Implications for the US policy

Following the Tiananmen Square crisis of 1989, a number of financial and technical cooperation programmes with China faced selective withholding by the US for several years. However, China still provides an opportunity for a unique experiment for the US in framing a coherent and effective policy as it has interlaced with the global economic and trading system but with large gaps in its adherence to global rules. There were three broad options for the US to respond:

  • • principle of accommodation;
  • • unrestricted strategic rivalry; and
  • • worldwide cooperation.

The third option could have been ideal in sorting out the array of conflicting interests between the US and China linked to climate change, P5+1 negotiation to roll back Iran’s nuclear weapons programme, and foreign aid, etc. The US envisaged a larger role for a constructive China while simultaneously building barriers and coalitions against pressure in China’s neighbourhood countries. On global issues, a workable approach should look for issues on which China, because of its own evolving interests, can and should play a greater role in supporting the global system. Examples include cybersecurity and cyber innovation, protecting the rights of foreign investors, central bank coordination, and protection of intellectual property rights. This intermediate policy framework may not brace the shock linked to accommodation or unrestrained rivalry, but it all needs an appropriate explanation how a radical roll in either direction would secure the complex range of US interests in its relationship with China. Moreover, China is ruled by the Communist Party, resistant to political liberalisation at home and employing nationalist rhetoric and behaviour in dealing with its neighbourhood, enhancing the chances for rivalry with the US.

Global value chains (GVCs): transition from crisis to opportunity

With the US-China trade conflict reaching to its zenith, the earlier value chain lead by China may not last. In August 2019, US announced an increase from 25 to 30% for the existing tariffs on US$250 billion of Chinese imports from October 2019 and new 15% tariffs on US$300 billion of Chinese imports from September 2019 (Jayant, 2019).1 The impact of the trade war in the medium to longer term seems irreversible as it is clear that the dispute is not transitory in nature.

Using various datasets, Yi Huang, Chen Lin, Sibo Liu, and Heiwai Tang (2019) documented that firms’ stock market responses are determined by the degree of their direct exposure to US-China trade and their indirect exposure through the GVCs. In particular, US firms that are more dependent on exports to and imports from China have lower stock returns and higher default risk, whereas the reduced import competition from China has a limited effect. As a consequence, US investment is now being diverted away from China into nations of South-East Asia. Investments in and from the US have also been equally affected following China’s reciprocal tariffs.

At this juncture, the international fragmentation of production can in fact lead to increased job creation and economic growth of the developing countries, contrary to the generalised belief that it would decline due to the trade conflict. To reap the gains from newer GVC participation, countries’ trade and investment policies need a modified and receptive approach. Nowadays, a single finished product often results from manufacturing and assembly in multiple countries, with each step in the process adding value to the end product. In order to achieve this, the manufacturing sector needs to be strong enough in terms of integration with GVCs.

Through GVCs, countries trade in products, know-how, and assemble things together. Imports of goods and services matter as much as exports to successful GVCs, which also integrate the know-how of lead firms and suppliers of key components along with stages of production in multiple offshore locations. The interfirm flow of know-how is the key characteristic of GVCs, which is a powerful driver of productivity growth, job creation, and helps increase living standards. Countries that embrace GVCs grow faster, import skills and technology, and boost employment. With GVC-driven development, countries generate growth by moving to higher-value-added tasks, and by embedding more technology and know-how in all their agriculture, manufacturing, and services production. GVCs provide countries the opportunity to leap-frog their development process. However, there are many practical difficulties that are looming large in this context. Take, for example, the case of India, which has officially declared the aim to be a $5 trillion economy by 2024, in which the manufacturing sector is anticipated to play a pivotal role (Sharma, 2019). However, the sector is decimated by its low integration in GVCs.

In their study, Soan and Miglani (2018) highlighted that India’s GVC integration, measured as the foreign value-added to India’s exports and domestic value-added to India’s intermediate good exports, remains weak. The reason for this is traced back to India’s historical inward-looking industrial policies, starting from import substitution, the licensing policy with major emphasis on state- led industrialisation. India overtly focused more on the large domestic market without considering the employment and technological benefits of being part of a higher value chain. Policies such as industrial corridors, de-licensing, and Make in India could be a step in the right direction but may not be sufficient. With some exceptions, there is a lack of leading firms in India, which are central to all aspects of a value chain, from sourcing supplies to the final product in GVCs. Firms like Tata Motors in the automobile sector and Ranbaxy in the pharmaceutical sector play key roles in transferring technology, forming supply chains, and attracting foreign investment. However, India has very few such sectoral lead firms. Skill mismatch and shortage, lack of access to finance, custom procedures, and high taxes are all the biggest constraints that prevent lead firms from developing in India. Manufacturing and trade policies thus need better coordination to focus on establishing stronger GVC linkages by attracting more global lead firms to India.

It may be noted that some of the developing countries have fully embarked on the GVC revolution, but they still face challenges in aligning GVCs with their national development strategies. The right strategies could help developing countries maximise their participation in GVCs. With the substantial repositioning of the GVCs, governments need to have a clear vision and mandate to improve coordination among players and ensure the greater involvement of the private sector. Opening borders and attracting investment can help jump-start entry in GVCs. Countries will derive the greatest benefit by maximising the absorption potential of the domestic economy and by strengthening its linkages with GVCs. Many diverse policy areas affect the success of GVCs. They include, among others, trade policy, logistics, and trade facilitation, regulation of business services, investment, business taxation, innovation, industrial development, conformity to international standards, and the wider business environment fostering entrepreneurship. Finally, countries should identify measures that will complement their GVC strategies. These include a large range of dimensions, from investment in education and vocational training to environment and urbanisation, from ICT and infrastructure building to labour market mobility.

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