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Economic & Labour Market Review May 2011
China and the UK
Changing patterns of international trade and investment
Graeme Chamberlin
Office for National Statistics
Linda Yueh
University of Oxford and Bloomberg TV
Summary
China’s economic growth over the last two decades has been truly remarkable. Averaging
near double–digit percentage growth each year, it is now the second largest economy in the
world based on gross domestic product (GDP) and is expected, one day, to overtake the
USA and become the largest. China’s growth has been predominantly export driven and
centred in manufacturing, especially since joining the World Trade Organisation (WTO) in
2001. This article looks at how the rise of China has impacted on the UK’s international
trade and investment and also how the continuing development of China may affect these
in the future.
Introduction
The current account part of the Balance of Payments reflects one nation’s transactions with the
rest of the world in goods trade, services trade, income flows and current transfers. Since 1992 the
UK has run a deficit on its current account averaging around 2 per cent of GDP (
Figure 1).
However, during this period, the UK’s current account deficit has varied from 0.1 per cent of GDP
in 1997 to 3.4 per cent in 2006. The share of the deficit accounted for by international transactions
with China has steadily increased. In 1992 the UK’s deficit with China was 0.1 per cent of GDP. By
2009 the deficit had grown to 1.2 per cent, with the size the deficit increasing faster after 1999.
Given that the overall UK current account deficit in 2009 was 1.1 per cent of GDP – it shows that
once China is excluded the UK’s current account position with the rest of the world would actually
be in surplus.
The UK’s growing current account deficit with China is the result of faster growth in debits (imports
and income outflows) than credits (exports and income inflows). Debits with China, as a
percentage of all debits, increased from 0.5 per cent in 1992 to 4.3 per cent in 2009, whilst the
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Economic & Labour Market Review May 2011
corresponding share of total credits accounted for by China increased from 0.3 per cent to 1.5 per
cent.
These are interesting figures showing that, despite China’s growing importance in the global
economy and the UK’s Balance of Payments, it still represents a fairly small part of the UK’s total
trade and income transactions with the rest of the world. Most of the transactions recorded in the
UK’s Balance of Payments are still with advanced mature economies, particularly within Europe
and the USA.
China’s main impact on the UK’s current account is in the trade in goods balance – particularly as
a source of goods imports into the UK. On the other hand, China–UK trade in services and income
flows related to the international ownership of financial assets – which are both an important part of
the UK’s current account due to the high degree of services specialisation in UK output and the
role of the City of London as a major international financial sector – are still very small.
The aim of this article is to look at the extent and nature of UK–China trade and investment in more
detail, not only recent trends but also how these might change as China continues its remarkable
and fast–paced development.
Figure 1 China and the UK current account
Per cent
-4
-3
-2
-1
0
1
2
3
4
5
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
China balance (per cent GDP)
Total balance (per cent GDP)
China credits (per cent total credits)
China debits (per cent total debits)
Source: ONS Pink Book
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Economic & Labour Market Review May 2011
Trade in goods
The UK’s deficit with China in the trade in goods has increased from a negligible amount in 1992
to 1.4 per cent of GDP in 2009 (
Figure 2). The UK now only imports more goods from Germany
and the USA than it does from China (
Table 1). In fact, other than the USA, China is the only non–
European country in the top 10 countries by imports (with Hong Kong and Japan just outside the
top 10). In 1992 Chinese goods represented about 0.2 per cent of all UK goods imports, by 2009
this share had risen to 7.9 per cent (just below the USA which accounts for 8.0 per cent, see
Figure 3a).
Figure 2 UK trade in goods balances, 1992–2009
Per cent GDP
-5
-4
-3
-2
-1
0
1
2
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
China
East Asia 9
Europe
USA
Other
Source: ONS Pink Book
East Asia 9 – Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand
China has also been a growing market for goods exports but it is still a relatively small one, with
most of the UK’s goods exports heading to the USA and Europe (
Figure 3b). China is in the UK’s
top 10 of countries by goods exports, but accounts for just 2.2 per cent of the total.
It should be noted though, that despite China’s growing prominence in goods trade, the UK’s
goods trade is still predominantly with Europe where the trade in goods deficit was 4.0 per cent of
GDP in 2009. Specifically, the group of EU 8 countries, despite seeing their shares of total goods
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Economic & Labour Market Review May 2011
imports and exports fall as a result of the rise in China and Eastern Europe – still accounted for
42.5 per cent of goods imports and 45.7 per cent of goods exports.
