Will US-China trade war reshape global value chains?

posted by Xi Sun on August 5, 2018 - 11:59pm

China says the United States has waged a trade war, while America’s intelligence agency is now terming it as a China-led cold war. Nevertheless, the trade brouhaha continues. Trumponomics ceases to be rhetoric anymore, and Xinomics is candidly reciprocal. In fact, neither countries were striving for autarky, nor is the situation as grim as it was in the 1930s. Yet the present scenario is destined to reach alarming proportions, as its spillover effect has begun to deter the global value chains (GVCs) that perennially define the geo-economic architecture of international business today.

It is true that the United States is experiencing a huge imbalance in merchandise trade with China. In 2017, the United States had a negative global trade balance of US$862 billion, whereas China enjoyed a positive global balance of trade accounting for more than US$430 billion. Moreover, the bilateral merchandise trade balance between the United States and China favors the Asian powerhouse by more than US$395 billion. That is unsustainable for the United States and unacceptable to President Donald Trump.

From China’s perspective, the trade imbalance with the United States is a structural and long-term problem and should be viewed rationally. It ought to be gradually solved through bilateral negotiations, rather than resorting to a trade war. This May, the two sides met and negotiated in both Beijing and Washington, and they agreed to resolve the relevant trade and economic issues through dialogue and consultation.

However, in June, the Trump administration eventually fired its shot with the first round of 25% tariffs on 818 Chinese products, including aircraft and other industrial goods worth US$34 billion. China calls it “the largest trade war in economic history.” China, however, immediately retaliated with tariffs of equal measure.

In July, the US announced the new 10% tariffs on US$200 billion of Chinese imports, including electronic goods, fisheries and cosmetics, among others. Recently, Trump said that he really likes President Xi Jinping a lot. But in his own country’s national interest, he threatened to impose a tariff on all Chinese imports worth over US$500 billion – the magic number that would make it a full-blown trade war.

There is no doubt that China is the “world’s factory” today, and is a key trading partner for more than a hundred countries spanning across geographies.

Today, more than 60% of the world’s trade happens in intermediate goods, with China being a major trader inter-linking the GVCs of large multinationals and other lead firms. China has enjoyed a 10% growth rate over the past three decades, and this was possible largely owing to the increasing GVC participation of its small and medium enterprises (SME). In fact, most export-led economies are dependent on import contents for their exports, such as the importation of raw materials, parts, components, etc.

The spillover effect created by the growing intensity of the ongoing US-China trade war will definitely have repercussions on the multilateral trading system. It can affect the export-led economies in several ways. This includes increased costs of the import contents of their export; increased tariffs on their exports, thus making their products costlier in an importing country; costs associated with supply-chain disruptions; spillover effect on partner countries and sectors; and impact on investment inflows.

Besides China and the US, some of the key export-led economies in East and Southeast Asia that have started feeling the heat include Hong Kong, Taiwan, South Korea, Japan, and Singapore – all of which are participants in the electronic goods GVCs through their value-added trade in components and semiconductors.

The spillover is gradually becoming so intense that manufacturers are now shifting their production lines outside China. Though this phenomenon was ongoing even before the trade war, the number is now growing up sharply.

Manufacturers in Hong Kong, especially those in the sectors of components and metallurgy, have already started relocating. One of the cost-effective destination now hosting such industries is Malaysia – a country that aspires to become a high-income economy by 2020.

Also, Taiwan is watching the situation very closely and fears a possible difficulty in inventory management for its manufacturing sectors. With its industrial production unexpectedly going down and its currency weakening, Taiwan is also revising its GDP growth forecast for 2018 from 2.6% to 2.4%.

Even South Korea’s exports of cars and electronic goods have fallen recently and the country’s growth rate is now forecasted to be lower than the earlier estimate of 3%. The growing unemployment in recent months can also be attributed to the rising intensity of the trade war.

In fact, SMEs in South Korea have internationalized themselves through China-centric and American orientations. Trump’s magic figure will likely deter the internationalization and value-chain upgrading process of these SMEs. Not only the SMEs, but the chaebols are also likely to be affected. Even the electrical machinery and equipment value chain across East Asian countries is robust and likely to be affected. For instance, more than half of South Korea’s US$163 billion global exports of electrical machinery and parts go to China.

Other countries, including Japan, Australia, Malaysia, Indonesia, Thailand and the Philippines, would be affected too, as they are either engaged in manufacturing automotive parts and components or are engaged in value-added activities pertinent to the basic metals and rare earth elements for this sector.

On the other side, to counter China, the US has agreed to work with the EU toward the “zero tariffs, zero non-tariff barriers and zero subsidies” deal. This is intended to largely secure the economic interests of the US – which are potentially at stake because of the trade war.

Interestingly, in this context, the role of mega-trade blocs like the Regional Comprehensive Economic Partnership (RCEP) cannot be undermined either. In the recently concluded 23rd round of negotiations of the RCEP, consultations on two key issues – trade facilitation and government procurement – have been completed. The RCEP free trade negotiations – once positioned against the US-led Trans-Pacific Partnership (TPP) – involve 16 countries (China, Japan, South Korea, India, Australia, New Zealand and the 10 ASEAN member states).

With such a free trade agreement in this region, which China is rigorously pushing for, the trade war may even take a back seat. This is because most of the production lines being relocated now owing to the fear of a trade war are going to those countries that will again come under the ambit of this trade agreement – thereby minimizing trade costs for the participating economies.

The repercussions of a full-blown trade war will be too complex to decipher, and too onerous to handle. It may even trigger a recession of a connotation – if not the magnitude – of what the Smoot-Hawley Tariff Act of 1930 did to the economic crisis of 1929-32.

Singapore’s prime minister, Lee Hsien Loong, has explained the global anxiety today in a very simple and lucid manner saying: “Nobody wants a trade war.” Thus, whether Xinomics survives or Trumponomics prevails, the export-led economies and global consumers are indeed getting ready to suffer!

This article was co-written by Dr Faisal Ahmed, associate professor and chair of international business at the FORE School of Management, New Delhi, India.