Post Brexit Britain: Signing a Trade Deal with China

Why we shouldn’t be so hung up on the idea of an FTA with China: Reclaiming sovereignty and signing trade deals

Back in the pre-Brexit era, when George Osbourne was doing his best to build a “golden era” of Sino-UK relations, PM David Cameron annoyed Brussels by talking up an EU-China trade deal in Beijing.

Brussels was pissed off because it’s the responsibility of the European Commission’s to talk trade deals with EU partners. But a year and a half from now, post-Brexit Britain will be negotiating its own trade deals.

According to Brexiteers, the freedom to negotiate on trade is part of Britain’s newly won ability to forge its own destiny. Whether you are optimistic about the prospect or not, a Britain will be free to sign new trade deals once it leaves the EU.

In many a post-Brexit vision China is a potential partner in the brokering of new trade agreements. But in reality, what are the chances of Britain and China signing a Free Trade Agreement (FTA), and would such an agreement bode well for Britain?

Is the UK keen on a China trade deal?

During the Brexit campaign, greater trade with China and other emerging economies was mooted as an alternative to trade with the EU. Turning towards China formed part of a new ‘global outlook‘ that would take Britain in a brand new direction.

The government is still keen on this rhetoric, and PM Theresa May frequently defines our future in terms of free trade and becoming a ‘truly Global Britain‘.

Secretary of State for International Trade, Liam Fox, and Chancellor Phillip Hammond both claim to champion a ‘liberal free trade agenda‘, motivated by the desire ‘to secure trade agreements around the world‘.

Hosting Chinese vice premier Ma Kai for trade talks in London, Hammond echoed the Cameron government’s “golden era” rhetoric, claiming that Brexit Britain’s ‘trade relationship with China is now more important than ever’.

Fox said something very similar on a visit to Hong Kong in January, and May, on her trip to China last year, promised again that Britain would become a ‘global leader in free trade’ and an ‘outward looking country’.

It is sometimes difficult to get a reading on how much attention the government pays its China policy. Currently for example, the British embassy in Beijing is busy tweeting about the 59th anniversary of Paddington Bear, rather than the all important Party Congress taking place. Responding to questions on International Trade last week, the UK’s three main trade ministers failed to mention China once over the course of half an hour.

But doubts over the government’s expertise aside, a trade deal with China clearly figures in the government’s “Global Britain” rhetoric.

China is an important part of the government’s vision for post-Brexit Britain.

Is the UK’s interest in a China deal realistic?

There is an important qualification to make here with regards to the issue of priorities.

In a paper on post-Brexit trade with China, Alicia Garcia-Herrero and Jianwei Xu argue that ‘establishing a new trade relationship with the EU’ would take priority over negotiating a deal with China.

Even Brexiteers might begrudgingly concede this point. Newly invigorated trade relationships beyond Europe might in time compensate for lessened EU trade, but we still trade more with Europe than with the rest of the world combined.

The evidence is fairly unequivocal: the UK is more dependent on trade with the EU than it is on trade with China. Garcia-Herrero clarified the situation to me in simple terms, saying ‘the UK has much more to lose than to gain in engaging in an FTA [Free Trade Agreement] with China before doing so with the EU’.

If we were able to negotiate our trade relationship with Europe quickly and simply, then there might be greater hope for an immediate deal with China, but Brexit negotiations are looking anything but fuss free. The issue of Britain’s schedule of concessions at the World Trade Organisation (WTO) is also a problem that the UK’s trade ministers would have to solve before concluding any deal with China.

On top of this, it must also be remembered that the UK’s available resources for negotiating trade deals, after forty years of having the EU handle trade, are limited. Although Liam Fox claims that he heads up the ‘A-team of trade talks‘, even Fox has admitted that capacity issues mean his department is ‘simply unable‘ to negotiate new trade deals ‘at the moment’.

In short, it is highly likely that Britain will have more important trade-related fish to fry for a while after Brexit. James Ashton-Bell is International Head of Trade Policy at the Confederation of British Industry. He told me that a China-UK FTA was ‘a prospect closer to a decade than the near term’.

