UK EXPORTS TO CHINA NOW AND IN THE FUTURE

UK EXPORTS TO CHINA NOW AND IN THE FUTURE FCO ECONOMICS UNIT January 213 1

STRUCTURE SECTION 1: GETTING PERSPECTIVE WHERE ARE WE NOW? Assessing the size of China s import market and the UK s position within it SECTION 2: SIZING THE MARKET WHICH SECTORS OFFER THE GREATEST OPPORTUNITY? Identifying which Chinese import sectors will grow the fastest by 22 SECTION 3: HOW MUCH OF THE MARKET COULD THE UK CAPTURE? Assessing the UK s export prospects in each sector ANNEX A: SECTOR SPECIFIC PROJECTIONS Details of the growth potential for UK exports in twelve strategic sectors ANNEX B: TRADE IN VALUE ADDED - THE WINGS ON THE AIRBUS EFFECT Assessing UK exports to China via third countries 2

SECTION 1: GETTING PERSPECTIVE WHERE ARE WE NOW? Assessing the size of China s import market and the UK s position within it 3

GETTING PERSPECTIVE China s Import Market Value of imports to China in individual sectors in 211 ( bn) 35 3 25 Services Goods Chinese Imports ( bn) 14 12 1 2 8 15 6 1 4 5 2 22 24 26 28 21 Source: UNCTAD Statistics and FCO Economics Unit Calculations Over the past decade the Chinese import market has grown by a factor of five to 1.2tn. The bulk of that growth has come from goods imports related to fixed asset investment. In 211, 32% of China s imports were fuels, metals and other raw materials. A further 28% related to machinery and electrical goods. Only 12% were services. 4

GETTING PERSPECTIVE UK Exports to China 2.5 2. Value of UK exports to China in 211 ( bn) Services Goods UK exports to China ( bn) 14 12 1 1.5 8 1..5 6 4 2. 22 24 26 28 21 Source: ONS, UNCTAD Statistics and FCO Economics Unit Calculations UK exports to China also grew rapidly over the past decade, but not quite quickly enough to keep pace with the market. Since 22, UK exports to China have quadrupled to 12.5bn. The UK s export mix is not particularly well-aligned with China s fastest growing sectors. In 211 over a quarter of UK exports to China were services. By contrast, machinery and electrical goods accounted for only 19% of UK exports and raw materials only 16%. 5

GETTING PERSPECTIVE UK market share versus EU-3 6% Goods Services Total Share of Chinese Goods Market Share of Chinese Services Market 6% Share of Total Chinese Import Market 6% 5% 5% 5% 4% 4% 4% 3% 3% 3% 2% 1% 6% 1% -4% % 22 25 28 211 UK Germany France Italy Share of Chinese Goods Market EU-3 2% 1% 22 25 28 211 % 22 25 28 211 UK Germany France Italy EU-3 2% 1% % 22 25 28 211 UK EU-3 Germany France Italy Germany France Italy Source: ONS, Eurostat, UNCTAD Statistics and FCO Economics Unit Calculations The UK s share of the Chinese market has fallen to around 1% over the past decade and has continued to lag behind France, Italy and Germany (EU-3). This underperformance is partly down to the way trade statistics are measured. A relatively high share of UK exports are intermediate goods, which flow to China via other countries, and hence are not directly recorded as UK exports to China. When we account for trade in value added, the UK performs better but still lags the EU-3 (see Annex B). Based on bilateral trade statistics, the UK s underperformance is most stark in the goods sector, and a little better in services. Overall, the UK s performance is roughly on a par with Italy. EU-3 UK 6

GETTING PERSPECTIVE Looking ahead - China s potential as an export market 35 3 25 Total Chinese Imports ( bn) IMF Forecasts Gains from maintaining market share in China by 22 ( 2.8bn) Gains from catching up with the market share of the EU-3 in China by 22 ( 25.7bn) 4 2 2 6 15 1 5 211 UK Exports to China ( 12.5bn) 8 2 22 24 26 28 21 212 214 216 218 22 UK EXPORTS TO CHINA BY 22 Source: UNCTAD Statistics, IMF World Economic Outlook and FCO Economics Unit Calculations The IMF s latest forecasts suggest China s import market will be worth over 3tn by 22. If the UK maintains its market share, UK exports to China will be worth just over 3bn by 22. But if the UK closes the gap on the EU-3, exports could rise from 12.5bn in 211 to almost 6bn by 22 - equivalent to around 1% of the total increase in UK exports needed to meet the Chancellor s 1tn export aspiration. 7

SECTION 2: SIZING THE MARKET Which sectors offer the greatest opportunity? Identifying which Chinese import sectors will grow the fastest by 22 8

SIZING THE MARKET Three scenarios for projecting sectoral growth We split the Chinese import market into 24 sectors using UNCTAD statistics, then construct three scenarios for forecasting import demand in each sector: SCENARIO 1: STATUS QUO Assume the structure of the Chinese economy in 22 remains exactly as it is now - the composition of imports equals its 26-21 average and the level of imports grows in line with the IMF s forecast for GDP growth. SCENARIO 2: REBALANCING Assume China s imports mix rebalances to match the average of other large economies. We use sectoral data on the share of imports relative to GDP for 5 of the world s largest economies to construct a global benchmark, then assume the Chinese economy rebalances towards it. The top chart shows the benchmark for the pharmaceutical sector. SCENARIO 3: BEST JUDGEMENT Using information on historical trends, international comparisons, and industry information we come up with our best judgement for the pace of import growth in each sector, bounded by the two scenarios above. On average across sectors this amounts to the Chinese economy rebalancing by around 25% compared with the status quo scenario (see bottom chart). 26-21 Average Pharmaceutical imports as a share of GDP (26-21 average) GLOBAL BENCHMARK Average share across world's largest economies (weighted by GDP) Composition of Chinese imports Status Quo Best Judgement Forecasts for 22 China World's largest economies, ranked by ratio of pharmaceutical imports to GDP Rebalancing 1% 1% 8% 6% 4% 2% % Services Other Goods Machinery Raw Materials 9% 8% 7% 6% 5% 4% 3% 2% 1% % 9

