Written submission from the UK Trade Policy Observatory (UKTPO) (TWC0026)

Written Evidence from

The UK Trade Policy Observatory (UKTPO)

Submitted by Dr Peter Holmes, Mrs Julia Magntorn Garrett and Professor Jim Rollo

October 2019 

University of Sussex

The following notes answer specific questions set out in the Terms of Reference for the House of Commons International Trade Select Committee inquiry into UK trade with China. The whole of the submission relates to the second bullet point in the ToR, namely, what are the main barriers to trade and investment between China and the UK at present and how might these be addressed?

Executive Summary

●        China is an important trading partner for the UK, notably in goods. China and the UK sell different goods to one another, which could form the basis for a successful UK-China Free Trade Agreement (FTA) in goods, as the potential gains from a FTA are typically higher if parties have competitive advantages in different types of products. The UK’s proposed No-deal tariffs, if unchanged, would mean these gains can be obtained on the Chinese side without a FTA.
 

●        China’s top goods exports to the UK are predominantly in products covered by the WTO Information Technology Agreement (ITA) where tariffs are typically already zero and an FTA offers little gain in these areas. Other key Chinese exports of goods to the UK are textiles and clothing, and eliminating duties on these products would likely be a priority for China and might offer the possibility for bilateral exchange of market access in goods and services.

●        Motor cars are a key UK export to China. However, the UK may not be reaching its full potential for this sector, likely, at least in part, due to high Chinese tariffs on vehicles (even after allowing for recent cuts from 25% to 15%).
 

●        China has relatively high barriers to services trade, including barriers for foreign investors. Reducing such barriers, particularly in sectors such as financial services and business services, where the UK is typically competitive, could be beneficial for UK investors and services suppliers. However, liberalising services is difficult and FTAs tend to provide only modest market access improvements in this area.
 

●        Our analysis shows that some UK sectors could benefit from an FTA with China. However, given the geographical distance between the UK and China, “gravity” effects would suggest that the overall effects from an FTA with China would be relatively small.[1]

1. How should the UK approach its trade and investment relationship with China? What opportunities does the relationship present, and what challenges and risks are involved?

1.1.   As table 1 shows, China is a significant trading partner for the UK, while the UK is a less significant partner for China.
 

1.2.   While both exports and imports with China have become more important as a share of the UK’s total trade over the last decade, this is relatively more pronounced for exports. UK’s exports to China has increased from 1.9% ($9.1bn) of the UK’s total exports in 2008, to 5.7% ($27.7bn) in 2018. The UK’s trade balance has improved somewhat in this period.

1.3.   Table 2 compares the share of China in UK’s total trade, with China’s share in some comparable countries’ total trade. It is unsurprising that Japan trades more intensively with China considering its geographical proximity to China, compared to the UK, Germany and France. Overall, we would expect such “gravity” effects to remain strong even if an FTA is agreed between the UK and China, and therefore the effect of an FTA would likely be relatively small overall.

Structure of goods trade between China and the UK

1.4.   Table A1 and A2 in the Appendix give the UK’s and China’s top ten exported products (by value) to each other at the 4-digit level of the Harmonised System (HS), with the corresponding tariffs they faced in the other’s market at the beginning of 2018. The UK’s top exports to China include products such as motor cars, crude petroleum, gold and medicaments. China’s top exports to the UK include products such as telephone sets, data processing machines, clothing and footwear.

1.5.   The UK’s exports to China are highly concentrated, with the top 10 products (out of around 1200 products at the HS 4-digit level) accounting for around 65% of the UK’s total goods exports to China. In contrast, China’s exports to the UK are more diversified, with the top 10 only accounting for around 31% of total Chinese goods exports to the UK.

1.6.   There is also relatively little overlap in the products that are traded between the two countries. Using the HS 6-digit level, where there are over 5000 different products in total, shows that across the UK’s top 100 exports to China, and China’s top 100 exports to the UK, only 10 products overlap.[2] The fact that China and the UK sell different goods to one another could form the basis for a successful UK-China Free Trade Agreement (FTA) in goods, since the potential gains from a FTA are typically higher if parties have competitive advantages in different types of products.

1.7.   Table A3 in the Appendix classifies the UK’s trade with China according to technology intensity. In 2008, medium-low technology products made up the largest share of UK’s imports from China, followed by high-tech products. By 2018, high-tech products had overtaken medium-low tech products, with both groups accounting for close to 30% each of UK’s total imports from China. UK exports to China are predominantly medium to medium-high tech products, but, interestingly, a higher share (29.8%) of China’s exports to the UK are in high-tech products compared to UK’s exports to China (10.3%).

1.8.   In 2018, around 45% of the UK’s exports to China were intermediates and around 26% were final (consumption) goods. In contrast, around 28% of China’s exports to the UK were intermediates and close to 40% were final goods (based on BEC classification of goods into five categories; Intermediates, Final, Capital, Fuels and Other goods).[3] The relatively high share of intermediates in UK’s exports suggests that UK exporters are engaged in global supply chain activity with China, and the greater the possibilities are for supply chain integration, the greater are the likely gains from a Free Trade Agreement.

