The general trend of the past 40 years has been toward lowering tariffs and nontariff barriers. But now the pendulum may be swinging in the other direction. Global value chains will respond to the changes in trade policy that ultimately emerge. The direct impact of the new US China tariffs could be relatively limited. China’s exports to the United States amount to 4% of its GDP, while its imports equal about 1%. Similarly, US exports to China are equivalent to 1% of its GDP, and its imports amount to 3%.
A full-blown trade war could have a cumulative negative impact of 1.6% on China’s GDP and 1.0% on US GDP by 2020. There were around 500,000 foreign enterprises operating in China. 40% of China’s exports are the products of foreign-owned enterprises and joint ventures between foreign and Chinese firms. The first two rounds of tariffs imposed by the United States on China amounted to $250 billions of goods. Half are on electronics or machinery—and foreign firms produce 87% of the electronics and 60% of machinery made in China. Higher tariffs affect firms in the United States, given that 29% of China’s exports to the United States are intermediate goods used in producing finished goods. As tariffs increase the cost of production in the United States, the effects can manifest as higher consumer prices and pressure on the bottom line for US manufacturers.
In the September 2018 McKinsey Global Executive Survey, 33% of companies said that uncertainty over trade policy was their top concern, and 25% said recent tariff increases were their biggest worry. Nearly half of respondents stated that their companies will shift their global footprint in response, and one-quarter said they expect to invest more in local supply chains. Rolling back globalization undermine global productivity growth and innovation. Research has found that global flows of goods, services, finance, people, and data boosted world GDP by around 10% in a decade over a scenario in which those flows did not exist. Openness to both inflows and outflows of all kinds has real economic value.
Change in the Geography of Global Demand
The map of global demand, once heavily tilted toward advanced economies, is being redrawn—and value chains are reconfiguring as companies decide how to compete in the many major consumer markets that are now dotted worldwide. According to current projections, emerging markets will consume almost two-thirds of the world’s manufactured goods by 2025, with products such as cars, building products, and machinery leading the way. By 2030, developing countries are projected to account for more than half of all global consumption. These nations continue to deepen their participation in global flows of goods, services, finance, people, and data.
The biggest wave of growth has been happening in China. China’s working-age population is one of the key global consumer segments. By 2030, they are projected to account for 12 cents of every $1 of worldwide urban consumption. China will have more millionaires than any other country in the world. China now represents roughly a third of the global market for luxury goods. In 2016, 40% more cars than were sold in China as compared with all of Europe. China also accounts for 40% of global textiles and apparel consumption. As consumption grows, more of what gets made in China is now sold in China leading to the decline in trade intensity.
China exported 17% of what it produced in 2007. By 2017, the share of exports was down to 9% which is on a par with the share in the United States but is far lower than the shares in Germany (34%), South Korea (28%, and Japan (14% ). China’s output, imports, and exports have all been rising so dramatically in absolute terms. But overall, China is rebalancing toward more domestic consumption.
China Building Domestic Supply Chains
There is an advantage in placing production close to their customers and building networks of suppliers in closer proximity to one another to improve coordination. Local industries become more vertically integrated and multinationals to serve these fast-growing domestic consumer markets.
China, which drove the expansion of global value chains, has now developed more comprehensive domestic supply chains. Since 2001 its manufacturing output began to soar as its share of overall global goods production grew from 6% in 1995 to hit 32% by 2017. Automotive, transportation equipment, and computers and electronics saw especially large increases. China now produces almost half of global output in three industries: glass, cement, and ceramics and electrical machinery.
China now builds new industrial capacity modernizing industries at the same time, phasing out aging factories and building more technologically advanced new plants. In computers and electronics, for instance, China first emerged as a place for low-cost assembly and re-export. Now China is developing its own capabilities to manufacture components, including sophisticated chips that it previously imported from advanced economies.
Building out domestic supply chains is enabling China to bring new jobs to its inland provinces—regions that did not make the same kind of economic gains as the coastal provinces during the recent export-led boom. China is now focusing on economic development in parts of the country that were left behind, and it has invested heavily in transportation infrastructure to move goods from the heartland to the coast. China hopes to take pressure off its biggest megacities and encourage more balanced development across a greater number of smaller cities.
Wages in Chinese coastal provinces have been rising but China can retain many types of manufacturing by moving production inland. In essence, Chinese companies can engage in labor-cost arbitrage within the country’s own borders. The “Made in China 2025” policy designates dozens of inland pilot cities for industrial upgrades. As a result of China’s growing domestic supply chains, its trade intensity has fallen. This new China effect explains the entirety of the recent slowdown in goods trade that has been observed at the global level. The steepest fall-off in China’s intermediate trade has occurred in computers and electronics. Measured as a share of global output, trade in intermediate inputs fell by 5.1%points between 2007 and 2017. China fully accounted for the fall; in fact, trade in intermediate inputs actually expanded slightly among other countries participating in this value chain. The industry’s overall trade intensity fell sharply over the decade as China’s industry became more vertically integrated and more of the computers, phones, and devices it turns out were sold to Chinese consumers rather than being shipped abroad.
The automotive industry’s global trade intensity similarly fell by 7.9% between 2007 and 2017. Two-thirds of this decline can be traced to the millions of vehicles being both made and sold in China. Trade intensity also tumbled by ten percentage points in the textiles and apparel industry during this period, with China accounting for 80% of the drop. China remains the world’s largest importer and exporter of goods. China’s focus on building domestic supply chains and vertically integrated industries has dampened the scope of the trading opportunities foreign companies once envisioned.
A full-blown trade war is likely to have a small negative impact on China’s GDP because China exports to the United States amount to only 4% of its GDP. Such trade confrontations will undermine global productivity growth and innovation because global flows of goods, services, finance, people, and data have so far boosted world GDP by around 10%. Openness to both inflows and outflows of all kinds has real economic value.
Emerging markets will consume almost two-thirds of the world’s manufactured goods by 2025. By 2030, developing countries are projected to account for more than half of all global consumption.
China, which has so far driven the expansion of global value chains is now developing its own domestic supply chains. China now produces almost half of global output in leading industries.