How do the Chinese feel about a trade agreement?

In her “Brexit speech” at Lancaster house May boasted that China had already expressed its interest in a trade deal. But are the Chinese really that interested?

As Chatham House’s Tim Summers notes in a special report on the impact of Brexit on EU-China relations, ‘For Beijing, the EU-China relationship will take priority over UK-China ties’.

Just as with the UK-EU relationship, it’s a question of arithmetic. Even minus the UK, the EU 27 bloc will dwarf the UK in trading potential. The Chinese have been pushing for an EU-China trade deal for half a decade, and an FTA with the EU would be more lucrative for the Chinese than a similar arrangement with the UK.

But, between a UK and an EU deal, which is the more likely option?

The EU’s insistence on ‘reciprocity‘, along with tensions over protectionism and dumping, mean that any agreement might be a long time in the making.

Although the EU and China seem to be edging closer to an ‘Investment Agreement‘, there are significant fears in Europe over the growing influence and potential consequences of unchecked Chinese investment in sensitive industries. Despite his free trade credentials, French President Emmanuel Macron has recently called for a “protection agenda” to defend European interests.

A 2016 Joint Communication on the EU‘s China strategy put it this way: The EU could ‘consider broader ambitions such as a deep and comprehensive FTA with China, when the conditions – including implementation of the necessary economic reforms in China – are right’.

In other words, the EU has a lot more reservations over trade with China than does the UK.

Britain has long been a pro-China voice in the EU. May’s momentary delay of the Chinese backed Hinkley project seems to have been something of a wobble, and as Tim Summers told me, although the “golden era” might be ‘somewhat less golden’, ‘not much has changed’.

Side note, UK fears:

Of course, there are warnings over the dangers of unbridled free trade in parliament, but they aren’t as heavy or frequently falling as doubts among some EU27 countries. Conservative MP Mark Prisk voiced ‘dumping’ fears in recent trade questions, and he told me that ‘if dumping occurs, regardless of country, we should be prepared to respond with proportionate, targeted and time limited measures’. However, he was also keen to emphasise that he ‘welcomes increasing trade with China’ and that his dumping point applied ‘regardless of country’. Despite the suffering of the UK’s steel industry, partly due to alleged Chinese dumping, UK politicians are generally very hesitant to point the finger at China. My general impression is that UK politicians across the board sing deeply in tune with Osbourne era ‘golden era’ rhetoric.

Somewhat ironically, Brexit will probably diminish the chances of an EU-China FTA. According to Summers, ‘liberal voices on economic policy towards China will be somewhat weaker among the post-Brexit EU27’.

Without Britain cheerleading, the EU will probably follow a more protectionist course with regards to China. Song Gao, Managing Partner at PRC Macro Advisers, elaborates: ‘China is apparently going to lose an ally within the EU Council’.

According to Song, this is a loss that could threaten China’s ongoing pursuit of “market economy status” at the World Trade Organisation, a designation that would benefit China, but which the EU has resisted due to China’s protectionist inclinations. (Song’s remarks reported here)

Deputy chair of the All Party Parliamentary China Group, Lord Clement-Jones, told me that, ‘as an advocate of the freest possible trade’ post-Brexit Britain will be arguing ‘from the outside’, whereas ‘at the moment we can argue from the inside as an EU member… it remains to be seen whether we can have the same impact and influence with regards to free trade post-Brexit’.

Clearly China has valued the strength of our free trade advocacy in the EU, and the absence of such a voice post-Brexit will come as a blow for Beijing.

However, China has a reputation for pragmatism when it comes to commercial interests. While Beijing might prefer an ally in the EU, our free trade advocacy makes us an easy touch when it comes to negotiating a trade deal.

An EU trade deal would be preferable, but a UK trade deal is a much more likely prospect.

The Chinese embassy in the UK declined to comment, but it did recommend a 2017 interview with the Ambassador, Liu Xiaoming, in which he stated China’s openness ‘to negotiating with the UK on a trade agreement’. In the speech, Liu acknowledges that Britain ‘has always been ahead of other Western countries’ when it comes to openness, but sees room for improvement.