Table 1 Trade in goods: country rankings
Imports Exports
2009 2008 2007 2006 2005 2004 2009 2008 2007 2006 2005 2004
Germany 1 1 1 1 1 1 USA111111
USA 2 2 2 3 3 2 Germany222322
China 3 5 5 6 6 7 Netherlands 3 35555
Netherlands 4 3 3 4 4 4 France 4 53233
France 5 4 4 2 2 3 Ireland544444
Norway 6 6 7 7 8 10 Belgium666666
Belgium 7 7 6 5 5 5 Spain777777
Ireland 8 9 9 10 10 8 Italy 8 88888
Italy 9 8 8 9 7 6 China 9 10 11 15 15 16
Spain 10 10 10 8 9 9 Sweden 10 9 9 9 11 9
Hong Kong 11 12 12 12 12 12 Switzerland 11 11 12 10 10 12
Japan 12 11 11 11 11 11 Hong Kong 12 16 16 16 14 14
Sweden 13 14 14 14 13 13 United Arab Emirates 13 15 17 13 9 13
Switzerland 14 16 16 17 18 16 Japan 14 14 10 11 12 10
Poland 15 20 20 18 25 29 Canada 15 17 13 12 13 11
Russia 16 13 15 15 14 15 Singapore 16 21 20 22 21 22
Turkey 17 17 17 19 20 20 Australia 17 18 19 19 17 15
India 18 19 19 23 22 25 India 18 13 14 18 16 17
Canada 19 15 13 16 16 14 Norway 19 20 18 24 19 19
Denmark 20 22 21 13 15 18 Poland 20 19 21 17 26 28
Source: ONS Pink Book
China's surge in goods exports took off in 1992 with the 'open door' as China’s exports grew at 17
per cent per annum on average during that decade. Since 2001 when it acceded to the World
Trade Organisation, China quickly became the world’s largest exporter accounting for nearly 10
per cent of global exports by 2009, overtaking Germany, the US and Japan.
The sector in which Chinese exports are most notable are consistent with its comparative
advantage in labour–intensive products, such as clothing and textiles (Table 2). In fact, it was held
back by the Multi–Fibre Agreement that had imposed a global quota system on exports of clothing
and textiles. When it ended in January 2005, it freed up Chinese exports to such an extent that
safeguards were imposed by the Europeans and Americans.
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Economic & Labour Market Review May 2011
Figure 3a Changing origin of goods imports*, 1992–2009
Percentage points
-10-8-6-4-20 2 4 6
China (7.9)
Other East Asia (9.2)
Other Asia (4.5)
EU 8 (42.5)
EFTA (7.0)
Other Europe (12.9)
USA (8.0)
Other Americas (3.8)
Oceania (1.0)
Africa (3.3)
8
Source: ONS Pink Book
Figure 3b Changing origin of goods exports*, 1992–2009
Percentage points
-10-8-6-4-20 2 4 6
China (2.3)
Other East Asia (7.0)
Other Asia (6.6)
EU 8 (45.7)
EFTA (3.0)
Other Europe (11.7)
USA (14.9)
Other Americas (3.6)
Oceania (1.5)
Africa (3.6)
8
Source: ONS Pink Book
* Change in percentage shares. Figures in brackets are shares in 2009.
Other East Asia are the East Asian 9 – Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea,
Taiwan, Thailand
EU 8 – Belgium, France, Germany, Ireland, Italy, Luxembourg, Netherlands and Spain
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Economic & Labour Market Review May 2011
Table 2 Goods imports from China by SITC classification
Standard Industrial Trade Classification (SITC)
Value in 2010
(£ millions)
Share of UK
total in 2010
(%)
Share of UK
total in 1999
(%)
Change in
shares 1999-
2010 (%)
84: Articles of apparel and clothing accessories 3,818 25.5 5.9 19.7
89: Miscellaneous manufactured articles 3,593 18.4 6.3 12.2
75: Office machines and ADP machines 3,218 23.8 1.6 22.2
76: Telecoms and sound recording and reproducing apparatus 2,815 16.1 1.9 14.2
77: Elementary machinery, apparatus and appliances 2,318 14.5 2.5 11.9
894: Baby carriages, toys, games and sporting goods 1,945 46.2 19.4 26.8
82: Furniture and parts, bedding, mattresses etc 1,612 33.6 5.7 27.9
69: Manufactures of metal 1,377 19.6 4.8 14.8
85: Footwear 1,128 31.0 5.7 25.3
74: General industrial machinery and equipment 889 8.3 0.9 7.3
65: Textile, yarn, fabrics, made up articles etc 773 17.6 2.8 14.8
893: Articles of plastics 584 16.9 6.8 10.1
66: Non-metallic mineral manufactures 565 6.9 0.9 6.0
83: Travel goods, handbags and similar containers 564 38.5 23.0 15.4
81: Prefab buildings, sanitation, plumbing, heating and lighting 496 25.7 8.8 16.9
68: Non-ferrous metals 357 4.0 1.2 2.8
62: Rubber manufacturers 348 12.5 0.9 11.5
899: Miscellaneous nes 341 18.5 12.0 6.5
78: Road vehicles 335 1.0 0.1 0.9
63: Cork and wood manufactures (excluding furniture) 328 19.2 2.9 16.3
64: Paper and paperboard 311 5.2 0.6 4.6
911: Postal packages 309 35.6 1.4 34.2
51: Organic chemicals 291 3.0 1.2 1.8
71: Power generating machinery and equipment 287 2.1 1.9 0.1
87: Professional, scientific and controlling instruments 265 3.9 0.7 3.2
Total 28,228 7.9 1.8 6.1
Source: HMRC
But, that is not the only area of China’s comparative advantage. What has been impressive about
the range of goods that China exports is its breadth. Across low–technology goods like toys to
higher technology items like semi–conductor chips, there has been a significant upgrading in
Chinese exports (the technology composition of Chinese exports is generally consistent with that of
a country with three times its average income). But, because foreign–invested enterprises have
produced more than half of Chinese exports since the mid–1990s and the share is higher in the
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Economic & Labour Market Review May 2011
more advanced output of high tech goods, there are questions as to whether or not it represents
shifting comparative advantage or the centrality of China as a global manufacturing hub.
