[This article was first published on Young China Watcher’s blog]
By: Insa Ewert and Jan Philipp Pöter
The outcome of the UK referendum on 23 June 2016—a decision to leave the European Union by 51.9 percent to 48.1 percent—not only triggered political turmoil within the UK and the EU, but also had significant effects on financial markets globally. At this point, uncertainties surround the question of whether Article 50 of the Lisbon Treaty, initiating the UK’s exit negotiations, will be invoked, as well as models for a UK/EU trade deal. Besides these considerations, there are significant uncertainties around the UK’s bilateral and multilateral relationships. In this article, we examine the potential impacts of Brexit on UK-China and EU-China relations—assuming significant negative effects on UK’s access to the EU single market.
The forecasted economic impacts for Brexit by organizations like the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) are severe. Especially for the UK-China relationship, a “lose-lose” outcome has been predicted. Hence, Beijing’s political leaders, among them President Xi Jinping and Premier Li Keqiang, have voiced their preference for “Remain.”
In the past decade, the UK and China mutually invested in an ever-closer multidimensional relationship, including strengthened political, economic, and trade ties. Leaders on both sides referred to this special relationship as entering a “golden era,” with now-beleaguered Chancellor George Osborne nominating the UK as China’s “best partner in the West.” The UK successfully focused on attracting investments and developing London’s financial center into the world’s second largest RMB clearing hub. The UK in many ways functions as an entry point and stepping stone for China to the EU, economically and politically. As a strong advocate for China within the EU, it was the first member state to apply for membership in the Asian International Infrastructure Bank (AIIB), despite opposition from the U.S., and it has supported within the EU.
Regarding economic relations, it is necessary to distinguish between two components: i) UK-specific investments and trade; and ii) EU-relevant investments and trade, e.g. those relying on access to the European market through the UK. With its 64 million people and $2.8 trillion GDP, the UK is Europe’s second-largest economy, constituting a substantial domestic market for investments. The UK is currently the largest recipient of Chinese foreign direct investment (FDI) in Europe, demonstrated by large Chinese-funded infrastructure projects such as the nuclear power plant Hinkley Point C in Somerset and the HS2 rail link. The relevance of the UK market for Chinese investments has grown and will sustain, although investment flows will strongly depend on the UK’s post-EU economic outlook.
However, investments with a primary focus on the UK are only one part of this story. All trade and investments in the UK that aim to profit from its single-market access are likely to diminish in the short-term, and only regain momentum if a favorable deal with Brussels materializes. Negative consequences will likely impact a number of projects envisaged at the UK-China Economic and Financial Dialogue in September 2015, such as those that address the distribution of financial products in the EU and assume the single market’s “passporting” rights for financial services.
If the UK left the EU, a new UK-China trade agreement may have to be negotiated bilaterally, otherwise the relationship would be governed by the less preferential WTO framework. The timing around this is a huge uncertainty, with an immediate impact on long-term trade and investment decisions. With trade and investment between the UK and the EU likely to decrease, the relative importance of Chinese investment and trade rises. A quick and comprehensive trade agreement shortly after Brexit will therefore be key.
Increasing the UK’s dependence on China might, however, prove dangerous if the Chinese economy has a hard landing ahead, as Damian Tobin asserts in this YCW Conversation. In addition, not everyone in the UK administration has been content with the current strategy towards China. A sea change in public policy—in favor of more nationalistic voters—could imply a more cautious approach.
The view from Beijing is of a less important UK, having lost access to the EU’s single market and, concomitantly, its bargaining power for China in EU forums. The threat of secession movements within the UK (e.g. Scotland) sharpens this decline in relative importance—and could trigger significant repercussions from China in light of its own domestic territorial disputes.
Post-Brexit, the EU will also look less muscular to China without the UK as a counterbalance to the U.S. in a multipolar world. Having lost one of its biggest allies around the EU table, it may refocus on other European partners. Due to its historically strong trade relationship with China, Germany (accounting for 40 percent of all EU-China trade) might profit from a weakened UK-China relationship. Alternatively, and in light of China’s ongoing investments in its One Belt One Road (OBOR) initiative in Eastern Europe, China may turn to Eastern European member states instead.
Finally, Brexit also impacts China domestically. One pre-referendum comment indicated that the referendum might undermine Xi’s leadership due to his embrace of the UK. In contrast, it could be grist to the mills of the Chinese Communist Party’s narrative about the inadequacies of the popular vote. In addition, if the RMB emerges relatively stronger than other currencies such as the Euro, this might erode China’s export competitiveness and negatively affect its trade with the EU. While this serves the administration an opportunity to further devaluate the Yuan, it has already reached a six-year low to the dollar, making China’s currency stability a particularly difficult task.
China-watchers should prepare for a noticeable shift in its relations with the UK and the EU. Whereas the UK is destined to be the single biggest loser (economically and politically), should Brexit go ahead then China and the EU will face significant changes to their relative positions. While the UK and the EU would both lose collective bargaining power vis-à-vis China, Beijing will need to rethink its strategic approach and partnerships towards the EU as a whole, as well as determine its key allies going forward. Two weeks after the vote, uncertainties about Brexit remain high, demanding a close eye on developments in the coming months. Once the road ahead becomes clearer, we can reassess the links between Beijing, London, and Brussels.