Blog Post

Assessing China’s post-Brexit globalisation strategy

As the world comes to terms with the result of the UK's Brexit referendum, what will it mean for China? The authors suggest that the short-term impact will be smaller for China than for other regions. But there are important considerations further ahead.

By: and Date: July 19, 2016 Topic: Global Economics & Governance

The United Kingdom’s Brexit referendum has brought about economic turmoil not only in Europe, but throughout the world. China is no exception. Following the referendum, China’s Shanghai Stock Exchange Composite Index dropped and the Chinese yuan depreciated against the US dollar (Figure 1). However, the impact in China has been mild compared to other regions of the world. This can be partially explained by China’s still limited financial exposure to the rest of the world because of capital controls.

Figure 1: The impact of Brexit on China’s stock market and the yuan

Figure 1 SSE

Figure 1 Exchange rate

 Source: CEIC database

 

In any event, financial variables pick up immediate effects but what matters is the longer term. The question really is whether Brexit will affect China’s globalisation strategy and, if so, how. China is the EU’s second largest trading partner and a major exporting competitor, and also an increasingly important source of investment. Among the EU countries, the UK has been an important economic partner for China. David Cameron and Xi Jinping visited each other in 2014 and 2015, with the two sides issuing in 2015 a joint declaration on Building a Global Comprehensive Strategic Partnership for the 21st Century. China no doubt views the UK as an important gateway into extending economic cooperation with the EU. If Brexit isolates the UK’s economy from the EU, China’s globalisation strategy would then be expected to be affected, at least in relation to the EU. Against this backdrop, we make an initial assessment of the impact of Brexit on China’s globalisation strategy. It is worth noting that our assessment is based on the status-quo scenario. We assume that the UK and the EU will reach an agreement in terms of their economic cooperation that will not be too different from the existing situation. In other words, we exclude for the purposes of our assessment the possibility that Brexit might bring about a much closer integration of the EU, or conversely, a fragmentation. Our analysis provides only a baseline assessment of China’s reaction to Brexit.

Impact on international trade

Brexit will have only a limited short-term impact on China’s trade with both the EU and the UK. There are concerns that Chinese enterprises are likely to switch their exports from the UK to other EU countries following Brexit. Actually, the distribution of China’s foreign trade with the EU is broad based. China’s five largest trading partners in the EU – Germany, the UK, the Netherlands, France and Italy – constitute 73 percent of China’s EU trade. The UK is second in this ranking, with of 15.3 percent of China’s total trade with the EU, reflecting the UK’s economic weight within Europe. The UK’s position in both exports and imports is quite balanced. In 2015, 16.7 percent of exports from China to the EU were destined to the UK compared to 20 percent to Germany; meanwhile, 15 percent of the EU’s exports to China were sourced from the UK compared to 42 percent from Germany (Figure 2). The UK is also an important provider of services to China. Figure 3 shows that Denmark, Germany, France and the UK captures the most gains from trade in services with China, within which the UK also plays an important role.

Figure 2: China’s foreign trade with the EU countries

Figure 2 Export

 

Figure 2 Import

Source: Bruegel and Eurostat. Note: Only countries with a trade share of 3 percent or more are labelled in the figure.

 

 

Undoubtedly, the UK is one of China’s most important EU trading partners. But to what extent does China’s trade with the UK hinge on the UK’s position in the EU, and would thus likely be affected by Brexit? The answer depends the proportion of China’s exports to the UK that are finally destined for other EU countries. Though such data is not readily available, we can provide a rough estimate by calculating the correlation of China’s exports to the UK and the UK’s exports to the EU.

Figure 4 shows that the growth rate of the UK’s exports to other EU countries is positively associated with the growth rate of China’s trade with the UK. Quantitatively, a simple ordinary least square regression exercise shows that a rise in the growth rate of China’s exports to the UK by 1 percent leads to 0.6 percent increase in the growth rate of the UK’s trade with other EU countries. With this estimate we can make a back-of-the-envelope calculation that, given that the UK’s exports to the EU have increased at an annual rate of 1.38 percent, China’s exports to the UK are estimated to have increased by 0.09 percent as a result. As the estimated share only accounts for 0.58 percent of China’s exports to the UK, the effect would be very limited.