The high concentration of foreign firms in Chinese exports is the result of long–standing policy that
aimed to attract and learn from foreign direct investment to help develop Chinese industry. This
policy began at the very start of reforms in December 1978 and centred on developing Chinese–
foreign joint ventures through the 1980s which accelerated in the 1990s with the 'take off' of the
open door policy. Then, with anticipated opening after WTO accession, wholly foreign–owned
enterprises rather than joint ventures gained greater prominence. But, through the past three
decades, the intent to attract and imitate the more advanced know–how of multinational
corporations has been evident. In some industries, this has resulted in Chinese firms becoming
competitive and stealing market share even from foreign firms such as in mobile handsets. But, in
other respects, China’s industrial upgrading still has some way to go.
Nevertheless, with rising wage pressures (real urban wages have risen by 10 percent on average
during the 2000s) and growing competition from southeast Asian nations such as Vietnam, China
had begun to move out of low–end manufactures. China seeks to move up the value chain and
had since the mid 1990s, developed High–Technology Development Zones which are akin to
science parks, as well as increased spending on technology and innovation. For instance, R&D
spending as a part of GDP in China now ranks among the highest even among OECD countries.
Therefore, part of the impressive growth across the technical expertise of Chinese exports is also
due to a focus on higher value–added production as sustained economic growth will increasingly
depend on more total factor productivity (TFP) growth.
Therefore, cheaper nations in southeast Asia may well benefit from the 'flying geese' pattern of
trade, first observed when cheap manufactures moved out of Japan to South Korea, Taiwan and
then to China and now to southeast Asia. But, for China, becoming competitive to be placed within
the regional production chains for electronics trade is more desirable and suits its policies that
have attempted to shape its dynamic comparative advantage.
Imports to China have also grown significantly over the last two decades but not so much from the
UK (Table 3). The main export markets provided by China are high–end capital goods such as
those sold by Germany and also by France. For instance, Germany is China’s 6th largest import
partner while the UK does not rank in the top 10. Consumer goods still comprise less than 3
percent of all Chinese imports. This is because of decades of protectionism of domestic markets
against foreign competition to develop its own firms and industries. The barriers were originally
tariff–based, for instance, there had been 100 per cent tariffs on imports. And the only foreign firms
allowed to invest in China were restricted to Special Economic Zones where they could produce for
export but not to sell their wares in China. After WTO accession, tariffs have fallen dramatically
across the board, but non–tariff barriers remain. For instance, permission and licenses can be hard
to obtain to access China’s markets. And thus, lack of 'market access' is one of the perennial
complaints of Western businesses.
The pattern of imports in China is likely to shift more towards consumer goods, only because there
is in general greater opening after WTO accession particularly of the services sector despite the
government’s protective policies because services was the sector where China agreed to open
under its WTO obligations. And, China is keen to develop its services sector. At 40 per cent of
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Economic & Labour Market Review May 2011
GDP, it is too low by comparative standards and has plateaued in the past decade despite the
government’s efforts. As services is partly non–tradable, it also suits the 're–balancing' aims of the
Chinese government as it tries to reduce its reliance on exports and increases the contribution of
domestic demand to economic growth.
