The UK’s trade relationship with China

As detailed in a previous post, discussion of UK trade in recent years has largely centred upon the issue of the ‘global race’ to seize opportunities in emerging markets, with Chinese markets being the grand prize over which exporters are jostling for the lions’ share. But to what extent is this really the best perspective from which to plan UK export strategy?

Ambitious targets for boosting bilateral trade with China have been a feature of the current government’s economic policy agenda from the outset, with the Chancellor stating as far back as 2010 that ‘China is one place we should be looking’. More recently, the Budget 2014 made explicit reference to the export opportunities arising from economic reforms in China, and with the announcement of policies such as doubling the number of British pupils studying Mandarin by 2016, there is a clear belief among the government that China has a role to play in the UK’s future exports.

Yet much of the rhetoric has centred on this ‘global race’ idea and the associated concept of ‘market share’ (as is discussed in the aforementioned post), with loss of the latter being highlighted as an area for concern in an FCO study. But with our exports to China rising sixfold in the past decade, can we really say the UK is losing out?

While our ability to compete with other exporters is highly important, perhaps of equal or even greater importance is ensuring that our exports are well aligned with the highly coveted Chinese import markets. If we produce what they demand, our exports will quite naturally take off.

This is the very idea behind trade complementarity, which measures the extent to which two countries are “natural trading partners”. Natural trading partnerships often thrive due to geographical proximity, a common currency or even a common language; none of which features in the UK’s trade relationship with China. This might help explain why the share of UK exports in Chinese markets has declined. As other emerging economies grow increasingly able to satisfy China’s import needs (so called South-South trade), they also have the added advantage of closer proximity and cheaper labour costs to push out UK exporters. Between 2007 and 2012, the exports of ASEAN member countries to China increased by $87.4 billion in value.

Reinforcing complementarities between our productive structures, particularly in sectors where we have a comparative advantage, and Chinese import markets is likely to quicken the pace of export growth to China. Yet the decline in the complementarity index appears to show that the opposite has happened and that alignment between the two has actually worsened since 2001 (incidentally, the year of China’s accession to the WTO). So how can these ‘complementarities’ be identified and exploited?

Firstly it should be recognised that the structure of the Chinese economy has been and still is changing – fast. This is likely to produce three effects with relevance to UK exports:

Increasing value of import markets

Chinese imports are likely to continue to increase in value, with the IMF predicting a market of over £3 trillion by 2020. The FCO estimate that this size effect will result in UK exports to China totalling over £30 billion by 2020, yet this still falls short of potential gains.

Rebalancing economy

China’s economic growth over recent years has been driven by huge levels of investment, a growth path that it has been suggested is not indefinitely sustainable.  The twelfth five-year plan of the Government of China explicitly outlines a series of measures aimed at “rebalancing” away from investment dependence and towards a consumption-driven economy. Through the modelling of rebalancing scenarios, the FCO have estimated that significant rebalancing could add up to a further £20 billion to UK exports by 2020 – 90% of which would be focused in the car, pharmaceuticals and financial and business services sectors.

Shifting consumption patterns

As China’s continued economic progress leads to ever higher per capita incomes for the growing middle class, the average consumption basket is likely to shift towards higher value products which, should Chinese domestic production not be able to shift in line with it, may lead to higher import demand from the likes of the UK.

It is the third of these effects that has received the least attention yet could be the most useful in helping direct trade policy. As Chinese consumers get richer they will demand higher quality products that the UK is in a better position to satisfy than many other exporters. It seems fairly intuitive that a tailor-made suit produced in Savile Row, London is far from comparable to one mass-produced in a factory in Cambodia, yet without taking quality into account we fail to account for many of the unique advantages that the UK economy boasts relative to other exporters.

This effect is hard to establish quantitatively, partly due to the lack of trade data that details the quality of a product. However, using a methodology proposed by Clovis Freire, trade data can be divided up into sub-groups according to their unit value so that we can analyse UK exports to China using price as a proxy for quality.

As can be seen in the chart, the UK’s share of the high value market is always greater than or equal to its share in the market for a product as a whole (if they were equal the points would sit on the 45° line).

This implies that we already have a significantly greater share in markets for ‘high quality’ exports. Rather than worrying about lost market share, it is building the capacity to meet the Chinese demand of tomorrow that should be the focus of trade policy. Beyond this, the first chart demonstrates that other emerging economies are becoming increasingly aligned with Chinese import markets, thus by aligning ourselves in the same way we are likely to enhance complementarity with these other emerging markets too.

The exporters that adapt fastest to changing demand will reap the largest rewards from future Chinese and other emerging market imports. The UK is in a good position to take the lead in this respect – just as long as we are looking in the right direction.

Steven Ayres