Furthermore, considering that the weighted average tariffs applied to goods imported to the EU are already as low as one percent, there is little room for further reductions in trade costs between the EU and the UK. It is therefore unlikely that Brexit would significantly alter China’s trade with the UK or other EU countries. More generally, since our baseline scenario includes a trade agreement between EU and UK, we doubt there will be major changes in trade flows between China and the EU/UK.

Figure 4: The correlation between China’s exports to the UK and the UK’s exports to the EU

Figure 4

Source: Bruegel

Note: trade data is sourced from IMF DOT database. We run a simple ordinary least square regression on the growth rate to avoid the unit-root issue.

 

In the long run, though, Brexit might slow down China’s free trade agreement negotiation process with the EU. This is because the UK is currently pushing for the deal from the EU side. In fact, despite China’s long-standing proposal to the EU for a free trade agreement, the EU still has major concerns over a possible agreement and has set a number of preconditions. Table 1 shows that, there are now only two non-EU European countries – Iceland and Switzerland – with a free trade agreement with China. In addition, a trade agreement between China and Norway is still under negotiation.

In the meantime, the relationship between China and the UK has entered what has been labelled a ‘golden era’. During David Cameron’s visit to China in 2013, the UK advocated a free trade agreement with China despite general opposition from other EU countries. This reflects the fact that the UK, with a comparative advantage in high-tech services, has a greater incentive to establish a free trade agreement with China.

China also views the trade relationship with the UK as a gateway to enhance trade cooperation with the EU. In the 2015 China-UK Joint Statement, the two countries explicitly stated that they “support the early conclusion of an ambitious and comprehensive China-EU Investment Agreement, and call for the swift launch of a joint feasibility study for a China-EU Free Trade Agreement”. Now following the Brexit vote, not only does the UK lose its attraction as China’s gateway into Europe, but China also needs to choose another country to break through into the EU market. China’s objective of pursuing a free trade agreement with the EU is expected to face more resistance.

Table 1. China’s regional trade agreements (RTAs)

1. Existing  RTAs Nature   Date concluded
China-New Zealand FTA Bilateral-developed country Apr-08
China-Singapore FTA Bilateral-developed country Oct-08
China-Iceland FTA Bilateral-developed country Apr-13
China-Switzerland FTA Bilateral-developed country Jul-13
China-Korea FTA Bilateral-developed country Jun-15
China-Australia FTA Bilateral-developed country Jun-15
China-Chile FTA Bilateral-developing country Nov-05
China-Pakistan FTA Bilateral-developing country Nov-06
China-Peru FTA Bilateral-developing country Apr-09
China-Costa Rica FTA Bilateral-developing country Apr-10
Mainland and Hong Kong Closer Economic and Partnership Arrangement Domestic Mar-03
Mainland and Macau Closer Economic and Partnership Arrangement Domestic Mar-03
China-ASEAN FTA Multilateral Nov-14
China-ASEAN FTA Upgrading Protocol Multilateral Nov-15
2. RTAs under negotiation     Negotiations
began from
China-Norway FTA Bilateral-developed country Sep-08
China-Georgia FTA Bilateral-developing country Dec-15
China-Maldives FTA Bilateral-developing country Dec-15
China-GCC(Gulf Cooperation Council) FTA Multilateral Jul-04
Regional Comprehensive Economic Partnership, RCEP Multilateral May-13
China-Japan-Korea FTA Multilateral Aug-13
3. RTAs under consideration     Joint feasibility study began from
China-Columbia FTA Joint Feasibility Study Bilateral-developing country May-12
China-Fiji FTA Joint Feasibility Study Bilateral-developing country 2015
China-Moldova FTA Joint Feasibility Study Bilateral-developing country Jan-15
China-NePal FTA Joint Feasibility Study Bilateral-developing country Mar-16
China-India Regional Trade Arrangement Joint Feasibility Study Multilateral 2003

Source: China FTA Network, Natixis.

