This article first appeared in Forum, The Edge Malaysia Weekly on May 27, 2024 - June 2, 2024

The drums of a trade war are beating. Investors may be underpricing how damaging the trade outcomes could be over the next year or two to the Asian region. The US and Europe are complaining about overcapacity in China, which they say causes surging Chinese exports that damage their economies. China has dismissed these complaints, insisting that there is no overcapacity, only a well-earned improvement in Chinese export competitiveness. In recent weeks, we have seen the US impose swingeing tariffs on a range of Chinese goods. Even the more circumspect European Union (EU) has launched investigations into Chinese subsidies for exports as a precursor to possible trade measures. China has vowed to retaliate against such moves.

As we show below, the changing patterns in world trade in recent years are politically untenable, making frictions inevitable. A negotiated compromise is unlikely for several reasons — geopolitical frictions have eroded the trust needed for compromise while the big trading nations are committed to economic strategies that are not likely to be adjusted anytime soon. Thus, even without an anti-trade administration in power in the US, trade conflicts are set to intensify. Because the implications for our trade dependent region are severe, it is vital that the region devise new strategies to mitigate these risks.

China is at the heart of the developments in world trade, so we need to first appreciate its unique position. China cannot be faulted for pursuing an export-led strategy that Japan, South Korea, Taiwan, Hong Kong and Singapore employed successfully to achieve impressive economic success. Unfortunately, the unique dimensions of China’s economy make its impact on its trading partners potentially damaging, unlike the experience with the earlier wave of export-oriented economies.

China’s sheer size means that anything it does will produce outsized effects. The imposing scale of China’s domestic market allows companies to exploit economies of scale that few other countries can dream of. Then there is the role played by local governments, which provide subsidies and other incentives to companies in their counties and cities including loans from state-owned banks on conditions which few other countries would ever permit. That helps these companies to achieve competitiveness far more quickly than in other countries. That competitiveness is further sharpened by another distinctive feature of China — the cut-throat competition among companies which far exceeds what one finds in the US, the EU or in other developing economies. More than 40 years of cumulative gains from these factors make China’s manufacturing ecosystem super-­efficient and difficult to compete against.

The result is that when China puts its mind to doing something — such as establishing itself as a major player in new emerging industries of the future — it can achieve its targets with unnerving speed and scale. But that also means that its export surges unfold very quickly, giving importing countries very little time to adjust to and absorb them. Much damage can be done to existing companies in importing nations in a very short period of time. The loss of jobs, the increase in companies going bust, the damage to communities and the political consequences of these are telescoped into a short window of time that make its political consequences highly salient.

The result is a set of economic patterns that are bound to create trade tensions:

•     China’s share of world exports has continued to rise. At the start of 2020, just as the Covid pandemic was breaking out, China’s export share was 12.9% — it is now 14.2%. But its share of world imports has edged down, from 10.8% to 10.6% in the same time frame. Whether justified or not, that feeds complaints that China is pursuing a highly mercantilist trade strategy where its trading partners do not gain much.

•     China’s gains are particularly impactful in certain sectors. While its success in electric vehicles, lithium batteries and solar panels is well known, it has also made substantial advances in market share in the electronic machinery as well, for example. It is also especially noteworthy that it has begun to regain market share in lower-value goods such as textiles and furniture in recent years. If China gains in both low-end and high-end, the question will be raised as to what is there left for other trading nations?

•     Even in areas where they achieve export success, Chinese manufacturers seem to be struggling in the domestic market. For example, industry experts say Chinese electric vehicle producers outside the top three lose RMB10,000 (RM6,500) to RMB30,000 per vehicle sold. This suggests that Chinese manufacturers in some industries are using export sales to support profitability, which is depressed by overinvestment. At least on the surface, that seems to support allegations in the US and Europe that China’s growth model creates excess capacity which then proves to be damaging to the rest of the world.

•     During the same period, China’s overall trade surplus has soared from about US$30 billion a month to about US$81 billion a month now.

The problem for China is that the world has changed from the 2000s when the major developed economies were prepared to allow massive Chinese exports even when their own manufacturing sectors contracted as a result. The political, social and economic costs of fidelity to free market ideals have proved too high for the political elite to stomach. As US Treasury Secretary Janet Yellen has said, and EU officials have noted, these countries are no longer willing to stand by passively and allow even more of their industry to be decimated.

Making things difficult for China, it is not only the western nations that are pushing back against Chinese export gains. A host of emerging economies, including India, Indonesia, Thailand, Vietnam, Mexico, Brazil and Chile, have also initiated measures against Chinese exports in the past few months.