SIZING THE MARKET: THE ROLE OF REBALANCING China s import mix compared with other large economies Weighted-average of world's largest economies China.2%.1%.%.2%.1%.% Recreational services Size of import sector relative to GDP (26-21 average) Sectors where China 'under-imports' Sectors where China 'over imports' 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Weighted-average of world's largest economies Relative to other large economies, China currently over-imports machinery, raw materials, plastics and chemicals - in part reflecting China s over reliance on investment-led growth. If China rebalances there is potential for strong growth in other sectors that are currently closed including financial services, cars and pharmaceuticals all areas of UK comparative advantage. The extent that China rebalances and opens up will thus have a significant bearing on import growth prospects for each sector and hence on UK export prospects. China Source: UNCTAD Statistics and FCO Economics Unit Calculations 1

SIZING THE MARKET: China s Import Market in 22 3 Scenarios Compared Recr Com Fina IT Cons Other Goods Fuels Metals Machinery/Electrical Products Recreational services Communication services Financial services IT Services Construction services Status Quo Best Judgement Rebalancing SMALL SECTORS 2 15 1 5 2 15 1 5 Royalties & license fees Pharmaceuticals Insurance services Clothing & Footwear Aerospace & Other Transport Other Chemicals Other Raw Materials Organic Chemicals Plastics Business Services Food & Beverages Travel Services Transportation Services Size of Chinese import market in 22 ( Billion) MEDIUM SECTORS Road Vehicles Precision Instruments 2 18 16 14 12 1 8 6 4 2 LARGE SECTORS 1 9 8 7 6 5 4 3 2 1 Source: UNCTAD Statistics, IMF and FCO Economics Unit Calculations Under all three scenarios the machinery and raw materials sectors dominates the Chinese market, accounting for 43-6% of total imports. By contrast, the service sector accounts for just 12-18%. The gains from rebalancing are largest in the pharmaceutical, food & drink, clothing, and car sectors - worth 6-12bn in each sector compared with the status quo. 11

SIZING THE MARKET: Which sectors offer the biggest gains? best judgement Machinery/Electrical Products Metals Fuels Other Goods Road Vehicles Precision Instruments Food & Beverages Organic Chemicals Plastics Other Chemicals Clothing & Footwear Other Raw Materials Aerospace & Other Transport Pharmaceuticals GOODS SECTORS 1 2 3 4 5 6 Change in goods import demand 211-22 under 'best judgement' scenario ( bn) Transportation Services Business Services Travel Services Insurance services Royalties & license fees Financial services Construction services IT Services Communication services Recreational services SERVICES SECTORS 2 4 6 8 1 Change in services import demand 211-22 under 'best judgement' scenario ( bn) UKTI Priority Sectors Source: UNCTAD statistics, IMF and FCO Economics Unit Calculations China s import market is forecast to increase from 1.2tn to 3tn between 211 and 22. Based on our best judgement, over 1tn or 56% of that increase will come from the four largest sectors - machinery, fuels, metals & and miscellaneous goods. Five other mid-size sectors are each predicted to increase by more than 7bn over the decade cars, transport services, business services, travel services, and precision instruments. UKTI s seven priority sectors together account for 8bn or 43% of the total increase. 12

SECTION 3: HOW MUCH OF THE MARKET COULD THE UK CAPTURE? Assessing the UK s export prospects in each sector 13

UK SECTOR PERFORMANCE Three scenarios for projecting the UK s market share We combine our forecasts for Chinese import growth in each sector with assumptions about the UK s share of the market to produce forecasts for UK exports to China in each sector. The three scenarios we consider are: SCENARIO A: CONSTANT MARKET SHARE Assume the UK s market share of each sector in 22 remains the same as the share recorded in 29-211. We use the average share over three years to smooth out one-off factors that could distort trade in a particular year. Overall, this means the UK continues to capture around 1% of the Chinese market. SCENARIO B: MATCHING THE UK S SHARE OF GLOBAL IMPORTS Assume the UK s share of each sector in the Chinese market changes to match the UK s average share of global imports. So if the UK currently captures 7% of the global import market for pharmaceuticals, but only 6% of the Chinese pharmaceuticals market, then by 22 we assume that the UK s share will rise to 7%. Averaging across sectors, this would equate to the UK s market share in China rising to around 3%. SCENARIO C: BEST JUDGEMENT Using information on historical trends and industry information, we come up with our best judgement of the UK s market share in each sector, bounded by the two scenarios above. Implicitly, this judgement assumes a sustained and ambitious effort by HMG to promote and encourage UK business in key sectors, reversing the trend of recent years and resulting in gains in market share. Overall, we assume the UK s share will rise to around 1.5% of the Chinese market by 22. 14

