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As Global Value Chains Shift, Will China Lose Its Dominance?

China’s position as a crucial link is likely to remain unaltered even under new patterns of production.

By Priyanka Pandit for
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As Global Value Chains Shift, Will China Lose Its Dominance?
Credit: Flickr/ Robert Scoble

Discussions about the end of globalization and disruptions in global value chains (GVCs) have been ongoing since the 2008 global financial crisis. The financial crisis, which originated in the subprime market of the United States, put the limitations and unequal benefits of the global capitalist system into the spotlight and exposed the vulnerability of GVCs to external shocks. The crisis also intensified the debate between pro-globalists and alter-globalists, forcing policymakers to realize the importance of regulation in the working of the modern capitalist system.

The financial storm that swept across the Atlantic to Europe and to the emerging economies in Asia revealed the pervasive nature of globalization and underscored the importance of GVCs in world trade. It confirmed that global trade, which involves multiple production stages, is more prone to economic shocks, which not only affect firms operating in final goods but also creates fluctuations in the supply and demand of intermediate goods via forward and backward linkages in GVCs.

While GVCs faced a temporary slowdown during the 2008-09 crisis, they quickly recovered from 2010 on. The post-crisis period also saw some profound changes in GVCs. Intraregional trade grew compared to interregional trade and China emerged as the crucial economy in global production, owing to its strong trade linkages with other countries. For example, the trade in regional value chains dominated by China replaced the traditional trade networks dominated by the United States, Germany, and Japan. China’s active participation in these value chains also challenges the traditional assumption that endpoints of value chains or final markets should be in the developed world.

The current economic crisis induced by the COVID-19 pandemic is, however, different. The pandemic has not only brought global economic activities to a near standstill and shaken both financial markets and investor confidence, but its continued impact also minimizes the chances of early recovery. As per IMF projections, the global economy is likely to contract by 3 percent this year, with countries facing “multi-layered shocks” owing to the breakdown of domestic health systems, shutting down of businesses and factories, sharp decline in external demand, reduced capital flows, and a collapse in commodity prices.

The measures taken by governments to contain and control the spread of the virus through unprecedented quarantines, travel bans, and social distancing have led to massive declines in consumption and production across countries. The impact has been felt in the supply networks too and GVCs currently face a shortage of raw materials, components, and major subsystems from emerging economies, and China in particular. Adding to the economic uncertainty is the fear of contagion, which continues to hold back economic recovery.

Given the current decline in consumption and production patterns across the globe, the existing supply networks are being carefully considered. The recent discussions about GVCs tend to center around two key issues. The first pertains to reducing dependence on China in GVCs, either through diversifying supply networks or by bringing production home. Although the above trends have been underway for quite some time due to the rising costs of labor, land, and logistics in China, the COVID-19 pandemic triggered some serious thinking around the phenomenon. China’s alleged cover up of the outbreak in its initial stage and attempts to obfuscate reality in its reporting to the World Health Organization (WHO) have generated a lot of global unease against Beijing, prompting countries to rethink their overdependence on China. Washington especially has been very vocal about “keeping vital supply chains at home” and the need to reduce its dependence on Beijing for generic drugs. Following the United States, Europe is also deliberating a roll back of its investments away from China, especially involving critical supplies.

The second aspect of the debate relates to the very nature of GVCs in the post-COVID period. With firms adopting technological solutions to strike a balance between social distancing norms and economic activities, many argue that this will lead to reshoring in GVCs. As part of the risk mitigation strategy, countries will bring all or part of their production activities back home or close to home. Although automation-driven reshoring is not new, the current pandemic has intensified the need given the change in customer preferences for digital technology over interactive economic activities and the spurt in inward-looking government policies.

As a result, GVCs are likely to become more regional in nature by moving closer to consumer markets and consolidated in terms of activities. The adoption of automation and digital technologies will also reduce countries’ traditional comparative advantages, which will be replaced by technological competitiveness. The technological component in GVCs is thus likely to grow stronger and the ability of different countries to embrace and adapt to technological innovations will determine their dominance in GVCs.

Although alternatives to China are being talked about in the discussion on GVCs, that is easier said than done. China is deeply integrated into the global manufacturing supply chains to the extent that any diversification of supply networks will not reduce its overall significance in GVCs. Although tech giants such as Apple, Microsoft, and Google are considering shifting a portion of their production to Southeast Asian countries in the post-pandemic period, a complete transition will be difficult. In fact, even after they shift their production to other countries, dependence on China for raw materials and equipment will remain.

The Chinese economy is also getting back to business after overcoming the coronavirus pandemic. While economies in most parts of the world are still struggling under the effects of pandemic, factories and restaurants are now operational in China. The Chinese consumer market is picking up post-COVID and online shopping has accelerated following the outbreak. Given these signs of recovery in Chinese economy, multinational firms will find it both costly and onerous to relocate production in the near term.

In recent years, China has paid lots of attention to moving up the GVC ladder. Through this, China not only avoided falling into the “middle income trap,” but also built up its technological competitiveness in GVCs. The development of AI-powered technologies in manufacturing and services has received a further boost under the “Made in China 2025” policy, and robots in Chinese manufacturing production are being rapidly deployed following the coronavirus outbreak.

As a result, China’s position in GVCs is likely to remain unaltered even under new patterns of production. What Beijing will find difficult to escape, however, is the impact of automation on its labor market. Creating sustainable jobs and employment opportunities thus will remain a vexing challenge for Chinese leadership in the post pandemic years.

Priyanka Pandit, Ph. D., is a Research Fellow at the Indian Council of World Affairs, New Delhi.