The Trump era was tumultuous in many ways, not least for the US trade policy during 2017-19. In particular, the prevailing trade spats between the US and China broke out into a full-scale trade war during 2018.
The US raised import tariffs from an average of 3.8% in mid-2018, to a peak average of 21% in mid-2019. China retaliated by raising average tariffs on US imports from 7.2% to almost 22% during the same period. These tariffs have largely remained in place on both sides. Besides tariff actions, an additional 200 Chinese companies such as Huawei were slapped with US export controls.
The Biden administration, which took office in January 2021, not only retained the high tariffs, but imposed further trade restrictions against China by adding to the “Chinese entities list” with whom the US persons and firms cannot have business dealings without a license. It also prohibited US investments in 59 Chinese entities that are involved in “defence and surveillance technology.”
The trade war provides a “natural experiment” (in this case, a dramatic change in economic policy targeted at one country) to gauge the readiness of next-in-line countries to become global manufacturing powerhouses. The trade war was expected to divert trade from China to other exporting countries, especially those that competed strongly with China for the US market.
Countries competing with China include some of its East Asian neighbours like Vietnam and Indonesia, South Asian countries like Bangladesh and India, and some Latin American countries, especially Mexico. What transpired? How did emerging market exports to the US market fare during this trade war? How ready are other countries, especially the leading exporters of South Asia, to replace China in the long-term?
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Impact on India and Bangladesh
In South Asia, the two biggest exporting nations are India and Bangladesh. India is among the top ten exporters to the US, and aspires to triple its global exports of goods to $1 trillion by 2028. Given its size and stage of development, vast endowment of labour (unskilled and skilled), diversified industrial base and a large and expanding domestic market to hone product innovations, India is sometimes seen as the natural country to replace China as the world’s factory.
Bangladesh, endowed with low-cost labour and enjoying extraordinary success in apparel exports, has significant unrealized potential to emulate Vietnam’s success in diversifying away from apparel exports and thereby sustain its export growth. Pakistan, for long the second biggest exporter in South Asia, has seen its exports stagnate over the last decade; Bangladesh became a bigger exporter in 2014, and the gap between the two countries has only grown larger since then.
To document the impact of the trade war, we compare the data for imports of manufactured goods in 2017, before the trade war started, to 2019, the year in which the full impact of the war was felt. We do not include 2020 data, since this is complicated by the impact of the pandemic. Moreover, there was a truce of sorts in February 2021, when the US and China brokered a phase one trade deal, even though the tariffs on imports from China were “agreed” at six times higher than before the trade war.
Between 2017 and 2019, US imports of manufactures from China fell by a hefty $53 billion, but this was dwarfed by a $209 billion surge in imports from other countries. Clearly, not all the increase can be attributed to the diversion in imports from China. Other factors that need to be taken into account include pre-existing trends in competitiveness of different countries, rise in overall US import demand and any other country and sector-specific demand-supply shocks that could confound the calculations of trade diversion away from China. This can be done via simple counter-factual analysis, which we have done in a forthcoming paper at the Centre for Policy Research.
Trade diversion is estimated at six-digit product levels, and focuses on products where imports from China fell at least by $50 million. For each product the total trade diversion is equal to the decline in imports from China; it is allocated across countries in proportion to the actual increase in their export of the product between 2017 and 2019. The benefits of trade diversion are reaped only when a country is a significant exporter of the products seriously affected by the trade war. For example, Mexico, the top gainer in overall exports, exported $39 billion more between 2019 and 2019, but its trade diversion gains were only $6.6 billion, the third highest among all countries.
Our results show that, contrary to expectations, India’s gains from trade diversion in manufactures over 2017-19 were only $1.2 billion, while Bangladesh’s were only $390 million. Pakistan’s gains were as low as $80 million. Vietnam, on the other hand, gained a much larger $8.5 billion. Vietnam’s market share in the US had already been rising prior to 2018, and accelerated further after the trade war.
However, India has more diversified exports than Vietnam’s, and a much greater overlap than Vietnam with the Chinese export basket to the US – hence, the prior was that India should have gained more than Vietnam from trade diversion in manufactures. Finally, apart from Vietnam, Cambodia also outperformed both Bangladesh and Pakistan.
Overall, South Asian countries did not match the trade diversion gains of their East Asian counterparts. The evidence is clear. Unless a country was already a strong competitor in 2017 in critical products which witnessed the sharpest decline in imports from China, there was less likelihood that it could scale up its supply to take sufficient advantage.
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The path ahead
Even prior to the trade wars, China was gradually giving some market space to other countries, especially in labour-intensive products. This trend is being accelerated by the US-China trade war and the pandemic, as importing countries try to diversify their sourcing away from over-reliance on China. There may also be opportunities in higher technology goods, as the US has stated its intention to diversify the sources of such goods. But the contest to prise away market shares from China will be tough, with many countries in the fray – including East Asian countries such as Vietnam and Cambodia, and Latin American countries such as Mexico. In higher technology products, while countries such as South Korea and Taiwan will be formidable competitors, they could also be partners in technological upgrading and global value chains.
The natural experiment in the form of the US-China trade war enabled us to enhance our understanding of competitive capabilities of some of the leading countries exporting to the US market. The results were not flattering to India and Bangladesh, the biggest South Asian exporters.
Moving forward, South Asian countries will need to do some dispassionate analysis of their trade and investment regimes. A common affliction in South Asia is high and rising protection, which hurts its capacity to become a core part of global value chains, even more so in a world in which reciprocity is getting to be the dominant mantra.
Apart from addressing its growing protection, India would benefit from a strategic review of its industrial promotion policies that is more consistent with a forward-looking trade agenda. In the case of Bangladesh, its impending graduation out of its “least developed country” status poses a formidable challenge to the sustainability of its export boom, and it needs an urgent and serious review of its trade and investment policies, including a roadmap for tariff reform.
Finally, for South Asia as a whole, one unexploited development opportunity lies in deeper regional economic integration – in the context of the current discussion, for example, developing regional value chains and intra-regional foreign direct investment as a springboard for export growth, within South Asia and beyond.
Sanjay Kathuria is senior visiting fellow at the Centre for Policy Research, India; fellow at the Wilson Center, Washington, D.C; non-resident senior fellow at the Institute of South Asian Studies, Singapore, and visiting professor at Georgetown University and Ashoka University. He tweets @Sanjay_1818.
T.G. Srinivasan is senior visiting fellow at the Centre for Policy Research, India.