UK SECTOR PERFORMANCE In which Chinese sectors does the UK do well? UK Share of Global Imports UK Share of China Imports Rising UK Comparative Advantage UK Market Share (average in 29-211) 45% 4% 35% 3% 25% 2% 15% 1% 5% % Source: UNCTAD statistics, ONS, and FCO Economics Unit Calculations Five sectors of strength - The UK dominates China s financial and recreational services sectors, but these sectors are small - worth less than.5bn in 211. The UK also does comparatively well in three mid-size goods sectors - road vehicles, aerospace and miscellaneous raw materials. But in all other sectors the UK underperforms in China relative to its share of the global import market. This may partly be because bilateral trade statistics do not account for UK trade with China through third countries e.g. Airbus exports via France. Nevertheless, the extent of underperformance is stark, particularly in the insurance and business service sectors. 15

Market Share Scenarios UK SECTOR PERFORMANCE Total UK exports to China under different scenarios Chinese Import Growth Scenarios UK EXPORTS TO CHINA IN 22 Scenario 1 Status Quo Scenario A Constant Market Share Scenario B Matching the UK's share of global imports Scenario C Best Judgement Scenario 2 Rebalancing Scenario 3 Best Judgement Gains from rebalancing (Scenario 2 minus Scenario 1) 29.9bn 49.8bn 36.5bn 19.9bn 87.7bn 16.2bn 92.5bn 18.5bn 4.3bn 58.3bn 46.1bn 18.1bn Gains from matching the UK s share of global imports (Scenario B minus Scenario A) 57.8bn 56.4bn 56.bn The more the UK replicates its global export performance in China, the higher the UK s market share and the better UK export growth prospects. The difference between holding market share and matching the UK s share of global imports is worth almost 6bn in extra exports by 22. UK exports are also likely to benefit from China rebalancing. Exports to China would be worth around 2bn more by 22 if China rebalances compared with the status quo. So the extent of rebalancing is important for UK export prospects, but gaining market share is even more important. 16

ENCOURAGING Change in UK exports by 22 of matching the UK's global export performance in China - Scenario 1B versus 1A ( bn) UK SECTOR PERFORMANCE Which sectors offer the biggest gains? 2 18 16 14 12 1 8 6 4 2-2 Metals Precision Instruments Machinery Organic Chemicals Fuels Insurance Services Business Services Other Goods Transportation Services Pharmaceuticals Key: UK exports in 22 assuming constant market share and no rebalancing (Scenario 1A) Financial Services Road Vehicles 1bn 5bn 1bn -4-4 -2 2 4 6 8 1 Change in UK exports by 22 as a result of the Chinese economy rebalancing - Scenario 2A versus 1A ( bn) ENABLING ENABLING BUSINESS - The car sector, pharmaceuticals sector and financial services all offer large export gains to the UK if China rebalances. Business services also stand out as an area of comparative advantage where the UK could achieve sizeable gains. Arguably these four sectors are where HMG should focus its lobbying effort - to open up the market. ENCOURAGING BUSINESS Nine others sectors offer significant export potential if the UK were able to replicate its performance in other markets in China: machinery, fuels, metals, precision instruments, business services, transportation services, insurance, organic chemicals & other goods. Arguably these are the areas where HMG should focus on encouraging UK businesses. 17

UK SECTOR PERFORMANCE Sectors with most to gain from China opening up Road Vehicles Pharmaceuticals Financial services Business Services Other Goods Recreational services Transportation Services Travel Services Communication services Clothing & Footwear Food & Beverages Other Chemicals IT Services Royalties & license fees Aerospace & Other Transport Fuels Construction services Insurance services Organic Chemicals Plastics Other Raw Materials Metals Precision Instruments Machinery/Electrical Products -8-6 -4-2 2 4 6 8 1 Change in UK exports by 22 from China rebalancing/opening up Scenario 2 minus Scenario 1 ( bn) Maximum potential gains from rebalancing based on best judgement of UK market share Range of uncertainty based on differing assumptions of the UK s market share GAINS FROM ENABLING UK BUSINESS Series3 Best Judgement UK exports could rise by 18bn by 22 if China rebalanced significantly. Over 9% of these gains come from four sectors: 1) Cars ( 5.5bn); 2) Pharmaceuticals ( 4.4bn); 3) Financial Services ( 4.1bn); and 4) Business Services ( 2.8bn) It is these sectors where the UK could gain the most from creating the conditions that allow UK businesses to thrive. Arguably, HMG s lobbying efforts should focus on enabling UK businesses in these four sectors. 18

UK SECTOR PERFORMANCE Sectors with most to gain from encouraging UK businesses to engage Machinery/Electrical Products Fuels Other Goods Business Services Metals Precision Instruments Transportation Services Insurance services Organic Chemicals Food & Beverages Travel Services Plastics Other Chemicals Royalties & license fees Clothing & Footwear Pharmaceuticals IT Services Construction services Communication services Aerospace & Other Transport Recreational services Other Raw Materials Maximum potential gains from increasing market share based on best judgement of the degree of rebalancing Range of uncertainty based on the degree of rebalancing Road Vehicles Financial services -6-4 -2 2 4 6 8 1 12 14 16 18 The potential gains from encouraging UK businesses to operate in China are high worth 56bn. A third of these gains come from fuels, metals and miscellaneous goods sectors where capacity constraints may make it difficult for the UK to expand market share. In six other sectors the gains are also large worth 32bn in total or 58% of all potential gains. Arguably these six sectors are where HMG should focus its effort on encouraging and promoting UK businesses: 1) Machinery ( 14.3bn); 2) Business Services ( 5.6bn); 3) Precision Instruments ( 3.7bn); GAINS FROM ENCOURAGING UK BUSINESS Change in UK exports to China by 22 from matching the UK s share of global imports Scenario B minus Scenario A ( bn) 4) Transportation Services ( 2.9bn); 5) Insurance ( 2.9bn); and 6) organic chemicals ( 2.9bn). 19 Series3 Best Judgement

