Leslie Young, Professor of Economics at CKGSB, argues that Brexit is a major setback for Sino-UK business, although some opportunities remain

China played a surprisingly prominent role in debates surrounding the United Kingdom’s 2016 referendum on membership of the European Union. For leading “Leavers” like Boris Johnson, now Foreign Secretary of the UK, Brexit was a chance for Britain to free itself from a stifling Brussels bureaucracy and build stronger trade relations with coming powers, like China and India.

But those expecting a blossoming in China-UK relations after Brexit might be disappointed, says Leslie Young, Professor of Economics at CKGSB. Professor Young is well-placed to understand the Sino-British economic relationship. His experience with the UK goes back to 1971, when he received a doctorate in mathematics from Oxford University at the age of 20. He is now a recognized authority in international economics with his book Black Hole Tariffs and Endogenous Redistribution Theory highly commended by two Nobel Prize winners.

In this interview, Professor Young explains to CKGSB Knowledge how Chinese business is likely to be impacted by the move of the UK to exit the EU.

Q. In recent years, the UK and Chinese governments have heralded a “golden era” in ties between the two countries, but this relationship has been tested by Brexit, political wrangling and Prime Minister Theresa May’s cooler attitude toward China. Is the “golden era” over?

A. I will address this question from a wider perspective because it opens the door to a broader set of interesting issues. When you walk down the main streets of central London, the grand buildings give it the feel of an imperial capital and, of course, 150 years ago, it was the center of the world’s largest empire. British people, especially the elite, growing up in London, studying at the public schools and Oxbridge with their grand ceremonies and traditions, then getting a grand job in, say, the City of London, the Foreign Office or the Treasury, think they’re world-class.

The reality is that the UK is not world-class. London is a world-class city in a second-class country. The UK has the world’s fifth-largest gross domestic product, but it lacks dynamism and efficiency. It has strong sectors like higher education, information technology and precision engineering, but there are significant inefficiencies and failures, such as a chaotic railway system, a hospital system which neglects many patients and has horrendous waiting times, neglect of the bottom layers of society and weak basic education in many regions. Brexit has revealed the government and the civil service as incompetent. So, there’s a discrepancy between the self-confident mindset that’s promoted by the UK’s grand institutions and buildings, and the reality.

China is the opposite: it is a world-class economy and society making progress on every important front, but lacks the self-confidence of a world-class country. That’s shown by the desire of Chinese people to study and shop overseas. Rich Chinese families try to send their children to Eton, Oxford and Cambridge, because they want the feeling of being world-class.

This discrepancy between mind-set and reality creates potential for misunderstandings. At the political level, it might not be a problem. At the business level, it could have serious consequences when British negotiators arrive at meetings with inflated notions about themselves and a misunderstanding about how sophisticated an economy China has become. They may still think that China makes mainly T-shirts and miss real opportunities that a partnership with Chinese companies can offer.

Q. Will this mindset change now that the UK is leaving the EU and China is growing in prominence as a world power?

A. Brexit is an issue not just for next year, but for the next 10 years. Most likely it will happen and will be a terrible mess, due to the incompetence and irresponsibility of the British elite. It’s certain to be a drag on the British economy and makes the UK much less attractive as a place to invest.

If Brexit had not happened, the UK would remain the natural entry point into Europe—the world’s largest economy—for Chinese investors because many Chinese speak English, but few speak French or German. They are also more familiar with British law and institutions than those of Germany or France.

But now everything is uncertain. You don’t know the rules of the game because the terms on which firms located in Britain can deal with Europe have not been agreed. The uncertainty will persist for up to a decade and, over that period, will disadvantage the UK as a destination for investment. I think the “golden era” of UK-China relations was pretty much killed off by Brexit.

Q. The UK has handed China two significant victories in recent years: becoming the first major Western power to join the Asian Infrastructure Investment Bank (AIIB) and buying a Chinese-made nuclear reactor, as part of the Hinkley Point C project. What do you think of these moves?

A. I think joining the AIIB was a political gesture to build goodwill with China, but will not bring real gain. With regard to the nuclear reactor, this has been a learning experience for China. That deal was negotiated, then the incoming Prime Minister Theresa May reviewed the agreement and decided not to proceed. That was a political gesture to the British public. Then, she changed her mind again because she didn’t want to antagonize China.

What this shows is that high-profile business deals between China and the UK have a political dimension. Chinese need to be aware of this and understand how the British political system works and how some British media will pander to prejudices of the British public. Even quite sophisticated British people can be quite ignorant about China.

