Up until the financial crisis in 2008, trade and investment interdependency among countries grew steadily. This was best reflected through the spread of global value chains (GVCs). Many countries – including the least developed – accepted that participating in GVCs meant higher income and growth, and thus deliberately focused on building forward linkages into these GVCs. This meant exporting their commodities or goods, sometimes services, as intermediate inputs for processing, mostly in China, and onward delivery to final markets for consumption.
In the process, China has grown to reach the same export market size for least developed countries (LDCs) as the European Union, with both slightly below 30 percent. The US share in comparison lies just above 9 percent. What happens to China’s trade and economic growth thus matters for LDCs, not only in terms of short cyclical impacts but also longer-term prospects as the Asian giant has also become a major investor and source of technology transfer in these countries.
Consequently, the trade war with the US, which adversely impacts the economic performance of China, must also impact this group of countries. This is especially the case for Asian LDCs which started to build forward linkages into Chinese processing for GVC trade.
What are the channels through which these trade war related impacts will be passed on?
The risk-carrying channels of the trade war for LDCs
Decoupling by reshoring
One risk-carrying channel is US companies operating in China deciding to move previously off-shored production back to the US (or a country with which the US has tight(er) and more predictable trade rules – for example within the US-Mexico-Canada Agreement). A reduction of GVC production and exports from China to the US because of reshoring implies a fall in exports from third countries supplying parts and components to China, including LDCs. This is “GVC as an engine of growth” operating in reverse and implies a loss of trade for those countries with forward GVC linkages to China.
Non-GVC trade contraction
Another risk comes from the overall impact of the trade war on the performance of the Chinese economy, as it is presumed that the effects – at least in the short run – will be negative. The fall in external demand for exports in a (still) export-dependent economy must be felt through lower growth and reduced demand for imports of final goods for consumption in China. Exports from LDCs might thus also be impacted adversely through this channel. One has to note, however, that this reduction in China’s import-dependency – both for final consumption and export production – started with a gradual re-examination of the sustainability of export-led growth in the aftermath of the 2008 global crisis. The trade war might have strengthened and accelerated this trend.
The opportunity-carrying channels of the trade war for LDCs
Decoupling by GVC rerouting
Remember a picture of the iPhone value chain? So many parts and components sourced from tens of different companies and countries, sometimes crossing mutual borders more than once, for final assembly in China and export to the US and other markets, including within China. It is not possible to simply reconfigure all of those links in the value chain in a short period of time and without massive investment. But what Apple can do is relocate parts of the production chain from China to other countries where similarly competitive productive capacities exist coupled with efficient logistics and other infrastructure. This is an opportunity to supplant China’s place in the supply chain. In the short run, the lesser the investment needs for rerouting the better. In the medium to a long run, this channel will likely require either greenfield or M&A foreign direct investment into the new location.
Non-GVC trade creation (or diversion)
Beyond GVC-linked products, there are other goods exported from China to the US (for example timber) as well as from the US to China (for example soybeans). As this trade becomes costlier – and administratively more complex – traders in both China and the US will look for alternative markets to buy close substitutes for import. Any supplier who can provide goods of similar quality and price will stand a chance to start exporting directly to these countries. This new trade creation would be similar to that seen in the aftermath of a free trade agreement with trade diverted from outside to within the agreement due to perceived cost advantages.
Some empirical results on possible impacts
The UN Economic and Social Commission for Asia and the Pacific (ESCAP) has calculated the possible impact on third countries, including LDCs in Asia, from the tariffs imposed by the US on China (up to July 2019).
Results show that the Association of Southeast Asian Nations (ASEAN) and advanced economies in East Asia might benefit from substitution opportunities for both GVC rerouting and non-GVC trade creation. Japan, South Korea, Thailand, and Vietnam are among the largest potential beneficiaries.
In principle, some LDCs might see new opportunities in labour-intensive and commodity exports. But it will be more difficult for these countries to be chosen as new locations for GVC-linked trade due to weaknesses in infrastructure and logistics, lack of spare production capacity and skilled labour, and trade taxes that remain relatively high because of the prevalence of tariff escalations in manufacturing and agricultural goods for low-income countries.
The ESCAP analysis identifies some opportunities for a few LDCs to jump into rerouted supply links – either as suppliers of commodities and intermediates (for example Lao PDR, Nepal, and Bhutan) or producers of goods for final consumption (for example Cambodia).
Source: ESCAP 2019
When looking at the opportunities of export creation in the US market for both intermediate and final goods, only Bangladesh and Cambodia feature in the results among LDCs. On the whole, final export production tends to be more labour intensive than upstream activities, yet not many LDCs in Asia appear to be in a position to ride this trade creation opportunity.
Source: ESCAP 2019
A concluding word of caution
Despite the potential realignment of GVCs, China will remain in all likelihood the most important GVC hub in Asia for the foreseeable future. China’s capacity, which has been improved through targeted enhancement of its service capabilities, workforce skills, digital infrastructure and efficiency in trade facilitation, will be difficult to upstage.
However, the trade war may lead to increased inefficiency if it becomes the new norm in the global economy. Companies serving final demand in China and developed markets will be forced to duplicate investment in more than one jurisdiction due to decoupling. This will lead to higher costs and lower investment returns in GVC operations. Consumers would eventually come to pay higher prices for a reduced variety and inferior quality of products. And the few opportunities that might arise for some LDCs will not make up for the lack of progress towards trade-related targets set in the 2030 Agenda for Sustainable Development.
A final word of caution. Wars are rarely fought on a single front, and the US-China trade war is no exception. While tariffs remain the main battlefield, digital technology, currency manipulation, and political issues are also involved. The conflict is now taking place at the World Trade Organization in Geneva over the governance of global trade and it should concern many more players than these two trading giants. After all, by the simple fact that almost 60 percent of global GDP depends on trade, all countries are affected by what is still termed a bilateral trade war.
Mia Mikic is Director of the Trade, Investment, and Innovation Division of the United Nations Economic and Social Commission for Asia and the Pacific.