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Economy

Moving Upstream: China Is Set to Reshape the Global Value Chain

Jun 06 , 2019
  • Zhang Monan

    Senior Fellow, China International Economic Exchanges Center

The world we live in is undergoing tremendous changes unseen for a century, while China also faces risks it has never encountered throughout its four decades of reform and opening up. The ongoing trade war between China and the US is set to profoundly disrupt and reshape the global industrial chain, value chain and supply chain. As a consequence, China’s pathway to integrate itself into the existing world market — currently dominated by multinationals — in a bid to achieve an industrial upgrade will have to be altered. China needs to make renewed long term planning for this purpose.

In a nutshell, the trade war’s profound disruptive effect on these three “chains” takes place across three primary aspects. First, the trade conflict’s spillover effects will fester and alter the course of development for the industrial chain, value chain and supply chain. Second, as the trade war grows in scope, it threatens to cut off these chains outright. Third, the US is determined to contain China’s high-tech sector, and disable China’s modus operandi whereby foreign companies make a deal of “Market for Technology.”

In order to rise to the challenge, China must bolster its science and technology sectors, empower its national strength through innovation, and prioritize the development of pilot free trade zones.

As the trade war will reshape the course of China’s economy and the global economic order at large, China must translate external pressure into internal incentives for expedited reforms. These include: efforts to deepen supply side structural reform; speed up the development of an innovation-driven economy; further roll out the negative list system under its new Foreign Investment Law; harmonize market rules and foster fair competition; as well as transform government functions through administration streamlining and expanded domestic consumption.

Structural reform aside, developing technological innovation is key to China’s growth, along with efforts to pursue the new model of “opening up based on rules and institutions,” fostering international synergy by promoting bilateral, multilateral and regional free trade networks, in order to create a favorable environment for future development both at home and abroad.

Several adjustments to Chinese development are called for under today’s new economic circumstances. Let us consider four major changes:

First, shifting from a global value chain to a combination of a global value chain and a national value chain, or GVC+NVC.

For many years, China’s industrial sector was part of the global value chain, reflecting the global division of labor, while largely ignoring demand from the domestic market. But with the diminishing comparative advantage derived from low-cost manufacturing, compounded by the ongoing China-US trade war, China needs to reevaluate the global industrial layout and make adjustments accordingly: it must shift the value chain model from one that is based on GVC to one that combines the GVC and NVC, which will help cushion the impact of the trade war and elevate China’s position in the global value chain of manufacturing.

Second, expediting the search for alternative sources to ensure China’s supply chains are not severed.

Importing via alternative sources does not mean giving up on import or turning inward, but harnessing trade it in a way that play to China’s comparative advantages.

This shift will help create an enabling environment for innovation-based industries and shore up Chinese technological prowess. Second, it is conducive to optimizing China’s domestic economic structure and enhancing endogenous economic growth. It will also elevate China’s position in the global division of labor, through accelerated industrialization and transformation of the Chinese economic growth model. All in all, it is imperative that China identifies alternative source of import, step up investment in high-end manufacturing, increase research and development in high value-added areas, thereby moving China up along the global value chain and translating the crisis into an opportunity for development.

Third, using the Belt and Road Initiative (BRI) to facilitate cooperation in restructuring the global value chain.

China is now the biggest trading partner and the biggest destination for exports and FDI for 25 of the BRI participating countries. China is in a position to leverage its own industrial capacity and quality resources to create synergy with cutting-edge technologies from Europe. Such cooperation based on comparative advantages is well-placed to tap potential demand through further opening-up of its market , which will lead to a more connected market in terms of production factors, services, capital and technologies, thus offering all the makings of a new system of industrial division of labor. The rationale is to bring more countries into the global supply chain’s network under the BRI framework, through various means such as economic and trade cooperation, cross-border industrial clusters and free-trade zones, which will also serve China well as it expands its capacity for transfers and cooperation overseas. In this sense, from a long-term perspective, the US-China trade war could push China to expedite this adjustment of the global industrial chain’s layout alongside restructuring all three chains on a global level.

Fourth, accelerating engagement in bilateral and multilateral trade agreements.

Over the past few decades, global demand has been generated primarily in developed economies, but that has changed with the growing cohort of emerging market economies and the restructuring of the global value chain. According to a McKinsey study, by 2025 emerging market economies will be consuming about two-thirds of global manufactured goods, including intermediate goods and capital goods—meaning automobiles, construction materials, and machinery. Statistics show that in the past decade, China’s share of exports to non-OECD countries has risen to 48% versus the 45% found in an earlier survey.

One could therefore suggest that China upgrade its free trade agreements, and in the meantime accelerate the progress of RCEP — its free trade pact with Japan and South Korea — as well as the China-EU Bilateral Investment Treaty, and even explore the feasibility of a full China-EU free trade agreement, in a holistic endeavor to connect with neighboring economies, advance cooperation with BRI participating countries, and expand the global network of free trade zones. Meanwhile, China should contribute to WTO modernization endeavors, and promote a fair global trade system to carve out a more conducive environment for its own development.

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