 

Impact on investment

Brexit is expected to reduce Chinese investment in the UK but open up opportunities for other EU countries. Chinese investment was initially targeted at Africa, Latin America and other developing economies, but over the past few years it has gradually switched towards the developed countries including the EU. Figure 5 shows that Chinese investment in the UK from 2010-2015 reached €15.16 billion, making the UK the number one EU destination for Chinese overseas direct investment[1]. Furthermore, the two parties reached 59 agreements with a total value exceeding €54 billion during Chinese president Xi Jingping’s five-day visit to the UK in October 2015. However, the UK is not the only investment hub via which China enters the EU market. Italy, France and Germany also take an important share of China’s investment in the EU.

In other words, despite its advantages in financial services and language, the UK’s ability to attract foreign investment is likely to be substituted by other EU countries. Once the UK loses its access to other EU markets after leaving the EU, it will also give away its advantage as a Chinese investment hub in Europe. In the same vein, as London loses part of its share of financial operations related to the EU, other cities such as Paris and Frankfurt should increase their capabilities as financial centres, with each probably specialising in different issues.

Figure 5: Chinese investment in the EU (2010-2015)

Figure 5

Source: Thilo Hanemann and Mikko Huotari (2016) A New Record Year for Chinese Outbound Investment in Europe: A Report by MERICS and Rhodium Group

 

China’s real estate investment in the UK should slow down, at least in the short run. One of the most important components of China’s investment in the EU is commercial real estate. Most Chinese corporations have opted for London for their EU headquarters. In 2015, Ping An Insurance and Tai Kang Life, two of China’s major insurance companies, successfully bid for real estate projects in London, with a total value exceeding $5 billion. After Brexit, as the trade and investment uncertainties between the UK and other EU countries have risen, China’s investment in the UK real estate market can be also expected to decline.

RMB internationalisation strategy

London will lose part of its attractiveness to China as an offshore renminbi centre for Europe. London is now the second largest renminbi offshore market after Hong Kong, and has the largest renminbi pool in Europe (Figure 6), accounting for 6.3 percent of all offshore transactions using the Chinese currency as at March 2016. The UK’s position in offshore RMB market reflects European companies’ increasing business transactions with China and London’s position as a gateway to Europe, which makes it an ideal city for offshore trading in renminbi.

In recent years, China and the UK have stepped up their economic and financial dialogue, reaching agreements on a number of projects, including various measures to cement London’s position as a renminbi clearing hub. However, with the UK leaving the EU, the UK will also lose its critical access to other EU markets, making it less attractive to Chinese financial investors. As such, China will have to adjust its global renminbi strategy and might need to relocate at least part of its offshore market to other cities such as Paris and Frankfurt. Luxembourg is, of course, also a good candidate.

Figure 6: RMB offshore transactions by countries

figure 6 new

Source: Hudson Lockett, ‘UK becomes second-largest offshore RMB clearing centre’, Financial Times, 28 April 2016

 

International student communication

The large flow of Chinese students to the UK is not likely to be affected by Brexit. The UK has long been the main destination for Chinese students in the EU. Figure 7 shows that more than 50 percent of Chinese students studying in the EU are in the UK. As English is the only major foreign language in China, language barriers will make the international students less likely to switch their education destination from the UK to the other countries. Furthermore, in the short run, the depreciation of sterling can only help. However, the effect is expected to be temporary because the depreciation will probably reverse and, even if does not, the depreciation should to a great extent pass on to prices.

 

All in all, and under the assumption that no major changes occur in the EU (no further integration or disintegration), China’s economic relationships with the UK and EU should not be severalty affected by Brexit in terms of trade and exchange of students. However, Chinese investment in the UK and the role of London as Europe’s only relevant offshore renminbi centre might be reduced. Other cities should gain ground in continental Europe at London’s expense.