China is not likely to shift away from the growth model that produces these trends. All the recent important policy meetings and documents indicate a continued commitment to supply-side strategies to boost China’s dominance in several sectors. At the same time, Chinese policymakers remain reluctant to boost consumer demand through support measures which President Xi Jinping and his colleagues consider “welfarism”. Thus a supply-side focused industrial strategy could produce more excess capacity in China since it does not seem as if deficient domestic demand is going to be addressed soon. On the other hand, the US, Europe and many emerging economies are committing themselves to industrial policies to strengthen their positions in key industries, many of which China is also targeting. Hence the clash of interests.

In the past, global trade tensions were resolved through negotiations. In the mid-1980s, Japan, Taiwan and South Korea agreed, through the Plaza Accord, to allow their currencies to appreciate in order to mitigate their export competitiveness. They also began building manufacturing capacity in the US so that American workers and suppliers could benefit from their sales in the American market. Today’s geopolitical tensions between a rising China and a US that is determined to protect its top position in the world make such compromises virtually impossible. Also, far from adjusting to correct the growing imbalances, currency movements are behaving perversely and aggravating the problem: Instead of depreciating to regain competitiveness in exports, the US dollar has maintained its extraordinary strength. The renminbi remains under pressure and is not strengthening as is needed to reflect its export prowess.

Moreover, the World Trade Organization (WTO) is no longer in a position to help manage trade frictions. Its arbitration panel, which adjudicates trade disputes, has been undermined by the US, which has vetoed all replacements to retiring judges, rendering the panel unviable.

Domestic politics adds to the difficulties. President Joe Biden is in a tight race with former president Donald Trump. Many of the key swing states that he needs to win were once industrial heartlands that were weakened by trade competition. More restrictive trade measures are likely as the election campaign heats up in the coming months.

Thus, it really does look as if there will be more protectionist measures and more inward-looking industrial policies that will combine to slow the growth of world trade. That can only be negative for this region. The growth in external demand will be lacklustre and commodity prices could weaken as a result. Protectionist measures against China could be used as a cloak for tariffs and other restrictions on exports from this region as well. If access to large markets in developed economies becomes more difficult, then foreign investors may think twice about building new capacity in emerging Asian economies. In other words, there will be damage on many fronts.

There might be some offsetting positives though. Companies will feel the need to hedge by relocating production out of China to other low-cost manufacturing centres. Countries that have free trade agreements with the developed countries that protect their market access could still see foreign investment come in. One example is the decision by AstraZeneca to build a S$2 billion pharmaceutical plant in Singapore as part of an overall strategy of having one China-centred supply chain to supply China and another one for global markets. However, these gains are unlikely to offset the downsides from worsening protectionism.

So far, countries in Asean have pursued strategies on an individual basis to mitigate these dangers. Vietnam and Singapore have continued to expand the free trade agreements that could offer them some shelter from protectionism. Malaysia and Thailand are following suit. Singapore is also actively engaged in digital economic partnership agreements. Others such as Indonesia are placing their bets on an inward-looking industrial policy of value addition in natural resources, buoyed by Indonesia’s initial success in nickel processing. Apart from Malaysia and Singapore’s pursuit of a special economic zone and Thailand’s continued success in cross-border trade with its neighbours, there are not many efforts at a region-wide strategy.

That is a pity because such individual strategies can only go so far given the scale of the risks the region faces. It is only collective action that can really help. Even Indonesia with a nominal gross domestic product (GDP) this year of around US$1.5 trillion does not have the economic weight to secure satisfactory outcomes in trade negotiations. But the collective Asean GDP of about US$4 trillion does give the region as a whole a good degree of clout. As the big powers contend for influence in the region, Asean working collectively could better secure economic dividends from the US and China.

So, what should Asean be doing? For starters, it should work harder at making the Asean Economic Community (AEC) something that produces material economic benefits by addressing its biggest failure so far — the proliferation of non-tariff barriers. But it needs to go well beyond that. It should take the lead to improve existing trade arrangements with other blocs such as the US, the EU, Japan and China.

Where these are not possible for domestic political reasons, perhaps the more trade-oriented economies such as Thailand, Malaysia, Vietnam and Singapore should go ahead to work out their own trade boosting agreements.

The last 10 years have seen few imaginative regional economic partnership initiatives from Asean, now that the AEC is done (in name though not in real substance) and the Regional Comprehensive Economic Partnership agreement has been concluded. This has to change.

Manu Bhaskaran is CEO of Centennial Asia Advisors

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