Suspension of China-EU investment deal: A hiccup in the short run but a major loss if prolonged

After more than seven years of negotiation, the ratification of the Comprehensive Agreement on Investment (CAI) - an agreement to facilitate investments between the European Union (EU) and China - has come to a halt in the European Parliament.

The CAI investment deal was designed to allow a greater level of access for investors between China and the EU. This deal would represent a major boost for the global economy and serve as a major tool for post-pandemic global recovery.

With the global resurgence of protectionism, the ratification of such a deal would represent an improvement in the general economic outlook. Further commitment to global trade and flow of investment is exactly what we need to ensure global prosperity.

Take the current fight against Covid-19 as an example. Countries are fighting to control the spread of the virus, trying to ensure an ample provision of medicines, personal protective equipment, vaccines and therapies for their citizens.

Given that supply chains are so intertwined and production units are so interconnected across geographies, an abundance of ammunition to fight Covid-19 can only be attained if we allow goods and intermediate goods to be traded freely. We also need foreign investments to set up plants and factories with no significant hurdles and delays.

The implications of the suspension may be more symbolic than economic in the short run. It may represent an economic and trade relationship hiccup for the EU and China. While the suspension will introduce some political noise and uncertainty to the international economic environment, ongoing businesses will experience minimal disruptions because several European economies currently have bilateral active investment treaties in force with China.

However, if the CAI deal is not approved after these years of negotiation, both parties will miss a golden opportunity to cement a path for economic prosperity and stability in the long run.

The signing and ratification of the CAI deal will reduce the level of uncertainty for business in the global economy. And this alone can play a significant role in shaping trade flows, welfare, and macroeconomic dynamics in the long run.

Recent findings suggest that one of the greatest benefits to the global economy with China's WTO accession was not brought about by the reduction of tariffs, but also by a reduction of trade policy uncertainty. Hence, the ratification of the CAI investment deal can also bring significant benefits to the global economy by reducing uncertainty over investment policies.

With the CAI in place, one can expect a stable regulatory system that could help reduce risks for foreign investors, assure businesses of the potential benefits of their investments, leading to an increase in foreign direct investment (FDI) inflows to both economic blocks. To the extent that we can reduce the level of uncertainty, investment flows will help countries to become more productive and more prosperous.

Ratifying the CAI agreement will certainly send a strong signal that the world will be more integrated, which is what the post-pandemic world needs to ensure a fast recovery.

Today, China is a major player in the trade of goods and services. It is also a major recipient and source of foreign investment in the world. Ratifying the CAI can help to mitigate uncertainty about investment policies between China and the EU, and that in turn, will translate into higher consumption and output for the two economies, leading to significant macroeconomic benefits for both parties. If we want to have a more prosperous and stable global economy, the solution will be further integration and not protectionism.

In a nutshell, investment agreements seek to "level the playing field" between domestic and foreign investors, guaranteeing equal legal and regulatory treatment to all investors, foreign or domestic.

In the context of the CAI deal, China has made significant commitments in manufacturing, which accounts for half of Europe's investment in China. European business in the automobile and basic materials industry, which includes the production of electric vehicles, chemicals, as well as telecoms and health equipment, will find the CAI deal conducive to their business planning.

The CAI deal will bind China to investment liberalisation for decades to come and facilitate the elimination of quantitative restrictions, equity caps or joint venture requirements in several sectors. In addition, it also provides a dispute resolution mechanism. In sum, the agreement provides improved legal certainty and market access to European companies in China.

Similarly, Europe-27 has also made significant commitments to Chinese investment. The flow of Chinese FDI to Europe has been declining in recent years, after experiencing a rapid increase from 2008-2017. In that sense, an investment deal that can provide a stable investment environment is essential for these two economic powerhouses to amplify their investment ties. An increase in FDI will increase the productivity level of all countries by encouraging new investments, especially by the most efficient firms. Higher investments would also lead to higher output, higher consumption, and a stronger labour demand market.

But the benefits do not end there. When foreign and domestic investors are subjected to the same legal and regulatory treatment, and none enjoys special rights or privileges, companies will find enough incentive to innovate. This competitive mechanism will be highly efficient for the host country, as capital can be allocated to the most productive sectors. In that sense, CAI can provide significant long-run economic benefits for all parties involved.

Whether the CAI deal will be ratified remains uncertain. The recent resolution by the European Parliament signals their vote intent, but we cannot rule out possible ratification by the end of 2021. Its ratification would depend on whether European members can present a convincing case for the social and economic benefits of CAI, and if China would present further concessions.

Given that China is now the EU's biggest trading partner, a deal that would seal their commitment to the development of international cooperation is inevitable, either through the ratification of the CAI or some other deal of similar features and foundations. Only then, the EU and China could cement the foundation for trade liberalisation and investment integration.

In the long run, the CAI would bring significant economic benefits that are much needed in a post-pandemic world. The failure to ratify it would be a wasted opportunity for the global economy to reap these benefits. Providing a clear direction to investors by ratifying the CAI sooner rather than later should be the way forward.

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