China is under pressure to give foreign companies the freedom to localise operations based on market needs, as restrictive regulations and market barriers erode confidence and force many to reassess.
European companies are increasingly being forced to silo their operations in China, part of a wider trend amid a tightening grip on national security, protectionist measures and regulatory fragmentation, the European Union Chamber of Commerce in China said in a report released on Thursday.
The report, based on surveys conducted between August and November and including responses from 128 member companies, added that siloing – the cutting off of China-based functions from operations in the rest of the world – is a strategic response by multinational companies to mitigate risks and comply with local regulations.
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Chinese legislations have guided companies to pursue extensive localisation, in their supply chains, workforce, sales and procurement functions, and many have siloed their R&D, data and IT systems, in hopes of ensuring market access and potential inclusions in procurements.
If they do not comply, they face market barriers and the threat of penalties for non-compliance, according to the report.
Geopolitics and escalating trade tensions also compel companies to adjust their supply chains and research-and-development strategies to ensure operational resilience.
“The more pessimistic companies are about these dynamics, the more comprehensive and far-reaching their risk-management approaches are likely to be,” the report said. “However, by doing so they have increased costs while sacrificing the ability to leverage economies of scale and global solutions, stripping away their global competitiveness.”
It added that siloing operations may still not grant them market access equal to that of a “domestic manufacturer”.
Despite a challenging policy landscape and precarious trade tensions, European investment in China has increased rapidly and continuously since the first quarter of 2023, reaching €3.8 billion (US$3.92 billion) in the second quarter of 2024, according to Rhodium Group.
This was the second-highest level of the past decade, bringing EU foreign direct investment (FDI) closer to levels seen in the early 2010s – a period of persistently high EU investor interest in China, the US research firm said.
To reverse the trend and better integrate with the global economy, China should “allow foreign companies the freedom to localise operations based solely on commercial needs, without imposing regulations that compel companies to act otherwise”.
China should also “engage more with stakeholders in the EU, multinational companies and industry associations” while steering “away from excessive self-reliance and self-sufficiency”, and “develop nuanced strategies for strengthening supply chains that do not err towards trade protectionism”, the report said.
As European companies shift their supply chains and FDI out of China, accelerating the loss of jobs and tax revenues, markets are also increasingly exploring tools to protect domestic companies from Chinese competition, a trend set to intensify if current policies that force foreign firms to silo remain unchanged, the report added.
For foreign companies operating in China, the high level of staff localisation and limited movement between China and other regions has led to weakened communication and trust between China subsidiaries and headquarters.
The reopening of borders and visa facilitations were a huge improvement compared with the cut-off seen during the Covid years, but visibility remains an issue and hurdles persist, said Jens Eskelund, president of the EU Chamber of Commerce in China.
“There is an enormous amount of uncertainty about what’s happening in the Chinese economy, how the demand situation is going to develop, trade tensions and going forward, and also, to some extent, reliability of Chinese data,” he said. “Increasing transparency, sharing data points and being open about the challenges being faced would create more confidence.
“Sometimes, even if it’s bad news, it can help, too.”
Data and IT siloing, aggravated by mandatory compliance with China’s stringent regulations, also comes at a high cost, impeding global innovation and creating inefficiencies by forcing companies to maintain separate systems that put them at a disadvantage to local competitors.
Similarly, siloing R&D efforts in China, particularly for sensitive products, results in duplicated work, escalating costs, and stifling innovation. This fragmentation not only undermines the competitive edge of foreign companies but also limits the potential benefits from China’s robust R&D ecosystem, affecting the global coherence of their operations, the chamber said.
EU companies should prioritise maintaining strong communication between their headquarters and China operations, ensuring that home offices receive accurate, on-the-ground insights for informed decision-making, the report suggested, adding that companies must also engage with European stakeholders to explain the complexities of doing business in China.
“It’s critical that companies in China stay connected to their global teams, or they risk losing touch with broader strategic goals,” it noted.
Establishing “decoupling teams” is also essential to assess the costs and risks of localising operations versus remaining connected to global systems, the chamber said.
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