Table 3 Goods exports from China by SITC classification
Standard Industrial Trade Classification (SITC)
Value in 2010
(£ millions)
Share of UK
total in 2010
(%)
Share of UK
total in 1999
(%)
Change in
shares 1999-
2010 (%)
78: Road vehicles 1,645 7.0 0.1 6.9
28: Metalliferous ores and metal scrap 751 18.5 1.5 17.0
71: Power generating machinery and equipment 624 3.7 0.9 2.8
74: General industrial machinery and equipment 448 4.5 1.8 2.8
54: Medical and pharmaceutical products 424 1.9 0.2 1.7
77: Elementary machinery, apparatus and appliances 348 3.2 0.8 2.4
25: Pulp and waste paper 296 54.6 4.4 50.2
87: Professional, scientific and controlling instruments 288 3.9 0.9 3.0
72: Machinery specialised for particular industries 265 3.9 1.9 2.0
68: Non-ferrous metals 249 4.3 0.5 3.7
89: Other transport equipment 199 1.3 0.2 1.0
79: Other transport equipment 145 1.4 0.5 0.9
57: Plastics in primary forms 130 4.2 0.6 3.6
76: Telecoms and sound recording and reproducing apparatus 127 1.8 2.2 -0.4
73: Metalworking machinery 106 11.9 2.5 9.4
69: Manufactures of metal nes 100 2.2 0.6 1.7
59: Chemical materials and products nes 97 2.1 0.5 1.6
67: Iron and steel 80 1.6 0.7 0.9
33: Petroleum, petroleum products and related materials 80 0.3 1.4 -1.2
75: Office machines and ADP machines 76 1.3 0.2 1.1
21: Hides, skins and furskins 75 46.1 5.0 41.1
51: Organic chemicals 66 0.7 0.5 0.2
52: Inorganic chemicals 62 1.8 1.1 0.7
88: Photographic and optical goods 61 3.5 1.3 2.2
11: Beverages 61 1.1 0.0 1.0
Total 7,225 2.8 0.7 2.0
Source: HMRC
As the Chinese middle class continues to develop consumer goods producers, especially those at
the higher quality end, will find that there is a great deal of repressed consumption. The wholesale
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Economic & Labour Market Review May 2011
and retail sector were only liberalised in the late 1980s and early 1990s out of the control of the
state-owned enterprises. In fact, food vouchers were only abolished in 1992. Of course, China will
continue to import high–tech capital goods since it cannot produce these at the moment and will
want to learn from the best technology in the West and Japan. Germany, France and Japan have
all grown well from exporting to China and this pattern is likely to continue as China undergoes its
second industrialisation. Its 12th Five Year Plan (2011–2015) includes ambitious infrastructure
building to supports its urbanisation policy and also China aims to re–orient its capital more
efficiently to reform its industries away from obsolete heavy industries and into higher tech sectors.
So, unlike the first industrialisation which took place during the command period, China’s industry
which is still 50 per cent of GDP as it was in 1979 on the eve of reform, will become re–oriented.
And urbanisation plus services sector development will require road, rail as well as 'soft
infrastructure' to deliver government services across large urbanised areas. All of this will justify
continuing capital accumulation growth and continue China’s need to import capital goods as well
as energy and commodities.
Trade in services
Services trade is very important to the UK current account. It reflects the UK’s comparative
advantage and goes someway to offsetting its perennial deficit in the trade in goods. Services
trade with China has increased in the last two decades but remains a small proportion of the total.
The UK’s surplus with China in services trade amounts to just 0.1 per cent of GDP (
Figure 4), tiny
when compared to the services trade surpluses with Europe (1.2 per cent of GDP), USA (1.0 per
cent) and even the rest of East Asia (0.4 per cent).
Although services imports from China have increased as a proportion of the total since 1992, they
still only represent around 1.0 per cent of the total in 2009 (
Figure 5a) and China is not in the top
20 list of countries by services imports (
Table 4). China’s place in UK exports of services is slightly
bigger, but not by much. Although China is in the top 20 list here, China took only 1.5 per cent of all
the UK’s services exports (
Figure 5b).
Even though China is, in terms of GDP, the second largest economy in the world, low services
trade largely reflects its relatively low development (low consumption), high degree of state
planning (limited business services) and relatively closed and restricted financial markets. For
instance, in 2009 the UK exported £43.9 billion in financial services, of which just £203 million (0.5
per cent) went to China (
Table 5). Likewise, business services exports by the UK in 2009 were
£42.2 billion, of which £386 million (0.9%) went to China. The UK’s largest source of services
exports with China in 2009 were in transport (£940 million, 4.5 per cent of the total) and travel
(£589 million, 3.1 per cent of the total). Travel is one part of the services industries were some
restrictions have been lifted with Chinese nationals being now able to visit foreign countries more
freely.
