Chinese Supply Chains Prove Resilient To Global Shocks And Pressure – Analysis

By Ka Zeng*

In the past couple of decades multinational corporations have invested heavily in China to cut production costs and capitalise on the rapidly growing domestic market. In the process, they turned the country into the factory of the world and a global supply chain hub.

But the ongoing trade war between the United States and China and the COVID-19 pandemic have highlighted the vulnerability of complex global supply chains to ongoing structural changes in the global economy resulting from rising labour costs, automation, protectionism and geopolitical tensions. These developments have prompted a critical re-evaluation of existing approaches to global sourcing and manufacturing activities to increase supply chain resilience and reduce external risks.

The extensive supply chain linkages China has developed with partner countries can be seen in both its backward and forward global value chain (GVC) linkages. Backward linkages are the share of foreign value added in China’s gross exports. Forward linkages are the share of domestic value added in the gross exports of the foreign exporting country. China’s backward GVC linkages with most regions experienced a gradual decline between 2005 and 2015, while its forward GVC linkages rose during the same period. This reflects a shift in China’s trade patterns away from processing trade and towards higher value-added activities that enhance its ability to engage in industrial upgrading and climb the value chain.

It is not yet clear how the trade war and pandemic have affected China-centred supply chains, but there is preliminary evidence that the impact has not been uniform across industries. Instead, the coping strategies of firms and industries may be heavily dependent on their relative ease of adjusting to external changes.

To be sure, the pressures on supply chain adjustments, especially those generated by the Fourth Industrial Revolution, predate the trade war and the pandemic. The scale and velocity of the recent global shocks have accelerated existing trends, forcing firms to react more swiftly and efficiently to abrupt changes in the global political and economic climate in order to weather the storm.

An important factor for China’s swift recovery from the pandemic is its integration in value chains in the Asia Pacific. Compared to other regions, the Asia Pacific has retained its importance for China’s global supply chains, with China’s backward and forward GVC linkages with APEC countries reaching over 11 per cent by 2015.

China became closely integrated with ASEAN after the signing of the ASEAN–China Free Trade Area in 2001. Its aggressive pursuit of regional initiatives such as the Belt and Road Initiative may have further increased its appeal as a trade and investment partner for regional economies. Deepening regional supply chain integration may have cushioned the impact of a major global crisis, even if it impedes allocative efficiency and limits the ability of firms to adjust to shocks originating from a specific country or region.

In view of the uncertainties generated by recent developments, what can be done to ensure the smooth functioning of supply chains and increase their ability to withstand the impact of future global crises?

Companies have already started searching for strategies that will allow them to balance the priority of improving operational efficiency against the need for contingency planning. In addition to accelerating the pace of new technology adoption, many have more actively sought to cultivate alternate sourcing, manufacturing, and transportation options and to prioritise the localisation and regionalisation of supply chain relationships.

Some have resorted to reshoring, near-shoring or the China+1 strategy to diversify sourcing alternatives and mitigate the risks of supply chain disruptions. The China+1 strategy has emerged as an attractive option for multinationals based in China as it allows them to maintain their existing business ties with China while hedging against pressures to decouple from the centre of the world’s manufacturing activities.

But policy also has an important role to play in ensuring supply chain resilience. With global shocks and rising protectionist pressures in major economies threatening global supply chains, it is important that governments are sensitive to diversified firm characteristics, preferences and demands, and that they adopt complementary policies to harness market forces.

It is more critical than ever that governments refrain from pursuing protectionist or mercantilist policies and instead strengthen regional economic cooperation to provide the institutional framework necessary for expanding global supply chain networks. The negotiation of new regional trade agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP) are positive steps. Both address barriers to the movement of goods and services. The CPTPP sets high standards in areas such as intellectual property rights, investment and subsidies, which increase the transparency and predictability of doing business in member countries.

While the rise of regional trade agreements is partly a response to firms’ desire for a more stable business environment, it also risks creating an unwieldy set of international trade rules that undercut rather than facilitate the ease of doing business transnationally. Stepping up international coordination is needed to revitalise the rules-based multilateral trading system, reintegrate and harmonise disparate national and regional standards and regulations, and prevent the balkanisation of regional economies.

*About the author: Ka Zeng is Professor of Political Science and Director of Asian Studies at the University of Arkansas.

Source: This article was published by East Asia Forum. An extended version of this article appears in the most recent edition of East Asia Forum Quarterly, ‘Reinventing global trade’, Vol. 13, No 2.