1.9.   On the other hand, intra-industry trade (IIT), measuring the extent of overlap between imports and exports of two countries, is typically also used as an indicator of value chain activity and IIT is relatively low between China and the UK (see table 3 below). However, detailed input-output analysis is needed to firmly establish the degree of supply chain activity between the UK and China.

Structure of tariffs between China and the UK

1.10.                        The average tariff (4.2%) that the UK levied on China’s exports in 2018 is lower than what China, on average, levied on the UK (9.4%). Overall, around 76% of China’s exports (by value) to the UK faced tariffs of 5% or below, compared to around 46% of the UK’s exports to China. Over 35% of the UK’s exports to China faced tariffs of over 10%, compared to only 11% of China’s exports to the UK.

1.11.                        Two things should be noted:

1.11.1.         China has made several cuts to its Most Favoured Nation tariff recently, and while the tariff data used in this report is relatively recent, from 2018, it does not reflect all of these changes. For example, China cut tariffs for most vehicles from 25% to 15% in July 2018. Similarly, tariffs on a wide range of consumer and industrial goods were reduced in 2018.

1.11.2.         Currently, as a member of the EU, the UK levies EU’s Most Favoured Nation tariff on China. However, in the event of a No-deal Brexit the UK has published its own temporary tariff regime. The initial (March 2019) list was notably liberal (95% of tariff lines and 87% of imports would be tariff free). Despite the fact that the tariff regime is only set to last for up to 12 months, the possibility of it caused Canada to walk away from rolling over CETA, and there have been worries from GSP partners on grounds of preference erosion. As we approach another No-deal deadline the government has announced a revised tariff list, which reinstates significant tariffs (12%) on some clothing items, potentially exported by China. In such a scenario, among China’s top ten HS 4-digit exports, only two product groups would potentially face tariffs in the UK market. Clearly, the adoption of these No-deal tariffs, particularly if they remain in place for longer than a year, could impact on China’s priorities and incentives. Tariffs on clothing could be cut preferentially towards China but this would cause preference erosion for LDCs, whose preferences were clearly in mind when the revised tariffs were proposed.

1.12.               With the UK’s largest goods export to China being motor cars, as well as car parts, which both face relatively high tariffs in the Chinese market, a trade agreement could be particularly beneficial for the UK automotive industry.

1.13.               In contrast, China’s largest exports, telephone sets and data processing machines, can already be exported duty free to the UK market, as a result of the WTO Information Technology Agreement, and therefore the UK cannot offer any further tariff concessions on these products. Textile and clothing products from China currently face tariffs of around 12% in the UK market. This is not necessarily an area where China is focused on growth for the future, but considering the importance of these products in China’s total exports currently it is likely that removing these tariffs would still be a priority. However, as discussed, in a No-deal Brexit, where the UK intends to cut many of these tariffs to zero, China could achieve tariff free access for some of these products even without an FTA.

1.14.               China is a major target of anti-dumping globally, notably in Europe and the US. China is also pursuing market economy status under the WTO. Separating the UK from the EU and the US on this topic may be part of any FTA. Note also that on leaving the EU, under WTO rules, EU anti-dumping duties will be removed from all products which the UK does not produce (no production no injury) and new injury assessments will be undertaken for the rest. The issue of market economy status will be important in any FTA negotiations. The UK can be expected to come under political pressure from the EU and the US on any attempt to relax the frequency or impact of such measures in Anglo-Chinese trade in pursuit of increased market access. Finally, any differences between UK and EU anti-dumping tariffs would cause further customs issues between the UK and the EU due to risks of trade deflection.

2. Should the UK seek a post-Brexit trade and/or investment agreement with China?

2.1.   One way of evaluating how the UK could benefit from a trade agreement with China is to identify the products where the UK currently appears to be underperforming in the Chinese market. To do this, we analyse if there are products where the UK is globally competitive, but less so in the Chinese market. This information could be used to guide the UK’s negotiating strategy with China.

2.2.   In table 5 we look at products where the UK’s total exports and China’s total imports are relatively large.[4] We identify the products where the UK is relatively competitive (products where the UK has a Revealed Comparative Advantage (RCA)) but where it sells relatively less to the Chinese market than it does the world as a whole (products where the UK’s Revealed Market Access (RMA) is low). We narrow the analysis down further by only including products where China’s average tariffs are 3% or higher.

2.3.   This analysis shows that, in particular, a number of vehicle and car component sectors appear to be underperforming in the Chinese market, as well as other machinery and mechanical appliances. Since tariffs on these products are currently high, there may be potential for the UK to increase its market share in China by eliminating these tariffs through an FTA.

2.4.   Of course, tariffs are only one explanation why UK exporters may struggle to penetrate the Chinese market. Other explanations could include differences in consumer tastes or the effect of geographical distance. While our focus here is on tariffs this is certainly not to say that these other effects are not important.

