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What the U.S.-China Trade Conflict Means for Asia

Jun 26, 2019
  • Rene Zou

    China-focused policy analyst with a dual master’s from Sciences Po, Paris and Peking University

As trade tensions escalate between the world’s two largest economies, China’s neighbours are counting the losses and gains. Despite President Trump’s promises to reduce trade imbalances, the U.S. trade deficit widened to a 10-year high in 2018, due to higher consumer and business spending fuelled by tax cuts and a stronger dollar. Instead of “re-shoring”, or bringing back factories to the U.S., most production is moving from China to America’s other trading partners. In Asia, China’s competitors have benefited from U.S. import substitution, yet analysts warn of weaker global economic growth as a result of disrupted supply chains and business uncertainty. 

Looking beyond the U.S.-China economic rivalry, what is left are forces of globalization and protectionism. Discussions about the U.S.-China trade deficit often ignore the reality of supply chain distortions, which overstate the U.S.-China trade imbalance by an estimated 35-40%. Asia is the best case study of integrated supply chains, especially for the technology sector. It is thus important to shift the dialogue from U.S.-China rivalry to the effects of globalization and protectionism, in order to take an honest look at the facts. This warrants a closer look at how economies and sectors are faring, especially with respect to trade and investment flows. 

Trade Flows     

A recent study by economists at Nomura show certain countries have benefited from U.S.-China trade diversion. In Vietnam, increased exports provided a 7.9% boost to its gross domestic product (GDP), a 2.1% increase for Taiwan, and a 1.3% increase for Malaysia. Meanwhile, Korea, Singapore and Thailand have gained 0.8%, 0.7% and 0.5% of their GDPs from increased exports, respectively. Tariffs imposed on Chinese goods make them more expensive, and thus goods from other countries more price competitive. This is a boon for exporters competing with China in industries such as electronics, electrical machinery, and furniture. 

That being said, countries gaining from increased exports to the U.S. also experience a fall in exports to China. In many cases, gains from trade diversion do not offset decreases from lower Chinese demand. Countries like South Korea, Taiwan, Vietnam and Malaysia all export intermediate goods, such as electronic parts and components for assembly in China before reaching U.S. markets. Most notably, exports from Taiwan fell 4.8% year-on-year in May, and dropped 9.4% in Korea, marking at least six consecutive months of decline in both countries. While some companies have gained new business, many others caught in the middle of the global supply chain are losing out. 

Investment Flows    

To avoid U.S. tariffs, many companies have accelerated plans to shift production from China to other developing countries in Asia, including Vietnam, Indonesia, Thailand and India — often in the form of “greenfield” foreign direct investment (FDI). Given rising costs and slower expected growth in China, this certainty isn’t a new trend; still, U.S.-China trade tensions have given many companies the final push. According to the Asian Development Bank (ADB), Chinese companies nearly tripled their investment in developing Asia in 2018, while U.S. investment surged 71%.  Vietnam, in particular, saw an 81% increase in FDI in April, compared to the same period last year.

Having said that, economies in South and Southeast Asia are not yet fully prepared to absorb all new FDI inflows due to a lack of skilled labour, infrastructure deficits and regulatory uncertainty. Supply chains are “sticky” and moving them requires significant investment—something not all companies can afford. While sectors like shoes and toys are more footloose, mid-level manufacturing requires a more literate and numerate workforce for quality assurance. Nevertheless, the substitution of low value-added manufacturing away from China and towards emerging economies coincides with Beijing’s efforts to move China’s industry up the value chain.

Key Takeaway 

If the U.S. strategy is to confront and contain China, it is missing the mark. The present trade conflict has revealed China’s economic vulnerabilities and rallied its citizens and corporations to address them. While trade and investment may be flowing out of the country, China is motivated to develop its own industries and focus on its internal market to shift to higher value-added industries – what the U.S. already enjoys. Indeed, China is bracing itself for a protracted confrontation. The escalation of tensions neither helps the U.S. reduce its trade deficit nor contains China’s efforts in becoming a dominant power in Asia. It has only accelerated strategic competition.

While some third-party economies may benefit from trade diversion, increased trade tensions will have a net negative economic impact on most countries due to dampened business confidence and falling Chinese and U.S. demand due to higher prices. Unilateral protectionist strategies backfire because they tend to reduce growth everywhere, especially for trade-reliant, open economies in Asia. If there is a slowdown in the Chinese economy, then other countries — with China as its largest trading partner — will suffer as well.

In a trade war between two of the world’s largest economies, there are no winners. The U.S.-China trade spat will have spillover effects, with severe consequences for not only Asia, but the rest of the world. Today’s highly integrated global supply chains ensure everyone is negatively impacted if either one is hurt. 

Without a doubt, there are important discussions left to be had on investors’ access to markets, intellectual property protection, state subsidies, and other trade-distorting government interventions. However, this should be considered on a multilateral, and not just bilateral basis. At present, a few may be helped, but more are hurt, and there is no accountability for those caught in the cross-fire.

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