SINGAPORE (Nov 25): Since the entry of China into the World Trade Organisation in 2001, national economies have been integrated into the global economy at an unprecedented pace. According to the WTO, more than half of world trade in goods and services consists of intermediate products which are mostly exchanged within global value chains, which have become worldwide networks for the production of goods and services.
Such high trade flows have in turn lead to higher investment flows. Hence, trade has also been a force for economic growth in the last decade. Singapore for one has been a huge beneficiary with trade volumes making up three times the size of its Gross Domestic Product.
But the biggest beneficiary yet, is China. From lifting 850 million of its people out of poverty, trade has propelled China to become the world’s second largest economy with an output of more than US$12 trillion a year.
Now, protectionism in the form of the slew of tariffs and measures imposed by US president Donald Trump is attempting to unbundle the tangled web of supply and value chains. In Trump’s simplified world view of economics, to make America great again, he wants to bring manufacturing jobs back to the US, and to do this, he wants to reverse its trade deficit with the rest of the world, in particular China.
But economics doesn’t work this way. Hypothetically speaking, Tian Lin an Assistant Professor at Insead specialising in international trade and spatial economics, says that a 25% tariff levied on all imports during the trade war will significantly increase the total production cost of the product, in the global value chains. In effect, the US firms and consumers may eventually bear a negligible share of the higher cost.
Using the production of T-shirts as an example, Tian says, the three stage-process involves : the US exporting raw cotton to India; India processing the cotton into fabric, and then exporting this to China for the material to be stitched and made ready for sale, most likely, to the US consumers. “Now during a trade war, if each country involved in the value chain [is imposed with a] 25% tariff, the tariff will be paid three times, each time it crosses the border,” Tian tells The Edge Singapore.
With textile exports from China having inputs from Japan, Korea and Asean (see chart 1), Tian’s example illustrates a spillover effect of the US’ tariffs on multiple countries.
The T-shirt is one example of an item with inputs from several countries. In more extreme supply chains such as the production of Apple’s (chart 2) iPhones, MacBooks and iPads, over 200 products are sourced from approximately 25 countries.
And so, a tariff imposed to an electronic gadget assembled in China, spills over to the 24 other countries, thereby affecting their trade balances as well.
Complicated supply chains
Tariffs and the threat of tariffs are driving Chinese firms offshore, to countries with cheaper costs of production in Southeast Asia. (Japanese firms made a similar move in the 1980s.)
Vietnam is widely considered to have benefitted the most from the relocation of firms out of China to circumvent Trump’s tariffs. However, Trump’s “America First” policies see him imposing tariffs on transhipments or ‘dumping’, meaning that
Vietnam may not retaining the advantages from the Chinese firms’ relocation. In fact it risks being imposed with tariffs.. “The benefit of lower prices from cost competencies is increasingly undermined as the US slaps tariffs on Chinese goods,” says notes Vishnu Varathan, head of economics and strategy at Mizuho Bank.
Michael Spencer, Chief Economist and Head of Research for Asia Pacific at Deutsche Bank says the cost of production in Vietnam also increased significantly because of the higher demand for services thereby making the cost savings of producing there negligible.
To reduce such costs, Tian notices firms “re-shaping their supply chains” through a consolidation of production into fewer countries. “A consolidation will minimize cross border dealings”, she notes. This translates to cost savings in transportation and logistics.
For now, the country of choice for the consolidation of production facilities “is left to be seen”, says Tian. And while it is possible that firms consolidate in the US, she feels “it is not an obvious choice”. Even though the possibility of lower costs through a consolidation is a promising mitigating factor, Tian says “it does not completely cancel out the impact the tariffs have already had”. Already, the uncertainties arising from the trade wars have disrupted global supply networks which may have a long-lasting impact on both consumers and firms, Tian points out.
And so, in the short term, the upending of supply chains through protectionism is likely to reduce trade globally and as a result the global economy is likely to slow.
Too much uncertainty
Trump’s impetuousness has led to uncertainty which is being increasingly blamed for a slowing world economy. In the first half of 2019, world merchandise trade was up 0.6% compared to the same period in the previous year. As a result, the WTO is projecting an estimated merchandise trade growth rate for this year of 0.5% to 1.6%, and for 1.7% to 3.7% in 2020, depending on whether trade tensions increase or recede.
Singapore’s economic indicators too have weakened progressively as the trade war wears on, Its non-oil domestic exports (NODx) have been in negative territory for most of this year – with October’s NODx shrinking 12.3% y-o-y, according to data released by trade agency Enterprise Singapore on Monday (chart 3). The drop which marks the eighth consecutive month of NODx’s decline was sharper than the 8.1% drop in September. It is also worse than the 10.4% decline estimated by financial house Refinitiv.
Likewise, Singapore’s Purchasing Managers’ Index (PMI) – which captures data from the manufacturing and services industries – has been falling steadily to hit 49.6 in October (chart 4). A reading below 50 indicates a contraction in the industry.
What could help a small open economy like Singapore’s is greater integration within Asean. Singapore has a small domestic market, while Asean’s economy is huge, thereby presenting a multitude of opportunities. With a population of close to 650 million and economic output of more than US$3 trillion, if Asean were a country it would rank no 8.
Yet, intra-Asean trade is just 25% of the region’s total trade compared to the 60% of total trade among countries in the EU bloc. The Asean Economic Community (AEC) mooted in 2003 and set up in 2015, has the potential to accelerate economic growth and facilitate the region’s trade development via a more seamless movement of goods, services, skilled labour and capital, says Vishnu.
Sychronised slowdown
The International Monetary Fund has already warned of a synchronised global economic slowdown, with global growth for this year likely to come in at 3%, the slowest since the global financial crisis. This could rise to 3.4% in 2020 but adds that the trade war could shave 0.8% off global GDP by 2020.
China’s exports and growth have slowed and caused a slowdown across Asean. GDP growth in the Middle Kingdom slowed to 6% in 3Q2019, the slowest rate in 27 years. Latest data shows that Chinese exports declined 0.9% in October, continuing its three month decline. US GDP growth slowed to 1.9% in 3Q2019, its slowest growth rate for this year.
Singapore barely escaped a technical recession, with a growth rate of 0.1% in 3Q2019. The IMF is forecasting growth for Asean-5 at 4.8% this year compared to 5.2% in 2018, and staying flat at 4.9% for 2020.
For the past 40 years, if the US sneezed, the rest of the world caught a cold. These days, if China sneezes, Asean certainly catches cold, a result of intertwined supply and value chains, and globalisation.