UK SECTOR PERFORMANCE UK exports to China in 22 best judgement Effect of change in UK market share (best judgement) Effect of China rebalancing (best judgement) Growth in market assuming the UK maintains constant market share and no relabancing (Scenario 1A) Market size in 211 Size of market in 22 based on best judgement of UK market share and extent of rebalancing UK Exports to China in 22 ( bn) 9.4 6.6 5.3 4.4 12 1 8 6.1.1.2.2.2.3.3.3.5.7.7.9 1. 1.3 2. 2. 2.1 2.3 2.4 2.5 4 2-2 Based on our best judgement, UK exports to China should rise from 12bn to 46bn by 22 and close half the gap on the EU-3. 85% of these exports will be concentrated in just ten sectors. For 4 sectors cars, pharmaceuticals, financial services & business services the gains will mainly come from China rebalancing and depend in part on HMG & broader international efforts to open China up. For 6 sectors machinery, business services, transportation services, precision instruments, insurance and organic chemicals - the gains will depend on the UK winning a greater share of the market and hence on HMG s efforts to support UK businesses. 2

CONCLUSIONS UK Exports to China China has enormous potential as a source of UK export growth. The total import market is forecast to grow from 1.2tn to 3tn by 22. If the UK maintains its current market share, exports to China will be worth just over 3bn by 22. But the UK can do better. If we matched the EU-3 s performance, UK exports could be worth almost 6bn by 22. Part of the reason the UK underperforms in China is because China s import demand is not wellaligned with the UK s sectors of comparative advantage. The more China rebalances, the greater the share of the market the UK could capture. Significant rebalancing could add up to 2bn to UK exports by 22-9% of which comes from 4 sectors: cars, pharmaceuticals, financial & business services. Arguably it is these sectors where HMG should focus its lobbying effort - to open them up. The other reason the UK underperforms in China is because UK businesses are not doing as well as they are in other countries. Matching the UK s performance in other markets could add up to 6bn to UK exports. 58% of these gains are concentrated in six sectors: machinery, business services, transportation services, precision instruments, insurance and organic chemicals. Arguably it is these sectors where HMG should focus its effort on encouraging UK businesses to engage. Overall, based on our best judgement of prospects for Chinese rebalancing and the UK s market share, we estimate that UK exports to China will be worth 46bn by 22 enough to close half the gap on the EU-3. To fully catch-up with the EU-3 will require either a significant degree of rebalancing and opening up or a step change in the number of UK businesses active in China. 21

ANNEX A SECTOR SPECIFIC PROJECTIONS Details of the growth potential for UK exports in twelve strategic sectors 22

SECTOR SPECIFIC PROJECTIONS SUMMARY UK EXPORTS TO CHINA ( BN) 22 Rank Sector 211 22 Best Judgement 22 Forecast Range Maximum potential gains from increasing market share by 22 1 Maximum potential gains from rebalancing by 22 2 Total 12.3 46.1 29.9 to 16.2 57.8 18.1 Goods 9.1 3.2 21.3 to 7.8 45.4 5.9 Services 3.2 15.9 8.6 to 35.4 12.4 12.2 1 Machinery/Electrical Products 2.3 9.4 4.8 to 23.8 14.3-3.4 2 Road Vehicles 2.3 6.6 2.5 to 8.8-1.5 5.5 3 Business Services.7 5.3 2.1 to 11.1 5.6 2.8 4 Transportation Services 1. 4.4 2.6 to 6.9 2.9 1.4 5 Metals 1.1 2.5 1.8 to 8.9 5.4-1. 6 Travel Services.8 2.4 2. to 5.2 1.5 1.2 7 Precision Instruments.6 2.3.7 to 6.2 3.7-1.6 8 Other Goods.5 2.1 1.2 to 12.7 6.3 2. 9 Pharmaceuticals.5 2..8 to 5.3.4 4.4 1 Financial services.2 2..4 to 7.7-1.8 4.1 11 Other Chemicals.3 1.3 1. to 3.1 1.3.4 12 Other Raw Materials.7 1..5 to 1.5 -.4 -.7 13 Plastics.2.9.4 to 2.4 1.3 -.6 14 Insurance services.1.7.1 to 3. 2.9 -.1 15 Food & Beverages.1.7.3 to 4. 2.2.4 16 Organic Chemicals.1.5.2 to 3.4 2.9 -.2 17 Aerospace & Other Transport.2.3.3 to.5 -.1.1 18 IT Services.1.3.2 to 1.1.3.4 19 Clothing & Footwear..3. to 1.4.4.6 2 Communication services.1.2.2 to 1.3. 1. 21 Fuels.1.2.2 to 8.6 7.2. 22 Recreational services.1.2.1 to 2.2 -.1 1.4 23 Royalties & license fees.1.1.1 to 2.4 1.3.1 24 Construction services..1.1 to.3.1. 1 Based on best judgement of the degree of rebalancing 2 Based on best judgement of UK market share 23

