The US-China decoupling is slow going but still offers India opportunities

Game theory tells us that players in any game are strategic, be they individuals, firms or nations. They adjust their strategy based on what the other player is expected to do, a bit like a game of chess. It is useful to keep that core insight in mind while looking at global trade patterns in the age of rising geopolitical tensions. China will adjust its strategy in response to US actions. Chinese goods could be getting into the US through new channels. Not everything has to be shipped out of Chinese ports directly to the US. In a different context, think about how Russia is working its way around US-led sanctions right now.

A new paper by four World Bank economists throws new light on some of the new realities of global trade (‘Is US Trade Policy Reshaping Global Supply Chains’, by Caroline Freund, Aaditya Mattoo, Alen Mulabdic, Michele Ruta). Based on a study of 17,891 products and 157 countries, they show that higher US tariffs on Chinese imports have begun to bite. China has lost substantial market share in the items that have been targeted by the US. However, this has not led to an overall fall in US imports of these goods. In other words, there is little evidence of re-shoring. The US is not making these items at home (at least yet). It is merely sourcing them from other countries.

The trade war with China has stimulated imports from other developing countries such as Vietnam or Mexico, though other research shows that US consumers are paying higher prices for most of the Chinese imports that the US is now trying to wean itself off.

There are two interesting insights in the paper by the four World Bank economists. First, the benefits in each line of trade have been captured by one dominant beneficiary, rather being spread widely across countries—a sign of a China Plus One strategy, rather than China Plus N. This is a lesson that Indian companies, policymakers and strategists need to keep in mind.

Second, many of the countries that are reporting an increase in exports to the US are also reporting an almost matching increase in imports from China. India is one of the few countries that has reported higher exports to the US between 2018 and 2022 without a similar increase in imports from China. The data suggest that the US is still plugged into Chinese supply chains via its new dominant trade partners. Trade has tight links with foreign direct investment, and there is other evidence to show that Chinese investment is growing in many countries that are increasing their exports to the US.

The endgame of this strategic tussle is not yet clear, but there are a few simple macroeconomic truths that also need attention. The Chinese trade surplus is way down from its peak, but it is still a fact. Many of the other large global economies have also been running trade surpluses. The US, Britain and India are among the few major economies that have trade deficits, and the latter two are not large enough to absorb the Chinese trade surplus. That leaves the US.

The global balances right now do not suggest that the two largest economies in the world can be decoupled painlessly. There is also the issue of financial flows. China needs to invest its surplus earnings in other economies. As Brad Setser of US think-tank Council on Foreign Relations has recently pointed out: “China’s goods surplus could not exist with a deficit of comparable size elsewhere, and that deficit is in the US." He adds that the global economy continues to be integrated while global politics is far more fractured.

The upshot: Global supply chains are being rewired because of the geopolitical tussle between the US and China. What is emerging appears to be a new form of globalization rather than full-blown de-globalization. India has a good chance to take advantage of the new supply chain map, especially given its growing internal market as well as its position as a counterweight to China.

India is an early gainer. The four World Bank economists show that the Chinese share of US imports has fallen by 5.3 percentage points (pp) between 2018 and 2022. The six biggest beneficiaries are Vietnam (1.9 pp), Taiwan (1 pp), Canada (0.75 pp), Mexico (0.64 pp), India (0.57 pp) and South Korea (0.53 pp).

However, India needs a more open trade policy to further benefit from such a reshuffle of trade partners by the US. For starters, New Delhi’s decision to stay out of major trading blocs as well as delays in signing bilateral trade deals with large economies can prove to be a major hurdle.