Global Intelligence Trust | 9 Aug 2016
The British Service Sector: Potential UK-China Free Trade Agreement
Since the Brexit referendum in June, talk in both the United Kingdom and China has begun about a possible bilateral trade agreement between the two major economies. Such a deal could not only open opportunities for investors in both countries, but would also be highly symbolic: China’s first such agreement with a major Western power. On August 2, the Chinese ministry of commerce expressed willingness to jointly conduct a feasibility study for a hypothetical FTA .
The drive for enhanced trade between the UK and China is nothing new. In 2013, then-Prime Minister David Cameron promised in a visit to China that he would push heavily for a free trade deal between the EU and China . And a year ago a large contingent of Chinese officials and businessman, including President Xi Jinping, visited Britain, where an assortment of investments was announced. David Cameron called the visit and the deals the beginning of a “golden era” for relations . That golden shine is somewhat dulled at the moment by newly elected Prime Minister Theresa May’s ordered review of a nuclear power station project . If the May government cancels Chinese investment agreements made under Cameron, the chance of negotiations might be shot, but long-term desire in both countries for greater economic linkages will persist—with good reason.
Trade between China and the UK totaled almost £60 billion in 2014. This largely reflects the high levels of Chinese imports into Britain; China is now Britain’s second largest importer, behind only the United States. The percentage of imports occupied by Chinese goods more than doubled since 2004 to 7% in 2014. China is the destination for 3.2% of British exports, still outside of the top 5. This lopsided trading relationship, similar to China’s with most developed countries, can be explained by the prominence of goods over services in the bilateral trade flows .
From 2004 to 2014 trade in goods represented 80% of total trade between China and the United Kingdom . This is not ideal for a country where services make up almost 80% of GDP . Britain’s Office for National Statistics most recently reported an annual deficit in trade in goods of £10.2 billion, and a surplus in trade in services of £21.7 billion. Put another way, trade in services accounts for about a fourth of UK imports, but almost half of the kingdom’s exports .
If Britain can negotiate a deal that reduces barriers in trade in services, the nation’s trade balance with China and on the aggregate could improve markedly. China has notoriously strict capital controls, which its leaders trumpet as protection from malicious speculators and volatility in the global economy. Additionally, these limits and requirements make it much more difficult for foreign banks to expand into China. And if they do, they must maintain a representative office in China for two years and have more than $10 billion in assets before incorporating in China. Even then, it takes at least another year to prove to regulators that they deserve the ability to offer domestic currency services (9). London’s world class banking industry would profitably leap into China if they could quickly begin providing services to the massive middle class.
England is also well known for its insurance services, and China for onerous stipulations for foreign insurers. Regulatory hurdles have kept the market share of foreign-invested companies around 1%. And in the life and health insurance sectors, foreign companies must enter the market in a joint-venture with at least 50% of the equity coming from a Chinese firm. 
For China, these limits are not only protectionist but pragmatic. They allow the party to make sure it keeps an eye on foreign companies, especially in sectors that are important to the health of the economy (or can endanger it). Convincing the CCP-controlled nation to relinquish such safeguards will not be easy. Liam Fox, responsible for Britain’s post-Brexit trade negotiations, might not aim so high.
Law firms, the final component of London’s high end services triumvirate, could see gains in their access to China with or without a deal. Though burdensome regulations linger, China is committed to making it easier for foreign legal service providers to operate in the country, as part of its accession deal with the WTO .
For the strong services sector, a trade agreement with China would be a boon. Increasing bilateral investment could also bring money to Britain, as well as open up new opportunities for British investors. But for the industrial sector; accounting for 20% of the economy, politically important, and already hurting, a wide-reaching trade deal with China would be a nightmare . Cheap Chinese-manufactured goods and industrial products, such as overproduced and cheap steel, would pummel prices in the United Kingdom and further punish a worker population besieged by globalization.
It will be interesting to see what details emerge in the next couple years if substantive negotiations begin. Both countries stand to seriously benefit from reduction of barriers in the other, but are loathe to forego their own protections.
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