SECTOR SPECIFIC PROJECTIONS Structure The following slides offer detailed projections & judgements for three categories of sector: ENABLING BUSINESS: SECTORS OFFERING LARGE GAINS FROM CHINA OPENING UP 1) Road Vehicles 5.5bn 2) Pharmaceuticals 4.4bn 3) Financial Services 4.1bn Potential export gains from opening up the market by 22 4) Business Services 2.8bn ENCOURAGING BUSINESS: SECTORS OFFERING LARGE GAINS FROM INCREASING MARKET SHARE 5) Machinery 14.3bn 4) Business Services 5.6bn 6) Precision instruments 3.7bn 7) Transportation Services 2.9bn Potential export gains from gaining market share by 22 8) Insurance 2.9bn 9) Organic Chemicals 2.9bn SCALE BUSINESS: OTHER SECTORS THAT OFFER LARGE GAINS DUE TO THEIR SIZE 1) Travel Services 1.6bn 11) Miscellaneous Goods 1.6bn Expected export gains by 22 12) Metals 1.3bn 24

SECTOR SPECIFIC PROJECTIONS ENABLING BUSINESS 1. Road Vehicles Chart 1: Size of import sector in China relative to other large economies Road vehicle imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) US China World's largest economies, ranked by ratio of road vehicle imports to GDP 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Chart 2: Scenarios for import growth prospects in the road vehicle sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 Road vehicles currently account for 3.3% of Chinese imports China s 11 th largest import sector. If China rebalances cars could be China s 4 th largest import by 22. JUDGEMENT ON REBALANCING The Chinese car market is relatively closed when compared with other large economies (Chart 1), but it has been gradually opening up as per capita incomes rise and urbanisation increases. We expect these trends to continue and optimistically assume that by 22, China s car imports will be on a par with the US another market with a large domestic car sector. JUDGEMENT ON UK MARKET SHARE The UK s share of the Chinese market has risen in recent years to 4.5% due to the success of companies like JLR, particularly at the top end of the market. We assume that as the market expands, the UK is able to maintain its current high share. This is a relatively upbeat assumption. Arguably, the more the Chinese car market opens up, the more lower-end cars will be imported, and the more difficult it will be for the UK to retain its position. 25 2 15 1 5 Chart 3: Forecast for UK exports to China in the road vehicle sector Forecast Range* Matching Global Share UK Exports to China ( bn) 1 9 8 7 6 5 4 3 2 1 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 4.6n 148.3bn UK share of Chinese Market ( 9-11) 4.5% UK share of World Market ( 9-11) 3.4% UK share by 22* 4.5% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement 2.3bn 6.6bn * Based on best judgement 25

SECTOR SPECIFIC PROJECTIONS ENABLING BUSINESS 2. Pharmaceuticals Chart 1: Size of import sector in China relative to other large economies Pharmaceutical imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) China World's largest economies, ranked by ratio of pharmaceutical imports to GDP 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Chart 2: Scenarios for import growth prospects in the pharmaceuticals sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 China s pharmaceutical sector is small and accounted for just.6% of total imports in 211 China s 18 th largest sector. But it has a lot of potential. JUDGEMENT ON REBALANCING China currently imports relatively few pharmaceutical products given the size of its economy (Chart 1). We expect the ratio of pharmaceutical imports to rise relative to GDP over the next decade. We calibrate our forecast based on the relationship with per capita income growth - as Chinese consumers become wealthier, we expect demand to pickup. JUDGEMENT ON UK MARKET SHARE The UK's share of China s pharmaceutical market has fallen back recently, but has previously been higher than the UK's share of the world market. We assume that the recent deterioration is a temporary blip, and as China opens up its healthcare sector over the next decade the UK will be able to capture more of the market - matching its performance in the rest of the world. 8 7 6 5 4 3 2 1 Chart 3: Forecast for UK exports to China in the pharmaceuticals sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 7.bn 28.8bn UK share of Chinese Market ( 9-11) 5.8% UK share of World Market ( 9-11) 7.1% UK share by 22* 7.1% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).5bn 2.bn * Based on best judgement 6 5 4 3 2 1 26

SECTOR SPECIFIC PROJECTIONS ENABLING BUSINESS 3. Financial Services Chart 1: Size of import sector in China relative to other large economies Financial services imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) France & Korea China World's largest economies, ranked by ratio of financial services imports to GDP 3.% 2.5% 2.% 1.5% 1.%.5%.% Chart 2: Scenarios for import growth prospects in the financial services sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 18 16 14 12 1 8 6 4 2 2 25 21 215 22 Financial services do not account for a substantial proportion of imports in the majority of the world s largest economies (Chart 1). Even so, China s financial sector is unusually closed, accounting for less than.1% of total imports. JUDGEMENT ON REBALANCING We assume that gradual economic reform over the next decade will lead to China s financial services sector opening up. By 22, we assume China s imports will be on a par with France and Japan two countries with large national banks. This implies a substantial rise in the ratio of financial services to GDP. There is a wide margin of error around this judgement. JUDGEMENT ON UK MARKET SHARE The UK's share of the Chinese market has been erratic in recent years, but has been on a downward trend as the market has grown larger and become more competitive. We expect this trend to continue - the UK s share falls over time, but remains larger than the UK's share of global financial services trade. Chart 3: Forecast for UK exports to China in the financial services sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22*.4bn 8.1bn UK share of Chinese Market ( 9-11) 41.6% UK share of World Market ( 9-11) 19.7% UK share by 22* 25.% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).2bn 2.bn * Based on best judgement 9 8 7 6 5 4 3 2 1 27

