Why Osborne Is So Desperate To Do Business With China

27th October 2015 / United Kingdom

Why the UK government is so interested in China

by James Meadway at NewEconomics.

China’s President Xi Jinping’s visit to the UK has been greeted with a flurry of announcements by the government on multi-billion pound deals with China.

Currently, the government is claiming that £40bn of deals have been struck during the course of the visit, although the Financial Times this week has noted that these appear subject to “inflation”, with the double-counting of existing deals bringing the total closer to perhaps £25bn.

Either way, the sums involved are huge – but also controversial. Chancellor George Osborne has sidelined commentary on China’s human rights record. In being so welcome to Chinese investment, he is breaking the Western consensus that has been generally wary about allowing China into critical infrastructure projects, such as nuclear power.

Britain had angered its closest partner, the US, earlier this year by signing up to China’s new Asian Infrastructure Investment Bank (AIIB), perceived by Washington – correctly – as an attempt to provide an alternative to the World Bank and IMF, free of US influence.

Chinese investments announced so far include large sums for Rolls-Royce aero engines, cruise ships, and sales of liquefied natural gas. But the critical announcement is funding for Hinkley Point C, a new nuclear power plant in Somerset. China’s state-owned General Nuclear Power Corporation has pledged £6bn towards the cost of building this.

However, France’s 85% state-owned EDF will provide the rest of the £12bn needed, with the £18bn total making it arguably the most expensive power plant ever built.

To secure this funding for a high-cost, long-term project, the government has promised exceptional returns. Electricity from Hinkley Point C will be sold at £92.50/MWh. This is double the current wholesale market price for electricity. This offer is so generous that the Austrian government is taking the British government to the European Court, claiming this exceptional promise breaches the EU’s “State Aid” rules.

The government’s enthusiasm for this controversial (and hugely expensive) deal can be explained in four parts.

Britain urgently needs to invest in infrastructure. With two major coal power-plants scheduled for decommissioning next year, the legacy of years of underinvestment is that electricity supply in the UK is now exceptionally tight, with barely 1% of spare capacity available. National Grid has warned of blackouts in the future, particularly if we have a cold winter. More generally, Britain’s woeful infrastructure is most likely the main reason behind the slump in productivity. Infrastructure investment has slumped under Osborne, from 3.3% of GDP in the last year of the Labour government, to 1.6% this year and 1.5% forecast for next. (For comparison, the OECD recommends an investment of 3.5% of GDP a year to avoid “implications for living standards”.)

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Osborne has largely failed to attract infrastructure investment from the UK’s private sector, with (for example) only £1bn promised of the £20bn he expected from pension funds. With interest rates still at all-time lows, government could borrow very cheaply to invest. But Osborne’s insistence on austerity (enshrined in the ridiculous “Fiscal Charter”) rules out increasing government debt, even for investment. So he has to look to investment from overseas. This has led to the farcical situation in which other countries’ state-owned firms can borrow cheaply to invest here, making a huge profit in the process, and relying on UK government guarantees to underwrite the investment. As a result, Hinkley Point C will be a nationalised power plant – but nationalised by China and France.

This extraordinary generosity only makes sense as part of a wider strategy. The government has identified China as a major new centre of economic activity. It also wishes to preserve the status of Britain’s financial services as a major global centre for money-dealing and related activities, since this is now one of Britain’s few remaining strategic strengths. Britain’s exports to China are currently very small – just 4.8% of the total exported, comparable to Belgium’s share. By offering generous terms to Chinese companies in the UK, the government can hope for reciprocal deals and so capture more of China’s growing domestic market. A major part of those exports will be “financial services” and “management consultancy”. Making Britain “open for business” (to quote Osborne) has already produced results: China’s first offshore renminbi loans are being sold in London.

Britain has the largest current account deficit in the developed world (relative to GDP). This means we, collectively, spend more domestically than we earn from the rest of the world. To make good the difference, we have to either sell assets here or borrow. By making it clear that Britain is an easy place to invest in, we can continue to attract loans from the rest of the world, and offer our assets to sale.

For China, the advantages are more obvious, given the generous investment terms offered. China itself faces a classic problem of over-investment, with decades of exceptionally high investment leading to companies unable to find a market for their products.

This has helped inspire government plans for immense infrastructure projects (for instance in building the “New Silk Road”), but has also led to the dumping of excess produce, such as steel.

The collapse of the world steel price, in turn, is what has led to Tata closing its UK steel plants at Redcar and Lanarkshire, threatening thousands of jobs. Osborne and Business Secretary Sajid Javid claim to be unable to assist these workers whilst, at the same time, offering enormous subsidies to Chinese and French corporations.

Article by James Meadway NewEconomics – Economics as if people and the planet mattered

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