$170 billion. China’s marginal propensity to import from the EU was just 1%.

By comparison, EU exports to the US grew by US$78.5 billion during the same period — more than export growth to China — despite US gross domestic product (GDP) growing far less than China’s. The EU’s goods trade deficit with China widened from EUR118 billion to EUR183 billion, underscoring the closed nature of China’s market and the dominance of statist, nationalistic economic structures that prioritize party-state objectives.

Trade exposure to China varies widely across EU member states. In 2020, Germany accounted for 48% of EU goods exports to China, yet these exports represented only 2.9% of Germany’s GDP. Italian exports to China totaled EUR12.8 billion, but that is just 6.1% of extra-EU exports and less than 1% of Italy’s GDP. Alongside Ireland and Finland, Germany is one of only three EU countries with a trade surplus with China.

These disparities complicate the EU’s ability to adopt a unified stance, but claims of overwhelming dependence on China remain overstated, even for Germany.

Autos dominate

The automotive sector sits at the core of EU-China economic ties. Machinery and vehicles account for 50% of EU exports to China (about EUR100 billion), while chemicals, the next largest category, total only EUR30 billion. Although German carmakers now produce more vehicles in China than in Germany, China still accounts for 13% of EU car exports, making it the third-largest export market after the UK and the US.

China’s vehicle market once embodied the promise that underpinned CAI negotiations. From 2005 to 2012, sales surged from 5.7 million to 18.4 million units, an 18% compound annual growth rate. Growth slowed to 8.5% annually through 2017, then reversed. By 2020, the market had contracted from a peak of 27.5 million units to 23.4 million units.

Profitability has followed a similar path. Volkswagen’s share of operating profits from China joint ventures fell from around EUR6 billion in 2016 to EUR4.4 billion in 2019, dropping further to EUR3.6 billion in 2020. Although China still accounts for about 40% of German car sales, questions loom over future market size, electric vehicle competitiveness, and China’s growing dominance in batteries and related value chains.

China’s future growth in question

China’s official GDP growth has slowed from over 10% annually between 2003 and 2013 to around 6%, with evidence suggesting overstatement by 1-2 percentage points. Growth has become increasingly investment-driven, particularly through real estate, while imports expanded at just 2% annually in nominal dollar terms over the past five years. Trade as a share of GDP has fallen below pre-World Trade Organization accession levels.

Demographic decline, slowing capital accumulation, and investment misallocation compound these uncertainties. Policies aimed at technological self-sufficiency and reduced foreign dependence signal a less favorable environment for foreign firms, raising questions about the long-term viability of deeper economic integration.

FDI flows

China’s cumulative direct investment in the EU stands at about EUR120 billion, or just 5.6% of its global outward foreign direct investment (FDI) stock and 1.5% of total FDI in the EU. Even substantial future growth would have limited macroeconomic impact at the EU level.

Much of China’s outbound FDI is state-driven, often guided by strategic rather than commercial considerations. This raises concerns about whether greater openness under the CAI would advance European interests, as the EU maintains open capital markets.

Foreign investments into China is valued primarily for the intellectual property it brings. Despite decades of international agreements on intellectual property protection, forced technology transfer remains widespread, from high-speed rail to aerospace.

FDI also provides China with foreign exchange that can support overseas expansion. Portfolio inflows and tighter capital controls have helped replenish reserves, enabling continued outward investment. In this context, the CAI risks facilitating technology transfer and capital inflows without guaranteeing reciprocal protections.

The road to ratification?

The CAI delivers incremental liberalization in areas such as electric vehicles, financial services, and healthcare, alongside modest improvements in ownership rules. It also seeks greater transparency around state subsidies and commitments to non-discriminatory behavior by state-owned enterprises, though implementation remains uncertain. Provisions on labor standards are limited to commitments to “work towards” international conventions, and the investor protection chapter remains unfinished.

Ratification of the agreement will force the EU to weigh modest, uncertain economic gains against its stated commitment to values-based, rules-driven economic policy. Chinese sanctions on European parliamentarians and pressure on EU companies during the ratification process have sharpened doubts. The CAI may matter less for its economic effects than for the debate it provokes about Europe’s future relationship with China — and whether moderated engagement better serves long-term interests.

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