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Economic & Labour Market Review May 2011
Figure 4 UK trade in services balances, 1992 – 2009
Per cent of GDP
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
China
East Asia 9
Europe
USA
Other
Source: ONS Pink Book
East Asia 9 – Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand
The Chinese service sector is likely to grow quickly in the next decade which may provide export
market opportunities for UK firms. Not only because of the WTO obligations but because China
wants to develop such services and is using a similar approach to its way of developing
manufacturing during the 1980s and 1990s. By attracting British banks and financial companies to
become minority equity investors (for example HSBC and Bank of Communications, China’s 5th
largest bank – a state-owned bank just under the top tier of the big four is a good example as
HSBC can only hold up to 20 per cent and the ceiling for foreign shareholding is 25 per cent), it is
similar to the joint venture policy for industry. By working alongside foreign firms, Chinese
managers and workers can learn best practise and know–how. This model pertains to all services.
The services sector has strong potential to grow because it is starting from a low base. Under the
planned economy, there was no need for services as the government provided all of them. Starting
in the mid–1980s, the PBOC became a central bank and the state–owned commercial banks were
created. In the early 1990s, the two stock exchanges (Shanghai and Shenzhen) were created and
financial services grew slowly as it was marred by scandal due to ineffective regulation. But, since
WTO accession in 2001, private firms can now list on the stock exchanges and the pace of
services development is rapid.
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Economic & Labour Market Review May 2011
Figure 5a Changing origin of services imports*, 1992–2009
Percentage points
-4 -3.5 -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 3
China (1.0)
East Asia 9 (7.0)
Other Asia (5.9)
EU 8 (36.7)
EFTA (3.9)
Other Europe (17.3)
USA (17.2)
Other Americas (4.8)
Oceania (2.3)
Africa (3.8)
Source: ONS Pink Book
Figure 5b Changing origin of services exports*, 1992–2009
Percentage points
-3.5 -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 3
China (1.5)
East Asia 9 (8.3)
Other Asia (6.7)
EU 8 (28.5)
EFTA (6.2)
Other Europe (15.9)
USA (20.7)
Other Americas (5.4)
Oceania (2.9)
Africa (4.0)
Source: ONS Pink Book
* Change in percentage shares. Figures in brackets are shares in 2009.
Other East Asia are the East Asian 9 – Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea,
Taiwan, Thailand
EU 8 – Belgium, France, Germany, Ireland, Italy, Luxembourg, Netherlands and Spain
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Economic & Labour Market Review May 2011
Table 4 Trade in services: country rankings
Imports Exports
2009 2008 2007 2006 2005 2004 2009 2008 2007 2006 2005 2004
USA 1 1 1 1 1 1 US
A
1 11111
Spain 2 2 2 2 2 2 German
y
2 22222
France 3 3 3 3 3 3 Netherlands 3 33333
Germany 4 4 4 4 4 4 France4 44454
Italy 5 5 5 5 5 5 Ireland5 55545
Netherlands 6 7 7 6 6 6 Switzerland 6 66666
Ireland 7 6 6 7 7 7 Spain 7 77789
Japan 8 8 8 8 9 11 Ital
y
8 98998
Switzerland 9 9 9 9 8 9 Japan 9 89877
Belgium 10 10 10 10 12 10 Australia 10 11 11 11 10 11
Australia 11 13 12 12 11 13 Singapore 11 13 10 10 12 12
Greece 12 12 11 11 10 8 Belgium 12 12 12 13 11 10
India 13 11 13 13 14 15 Denmark 13 19 17 15 18 17
Sweden 14 18 18 15 15 14 The Channel Islands 14 10 13 14 14 16
Portugal 15 14 14 14 13 12 Canada 15 14 15 16 17 13
Singapore 16 20 29 26 27 28 Sweden 16 18 19 17 16 15
Bermuda 17 17 16 17 43 - China 17 17 23 21 20 19
United Arab Emirates 18 22 23 27 26 31 Norwa
y
18 15 16 18 15 18
Russia 19 26 28 30 32 30 Luxembourg 19 23 24 26 28 28
Turkey 20 16 21 20 18 19 Saudi Arabia 20 16 14 12 13 34
China 25 19 26 29 24 29
Source: ONS Pink Book
Because of the middle class achieving lower middle income level for the first time in the early
2000s, there is now a need for services. For instance, the lack of financial services and the
existence of financial repression (legal/policy measures to distort credit decisions) mean that the
high savings of Chinese households (22 per cent of GDP) are inefficiently allocated. The same
applies to firms which have a savings rate that is now equal to households for the first time. The
need for financial intermediation is apparent and the government is loosening its policies rapidly to
develop the sector, albeit on an experimental basis. However, the access for foreign firms is likely
to be difficult since like manufacturing before it, the Chinese government is wary of allowing large
firms to dominate an under–developed sector. But, with China’s greater global integration, it is
more difficult to restrict access and its own firms will play an active role in wanting greater opening
to partner with and transact with foreign players.
Shanghai may well rise to eventually become a competitor to London. But, as with the rise of Hong
Kong or Frankfurt, there is scope for a number of financial centres and once established, spatial
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Economic & Labour Market Review May 2011
agglomeration studies suggest that it is difficult to dislodge an existing hub of specialisation
whether it is the City of London, Hollywood or Silicon Valley.
