CHINA’S CLAWS ON THE UK ECONOMY
The UK wooed China five years ago, but now many sectors of the economy may have to unravel those ties
‘Under Osborne and Cameron, it became, let’s go for trade and not get bogged down in complex arguments about values’
‘No economy in the world is as open to Chinese investment as the UK,” declared George Osborne on a visit in 2015. Few Western nations would make such a claim today, but the then-chancellor was on an unapologetic charm offensive, batting away questions over human rights violations while claiming China stood up for free trade. He even touted the expanding global presence of tech titan Huawei as an example of how the ruling Communist party had embraced free market capitalism.
“There is always more we could be doing with China because I see China as an opportunity not a threat,” he said on one of his visits. China was the future and Britain wanted to be front of the queue to reap the benefits.
The new “golden era” of UK-China relations that Osborne hailed has lost its shine in the years since. Wounds stretching back centuries to the Opium Wars have reopened while the 21st century issues of 5G and tech infrastructure security have created new sources of tension. Kerry Brown, a professor of Chinese Studies at King’s College London, says: “Under Osborne and Cameron, it became ‘let’s go for investment and trade’ and not get bogged down in complex arguments about values. We are seeing now the end of this engagement policy… China has not been what people thought it would be.”
Relations with Beijing have hit a low not seen in decades. Chinese technology will be ripped out of British infrastructure amid fears that Beijing is using the likes of Huawei to spy on the West.
Meanwhile China has said there will be “consequences” as a result of the UK’s opposition to its tightened grip on Hong Kong with a new National Security Law. In 1841, Britain took the city state as part of an agreement with China to end the First Opium War before handing it back in 1997 under the “one country, two systems” deal.
But that agreement has wilted as Beijing undermines Hong Kong’s independence. Meanwhile economic power has shifted hugely in the last 23 years: UK GDP was more than 60pc larger than China’s in 1997 but is a fifth of its size today.
It has been a long five years for UK-China relations since Osborne’s kowtow. China’s ties to the UK have deepened even as tensions have grown. To understand the connections between the two countries, it’s important to look at each of the sectors that have, until now at least, welcomed Chinese investment with open arms.
Britain is a very open country and China is now the UK’s sixth biggest export market and fourth biggest source of imports, up from 26th and 15th back in 1999. Similarly it is a major player in foreign direct investment. Including Hong Kong and mainland China, IMF data indicates it is a top 20 investor in the UK while it is the fourth-biggest recipient of British outbound investment.
British consumers have enjoyed higher living standards on the back of cheaper goods, with businesses thriving on low-cost supplies and an increasingly wealthy market to sell into. Syed Kamall at the Institute of Economic Affairs says altering our relations with China is not like an embargo against Iran: “there is so much interdependency with China” that changes cannot happen quickly.
Coronavirus has illustrated this interdependency clearly, with some British manufacturers suddenly struggling to source supplies.
“Even as early as February at least one major equipment manufacturer had to briefly halt production because of a lack of parts supplied from China,” says Yael Selfin, economist at KPMG.
“In the same month one of the UK’s biggest carmakers had to fly component parts in suitcases as the virus had disrupted the usual routes.”
Kamall downplays the likelihood of this dependency changing any time soon. Consumers could pressure companies to change their suppliers, but this would risk price rises. The Government may also be reluctant to intervene except in cases where there is a national security concern.
Huawei is one such example; the cost of removing its kit is expected to be at least £2bn, not to mention the cost to the economy of a slower 5G rollout.
Some British companies would run into trouble if they were no longer able to source from China. The factory sector imports £46bn of goods from China annually, second only to Germany, and the Asian giant is the fifth-largest export market, worth about £18.3bn a year.
Research by trade association Make UK found that 65pc of large UK manufacturing companies import components used in their processes from China, and 31pc of SMEs.
Tim Figures at Make UK warns that there would almost certainly be widespread disruption among British manufacturing, which makes up 10pc of the UK economy, if supplies from China were halted.
Companies would have to find alternative sources for components, which would most likely be more expensive, and would probably not come from the UK.
“The best guess would be that manufacturers would not reshore production of components they previously got from China, they’d more likely seek alternative foreign suppliers,” Figures says.
“However, that would take time and probably come with extra cost, so almost certainly if the order came to stop doing business with China, we’d see a halt to a lot of UK manufacturing, at least for a while until the disruption was sorted out.”
Much of Britain’s automotive sector relies on China for components and finding new sources could taken even longer, given that many parts need to be certified for safety. When it comes to specific industrial companies with close links to China, the largest is British Steel, which is currently in the process of being bought by Jingye, a deal that is expected to save about 3,000 jobs mainly in Scunthorpe.
Another key company is Chinese automotive group Geely. It owns LEVC, and has pumped hundreds of millions into building electric black cabs and vans at a new factory near Coventry. It has also taken a controlling stake in Norfolk-based sports carmaker Lotus.
International sales are key to both these companies, and uprooting production from the UK remains highly unlikely in the medium to short term – no matter how strained relations with Beijing become.
Chinese investors have become a key part of London’s residential market amid a boom in the years following the financial crisis; much of the new-build sector is dependent on them.
Since 2017, Chinese investors have become the single largest foreign buyer of London property by number, according to Knight Frank.
Liam Bailey, of Knight Frank, says that in the last 12 months Chinese buyers accounted for 3.6pc of all prime central London sales. Their role in London’s development sector is even bigger. Georg Chmiel, of Juwai IQI, an online marketplace for overseas properties, says that in some projects Chinese investors account for a third of total sales.
Chinese developers have moved into Britain, too. Players with major projects include R&F Properties, CC Land and Country Garden.
Jonathan Benarr, of buying service Quintessentially Estates, says that Chinese investment is concentrated “almost unequivocally” in new build.