SECTOR SPECIFIC PROJECTIONS - ENABLING & ENCOURAGING 4. Business Services Chart 1: Size of import sector in China relative to other large economies Business services imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) Brazil China World's largest economies, ranked by ratio of business services imports to GDP 18.% 16.% 14.% 12.% 1.% 8.% 6.% 4.% 2.%.% Chart 2: Scenarios for import growth prospects in the business service sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 Business services currently account for 2% of Chinese imports China s 14 th largest import sector. JUDGEMENT ON REBALANCING Imports of business services into China have fallen relative to GDP since the financial crisis. We assume this decline is temporary, so that by 22 business services imports as a share of GDP will rise to its pre-crisis peak equivalent to China opening up as much as Brazil (Chart 1). JUDGEMENT ON UK MARKET SHARE The UK significantly underperforms in China on business services, but the trend is positive - since 27 the UK's share of business services imports has risen. We assume this trend continues so that by 22 the UK captures over 5% of the market. This is still less than the UK s share of the global market for business services, but reflects a significant gain compared to its current position. 14 12 1 8 6 4 2 Chart 3: Forecast for UK exports to China in the business service sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 24.6n 97.8bn UK share of Chinese Market ( 9-11) 2.6% UK share of World Market ( 9-11) 8.3% UK share by 22* 5.5% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).7bn 5.3bn * Based on best judgement 12 1 8 6 4 2 28

SECTOR SPECIFIC PROJECTIONS ENCOURAGING BUSINESS 5. Machinery & Electrical Products Chart 1: Size of import sector in China relative to other large economies Imported Machinery & Electrical products as a share of GDP (26-21 average) 12% Chart 2: Scenarios for import growth prospects in the machinery sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 12 Chart 3: Forecast for UK exports to China in the machinery sector Forecast Range Matching Global Share Constant share Best Judgement UK Exports to China ( bn) 25 China Average share across world's largest economies (weighted by GDP) 1% 8% 6% 4% 2% 1 8 6 4 2 2 15 1 5 World's largest economies, ranked by ratio of machinery imports to GDP % 2 25 21 215 22 Machinery & electrical products currently account for 28% of all Chinese imports. It is China s largest sector and is expected to remain so in 22. JUDGEMENT ON REBALANCING China s share of machinery imports relative to GDP is similar to other large markets (Chart 1) and has been declining in recent years. We assume this trend continues so that by 22 China will have rebalanced half of the remaining gap to the global benchmark. JUDGEMENT ON UK MARKET SHARE The UK currently captures a low share of China s machinery sector both from an historical perspective and relative to the UK s performance in other countries. We assume that increased efforts to encourage UK businesses into the market results in a modest rise in market share. Even this small change is a significant judgement it is the main reason why UK exports in the sector are expected to quadruple by 22. 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 341.8bn 852.5bn UK share of Chinese Market ( 9-11).7% UK share of World Market ( 9-11) 2.4% UK share by 22* 1.1% UK Exports to China in 211 UK Exports to China by 22* 2.3bn 9.4bn * Based on best judgement 29

SECTOR SPECIFIC PROJECTIONS ENCOURAGING BUSINESS 6. Precision Instruments Chart 1: Size of import sector in China relative to other large economies Precision instrument imports as a share of GDP (26-21 average) China Korea Average share across world's largest economies (weighted by GDP) World's largest economies, ranked by ratio of precision instrument imports to GDP 9% 8% 7% 6% 5% 4% 3% 2% 1% % Chart 2: Scenarios for import growth prospects in the precision instruments services sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 18 16 14 12 1 8 6 4 2 2 25 21 215 22 In 211, precision instruments (e.g. cameras, watches, scientific & medical equipment) accounted for 5% of Chinese imports its 5 th largest import sector. JUDGEMENT ON REBALANCING The ratio of precision instrument imports to GDP is relatively high in China compared with other countries (Chart 1), but has been on a declining trend. We assume the ratio stabilises around Korea s level another large economy in the region at a higher state of development. JUDGEMENT ON UK MARKET SHARE The UK's share of the imported precision instruments market fell sharply in the early 2s and has since bottomed out around the 1% level - considerably lower than the UK's share of the world market. Given this sector is an area of comparative advantage, we assume that the UK is able to regain some of its lost market share over the course of the decade. By 22, we assume the UK captures 1.5% of the market. Chart 3: Forecast for UK exports to China in the precision instruments sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 61.6bn 155.7bn UK share of Chinese Market ( 9-11) 1.% UK share of World Market ( 9-11) 3.3% UK share by 22* 1.5% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).6bn 2.3bn * Based on best judgement 7 6 5 4 3 2 1 3

SECTOR SPECIFIC PROJECTIONS ENCOURAGING BUSINESS 7. Transportation Services Chart 1: Size of import sector in China relative to other large economies Transport services imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) China World's largest economies, ranked by ratio of transport services imports to GDP 16% 14% 12% 1% 8% 6% 4% 2% % Chart 2: Scenarios for import growth prospects in the transportation services sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 Transportation services (primarily freight services, passenger airfares, and agency fees) accounted for 4.1% of Chinese imports in 211 its 6 th largest import sector. JUDGEMENT ON REBALANCING China currently under-imports transportation services compared with other large economies (Chart 1). Partly, this reflects a notable drop in imports following the decline in global trade during the financial crisis. In more recent years, the ratio of imported services to GDP has begun to pick up and we assume this trend continues. By 22 we forecast the ratio of transportation service to GDP to return to its pre-crisis peak putting China on a par with Australia in terms of openness. JUDGEMENT ON UK MARKET SHARE The UK's share of the Chinese imported transportation market has been erratic since 24, ranging between 1.9% and 3.7% of the market. We assume that the UK's share closes in on its share of the world market, rising to 3.1% by the end of the decade. 18 16 14 12 1 8 6 4 2 Chart 3: Forecast for UK exports to China in the transportation services sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 5.2bn 14.bn UK share of Chinese Market ( 9-11) 2.1% UK share of World Market ( 9-11) 4.2% UK share by 22* 3.1% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn) 1.bn 4.4bn * Based on best judgement 8 7 6 5 4 3 2 1 31