Table 5 Composition of China–UK trade in services
Exports Imports
2009 2008 2009 2008
China Grand total China % China Grand total China % China Grand total China % China Grand total China %
Transportation 940 20,708 4.5 1,012 20,884 4.8 331 19,175 1.7 318 17,707 1.8
Travel 589 19,282 3.1 516 19,598 2.6 306 37,256 0.8 248 32,297 0.8
Communications 40 4,485 0.9 28 4,262 0.7 45 4,346 1.0 41 4,041 1.0
Construction 6 1,625 0.4 .. 1,246 .. 23 1,095 2.1 8 1,433 0.6
Insurance 25 8,333 0.3 24 7,604 0.3 62 1,108 5.6 65 1,006 6.5
Financial 203 43,852 0.5 387 52,821 0.7 205 13,146 1.6 34 10,933 0.3
Computer and information 20 6,902 0.3 21 7,258 0.3 12 3,391 0.4 14 3,818 0.4
Royalties and license fees 38 7,610 0.5 56 7,987 0.7 5 5,750 0.1 2 5,814 0.0
Other business services 386 42,243 0.9 367 44,727 0.8 343 25,218 1.4 318 27,750 1.1
Personal, cultural and recreational 56 1,951 2.9 .. 2,274 .. .. 1,094 .. 2 667 0.3
Government 12 2,120 0.6 14 2,158 0.6 .. 3,884 .. 10 3,793 0.3
Total services 2,315 159,111 1.5 2,454 170,819 1.4 1,342 115,463 1.2 1,060 109,259 1.0
Source: ONS Pink Book
International income and investment
Income flows (and current transfers) are an important part of the UK current account. For instance,
in recent years, the UK’s surplus on its income balance has sometimes been as important as its
surplus in services trade.
Income flows represent earnings and payments relating to the international ownership of financial
assets. As the UK has historically been a large (relative to GDP) investor and receiver of
international investment the investment income balance has always been meaningful in the
Balance of Payments. The City of London’s position has a major financial centre is central to this.
Figure 6a shows that the UK’s income balance with China has been increasing as a percentage of
GDP – but is still fairly small. Income credits and payments have generally been trending upwards
(except in 2008 and 2009 when the financial crisis and recession reduced Chinese earnings from
UK assets) but are still a low proportion of GDP. Figure 6b looks to put the significance of China–
UK income flows in a more international context. From a regional perspective, China’s share of
East Asia credits has been rising, debits have also risen but not as quickly. However, this may in
part reflect the aftermath of the Asian financial crisis. China, with its relatively closed financial
markets was largely insulated from the crisis. It is still apparent from Figure 6b, that compared to
the rest of the world, Chinese income flows with the UK are relatively small and not really growing
that fast.
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Economic & Labour Market Review May 2011
Figure 6a China–UK income balance
Per cent of GDP
-0.04
-0.02
0.00
0.02
0.04
0.06
0.08
0.10
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Balance
Credits
Debits
Source: ONS Pink Book
Figure 6b China–UK income flows relative to East Asia and total
Percentage share
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Credit: East Asia 10
Debit: East Asia 10
Credit: Total
Debit: Total
Source: ONS Pink Book
East Asia 10: China, Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand
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Economic & Labour Market Review May 2011
Income flows are connected with the ownership of assets. As an open economy with a large
financial sector the UK has a large stock of overseas assets (7.6 times GDP in 2008) and liabilities
(7.7 times GDP in 2008). Much of this reflects the City of London's role as an international financial
intermediary – for example borrowing £100million from wholesale markets in Asia to lend
commercially in Europe and so means the UK ends up with large stocks of assets and liabilities
that do not differ that much in size. In comparison, China is a tiny part of the UK's International
Investment Position (IIP or net asset position). UK assets in China in 2008 were about (2.1 per
cent of UK GDP) and UK liabilities to China were (1.1 per cent of UK GDP).
The UK’s IIP with China has increased, both as a proportion of GDP (Figure 7a) and relative to the
rest of East Asia (Figure 7b). However, its incidence is still small, especially compared to the UK’s
total assets and liabilities with the rest of the world. As Table 6 shows, most of the UK’s
international investment is with other advanced economies.
China's low share of assets and liabilities in the IIP is not surprising when considering that most of
these assets are portfolio (equities and interest–bearing financial assets) and that China's financial
markets are both underdeveloped and closed to international investors. It might be expected that
given China's strong position in manufacturing trade and its attraction of foreign firms to joint
ventures in Special Economic Zones that direct investments may be more significant. However, as
Figures 8a and 8b show, FDI from the UK to China and from China to the UK are still both fairly
small compared to the UK's FDI flows with other countries and regions. This may partly reflect the
UK's shrinking manufacturing sector, but is mainly due to the fact that FDI positions are generally
built up over many years. China is a relative newcomer to the global economy (WTO membership
in 2001) and despite this it also maintains a large number of restrictions limiting investment in and
out of the country.