Of course, Beijing’s resources aren’t infinite either, and Britain might have to wait its turn. Recently, Beijing rescheduled May’s long-awaited trade trip to China, choosing to prioritise Trump’s impending visit instead.

This move might not reflect China’s interest in a trade deal, rather its recognition of reality. To put it bluntly, Beijing knows that if it tells us to wait, we will wait.

Side note, Chinese perspective:

This interesting European Council on Foreign Relations (ECFR) paper explores Brexit from a Chinese perspective. It finds two causes for optimism amongst Chinese academics: further division of the EU, along with greater UK dependence on China. Of course, division of the EU is not an official objective of Chinese foreign policy, but it’s a common suspicion that China likes to play off EU member states against one another.

In terms of British dependence on China, there is undeniable symbolic value in the changing power dynamic; in just over a century, China has gone from being humiliated by unfair British trade agreements to having the opportunity to leverage its own strong trade deals.

What will a China-UK FTA look like?

The Swiss-China FTA signed in 2013 is sometimes held up as a model for a post-Brexit deal with China. Not only is the agreement one of only two Chinese FTAs with European countries (the other is with Iceland), but the UK and Switzerland both have a large proportion (around three-quarters) of value added in the services sector.

However, the agreement signed was more about trade in goods than services, which account for less than 25% of Swiss exports to China. The 2013 FTA includes few improvements on China’s commitments under the WTO wide General Agreement on Trade in Services (GATS). In terms of financial services, a sector that is very important to Britain, the FTA is even more disappointing.

So, the Swiss deal might not be such a good model for the UK because it neglects services.

This doesn’t necessarily mean it was a bad deal for Switzerland. Although services are important to Switzerland, the small country also runs a large trade surplus in goods with China, exporting more than it imports.

Exports are less important to the UK, but British industry could still benefit from tariff reductions.

But this benefit is limited. The UK’s top ten export categories constitute 70% of everything the UK ships to China. Automotives come top, but the next largest category, gold (17%), faces literally zero tariffs in China. The next biggest export category, ‘medicaments’ (medicine related stuff) faces fairly low tariffs of around 5%. (source)

Britain’s automotive industry, which suffers 25% tariffs in China, is the only sector that would substantially benefit from tariff reductions, but how likely is China to concede this point?

Britain is of course much larger than Switzerland, but, as Garcia-Herrero notes, ‘it is not likely that the UK would fare much differently’. Steve Woolcock, a trade expert at the London School of Economics, would most likely concur. He told me that, in the event of trade talks, ‘the Chinese would have all the negotiating leverage’.

This is partly a question of size (even though the UK is the world’s fifth largest economy, it is roughly afifth of China’s size), but it is also a question of relative openness.

Whereas China still has a long way to go in terms of tariff reduction and opening up its market, the UK is already relatively open; it has little to offer in return for market access. China joined the WTO in 2001 with high tariffs and they have only since dropped to around 10% on average, whereas the UK will rejoin the WTO in 2009 with tariffs around 2%.

In essence, China already trades with Britain on fairly favourable terms, and so has little incentive to give the UK any juicy concessions.

Running trade deficits and unilaterally lowering tariffs for imports isn’t always a bad move for the economy. Opening the way for cheap Chinese goods could benefit the UK consumer. But the fact that the UK is already relatively open means that there are few tariffs to reduce, and little for the consumer to gain.

We could save a little money on sweaters, but few Chinese goods imports face significant tariffs.

Brexit minister David Davis has argued that the UK car industry might benefit from lowered tariffs on Chinese car components, but the tariff rates for these, and most ‘intermediate goods’ are already low. The UK currently charges only a 3.81% tariff on automotive parts. Hypothetically the UK could change its basic Most Favoured Nation (MFN) tariffs at the WTO in 2019, but this really would open up a world of pain – the UK doesn’t want to start a trade war with the whole world.

