Economic security-related policies implemented in the context of the U.S.-China rivalry have expanded from tariff hikes to technological decoupling through tougher export controls on high-tech products, export restrictions on critical minerals, and industrial policies related to semiconductors and electric vehicles (EVs). Some of these measures represent breaches of existing trade rules, weakening the rules-based international trading order.
Trade regulations may be further enhanced in the name of security in the future. However, neither the United States nor China alone has the power to divide the world economy in two. Many third countries that are neutral to the U.S.-China rivalry will continue to operate in that manner. In the end, the decoupling of the Chinese economy from the West may remain limited to certain sectors, leaving large-scale trade and investment to continue between the West and China.
Japan and other middle powers, despite difficulties in halting the U.S.-China rivalry, must maintain free economic activities and preserve the rules-based trading order in economic zones outside the rivalry.
One challenging issue is the extent to which the fence between economic areas subject to regulations and those left to free economic activities can be clarified. With regard to trade and investment with China, uncertainties about current and future policies may be resulting in excessive contraction of economic activities.
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I conducted empirical research on the impacts of strengthened export controls by the U.S. and other countries on high-tech products with Keio University Professor Mitsuyo Ando and Kazunobu Hayakawa, a senior researcher at the Institute of Developing Economies of the Japan External Trade Organization (IDE, JETRO). We found that a decline in exports to China resulting from several measures was limited to a narrow range of products, with minimal macroeconomic or industry-level impacts.
On the other hand, net foreign direct investment in China based on preliminary balance of payments statistics released in February fell by 82% year-on-year in 2023. While there is no evidence of a massive withdrawal of foreign companies from China, new foreign investment in China declined sharply. While this may be partly attributed to a slowdown in the Chinese economy, uncertainties about China's investment climate and the future expansion of export controls may be having a larger effect on investment in China than trade.
In Japan, there are strong calls to reduce economic dependence on China to the largest extent possible. However, unless Japanese companies are prepared to completely abandon business in the Chinese market or collaboration with Chinese companies, there will be a need to distinguish between highly regulated and less regulated parts of the economy.
Based on the dialogue with the U.S. government, the Japanese government should define such boundaries as clearly as possible and create an environment in which Japanese companies are not excessively constrained. Japan should also cooperate with the European Union (EU) and others to try to ensure that economic security-related policies fall within the framework of existing trade rules.
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What is the situation in third countries? Let's take a look at the Association of Southeast Asian Nations (ASEAN), which is deeply involved in international production networks centered on the machinery industry.
ASEAN countries have taken a neutral stance, not aligning with either the U.S. or China. Economically, they have maintained close ties with both camps and managed their positions effectively. During U.S.-China tariff war that began in 2018, Viet Nam and other ASEAN countries took advantage of the "positive trade diversion effect" to attract investment and increase exports to the United States. During the COVID-19 pandemic which began in 2020, ASEAN nations initially had success in preventing the spread of the virus and withstood the crisis with only a minor economic downturn.
While third countries’ exports to China have partially been subjected to the stronger U.S. export controls on high-tech goods, it seems that there was no impediment to exports from ASEAN. The region has achieved a solid annual economic growth rate of 4-5%.
The figure shows a breakdown of ASEAN countries' exports and imports by partner country. In 2022, China (including Hong Kong and Macau) accounted for 21% of exports from the entire ASEAN region and 24% of imports into the region. Japan and other Western economies (the United States, the EU, South Korea, and Taiwan) captured 37% of ASEAN exports and 35% of imports into ASEAN.
Source: International Monetary Fund (IMF) “Direction of Trade Statistics (DOTS)”
China’s share of imports into the four least developed ASEAN countries (Cambodia, Lao PDR, Myanmar, and Viet Nam) is particularly large. In Viet Nam, Indonesia, Thailand, and Malaysia, China's share of imports is larger than that of exports. This is because China is strengthening its position as a supply base for parts and intermediate goods for these ASEAN countries. While trade shares alone do not provide an accurate representation of the depth of economic relationships, it is clear that ASEAN countries have deep economic ties with both China and the West.
One remarkable change from 2014 to 2022 is the case of Indonesia, where the share of exports to China from Indonesia surged from 12% to 22% and that of imports into that country from 18% to 28%. ASEAN is one of the most reliable regions in the world for both Western and Chinese companies in terms of business expansion. ASEAN countries are concerned about China's rapidly expanding presence and often express an interest in deepening economic relations with the West to strike a balance between their relations with China and those with the West.
A rules-based international trade order is extremely important for ASEAN. However, the order has weakened considerably. The Appellate Body, the second tier of the trade dispute settlement system for the World Trade Organization (WTO), has ceased to function due to the United States blocking the appointment of Appellate Body members since the Trump administration. With this situation, even if the Dispute Settlement Body issues a ruling as the first tier of the WTO system, currently, an appeal against the first ruling can be filed with the dysfunctional Appellate Body, essentially halting the WTO dispute settlement process without further progress.
As of the end of 2023, there are 24 cases of such appeals halting the dispute settlement process (known as “appeals into the void”), including those on important issues such as an Indonesian ban on nickel exports. Also concerning is the fact that since 2020, fewer than 10 trade disputes have been brought to the WTO annually.
Although some WTO rules do not stand up to serious economic scrutiny, the existence of WTO rules helps to maintain a certain level of international trade order. Middle powers and ASEAN must deepen cooperation now to support the WTO during this crisis.
In March 2023, Japan offered to join the Multi-Party Interim Appeal Arbitration Arrangement (MPIA) which was launched at the initiative of the EU to temporarily replace the Appellate Body, however currently Singapore is the only ASEAN nation participating in the MPIA (Note 1). It should call on other ASEAN countries to take part in the arrangement.
ASEAN countries have a strong desire to gain developed country status and have shown a willingness to accept international rules to achieve this goal. Indonesia is aiming to join the Organization for Economic Cooperation and Development (OECD) as a sign of its developed country status. In February 2024, negotiations for Indonesia’s accession to the OECD were decided, and in June, a similar decision was made for Thailand.
Indonesia is also strongly interested in joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and Japan should make efforts to support Indonesia’s participation in the CPTPP.
Despite growing geopolitical tensions, vigorous economic activity continues around the world and Japanese companies should maintain their international economic engagement. Japan and other middle powers would also benefit significantly by cooperating with Global South countries to support the rules-based international trade order.
>> Original text in Japanese
* Translated by RIETI.
July 18, 2024 Nihon Keizai Shimbun