Q. Chinese investment in the UK has increased since the referendum. One prominent deal in 2017 was the $14 billion purchase of the London-based warehouse company Logicor by China Investment Corporation, the Chinese sovereign wealth fund. Why have these deals continued to be attractive to both sides?

A. Connect this back to what I said about possible misunderstandings. The Logicor deal is a good purchase, an intelligent choice. It’s in a non-sensitive industry and plays to China’s strength and involves relatively little contact with the British public. China is world-class in terms of logistics. It has a lot of experience in managing shipments because, as the leading manufacturing economy, it has connections, expertise and technology. So, investing in this kind of private infrastructure is a good choice.

But if a Chinese company wanted to buy a television station or newspaper, some British people would scream and yell for fear of “Communist propaganda.” There could be antagonism even if a Chinese company tried to buy a high street retailer like Marks & Spencer, although it’s not a strategic or threatening purchase.

I don’t believe that purchasing a retailer would be a smart decision for a Chinese company. Success requires understanding the peculiarities of the British people as customers and as suppliers. It requires understanding British labor and commercial law, health and safety regulations, marketing conventions and public relations. It also requires cultural or soft knowledge of British people, which Chinese sometimes lack. It plays to China’s weaknesses. My suggestion to Chinese companies is not to get involved in investments that require detailed knowledge of British people, British companies or how British business is done. That could bring some costly surprises.

Q. The UK is keen to negotiate a free trade agreement with China after Brexit. How likely is that?

A. Until Brexit happens, EU rules make it illegal for the UK to negotiate a free trade agreement with any other country. Here is an example of the problems that Britain finds itself in. One of the selling points of Brexit was that Britain would be free to negotiate great trade agreements with every other country. First on the list were Australia and New Zealand because of historical ties. Last week, it was reported that the EU is negotiating FTAs with Australia and New Zealand, so before the British can even get started, the Europeans are already there.

Q. Though China and US are not yet in a full-blown trade war, tensions are heightened. How do you see Britain’s position in this?

A. A big opportunity comes from the Iran situation. The US unilaterally exited the Iran nuclear deal agreed in 2015 and stated that it will impose sanctions on foreign companies that continue to do business with Iran. Some companies may not worry at first, because they’re not interested in doing business in the United States, but there’s a second problem: they have to use the international banking system.

The US might sanction, say, a German bank that finances a company doing business with Iran. So, that company might find itself unable to get financing from any bank that operates in the US. Because the dollar is the international currency and the US financial system has global reach, companies can be hurt even if they don’t do business with the US as they still need to do business through the American-dominated global financial system.

Currently, if a Chinese company wishes to do business in Russia, it might exchange RMB to US dollars, then US dollars to the Russian ruble. This could expose it to US sanctions on international banks. But this would no longer be true if it could switch directly from the RMB to the ruble. Many companies are in this position, which opens the possibility for the RMB to emerge as a rival global currency, which is part of being a global power. I’m not saying that’s going to happen overnight, but people are thinking about this. This is an opportunity for the City of London to become the global center for RMB transactions as it is used to handling another country’s currency and has genuine expertise. It would be a natural match, a real partnership, but that requires the UK to detach itself emotionally from the US.

Q. Do you think Chinese investment in the UK will continue to be strong in 2018 and beyond?

A. Here we have to circle back to my opening description of the UK as an economy and as a country. It has sectors that are world-class: higher education, finance and information technology, where it is the strongest center in the world after Silicon Valley.

International companies also go to London for a very interesting reason. To travel from Cambridge to London by train takes one hour. To travel from Oxford to London takes one hour. So, essentially both can be reached in the same time that a journey across London takes. If you count the universities in London that are world-class, plus Oxford and Cambridge, there are seven in total. No other city in the world has this concentration of educational resources. The UK also attracts the intellectual elite from Australia, Canada and New Zealand due to historic connections. Some Chinese look down on the UK as a fading second-rate country, thinking it’s just a place for traveling and shopping, but it has these real strengths. Opportunities exist in the UK in knowledge-intensive industries, but it is not clear how China can take advantage of them, or how we can create win-win situations.

An obvious vulnerability of the UK is that its university staff are low-paid, so it is difficult to hire world-class people. They still manage to do so. This is because the UK is attractive as a country to live in, but you have to make a financial sacrifice to join a British university. So, I sense an opportunity for Chinese money to support the UK in this area. Britain has both excellent hard and soft infrastructure for education, and, frankly, China has substantial weaknesses here. I think there should be a way for China to support UK education and research in scientific and engineering subjects and create a win-win situation. Such collaboration is becoming more difficult with the US because of rising suspicion and strategic rivalry.