This Dis­pute Could Hit Global Sup­ply Chains

Global Asia - - CONTENTS - By Ai­dan Yao & Shirley Shen

the prospect of trade talks restart­ing be­tween the Us and China is un­likely to lead to a ma­jor break­through.

the Prospect of trade talks restart­ing be­tween the Us and China has brought a sigh of re­lief to mar­kets that have been ag­i­tated by the es­ca­la­tion of trade ten­sions. While a pos­i­tive de­vel­op­ment, we doubt if the meet­ing will lead to a ma­jor break­through, given the struc­tural dif­fer­ences un­der­pin­ning the trade dis­pute and the po­lit­i­cal mo­tives that will likely keep Us Pres­i­dent Don­ald trump on a col­li­sion course with Bei­jing be­fore the Us midterm elec­tions in novem­ber.

We have two re­search notes pub­lished this month ex­am­in­ing how the trade war may im­pact the two key play­ers: the Us and China. How­ever, as we ex­plained in the sec­ond note, the im­pact would not be con­fined on a bi­lat­eral ba­sis, as a sig­nif­i­cant por­tion of Chi­nese prod­ucts hit by the Us tar­iffs are not man­u­fac­tured en­tirely in China. Our data show that pro­cess­ing and as­sem­bling ex­ports make up over 30 per­cent of Chi­nese to­tal ex­ports, de­spite the fact that the ra­tio has been de­clin­ing over the past decade (see Fig­ure 1). For prod­ucts such as elec­tron­ics, over 40 per­cent of ex­port val­ues are still cre­ated by China’s sup­ply-chain part­ners. Our anal­y­sis in Fig­ure 2 shows that of the top four cat­e­gories of prod­ucts, which ac­count for al­most the en­tire $50 bil­lion in tar­iffs and over 60 per­cent of the $250 bil­lion (see Fig­ure 3), be­tween 23 per­cent and 43 per­cent of ex­port val­ues can be traced to for­eign pro­duc­ers. Fig­ure 4 pro­vides an illustration of how the global sup­ply chain func­tions in the pro­duc­tion of elec­tronic goods that meet the fi­nal de­mand in the Us. It shows that China, mex­ico and Canada are im­por­tant “car­ri­ers” of ex­port val­ues for up­stream pro­duc­ers,

such as Ja­pan, south Korea, tai­wan, Ger­many and even the Us it­self.

this sup­ply-chain con­nec­tion means that the shock from the China-us trade war will be con­ta­gious for many coun­tries that co-pro­duce with China. as China’s ex­ports to the Us de­cline, its im­ports of com­po­nents and in­puts from sup­ply­chain part­ners will also de­crease, spread­ing the neg­a­tive shock across the global pro­duc­tion process. Fig­ure 5 pro­vides an illustration of which coun­tries are re­liant on China’s role as the “fac­tory of the world,” and how big their ex­po­sures are to the prod­ucts that will be hit by the Us tar­iffs. Ja­pan, south Korea and tai­wan are large pro­duc­ers of value car­ried by China’s ex­ports (mainly elec­tron­ics) to the Us. the sec­ond block of Fig­ure 5 presents these ex­po­sures as per­cent­ages of their nom­i­nal gross do­mes­tic prod­uct (GDP). It shows that sin­ga­pore, tai­wan, Ja­pan, malaysia, south Korea and Viet­nam all have more than 1 per­cent of their GDP ex­posed to the po­ten­tial shock from the China-us trade war. Un­der the as­sump­tion of 25 per­cent tar­iffs on $250 bil­lion of Chi­nese ex­ports, we es­ti­mate the di­rect (al­beit par­tial, as we con­sider only the top four cat­e­gories of goods) im­pact on these coun­tries will be be­tween 0.02 per­cent and 0.64 per­cent of GDP, with asian coun­tries bear­ing the brunt of the shock (see Fig­ure 6 over­leaf). as for China, this bur­den-shar­ing will re­duce the hit for its own econ­omy, which we es­ti­mate to be worth 0.2 per­cent.

But not all is bad news. For China’s com­peti­tors in the Us mar­ket, many of whom are also China’s sup­ply-chain part­ners for dif­fer­ent prod­ucts, there are po­ten­tial gains if they pick up the mar­ket share that China leaves be­hind. Fig­ure 7 shows the top for­eign sup­pli­ers of the tar­iff-hit goods to the Us mar­ket. to es­ti­mate their po­ten­tial gains from the mar­ket-share re­dis­tri­bu­tion af­ter China’s exit, we present two sce­nar­ios: 1) the en­tire mar­ket share left by China is re-al­lo­cated pro­por­tion­ally to non-us pro­duc­ers; and 2) only half of the mar­ket share is re­dis­tributed among for­eign pro­duc­ers, with the other half picked up by Us do­mes­tic firms. as­sump­tion 2 is un­der­scored by Fig­ure 8, which shows that the im­port pen­e­tra­tion of the tar­iff-hit sec­tors in the Us ranges from 20 per­cent to 60 per­cent, mean­ing that the Us prod­ucts are not com­pletely un­com­pet­i­tive. Fig­ure 9 il­lus­trates the long-term gains for some of China’s top com­peti­tors, while Fig­ure 10 com­bines them with the short-term knock-on ef­fects, show­ing that mex­ico and Canada are net ben­e­fi­cia­ries of China’s loss, while most asian coun­tries are (net) ca­su­al­ties of the trade war.

a few caveats in con­clu­sion. First, the ex­port value-added data is from the OECD, with the lat­est up­date be­ing 2011. We have to es­ti­mate the 2017 num­bers based on some as­sump­tions, which we think are log­i­cal, but may not match the re­al­ity. sec­ond, we as­sume the neg­a­tive tar­iff shocks will be di­rectly passed onto China’s sup­ply-chain part­ners, as­sum­ing uni­tary price elas­tic­ity of de­mand (e.g. quan­tity and price ad­just pro­por­tion­ally). We also make no con­sid­er­a­tion for any be­hav­ior changes of pro­duc­ers due to ex­change rate vari­a­tions. Fi­nally, even though Fig­ure 10 puts the pos­i­tive and neg­a­tive im­pacts side by side, it is worth not­ing that the neg­a­tive shocks will likely hit much faster than any po­ten­tial gains are re­al­ized. For many coun­tries, the lat­ter is only pos­si­ble af­ter a sig­nif­i­cant ex­pan­sion of their ex­ist­ing pro­duc­tion ca­pac­ity, which may take time and is sub­ject to un­cer­tainty.

ai­dan yao is se­nior Emerg­ing asia Econ­o­mist and shirley shen is se­nior re­search as­sis­tant at axa in­vest­ment Man­agers.

China, Mex­ico and Canada are im­por­tant ‘car­ri­ers’ of ex­port val­ues for up­stream pro­duc­ers, such as Ja­pan, South Korea, Tai­wan, Ger­many and even the US it­self.

This sup­ply-chain con­nec­tion means that the shock from the China-us trade war will be con­ta­gious for many coun­tries that co-pro­duce with China.

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