March 1st came and went without further escalation of already tense US-China trade and investment relationships. It is, however, too soon to fill in champagne glasses. Protectionist policies implemented so far by the world’s largest economy and corresponding retaliatory tariffs by other countries have already caused immense uncertainty regarding the future structure of global trade and the global trade system. In the meantime, what are potential ripple effects on sustainable economic development in the Asia-Pacific region?
The number of countries partaking in tariff escalations has painted the situation as a global trade war, but tariff escalations between China and the US are of particular concern given the scale of trade items covered by their additional tariffs. The US is currently imposing tariffs on half of its imports from China, while China is imposing retaliatory tariffs on two-thirds of its imports from the US. None of the other tariff escalations come near, either in terms of magnitude or sectoral coverage.
While it now appears that there will be no imminent additional tariff increases, there are also no signs of action to repeal or reduce newly erected higher tariffs. It appears they will stay in place until the two countries resolve their conflict1. When -if at all- that will be, remains highly uncertain.
All countries in the region should, therefore, prepare themselves for the impacts of a continued period of trade tensions. For traditional trading nations in the Asia-Pacific region, there are far-reaching implications. This is because China has established itself as the global value chain (GVC) assembly hub of intermediate goods and components produced in the region. To give context, in 2017, exports of raw materials and intermediate capital goods accounted for over two-thirds of total exports by the Asia-Pacific region, with exports to China accounting for nearly one-third of these exports. Therefore, there is a plethora of potential effects, ranging from impacts on GDP and employment to shifting production lines and changes in regional GVC architecture.
To evaluate the impacts of demand shocks likely to arise from the trade tensions, in the 2018 Asia-Pacific Trade and Investment Report, we have constructed indices to assess the exposure of Asia-Pacific economies to risks and opportunities through international production linkages by using trade in value-added data produced by the Asian Development Bank. On the risk side, the index captures the country’s reliance on China as an export market and export platform. Hence, a country with high reliance on exports to and through China, such as Mongolia, faces a high risk to be adversely affected by this trade war.
Despite the clear risks of the trade war, there could be some positive implications mostly linked to the possible redirections of trade and investment among the countries in the region. Using a multi-dimensional composite index of opportunity that considers several factors influencing the redirection of trade and investment, several potential winners can be identified (see figure). Viet Nam and Indonesia appear most ideally positioned to serve as a new regional assembly centre, with a high potential for attracting labour-intensive manufacturing sectors. On the other hand, Japan and Republic of Korea emerge well-placed to benefit from their competitiveness in high-tech manufacturing.
Source: ESCAP (2018)
However, there are several limitations to the indices. Since the risk and opportunity analyses are limited to tariff increases by the US only and do not account for retaliatory tariffs by China or any other countries, they do not reflect the full impacts of trade tensions. Additionally, the opportunity index only highlights countries in the region that are well-positioned to benefit from the trade war. Converting opportunity into concrete exports and income gains will depend strongly on these countries’ ability to expand productive capacity, which is also linked to a country’s ability to invest or attract foreign direct investment (FDI).
In addition, as re-configuration of GVCs requires massive and time-consuming redirection of investment, unless these trade tensions become permanent, we do not expect to see a complete redirection of GVCs in the region. It is more likely to see multinational enterprises diversifying their investments as a risk mitigation strategy in the medium term. In the immediate term, we would see them following a wait-and-see strategy on their FDI. Hence, impacts of the trade war would be felt much more by FDI than by trade flows, and consumers would bear additional costs through increases in retail and wholesale prices, especially in the two participating countries.
The above results highlight a case of collective winners, in which countries with proactive approaches towards trade integration, investment in hard and soft trade-related infrastructure and human capital development have found themselves enjoying the advantages of being strongly connected to GVCs. Thus, they have better market access opportunity and, hence, are well-positioned to deal with the growing trade tensions. The path these high-opportunity countries have followed provides a good example for other countries in the region to enable them to withstand and benefit from possible future shocks.
1 For the US, existing tariffs include 25 percent tariffs on US$34 billion worth of goods, effective July 6, 2018; 25 percent tariffs on US$16 billion worth of goods, effective August 23, 2018; and 10 percent tariffs on US$200 billion worth of goods, effective September 24, 2018. China has tariffs ranging between five and 25 percent on US$110 bllion worth of US goods.