 

[1] The number we use is sourced from the MERICS report by Hanemann and Huotari (2016) as shown in Figure 5. It is larger than the Chinese official statistic for China’s outward foreign direct investment (OFDI) in the UK, but it is well known that the official number is affected by measurement error caused by the major role of offshore centres as intermediaries for OFDI.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Opinion

China’s debt is still piling up – and the pile-up is getting faster

With looser monetary policy, China's policymakers hope to encourage banks to lend more to the private sector. This seems to imply a change from the deleveraging drive begun in mid-2017. Although this should be good news for China's growth in the short term, such a continued accumulation of debt cannot but imply deflationary pressures and a lower potential growth further down the road.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 19, 2019
Read about event More on this topic

Upcoming Event

Mar
20
08:15

The trade crisis: good and bad scenarios and the EU's response

What role will the EU play in the resolution of the global trade crisis?

Speakers: Uri Dadush, Maria Demertzis and Denis Redonnet Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author

Opinion

New EU industrial policy can only succeed with focus on completion of single market and public procurement

France and Germany recently unveiled a manifesto for a European industrial policy fit for the 21st century, sparking a lively debate across the continent. The fundamental idea underpinning the manifesto is a good one: Europe does need an industrial policy to ensure that EU companies remain highly competitive globally, notwithstanding strong competition from China and other big players. However, the Franco-German priorities are unsuitable for the pursuit of this goal.

By: Simone Tagliapietra Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: March 18, 2019
Read article More on this topic More by this author

Opinion

Tense transatlantic relations put EU in tough spot

The global multilateral system is being challenged by the US and China, which prompts the EU to rethink how well it can compete in the world.

By: Maria Demertzis Topic: Global Economics & Governance Date: March 5, 2019
Read article More on this topic More by this author

Blog Post

The possible Chinese-US trade deal

The future of Sino-American relations after the incoming end of trade talks between Beijing and Washington. We review opinions in the English-speaking blogosphere on the likely content of the deal and the message this agreement sends to the world.

By: Jan Mazza Topic: Global Economics & Governance Date: March 4, 2019
Read article More on this topic More by this author

Opinion

China's strategy: Growth, alliances, and tech acquisition

Despite the pause in the US-China trade war, the US and China are strategic competitors, and will continue to be so for the foreseeable future. China realizes that there is little room to settle long-term disputes and, as a result has shifted towards a strategy that focuses on sustaining growth at any cost, expanding alliances, and advancing its technology.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: February 27, 2019
Read article

Opinion

What can the EU do to keep its firms globally relevant?

There is a fear that EU companies will find it increasingly difficult to be on top of global value chains. Many argue that EU-based firms simply lack the critical scale to compete and, in order to address this problem, that Europe’s merger control should become less strict. But the real question is where the EU can strengthen itself beyond the realm of competition policy.

By: Georgios Petropoulos and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: February 15, 2019
Read about event

Past Event

Past Event

Is the European automotive industry ready for the global electric vehicle revolution?

How can Europe catch up on the global electric vehicle race?

Speakers: Eric Feunteun, Jacques Pieraerts, Julia Poliscanova, Simone Tagliapietra and Reinhilde Veugelers Topic: Energy & Climate, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 12, 2019
Read about event More on this topic

Past Event

Past Event

The world’s response to China’s Belt and Road Initiative

This event will look at the Chinese Belt and Road Initiative as well as the response from the rest of the world.

Speakers: George Cunningham, Uri Dadush, Jean-Francois Di Meglio, Theresa Fallon, Alicia García-Herrero and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 8, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Reflections on five years of China's Belt and Road Initiative

Bruegel fellows Alicia García-Herrero and Uri Dadush join Guntram Wolff for this Director's Cut of 'The Sound of Economics', focusing on the progress made by China's Belt and Road Initiative, how it will continue to develop, and the reactions it has stirred across the world.

By: The Sound of Economics Topic: Global Economics & Governance Date: February 7, 2019
Read article Download PDF More on this topic

Working Paper

Countries’ perceptions of China’s Belt and Road Initiative: A big data analysis

Drawing on a global database of media articles, the authors quantitatively assess perceptions of China’s Belt and Road Initiative (BRI) in different countries and regions. They also identify the topics that are most frequently associated with the BRI.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: February 6, 2019
Read article More on this topic More by this author

Opinion

The EU needs a Brexit endgame

Britain and the EU must try to preserve the longstanding economic, political, and security links and, despite the last 31 months spent arguing over Brexit, they should try to follow a new path toward convergence.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: January 31, 2019
Load more posts