The annual ``Competitiveness Report'' by the EU's executive commission warns that the mainland is ``turning itself into a low-cost competitor in high-skill industries''.

The lesson for companies in the West is that they must pour funds into research and development, and continually adapt, if they are to fend off the seemingly unstoppable rise of China.

China is the 25-nation EU's second largest trading partner after the United States. But much of that trade is one-way. From a surplus in 1995 with the EU's older 15 members, the bloc now has a massive deficit with China of more than 10 billion euros (HK$102.8 billion). And Chinese exports are no longer confined to shoes, toys, textiles or low-end electronics, according to the 354-page report, which is largely devoted to the new threat facing Europe from the East.

Apeing Japan's post-war economic miracle, China's communist government has focused foreign investment on targeted sectors in order to grab Western know-how in areas such as cars and computing, the EU report says.

And like Japan immediately after World War II, China is building up ``national champions'' that can take Western companies on at their own game, secure at home with a protected market reliant on cheap labour.

``The growth of Chinese brand-name producers exploiting these advantages will become a major challenge to established multinationals and brand owners affecting to a large extent well-positioned EU-15 companies,'' the report reads.

The pain is being particularly felt in the 10 countries that joined the EU in May. The mostly ex-communist states are still trying to overhaul their economies and in some areas, have set themselves up in competition to China.

The electronics sector in Hungary has notably lost jobs to China, which has poured investment into cutting-edge sectors such as production of dynamic random access memory chips to leapfrog past eastern European rivals.

Whereas Chinese exports of information-technology goods to the EU-15 countries rose by about 25 per cent over 1996-2002, they soared by more than 50 per cent to the 10 new members over the same period.

A similar picture is evident in domestic appliances, chemicals and the textiles trade, with the EU-10 taking in far more Chinese imports over 1996-2002 than the richer, older member states.

China looks set to entrench its dominance in the rag trade when global import quotas are lifted from January, leading to EU warnings that it will safeguard its textiles industry to prevent a flood of Chinese imports. But the textiles trade provides a case in point for how the EU can respond to the growing might of China, the report said.

The quotas are being lifted in the context of rules set by the World Trade Organisation - of which China is now a member.

``Many market access barriers have been dismantled due to the process of market reforms and with China's accession to the WTO, the situation has further improved,'' the report said.

``Also, as European firms have been relocating activities to China in order to profit from its cost advantage ... they have been improving their overall competitiveness vis-a-vis international competitors.''