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

Blog Post

Brexit, phase two (and beyond): The future of the EU-UK relationship

Whether it looks more like ‘CETA-plus’ or ‘EEA-minus’, the trade deal that emerges from phase two of the Brexit negotiations should not be the limit of ambition for future partnership between the EU and the UK

By: Maria Demertzis and André Sapir Topic: European Macroeconomics & Governance Date: December 13, 2017
Read about event More on this topic

Past Event

Past Event

The impact of Brexit for Research & Innovation in Europe

This event featured a new and interactive format, with a restricted and high-level on-site audience and in parallel, it has been livestreamed on our website to remain public and attract the widest participation.

Speakers: Alastair Buchan, Matt Dann, David Earnshaw, Kurt Deketelaere, Maryline Fiaschi, Martin Muller, Christian Naczinsky and Reinhilde Veugelers Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: December 12, 2017
Read article More on this topic More by this author

Opinion

Brexit: When the banks leave

More than a tenth of the City’s business is now bound to go, but how much worse could things get?

By: Nicolas Véron Topic: Finance & Financial Regulation Date: December 1, 2017
Read article More by this author

Blog Post

The impact of Brexit on the Irish energy system – pragmatism vs. principles

Brexit promises pain for Ireland that could be cut off from the EU internal market and be left exposed to market instability in the UK. Georg Zachmann assesses the scale of the possible damage for Ireland, and how the UK and EU might use the special energy relations on the Irish island to commit to a pragmatic solution.

By: Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance Date: November 21, 2017
Read article Download PDF More on this topic

External Publication

Central Asia—twenty-five years after the breakup of the USSR

Central Asia consists of five culturally and ethnically diverse countries that have followed different paths to political and economic transformation in the past 25 years. The main policy challenge for the five Central Asian economies is to move away from commodity-based growth strategies to market-oriented diversification and adoption of a broad spectrum of economic, institutional and political reforms

By: Marek Dabrowski and Uuriintuya Batsaikhan Topic: Global Economics & Governance Date: November 14, 2017
Read article Download PDF

Policy Contribution

A ‘twin peaks’ vision for Europe

The organisation of the European Supervisory Authorities (ESAs) is based on a sectoral approach with one ESA for each sector, with separate authorities for banking, insurance and securities and markets. But is this sectoral approach still valid? This Policy Contribution outlines a long-term vision for the supervisory architecture in the European Union.

By: Dirk Schoenmaker and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 13, 2017
Read article More by this author

Blog Post

European worries about isolationist trends

Populist shocks in the UK and US threaten the multilateral order on which the EU depends. What lies behind these earthquakes, and what does it mean for Europe? Withdrawing from the world is no solution to geo-political upheavals, but Europe needs to reassess the future of globalisation.

By: Maria Demertzis Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 7, 2017
Read article More on this topic More by this author

Blog Post

The Bank of England’s dovish hike

For the first time since 2007, the Bank of England raised interest rates, with a hike of 25 basis points. At the same time, it provided forward guidance that outlines a very gradual path for future increases. We review the economic blogosphere’s reaction to this decision.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: November 6, 2017
Read article More on this topic More by this author

Blog Post

Falling Pound might not bring UK trade balance boost

The Pound Sterling depreciated by 14% against a basket of world currencies in the four months after the referendum vote to leave the EU. A number of pundits claimed that this would improve the UK trade balance and boost the economy. But the data do not show any visible improvement in the trade balance to date. Could it be that currency depreciations have less impact on trade balances than before?

By: Nicholas Branigan Topic: European Macroeconomics & Governance Date: October 31, 2017
Read article More on this topic More by this author

Blog Post

EU borders: walking backwards from Northern Ireland to Cyprus

The Good Friday agreement put to rest age-old conflicts on Ireland. It also offered hope that the reunification of Cyprus might be possible within the European Union. Lately, however, the “Green Line” that divides the easternmost island of the EU, is viewed as a template for a soft border at the westernmost island of the Union after Brexit.

By: Stavros Zenios Topic: European Macroeconomics & Governance Date: October 25, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Long-term growth potential, or dead in the long run?

By linking growth with both employment and the imperative for India to hold its own with China for strategic autonomy, Prime Minister Modi has brought sustainable, high quality, inclusive economic growth to the centre of political discussion, which is where it rightfully belongs.

By: Suman Bery Topic: Global Economics & Governance Date: October 5, 2017
Load more posts