China still officially has a closed financial account, though there are some moves to liberalise,
mainly around Chinese firms and households moving some of their money to Hong Kong. The
stock market is still closed as well. Only select foreign investors can invest, those known as
Qualified Foreign Institutional Investors as of 2002, can invest in the 'A' share market which hold
the main RMB–denominated stocks. The reasons are because of worries over the fragility of the
banks, which have suffered from non–performing loans but are awash with cash because of the
trapped savings in China. For instance, the current gap between the deposit and the lending rate in
China (300 basis points) is simply to preserve bank margins.
Also, the Chinese are worried about liberalisation effects on the exchange rate. But, because of
liquidity pressures (M2 money supply growth has been near 20 per cent in the past year) and the
pressure from mature Chinese firms to operate globally, there are numerous policies that are
gradually opening the financial account. Domestically, the stock exchanges are also undergoing
reforms, including making all of the shares tradable (for most of the reform period, only third of the
shares were tradable since all listed firms were state–owned enterprises and the majority of the
shares were held by the state and legal persons which were other state–owned enterprises). For
instance, exchange traded funds are being developed and greater foreign participation is being
encouraged in the financial sector as the Chinese in particular are keen to develop its under–
developed capital markets.
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Economic & Labour Market Review May 2011
Figure 7a China–UK IIP
Per cent of GDP
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
2001 2002 2003 2004 2005 2006 2007 2008
IIP
Assets
Liabilities
Source: ONS Pink Book
Figure 7b China assets and liabilities relative to East Asia and total
Percentage share
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2001 2002 2003 2004 2005 2006 2007 2008
Assets: East Asia 10
Liabilities: East Asia 10
Assets: Total
Liabilities: Total
Source: ONS Pink Book
East Asia 10: China, Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand
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Economic & Labour Market Review May 2011
Table 6 UK IIP assets and liabilities, 2009
Percentage of GDP
UK GDP in 2009 = £1.39 trillion
Assets Liabilities
Total 759.6 Total 766.6
EU 27 340.9 EU 27 331.7
USA 219.0 USA 210.4
Germany 74.2 Germany 83.8
France 68.3 France 63.8
East Asia 10 50.8 East Asia 10 62.8
Netherlands 45.4 Netherlands 50.7
Ireland 38.6 Ireland 38.4
EFTA 33.3 EFTA 38.3
Japan 27.5 Japan 33.2
Spain 24.6 Hong Kong 13.2
Italy 17.1 Singapore 11.7
Singapore 8.2 Spain 11.5
Hong Kong 7.0 Italy 9.9
South Korea 3.2 South Korea 1.8
India 3.2 India 1.4
China 2.1 China 1.1
Taiwan 1.1 Taiwan 0.8
Malaysia 0.6 Thailand 0.4
Thailand 0.4 Malaysia 0.4
Indonesia 0.3 Philippines 0.2
Philippines 0.3 Indonesia 0.1
Source: ONS Pink Book
Given the policy distortions affecting bank lending which are biased towards state–owned
enterprises, capital markets (bond markets are also very under–developed) are needed to offer
financing, particularly venture capital to support entrepreneurs and private firms which are credit–
constrained despite the excess liquidity in the economy. The first 'dim sum' bonds have been
issued (the very first was MacDonald’s earlier this year) which are RMB–denominated corporate
bonds issued in Hong Kong to try and raise money from China and entice Chinese savers to put
their money somewhere other than housing and the stock markets.