SECTOR SPECIFIC PROJECTIONS ENCOURAGING BUSINESS 8. Insurance Services Chart 1: Size of import sector in China relative to other large economies Insurance services imports as a share of GDP (26-21 average) China Average share across world's largest economies (weighted by GDP) World's largest economies, ranked by ratio of insurance services imports to GDP 2.% 1.5% 1.%.5%.% Chart 2: Scenarios for import growth prospects in the insurance services sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 China s insurance service market accounts for 1% of total imports and the sector is similar in size to other economies of comparable size (Chart 1). JUDGEMENT ON REBALANCING Given the similarity between the size of China s insurance market and those of other large economies there appears limited scope for the insurance market to grow substantially as a result of China rebalancing. We therefore assume insurance imports simply rise in line with GDP. JUDGEMENT ON UK MARKET SHARE The UK's share of the Chinese insurance services market is low compared with the UK's share of the world market, despite rising in recent years. We assume that the upward trend continues, partly as a result of sustained efforts from HMG to encourage UK businesses into the market. Ambitiously, we suggest the UK's share could rise from.5% now to 2.4% by 22. 35 3 25 2 15 1 5 Chart 3: Forecast for UK exports to China in the insurance services sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 12.3bn 31.3bn UK share of Chinese Market ( 9-11).5% UK share of World Market ( 9-11) 9.7% UK share by 22* 2.4% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).1bn.7bn * Based on best judgement 4 3 3 2 2 1 1 32

SECTOR SPECIFIC PROJECTIONS ENCOURAGING BUSINESS 9. Organic Chemicals Chart 1: Size of import sector in China relative to other large economies Organic chemical imports as a share of GDP (26-21 average) China Germany Average share across world's largest economies (weighted by GDP) 7% 6% 5% 4% 3% 2% 1% Chart 2: Scenarios for import growth prospects in the organic chemicals sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 12 1 8 6 4 2 Chart 3: Forecast for UK exports to China in the organic chemicals sector Forecast Range* Matching Global Share Constant share Best Judgement UK Exports to China ( bn) 4 3 2 1 World's largest economies, ranked by ratio of organic chemical imports to GDP % 2 25 21 215 22 China s organic chemicals market is big compared with other large economies (Chart 1), partly reflecting China s position in global supply chains. Organic chemicals are typically used as intermediate inputs into the production of other goods e.g. nylon. The sector currently accounts for 3.2% of all Chinese imports. JUDGEMENT ON REBALANCING We assume that as China rebalances toward consumption-led growth, demand for intermediate inputs will fall relative to finished consumer goods. But this process will be gradual. By 22 we assume China s import to GDP ratio will match Germany s another large manufacturer. JUDGEMENT ON UK MARKET SHARE The UK's share of the market has fallen rapidly since the early 2s, but has recently begun to stabilise. Given the UK's comparative advantage in the sector we assume that sustained effort from HMG to encourage UK businesses results in a gradual rebound in market share. By 22 we assume the UK's market share rises to match the average of the past decade. 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 39.2bn 9.6bn UK share of Chinese Market ( 9-11).3% UK share of World Market ( 9-11) 3.5% UK share by 22*.6% UK Exports to China in 211 UK Exports to China by 22*.1bn.5bn * Based on best judgement 33

SECTOR SPECIFIC PROJECTIONS SCALE BUSINESS 1. Travel Services Chart 1: Size of import sector in China relative to other large economies Travel services imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) China World's largest economies, ranked by ratio of travel services imports to GDP 9% 8% 7% 6% 5% 4% 3% 2% 1% % Chart 2: Scenarios for import growth prospects in the travel services sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 In 211, travel services (goods and services purchased by Chinese tourists abroad) accounted for 3.7% of Chinese imports its 8 th largest import sector. JUDGEMENT ON REBALANCING China s ratio of travel services to GDP has been fairly stable in recent years. Internationally, the ratio is a little lower than in economies of similar size (Chart 1). We expect the ratio to rise gradually over the decade as per capita incomes increase and foreign travel becomes more prevalent. JUDGEMENT ON UK MARKET SHARE The UK's share of the Chinese travel services market has been on a steadily declining trend in recent years. We assume that as Chinese tourism grows, particularly among middle income households, this new group of tourists is more likely to visit markets closer to home, partly due to cost and partly due to the UK's visa regime. As a result, we assume the UK just manages to maintain its current level of market share. Though if the recent trend continues, the UK s share is likely to fall. 18 16 14 12 1 8 6 4 2 Chart 3: Forecast for UK exports to China in the travel services sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 45.2bn 116.9bn UK share of Chinese Market ( 9-11) 2.1% UK share of World Market ( 9-11) 3.4% UK share by 22* 2.1% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).8bn 2.4bn * Based on best judgement 6 5 4 3 2 1 34

