One of the most striking features of international trade and investment over the last 20 years has been China’s continued economic rise and integration in the global economy, which has gone hand in hand with it becoming one of the world’s leading trading nations. Before 2001 (the year China joined the WTO), 80 per cent of countries had a larger volume of merchandise trade with the US than with China. By 2018, only 30 per cent of countries traded more with the US than they did with China. China overtook the US as the EU’s most important trading partner for goods in 2020, although when services are taken into account the US remains the EU’s largest trading partner by far.
A debate that figures prominently at the moment concerns whether the world economy is fracturing into two major economic blocs: one made up of the advanced democracies (i.e. the US-dominated G7 plus other like-minded democracies); and the other being a China-aligned bloc that includes Russia. There are signs that geopolitical considerations and national security concerns are playing a greater role in economic policy decisions, for example in the form of export controls and investment screening. But a division of the world into two economic blocs is not as straightforward as commonly suggested. Several developments call into question how solid such blocs would be. For example, despite Brussels’ broad political alignment with the US, the EU’s trade with China has continued to rise. And (especially with ties with Russia now cut) Germany is determined to keep trading with China, even though it has adopted a tougher and less commercially-driven approach to relations with Beijing in recent years.
A division of the world into two economic blocs is not as straightforward as commonly suggested.
Furthermore, there is no strong evidence of decoupling in aggregate trade and investment data. According to survey findings published by the American Chamber of Commerce in Shanghai in October 2022, just 17 per cent of firms said they were considering moving operations or footprint out of China in the next one to three years. While this is up from 10 per cent in 2021, the majority of businesses surveyed intend keeping their footprint and 30 per cent of companies are increasing investment. The principal reasons given for reducing investment in China in the short term were the country’s (then) zero-COVID policy and related shutdowns as well as travel restrictions. The primary reason cited for increasing investment is the growth potential of the Chinese market. But amid ongoing tensions in US–China relations, and broader concerns over China’s use of coercive economic tactics (as seen against countries such as Australia and Lithuania),the overall long-term business outlook is very challenging.
The G7 will likely put greater emphasis on efforts to strengthen supply-chain resilience and reduce economic dependence on China. But full decoupling from China is unlikely.
Many countries – particularly those in the Asia-Pacific – do not want to ‘choose sides’ between a US-dominated G7 bloc and a China-aligned bloc. Given the sheer size of the Chinese economy, and existing economic links, many Asia-Pacific countries need and want to trade with China despite concerns around Beijing’s military and economic coercion tactics.
What all of this means for the future of global trade is less than clear. In theory, reduced trade between the G7- and China-aligned blocs could make way for increased trade within these blocs. But given the current lack of appetite (especially in the US) to strike new free-trade agreements (FTAs), it is unlikely that members of the G7-centred bloc will aim for an ambitious and deep integration of their markets in the near future. Instead, the G7-aligned bloc will likely focus on joint concerns regarding China’s non-market economy policies and practices (such as subsidies, operation of state-owned enterprises, and forced technology transfer) as well as human rights issues such as forced labour in supply chains.
Moreover, the G7 will likely put greater emphasis on efforts to strengthen supply-chain resilience and reduce economic dependence on China. The EU’s embrace of ‘open strategic autonomy’ resembles the ‘friendshoring’ aspirations of the US. Given Japan’s emphasis on economic security, this will likely be an area for cooperation under the Japanese presidency of the G7 in 2023. The G7 members will almost certainly focus on greater diversification of critical supply chains, underpinned by open and predictable trade rules. Complete decoupling and reshoring from China would not produce the desired results in terms of increased supply-chain resilience. Instead, the concentration of production at home would replace international vulnerabilities with more local ones, including those linked to natural disasters or outbreaks of diseases.
In short, full decoupling from China is unlikely. A more likely scenario involves different categories of trade and investment with varying degrees of (dis-)integration. The first category concerns strategic sectors that are vital to national security (such as arms and advanced technologies), for which trade and investment will continue to be off limits. The second involves sensitive sectors (such as critical raw materials and technologies, as well as pharmaceuticals), for which supply chains will increasingly be shifted away from China. For most other economic sectors, trade and investment ties will likely continue to operate as before – i.e. without many restrictions and in accordance with existing WTO law and other bilateral/regional agreements in place. But even trade and investment flows concerning non-critical or non-sensitive sectors (such as furniture, appliances, electronics and toys) are likely to come under increased scrutiny in light of concerns about China’s human rights violations (for example, US legislation banning cotton from China’s Xinjiang region) and/or concerns that Beijing could exploit economic links through coercive tactics (such as punitive trade measures against Australian meat, wine and timber). In other words, supply-chain diversification will likely be seen as beneficial for all sectors.
The transatlantic partners will need to continue to manage frictions in their own bilateral relationship and differences over how best to deal with China.
Meanwhile, the transatlantic partners will need to continue to manage frictions in their own bilateral relationship and differences over how best to deal with China. For example, the EU and the US have the ambition to conclude negotiations on global steel and aluminium arrangements by the end of October 2023. This is part of an agreement, reached in October 2021, to replace the US Section 232 tariffs that were introduced by the Trump administration in the name of national security. The aim for global arrangements also reflects the desire of both the US and the EU to confront the threats of climate change (by addressing the high carbon intensity of steel and aluminium manufacturing) and tackle global market distortions (which imply China’s overcapacity in the sectors, without naming the country directly).
One important question for the US and the EU, as well as like-minded partners, remains how best to engage with China in the WTO. Considering the difference in economic systems between market economies and China’s model, as well as clear geopolitical fault lines, the future of the world trade system is not about convergence but coexistence.