If Chinese buyers were to leave, “London’s real estate market would be absolutely annihilated”, Benarr says. “Projects would get mothballed – and that’s just where it would start.”
Regional cities such as Manchester and Birmingham, where some Chinese investors have chased yields and capital appreciation, would also be hit.
Chinese investors typically purchase off plan – either to sell on completion or to let out. As a result many developers market projects in China to help fund building back in the UK. Any fall in demand in China would thus have a knock-on effect on the supply of new homes in Britain, says Benarr. But there is a flip side. Any drop in Chinese investors would almost certainly coincide with a surge of Hong Kong relocators. The Foreign Office estimates that 200,000 of the three million residents eligible for British National Overseas passports are likely to move.
One of Osborne’s pledges as Chancellor was to make London “China’s bridge into Western financial markets”. This push helped London become the world’s largest renminbi hub outside China.
Trades of nearly 3 trillion RMB (£337bn) were cleared in the City between September and November last year, according to the City of London Corporation. Beyond that, however, the immediate impact of any breakdown in ties with China would be limited, as the country accounts for less than 2pc of the UK’s financial services exports.
The sector is a rare net exporter to China. It generated £359m of sales and imported just £57m in 2018, according to the most recent ONS figures. The real cost of diplomatic discord could be opportunity: the City has long regarded China as a major frontier for expansion. The likes of Prudential have calculated that even a small slice of China’s savings and insurance markets could turbocharge revenues.
UK-listed banks such as HSBC and Standard Chartered are big players in China and the wider region. But they now risk being targeted by a state-led campaign to boycott British firms, which could in turn hurt shareholders’ investments. Chinese state media warned this week that Beijing may have “to strike at British companies like HSBC” if political hostilities continue. Backing companies in tech and finance hubs such as Shenzhen and Shanghai offers UK investors the chance of attractive returns.
That opportunity could also be lost if China reverses its market liberalisation and makes access more difficult. The Shanghai London Stock Connect programme gives Shanghailisted companies the option to raise funds in London and vice versa.
The initiative is stuttering against the backdrop of political tensions and only two Chinese companies have used it so far. As Hong Kong moves further into Beijing’s grip, the Communist Party could also come to exert stronger influence on companies investing in the city, which has become a leading international finance hub and home to offices for a host of UK legal and financial firms.
China gained a foothold in the UK’s nuclear power industry via its partnership with France’s state-owned company EDF. China General Nuclear and EDF are building the £20bn Hinkley Point C power station in Somerset together, and are also planning to build a second station, Sizewell C, in Suffolk.
As a smaller financial partner to EDF on those sites, its influence is capped. But China also hopes to build its own HPR 1000 reactors at a third site, Bradwell in Essex, giving it far greater control over the UK’s power supplies.
Approval for its technology at Bradwell by the UK’s inspection regime would also help China as it tries to export the technology. Nuclear accounts for about 20pc of UK power supply, although there is fierce debate about whether it should remain at that level. China’s involvement in UK infrastructure does not end there. The China Investment Corporation sovereign wealth fund owns 8.7pc of Thames Water, London’s water supplier with about 15m customers, which it bought in 2012.
The same year the CIC snapped up a 10pc stake in Heathrow Airport, while in 2016 it was part of a consortium that bought 61pc of Cadent Gas, which supplies around 11m homes and businesses, from National Grid.
The consortium, which includes the Australian bank Macquarie, bought the rest of Cadent last year. John Pettigrew, National Grid’s chief executive said in 2016 that CIC was “well known in the UK infrastructure market today”, adding: “There are absolutely no concerns.”
Gas and water networks are considered solid infrastructure investments and should easily attract other buyers if China wanted to exit. But finding another company willing to bankroll nuclear power plants is far from certain.
Japanese and South Korean investors have both backed away from their interest in UK nuclear in recent years, although a new funding model being explored by the Government could yet revive talks.
‘Meanwhile economic power has shifted hugely: UK GDP was more than 60pc larger than China’s in 1997 but is a fifth today’
It is China’s role in Britain’s technology sector that has raised the most concerns. Chinese firms have been building up their presence for years, the best-known being Huawei, the telecoms company behind a significant chunk of the kit for Britain’s mobile and broadband networks.
Viral video app TikTok has also made a push into the UK, and was this year hunting for a 30,000 sq ft office in London to more than treble its staff numbers in Britain. Last year, almost a fifth of the Chinese firms operating in the UK were in the tech sector.
George Magnus, research associate at Oxford’s China Centre, says it is hardly surprising the UK has been seen as a key destination for Chinese tech investment. “It was particularly generous in welcoming China and Beijing saw lots of advantages in finding start-up tech firms and tapping into our R&D capability.”
This looks set to change. Concerns over Chinese cyber-espionage have been on the rise. Washington is piling on the pressure for Britain to sever ties, resulting in the decision to strip Huawei from mobile infrastructure.
Other relationships may prove even trickier to untangle. Some, including semiconductor company Imagination Technologies, are owned by Chinesebacked investors. Trying to undo this could mean forcing through a sale, something that few are keen to press.
More broadly, many British firms have supply agreements with China. Dialog Semiconductor told The Daily
Telegraph last year that the electronics industry would have no choice but to side with China against the US if the trade war escalated. If Britain blocked those relationships or introduced wider export licence restrictions, it could prompt many companies to relocate and hike costs for those remaining in the UK.
Five years on from Osborne’s claim about Britain welcoming Chinese investment, the mood music has changed. But reversing the tide in any meaningful sense may prove difficult.
‘If the order came to stop doing business with China, we’d see a halt to a lot of UK production’
Boris Johnson encounters a Chinese ‘lion’ in celebration of the Chinese New Year. The welcoming policy of his predecessors has come under increasing stress