SECTOR SPECIFIC PROJECTIONS SCALE BUSINESS 11. Miscellaneous Goods Chart 1: Size of import sector in China relative to other large economies Imports of miscellaneous goods as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) US China World's largest economies, ranked by ratio of miscellaneous goods imports to GDP 35% 3% 25% 2% 15% 1% 5% % Chart 2: Scenarios for import growth prospects in the miscellaneous goods sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 The other goods sector includes a wide range of products such as furniture, gold & other monetary commodities, and various intermediate inputs like leather and paper. In 211, it accounted for 6.2% of China s import its 4 th largest sector. JUDGEMENT ON REBALANCING China s ratio of other goods imports to GDP fell during the early 2s but has since rebounded. We assume this rebound continues so that the ratio of other goods to GDP rises to match that of the US an economy of similar size. This is a somewhat arbitrary assumption, but given the wide array of goods involved it is a simplifying one. JUDGEMENT ON UK MARKET SHARE The UK's share of the other goods market had been on a steady upward trend since the early 2s thanks largely to the success of paper and publishing exports. But in the years following the financial crisis, the UK has lost share. We assume the recent fall is a blip and the UK's share returns to its average of the past decade by 22. 4 35 3 25 2 15 1 5 Chart 3: Forecast for UK exports to China in the miscellaneous goods sector Forecast Range* Matching Global Share 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 77.bn 24.6bn UK share of Chinese Market ( 9-11).8% UK share of World Market ( 9-11) 3.4% UK share by 22*.9% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement UK Exports to China ( bn).5bn 2.1bn * Based on best judgement 14 12 1 8 6 4 2 35

SECTOR SPECIFIC PROJECTIONS SCALE BUSINESS 12. Metals Chart 1: Size of import sector in China relative to other large economies China Metal imports as a share of GDP (26-21 average) Average share across world's largest economies (weighted by GDP) World's largest economies, ranked by ratio of metal imports to GDP 14% 12% 1% 8% 6% 4% 2% % Chart 2: Scenarios for import growth prospects in the metals sector 1: Status Quo 2: Rebalancing 3: Best Judgement Size of Chinese import market ( bn) 2 25 21 215 22 In 211, metals accounted for 14% of Chinese imports -its 2 nd largest import sector. JUDGEMENT ON REBALANCING China over-imports metals compared with other large economies (Chart 1). This partly reflects China s high rate of investment, particularly in infrastructure. We assume that as the economy gradually rebalances away from investment-led spending, metal imports will fall as a share of GDP. That said, a sharp move in commodity prices could significantly affect this judgement. JUDGEMENT ON UK MARKET SHARE The UK's share of the metals market has been fairly flat for the past decade. Due to capacity constraints, we judge it is unlikely the UK will be able to expand its share in China. Instead we assume the UK just manages to hold share in the rapidly expanding market. 45 4 35 3 25 2 15 1 5 Chart 3: Forecast for UK exports to China in the metals sector Forecast Range* Matching Global Share UK Exports to China ( bn) 1 9 8 7 6 5 4 3 2 1 2 25 21 215 22 * The coloured lines on Chart 3 assume the Chinese market grows in line with the best judgement scenario in Chart 2, while the forecast range shows the maximum and minimum values for UK exports implied by the other two scenarios for market growth. KEY SECTOR STATISTICS: Size of import market in 211 Size of import market in 22* 176.bn 361.4bn UK share of Chinese Market ( 9-11).7% UK share of World Market ( 9-11) 2.2% UK share by 22*.7% UK Exports to China in 211 UK Exports to China by 22* Constant share Best Judgement 1.1bn 2.5bn * Based on best judgement 36

ANNEX B TRADE IN VALUE ADDED THE WINGS ON THE AIRBUS EFFECT Assessing UK exports to China via third countries 37

TRADE IN VALUE ADDED The Wings on the Airbus Effect Chart 1: Exports to China Chart 2: Share of the Chinese market Conventional trade data (gross exports) Trade in Value Added data Exports to China in 29 ( bn) UK EU-3 Italy France Germany 45 4 35 3 25 2 15 1 5 Conventional trade data (gross exports) Trade in Value Added data Share of Chinese Import Market in 29 UK EU-3 Italy France Germany Source: UNCTAD statistics, OECD and FCO Economics Unit Calculations Conventional trade statistics measure direct trade flows between two countries e.g. UK exports to China. They do not account for trade that flows via third countries as part of a global supply chain. For example, the UK produces Airbus wings that are shipped to France for assembly and then re-exported to China. Conventional export statistics will record the wings as UK exports to France, and the planes as French exports to China, even though the UK is indirectly exporting wings to China. This Wings on the Airbus effect can mean that the UK appears to underperform in China, simply because of the way trade statistics are measured. A new OECD/WTO trade database offers a different way of measuring trade based on the value added by each country during the production chain. In value added terms, UK exports to China are worth slightly more than based on standard trade figures, while EU-3 exports to China are worth slightly less (Chart 1). This reflects the fact that more of the UK s trade with China is through intermediate goods. So a small part of the UK s underperformance in China is down to the Wings on the Airbus effect. The value added data also has implications for the size of the Chinese import market. Many Chinese imports are not ultimately destined for consumption in China, but are instead re-exported to other markets around the world. In 29, total Chinese imports were worth 74bn, but only 43bn of those imports were consumed domestically. When viewed in value added terms, the size of the Chinese import market is significantly smaller, and hence the UK (and EU-3 s) share of the market is significantly higher (Chart 2). 9% 8% 7% 6% 5% 4% 3% 2% 1% % 38