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Economic & Labour Market Review May 2011
Figure 8a UK stocks of direct investment abroad, 2009
£ millions
2,991
3,027
4,474
5,198
5,326
6,995
9,310
10,053
10,540
11,698
14,277
15,509
16,150
20,443
22,111
27,149
29,095
29,372
29,398
29,462
32,930
41,027
126,143
154,767
252,269
0 50,000 100,000 150,000 200,000 250,000 300,000
South Korea (0.3)
Japan (0.3)
China (0.4)
Singapore (0.5)
Norway (0.5)
Denmark (0.7)
India (0.9)
Russia (1.0)
Belgium (1.0)
Italy (1.1)
South Africa (1.4)
Bermuda (1.5)
Australia (1.6)
Switzerland (2.0)
Sweden (2.1)
UK offshore islands (2.6)
Irish Republic (2.8)
Germany (2.9)
Hong Kong (2.9)
Canada (2.9)
Spain (3.2)
France (4.0)
Luxembourg (12.3)
Netherlands (15.0)
USA (24.5)
Source: ONS Foreign direct investment
Figures in brackets are percentage shares of total
Figure 8b Overseas stocks of direct investment into the UK
£ millions
520
615
779
787
1,742
1,841
2,978
5,125
5,550
6,641
7,263
12,124
12,261
18,389
21,251
23,080
27,089
27,465
30,733
68,850
73,826
110,587
158,689
0 20,000 40,000 60,000 80,000 100,000 120,000 140,000 160,000 180,000
Bermuda* (-)
Hong Kong (-)**
South Africa (0.1)
China (0.1)
Russia (0.1)
South Korea (0.1)
Norway (0.3)
India (0.3)
Singapore (0.5)
Belgium (0.8)
Denmark (0.8)
Sweden (1.0)
Italy (1.1)
Irish Republic (1.9)
Australia (1.9)
Canada (2.8)
Japan (3.3)
UK offshore islands (3.5)
Switzerland (4.1)
Spain (4.2)
Luxembourg (4.7)
Germany (10.5)
France (11.3)
Netherlands (16.9)
USA (24.3)
Source: ONS Foreign direct investment
Figures in brackets are percentage shares of total
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Economic & Labour Market Review May 2011
Hong Kong is the place where the Chinese tend to experiment. The 'dim sum' bonds and
liberalisation measures extending only to Hong Kong are examples. Hong Kong has 50 years from
1997 to remain a separate economic entity. Its market development is likely to influence Chinese
markets greatly, since the financial system is more developed and can positively influence
regulation on the mainland. But, because of the gradual nature of Chinese reforms, experimenting
in Hong Kong has limited cost especially since Hong Kong still has its own currency so any capital
outflows will not affect the RMB. If it works in Hong Kong, then it has a greater chance of being
introduced in China.
There is a catalogue of permitted investments by foreigners governed by various ministries,
ultimately by the State Council, the highest governing body. The National Development Reform
Commission (NDRC) is the highest policy body (they formulate the Five Year Plans) and tend to
reveal the policy direction. But, politics and competition among ministries is fierce, which is often
why statements can be contradictory. Also, provincial authorities are powerful, and decentralisation
is one of the keys for successful Chinese growth, so they experiment and can ignore what the
central government says is the criteria for foreign investment. This is unlikely to change as China
develops, but more coordinated policymaking is one of the reform goals.
Chinese corporations and sovereign wealth funds are also likely to become more active investors
in FDI. There are three sources of sovereign wealth funds
• CIC or China Investment Corporation are the official ones
• SAFE state administration for foreign exchange; and
• China Development Bank – one of the 3 policy banks spun off from the People's Bank of China
(PBOC) when it became a central bank
They are trying to diversify China’s capital outflows from its large holdings of US Treasuries by
increasing overseas investments. In 2008, two–thirds of FDI was in financials and the rest in non–
financials. With $3 trillion in reserves, China will be diversifying more including funding its 'going
global' policy.
Launched in 2000, the first ever commercial overseas FDI deal was struck in 2003/4 when TCL
bought France’s Thomson brand. This is the 'going out' of Chinese firms to make them
multinational corporations. But the pace is slow. They are after what China does not have a
comparative advantage in, which is unusual. But, they invest in technology, financial services, all
areas where China seeks expertise. These are private firms, but with state connections because
they need permission to invest overseas. Also, China is using its reserves to fund such
investments which is controversial. But, as countries develop, it is not surprising that outward FDI
will begin and multinational corporations form. It is also China’s tool to liberalise the financial
account but only through FDI. But, as they also want to internationalise the RMB (making it
eventually into a reserve currency), it raises questions about whether they can achieve this
objective without further financial account liberalisation.
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Economic & Labour Market Review May 2011
Final remarks
China's trade has grown rapidly since it adopted its open door policy in the early 1990s and
ascended to WTO membership in 2001. However, this has been largely concentrated in the global
trade of manufactures, so whilst the UK is now importing more than ever from China exports of
goods and services to China are yet to surge. For instance, compared to Germany and France the
UK has been relatively unsuccessful in selling its wares to China.
China's continued growth is likely to see demand for consumer goods and services rise – the
development of a services sector, especially in finance, may be an opportunity for the UK to deploy
its comparative advantage in a new and growing market. However, restrictions on access to the
Chinese market are likely to be removed slowly as China looks to protect is domestic firms from
foreign competition and seeks to assimilate knowledge through joint ventures.
China's closed financial markets are also likely to be slowly deregulated. It is also likely that
Chinese sovereign wealth firms and corporations are likely to look to acquire foreign FDI, in order
to diversify reserves away from US Treasuries and as Chinese firms become increasingly mature
and look to operate in global markets.
Contact
elmr@ons.gov.uk
Office for National Statistics
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