Historians have been quick to point out that the mounting tensions between the US and China lack the ideological component that many believe was the defining characteristic of the first Cold War. That may be true, but so what? The possibility of a protracted conflict between the world’s two largest economies, whatever its cause, should not be taken lightly.
Nevertheless, even if there is a permanent fracture between the US and China, the $87 trillion global economy is unlikely to split into two blocs in 2020 and beyond. The reason is simple: bilateral action cannot divide a tightly linked multilateral trade system.
Today’s global economy is far more integrated than ever before. Despite a protracted slowdown of world trade growth in the aftermath of the 2008-09 global financial crisis, trade still stands at around 28% of world GDP. That’s essentially double the 13.5% average share in 1947-91, during the Cold War. The tighter that trade is woven into the fabric of global commerce, the tougher it will be to disentangle those linkages—and the lower the odds of a more pervasive and disruptive decoupling.
Moreover, the nature of today’s trade linkages makes global decoupling all the more unlikely. Traditional exports and imports of finished goods that were fully produced in individual countries have been increasingly supplanted by fragmented trade in components and parts that are both produced and assembled in a vast network of multi-country global value chains (GVCs). According to a recent study by the International Monetary Fund, the expansion of GVCs accounted for fully 73% of the explosive fivefold growth in global trade between 1993 and 2013. This diffusion of bilateral trade through multi-country supply chains would dampen the effects of a bilateral decoupling of any two economies, no matter how large.
These considerations bear critically on the potential impact of a US-China trade conflict. US politicians like to argue that America’s trade problem is a China problem. After all, they say, over the past six years (2013-18), China accounted for 47% of a gaping US merchandise trade deficit. What US politicians don’t admit (or understand) is that the overall trade deficit is an outgrowth of America’s chronically low net domestic saving rate of just 2.4% of GDP in 2018—well below the 6.3% average in the final three decades of the twentieth century.
Lacking in saving and wanting to invest and grow, the US must import surplus saving from abroad, running a chronic current-account deficit to attract foreign capital. This macroeconomic imbalance puts China in good company as just one component—albeit a very large one—of America’s multilateral deficit in merchandise trade with 102 countries (as of 2018).
Politicians, of course, would be the last to admit that they are the root of the problem, responsible as they are for the chronically large budget deficits that account for the bulk of America’s protracted shortfall of domestic saving. Unfortunately, that key feature of America’s trade position is likely to be further compounded by the US federal budget outlook, which is going from bad to worse.
The saving shortfall underpinning America’s persistent macro imbalances implies that a trade war with China needs to be seen in a different light, and that the decoupling debate should be reframed accordingly. Without addressing the US saving shortfall, raising tariffs and other barriers on China will simply divert trade away from Chinese sourcing toward America’s other trading partners. Bilateral decoupling does not mean global decoupling; it means trade diversion.
That diversion will be compounded by global value chains. Based on trade-in-value-added data from the OECD and the World Trade Organization, it turns out that around 20% of the outsize US-China merchandise trade deficit is not made in China; instead, it reflects components, parts, and other inputs from other countries that participate in China-centric supply chains. This suggests that official measures of the US-China bilateral trade deficit are exaggerated, further compromising the rationale for a Chinese solution to America’s multilateral trade deficit. The shift in the structure of trade, from traditional exchange of finished goods produced in individual countries to GVC-driven trade from multiple production platforms, reflects a fundamental realignment of an increasingly integrated pan-Asian factory. Research reported in the 2019 Global Value Chain Development Report found that the massive widening of the US-China merchandise trade deficit since China’s accession to the WTO in 2001 stems mainly from offshoring to China by other developed countries (especially Japan and Asia’s newly industrialized economies such as South Korea and Taiwan). This is very different from the China blame game of which most US politicians are enamored.
As a result, increased GVC connectivity means that tariffs imposed on shipments of finished goods from China to the US will be felt not only by Chinese exporters, but also by third-party countries that are linked to China-centric supply chains. Little wonder, then, that US tariffs are having a broad-based impact, not just on China, but also on other trade-sensitive economies in East Asia. Supply-chain linkages have spread the so-called China fix throughout the region.
None of this implies that there can’t be a decoupling of the US-China relationship – both in real terms through trade flows and in financial terms through capital flows. In fact, I stressed precisely this concern in a book I published a few years ago on the perils of Sino-American codependency. With China reliant on the US consumer as a major source of external support for its export-led growth model, and the US dependent on China as its third-largest and fastest-growing export market (as well as the largest foreign buyer of Treasury securities), both countries needed and welcomed the other’s support. But, as with human beings, conflict arises when one codependent partner changes the terms of the relationship, as China has done by shifting from export—to consumer-led growth. The current trade war is a classic example of the conflict phase of codependency.
There is a striking irony to a tariff war being instigated by the US, the world’s largest deficit saver. In light of its ominous fiscal trajectory, America will be even more prone to large trade deficits in the years ahead. Closing off the China option through a bilateral decoupling will do nothing to reduce the overall size of the US trade gap. It will merely force a rearrangement of the pieces of America’s multilateral trade deficit with its other trading partners.
That poses an even thornier political problem. The trade diversion arising from bilateral decoupling would mean that US sourcing would migrate from low-cost Chinese production platforms to a broad constellation of foreign producers. Whether that pushes trade to other Asian platforms or even “re-shores" it back to the US, as President Donald Trump has long insisted would happen, the bottom line is a likely shift to higher-cost production platforms. Ironically, that would be the functional equivalent of a tax hike on US companies, workers, and households. In the end, that underscores the potential for the most contentious decoupling of all in the years ahead—between America’s politicians and its long-beleaguered middle class.
Stephen S. Roach is a faculty member at Yale University, former chairman of Morgan Stanley Asia and is the author of Unbalanced: The Codependency of America and China.