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UK-China agreement on trade in services is no substitute for a UK-EU deal

The UK government has high hopes that new trade deals with non-EU states will offer an economic boost after Brexit. But how likely is this to materialise? The authors show that a FTA with China is unlikely to offer much to the UK's prominent services sector. Strong links with the EU will remain vital.

By: and Date: December 6, 2016 Topic: Global Economics & Governance

The United Kingdom’s greatest comparative advantage in international trade is in services. Many policymakers expect that the UK will be able to broaden its trade in services with non-EU countries, particularly China, following Brexit. But the results could prove to be far below expectations.

Although services are an important part of the UK’s international trade, comprising about 40 percent of UK exports and 24 percent of UK imports, services are only a tiny part of the UK’s bilateral trade with China. Net services exports to China account for only 2.5 percent of the UK’s total services trade surplus, and 0.12 percent of UK GDP. Against such backdrop, a bilateral free trade agreement would disappoint those who expect it to alter fundamentals of the UK-China bilateral services trade.

UK exporters would find it hard to penetrate the Chinese market for services

China’s services market, though large and promising to any potential entrants, is very difficult for foreigners to penetrate. Except for Australia and New Zealand, and two Asian countries – Japan and Korea – all other countries do less than 5 percent of their services trade in China. For Australia and New Zealand, nearly 90 percent of their service trade surplus with China comes from tourism. Tourism also makes up a large part of Japan’s and Korea’s services trade surpluses with China (32.5 percent and 41.9 percent respectively), but they also sell transportation services to China, which is directly linked to trade in goods (27.8 percent and 35.3 percent respectively). In Europe, Denmark and Germany have the closest services trade relationships with China, but the size of this trade is in general very limited: only about 3 percent of Danish and German services exports are sold to China.

At sector level, the international services trade with China is dominated by travel/tourism and transport services related to the manufacturing trade. The reasons for this are straightforward: China’s government has always steered the economy through the implementation of industrial policy to promote the industries with comparative advantage and protect ‘infant industries’.

Fearing that industries without a comparative advantage could be overwhelmed by giant multinational corporations, the Chinese government imposes a series of restrictions on imported services. According to the European Chamber of Commerce in China, Chinese market access restrictions are one of the toughest issues that EU businesses face in this country, especially in the major services sectors: finance, education, culture, healthcare[1].

Consequently, the main possibility for the UK to increase its services trade with China is travel and tourism. However, this depends less on a free trade agreement and rather more on the relaxation of visa restrictions. The dramatic increase in Chinese tourists visiting Japan and Korea can be attributed to both countries’ ease of visa application procedure for Chinese visitors in recent years[2]. But the UK, like other EU countries, has imposed very restrictive and expensive visa application requirements and procedures for Chinese visitors, partly for reciprocal reasons.

The Swiss example

An example for the UK comes from Switzerland. Switzerland reached a free trade agreement with China in 2013, with the agreement coming into force one year later. Since both Switzerland and the UK have very high value added shares in the services sector (73 percent and 78.4 percent respectively in 2014), Switzerland might be viewed as a model for the UK in negotiating with China.

However, a granular analysis indicates that Switzerland signed the agreement with China more from the trade in goods perspective than the services perspective. Trade in goods still dominates Swiss-Chinese bilateral relations, goods exports accounting for more than 75 percent of Switzerland’s total export value to China. China (including Hong Kong) has become Switzerland’s second largest trading partner, with Switzerland accumulating a tremendous trade surplus with China since 2013. The UK is not similar to Switzerland in these respects. The UK has run a trade deficit with China for long time, and striking a free trade agreement could even worsen the current goods trade deficit.

In terms of services, although the Swiss-Chinese free trade agreement included a chapter dealing with services trade, a comparison between China’s commitments under the FTA and those under the General Agreement on Trade in Services (GATS) suggests no significant difference between the two treaties. There is virtually no improvement for the construction, distribution, IT, business consulting or advertising sectors, which are of particular interest to Swiss investors.

As for financial services, the FTA and GATS have very similar schedules. For example, non-life insurers are permitted to operate in China but with no more than 50 percent ownership, and banks can only provide financial services for foreign currency business[3]. Switzerland has seemingly not successfully broken into the potential services market in China. Even though the UK is much larger in economic size than Switzerland, it is not likely that the UK would fare much differently, especially after the UK leaves the EU and its bargaining power becomes weaker.

Conclusions and suggestions

All in all, it is not realistic for the UK to expect any major increase in its trade in services with China following Brexit, at least not necessarily as a result of signing an FTA. China is still very protectionist, especially when it comes to services, and an FTA will not change the picture. Until now, no country has managed to become an integral part of China’s services market, and the UK is very unlikely to change that, especially when it has lost its bargaining power as a member of the EU.

Furthermore, the services that countries trade most with China are travel/tourism and transportation. The former is held back by visa restrictions, which the UK could loosen even without leaving the EU. The latter is related to trade in goods. The UK’s trade in goods with China will not easily be improved after Brexit[4], so sales of transportation services should not see a significant increase. An FTA with China therefore is likely to be of little help to the UK, even were services to be included. On this basis, the UK might want to refocus on its negotiating strategy with the EU instead of starting a new venture with China before a deal with the EU is struck.

[1] European Chamber of Commerce in China, ‘European Business in China Position: 2016/2017’, available at http://www.europeanchamber.com.cn/en/publications-position-paper.

[2] Adam Minter, “Why Chinese Tourists Love Japan”, Bloomberg. https://www.bloomberg.com/view/articles/2015-03-25/why-chinese-tourists-love-japan.

[3] Wenfei Law, A practical guide to the new free-trade agreement between Switzerland and China, available at http://www.wenfei.com/fileadmin/pdfs/China_Publications/Wenfei_FTA_Publication_December_2013.pdf.

[4] Alicia and Xu, “What consequences would a post-Brexit China-UK trade deal have for the EU?”,  http://bruegel.org/2016/10/what-consequences-would-a-post-brexit-china-uk-trade-deal-have-for-the-eu/.


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