There is one caveat to add here about potential. Given that a China-UK negotiation might take a while, there is no knowing what our trade relationship might look like years hence. As the Confederation of British Institute’s James Ashton-Bell told me, ‘we are only just beginning to tap into the potential that exists across high end goods and our extensive services sectors as China begins to open their market’.

In the years to come, the shifting shape of the Chinese market will be far more important to trade than any deal we could conclude now.

Forget tariffs

Nowadays it is commonplace to talk about ‘Non-Tariff Barriers‘ (NTBs) to trade. The idea is: in the 21st century there are more expedient ways to smooth trade than lowering tariffs, which is an old-fashioned practice from pre-WTO days when protectionism was more commonplace.

Essentially, tariffs aren’t as important to trade as they once were.

Some NTBs, like geographical distance and speaking different languages, are difficult to reduce.

Others are combatted through measures that go beyond traditional FTAs. In a way, the EU single market is essentially an exercise in NTB reduction, smoothing the international transfer of goods and especially services. This happens through conventions like ‘freedom of movement’, which allows Poland to export ‘plumbing’ to the UK.

Obviously, a single market with China is unlikely.

Harmonizing standards is another way to reduce NTBs. It was also one of the causes of public ire for the EU (think straight bananas).

But with regards to China, facilitating greater trade would most likely involve lowering British standards, rather than keeping to annoyingly rigorous EU standards.

Importing chlorine-washed US chickens was a politically volatile notion, so you can imagine that lowering the bar to facilitate trade with China might provoke similar controversy.

Here we come to a larger point about post-Brexit trade. If Brexit does mean moving closer towards the trade orbit of China and leaving behind the more protectionist impulses of the EU, what does this mean in terms of the kind of economy the UK will become?

Although strict EU legislation has caused consternation in Britain, it is worth remembering that unbridled free trade comes with collateral damage in the form of lowered standards and diminished workers’ rights.

Is this free trade collateral damage worthwhile? This is not a question of pro or anti-Brexit, but a larger political question of free trade vs. fair trade. The answer simply depends on your perspective

Forget trade deals

A trade deal with China is far from being the panacea for post-Brexit difficulties that some claim it to be.

An FTA would take a long time to conclude, both sides have demonstrated reservations or different priorities, and based on our current trade relationship, it wouldn’t exactly deliver ground-shaking benefits to either country.

The idea is worth pursuing as a long-burner. For a start, it would be symbolically important. Furthermore, the changing dynamic of China’s economy might make an FTA more relevant in the future.

But beyond that, we shouldn’t get too hung up on pursuing a China-UK deal.

As this article has shown, an FTA with China is problematic.

But this doesn’t mean that there aren’t opportunities for the post-Brexit China-UK trade relationship.

As the brief section on NTBs outlined, focus on tariff reduction is increasingly considered an outmoded way of doing things. While more modern comprehensive trade agreements do aim at tackling NTBs and promoting services, this might not be the best avenue to pursue with China.

According to Ashton-Bell, FTAs ‘are never very good at opening market access’ on services. This is especially the case with China, where the state plays a very protective and active part in organising the economy.

The Vice Chair for Trade & Industry of the All Party Parliamentary China Group, the MP Geoffery Robinson, told me that ‘China looms’ as a ‘significant opportunity’ for Britain. Declining to speak for the possibility of a UK-China FTA, he said instead that there were ample trade opportunities under ‘present arrangements’.

Ashton-Bell developed this point: ‘those who say that trade prospects with China transcend an FTA are absolutely right… An FTA is by no means the best way of building trust with a non-capitalist economy which has only recently taken significant forays into opening its internal market’.

An FTA is not necessarily the first priority for British business. Instead, according to Ashton-Bell, the ‘UK government and UK business need to be more coordinated and more proactive when investing time and money in the Chinese market’.

The biggest change in trade relations will not be brought about by an FTA but by domestic changes in the Chinese market.

In terms of what Britain can actively do to improve relations, it seems that the key is a focus on government-to-government trust building and business-to-business partnerships.

In other words, time and energy aren’t best spent pursuing an FTA.