UK - China Services Trade

2.5.   China accounted for 1.6% of the UK’s total cross-border services exports and 0.9% of the UK’s services imports across 2017-2018. This places China as the UK’s 13th largest export partner and 26th largest import partner.[5] Thus, relative to its significance in goods trade, China is a smaller trading partner for the UK when it comes to services, particularly compared to other major non-EU trading partners such as the USA and Japan, which respectively accounted for 22.3% (£62.8 bn) and 2.5% (£7.1bn) of UK’s services exports and 17.6% (£30.1bn) and 2.9% (£4.9bn) of imports. This information could be used to guide the UK’s negotiating strategy with China.

2.6.   Table 6 lists the UK’s top three services exports and imports from China. As can be seen, the same three sectors, Transport, Travel and Business Services, figure as both the top imports and the top exports. Breaking these categories down further shows that personal travel services[6] account for 23% of the UK’s imports from China and 18% of UK exports. In the transport sector, sea transport is the largest sector, accounting for 10% of exports and 14% of imports. Architectural, engineering, scientific and other technical services is a relatively important category of business services exports, accounting for 7% of the UK’s total exports to China.

2.7.   The OECD’s Services Trade Restrictiveness Index can be used to compare the barriers to services trade between the UK and China. The STRI indices take values between zero and one, one being the most restrictive. Figure 1 gives the UK’s and China’s STRI scores across 22 sectors, as well as the average STRI across all 45 countries which the OECD STRI covers.

Source: OECD Services Trade Restrictiveness Index (2018), authors’ own calculations.

2.8.   The first thing to note is that China has a higher (more restrictive) score in every sector compared to the UK. Second, there is only one sector (Architecture services) where China has a lower (more liberal) STRI than the average for all 45 countries. For China, the three sectors with the highest (most restricted) STRI score compared to the average STRI for all countries are Courier services, Telecom services and Accounting services. Restrictions in these sectors include, for example, requirements for majority owners of basic telecommunications providers to be Chinese nationals, and Government control over all major telecom firms. For courier services, while highly restricted, foreign firms can supply express delivery services from a destination outside China to a destination within China. [7]

2.9.   Figure 2 looks more closely at the type of restrictions that exist for the five services sectors with the highest overall STRI score in China (the most restricted sectors). Most of these have relatively high restrictions on foreign entry, creating barriers for foreign investors. In fact, broadcasting services, motion picture services and courier services are the three sectors with the highest barriers to foreign entry in China.

Source: OECD Services Trade Restrictiveness Index (2018)

2.10.                        To analyse which services sectors would be strategically important for the UK in a negotiation with China, we look at sectors which are important in UK’s total cross-border services trade, but less so in UK’s trade with China. Three sectors in particular stand out: Financial services, which accounted for 21.4% of UK’s total services exports to the world in 2017-2018, but only 7.5% of UK’s exports to China. Legal, accounting, management consulting and public relations services accounted for 8.5% of UK’s total services exports but only 2.9% of UK’s exports to China. Finally, Insurance and Pension services accounted for 6.8% of UK’s total services exports, but only 0.5% of UK’s exports to China. Thus, currently the UK may not reach its full potential in these sectors in the Chinese market.

2.11.                        Table 7 breaks down China’s STRI scores for these categories. For all four sectors, barriers to foreign entry makes up more than half of the total STRI scores. Further, legal and accounting sectors have relatively high restrictions on movement of people, whereas banking and insurance have relatively higher barriers to competition. These are some of the areas where the UK could try to negotiate better access for its service suppliers. However, a services FTA with China would be especially problematic given the limited scope for reciprocal liberalisation as the UK is already considerably more liberalised than China.

2.12.                        Further, it should be noted that breaking down barriers to services trade is difficult, as services trade centers around regulations, which are more complex than tariffs to negotiate. Therefore, FTAs typically only achieve modest improvements in market access in services.
 

2.13.                        Finally, it should be noted that things change quickly in China and its interests and priorities in trade relations may well shift faster than trade negotiations can keep up.

2.14.                        Further, the political difficulties between China and the US may mean that the cost of an FTA with one is the possibility of an FTA with the other. Further, while not covered in this note, Human Rights and security issues make an FTA with China politically sensitive. Environmental issues may also be contentious, although China might not necessarily object to provisions which give incentives for Chinese firms to go greener.

3. Conclusions/Reprise

3.1.   Overall there are potential gains for the UK from an FTA with China, but it will be hard to negotiate. It is not entirely clear what the UK can offer China in exchange for cuts in car tariffs and services liberalisation, especially since the UK is proposing extremely low tariffs on goods in a No-deal scenario (with the possible exception of the clothing tariffs introduced in the Oct 8th tariff revision).

3.2.   To secure bargaining chips the UK would have to change its eventual tariffs from the current No-deal tariff plan.

3.3.   Anti-dumping is an area where the UK could opt for a softer line than the US and the EU, but if it did so it would run into political opposition from the EU and the US, and also would create further border control problems with the EU due to the risks of trade deflection.

3.4.   It is possible that China would be accommodating to secure an FTA but given the USTR’s negotiating mandate, it is clear that the US would object.

3.5.   A solid trade relationship with China is crucial for the UK, given China’s importance in the world economy. But to secure anything more than a symbolic shallow FTA would probably require more negotiating capital than the UK currently has.

Appendix