China’s economic slowdown & its impact on UK manufacturing

Posted on 18 Oct 2015 by The Manufacturer

Pemberton Capital’s Nick Brainsby explores the recent turbulence in global stock and commodity markets directly linked to the slowdown in the Chinese economy.

For three decades China’s economy has averaged double-digit economic growth, transforming it from an economic backwater to the world’s industrial locomotive.

Nick Brainsby, director and partner, Pemberton Capital
Nick Brainsby, director and partner, Pemberton Capital.

By comparison, the world economy grew by about 2.8% over the same period.

China’s impressive growth rate is now running out of steam, and is having the greatest impact in the commodity markets, with the result that emerging market economies are suffering first.

But in order to assess the impact of China’s slowdown on advanced economies and in particular on UK manufacturers, we have to dig a little deeper into the nature of the slowdown. As ever, the picture is complex.

It is first worth noting that the growth in commodity demand from China has fallen more sharply than its overall GDP, because of the shift in the composition of growth away from the industrial sector towards consumer consumption, services and finance.

That is certainly bad news for commodity exporters, but not necessarily bad news for exporters of manufactured goods.

Although the slowdown in China has hit consumer confidence, resulting in less consumption in the short term, the “rebalancing” of the Chinese economy towards consumption should benefit the UK’s exporters of specialised and high value added manufactured products in the medium to long term.

M&A deals were up in 2014 and the volume spiked drastically in the fourth quarter of 2014.
China’s economy has averaged double-digit economic growth for three decades.

In the meantime, it seems that pessimism about the effect of the China slowdown on UK manufacturers is probably overstated for three reasons.

Firstly, the latest available data shows that the Chinese economy did not show any further sign of slowdown in September – so the worst may have already passed.

Secondly, although global industrial production has declined relative to services in the second quarter of 2015, this is largely due to currently weak production in the US, not in China.

Thirdly, although exports of both goods and services to China are an important element of the economy, we should not overstate China’s place among the UK’s trading partners.

Certainly, the importance of China to the UK economy as a trading partner has increased consistently over the past ten years. According to the Office for National Statistics, exports to China have risen since 2004 from £4bn to £16.7bn in 2014, and now account for 3.2% of all UK exports.

UK Overseas Export
UK exports to China have risen since 2004 from £4bn to £16.7bn in 2014, and now account for 3.2% of all UK exports.

Most of those exports have been manufactured goods rather than services, accounting for more than 80% of all UK trade with China every year since 2004.

However, bilateral UK-China trade is around £43bn a year versus £143bn in UK exports to the EU. In other words, the current state of the EU economy is far more important to the UK than the current state of the Chinese economy.

Taking these points into account, in the short term it seems inevitable that the growth in manufacturing exports to China will slow down. The latest statistics on UK manufacturing output seem to support this.

Last month, the official data confirmed that manufacturing output had contracted by two consecutive quarters. As investors in a number of SME manufacturers, we have seen a slight slowdown in activity over the past few months, but I think the China slowdown has accounted for only a small part of that dip.

In any event, given the relatively small share of those exports compared with the EU, any pain should not be too great, particularly since the outlook for the EU and US economies seems to be improving, albeit at a slow pace.

CBI EU report-cover
The current state of the EU economy is far more important to the UK than the current state of the Chinese economy.

In the medium term, the view for UK manufacturing exports to China is positive. Once the rebalancing of the Chinese economy takes shape, UK manufacturing exporters of competitive, high added value products will surely benefit.

However, the longer term may present some complex challenges.

Although the competitive advantage of Chinese manufacturing has been declining, with manufacturing wages in China rising by an average of 12% a year since 2001, Chinese manufacturing is likely to present direct challenges to manufacturers in advanced economies in the coming years.

As domestic consumption rises, Chinese manufacturers will seek to take a greater share of the value of that market and will surely invest in automation and innovation as a result in order to boost competitiveness – that will be a greater issue to overcome than the effects of the current slowdown.