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China to mitigate effects of global value chain adjustment

PENG ZHIWEI | 2021-01-27 | Hits:
(Chinese Social Sciences Today)

Employees of Guodian United Power Corporation check the intelligent production line at a factory in Lianyungang, Jiangsu Province, on July 2, 2020.  Photo: CFP

Since the reform and opening up, China has reaped the rewards of foreign investment and an abundant domestic labor force to integrate itself into the world production system and labor division through processing trade. As China grows into the center of the Asian value chain, its share of global trade has risen from about 2% in the 1990s to more than 10% today.

In this process, China's participation in the global value chain (GVC) division has successively displayed major structural changes. The first change occurred in 1999, when the proportion of processing trade began to decline, while the proportion of general trade increased. Then, Chinese enterprises' contributions to imports and exports, especially in private sectors, continued to rise. Another change occurred after 2012, when domestic intermediate goods began replacing imports, making the proportion of intermediate imports from total imports drop. The final structural change occurred over time, and recently became visible. Since 1995, the share of real trade gains collected from China by foreign countries through the GVC division, in terms of China's real output, has witnessed an inverted V-shaped change. In this "V," 2006 is the divide, with foreign gains rising first and then falling, whereas China's gains from the rest of the world—by participating in the GVC division—have maintained an upward momentum. 
In the 21st century, the development of the GVC has entered a new stage. This article aims to systematically summarize the trends and motivations of the GVC’s adjustments, and propose countermeasures China can take against the backdrop of worrisome global prospects.
Global value chain adjustment
Since the 1990s, a "borderless production" system has taken shape, with an increase in the proportion of intermediate goods trade, which promotes the rapid expansion of global trade. Three regional value chains form in Asia, Europe, and North America, with China, Germany, and the United States as the center, respectively. Since the outbreak of the global economic crisis in 2008, economic globalization has stepped into deep adjustment, and the evolution of GVC has shown the following new characteristics.
To start with, transnational division of labor is more concentrated toward specific regional production networks, thus reducing cross-border flows of intermediate goods and the scale of transnational direct investment. From 2012 onward, global trade ended a 20-year period of high growth that was twice as fast as GDP growth, and the growth rate of trade in goods declined faster than that of trade in services. From 2016 to 2018, global foreign direct investment (FDI) volume declined for three consecutive years. In 2019, global FDI rebounded, but it was still below the past decade's average.
Now, a rewriting of international economic and trade rules is underway. Against the background of economic recession, various forms of protectionism are on the rise, threatening existing international economic and trade rules and shoring up uncertainties in transnational trade and investment. When multilateral trade negotiations hit rock bottom, many countries accelerated negotiations on bilateral or regional free trade agreements in an attempt to create a favorable external environment suitable to their comparative advantages. 
It is worth noting that the central topic of negotiations has shifted from market access-centered opening up policies to rule and regulation integration-centered ones, triggering a new round of competition in reshaping global economic and trade rules.
In response, developed countries have taken measures to attract manufacturing back, and strengthened their intervention in industrial transfers. At present, the world is undergoing the fourth industrial transfer since the 1950s, and Southeast Asia has become the primary destination for this new round of industrial transfer.
Opportunities amid challenges
Our studies show that real gains of a country’s participation in the international division of labor depend on the quantity penetration ratio of intermediate goods it provides, and the degree to which these goods are embedded into production networks in the destined countries. The latter is associated with technical complexity, diversities of intermediates, and the degree of forward and backward linkages of these intermediates in local production networks. 
Simulation results reveal that the quantity penetration ratio of intermediates China produced in domestic and foreign production networks declines after 2004, due to the rise of production factor costs, while the increase of intermediate goods’ embeddedness in the production networks contributes primarily to the rise of China’s trade gains at home and abroad. China’s increasingly integrated domestic supply chain network and growing technological complexity of intermediates have worked together to accomplish this. 
This conclusion echoes the research of other scholars: In recent years, China’s domestic intermediate production network has matured, shifting the sourcing of intermediate inputs from foreign to domestic suppliers, which then proves that the overall technology gap between China and developed countries is narrowing.
The COVID-19 outbreak has made many economies more aware of the risks that stem from high dependence on the GVC division. This also prompts some countries to step up policy interventions to draw manufacturing back to their home country or to encourage enterprises with investment in China to relocate, creating shocks and uncertainties to regular global economic and trade activities, including GVC operation.
However, many countries still have the motivation for mutual economic and trade cooperation. Take China and the United States as an example. Both empirical studies and investigations confirm that since 2018, when the United States raised tariffs on Chinese imports, US importers and consumers have borne a considerable part of the cost, which in turn lowered the welfare of US consumers.  
It is almost impossible for the United States to find stable and reliable import sources of many necessaries outside China, both in the current stage and in the coming future. In the context of highly developed globalized production, no country can precisely block trade with specific countries through tariffs or other means, without hurting its own enterprises. 
Finally, the size of China's domestic consumer market has been close to that of the United States, and its per capita GDP has exceeded $10,000. It is quite unwise for any enterprise with a global view to forfeit the Chinese market with such huge size and growth potential.
The policy measures implemented by some developed countries may temporarily accelerate certain enterprises shifting their production bases from China to other regions like Southeast Asia. However, since China's economy has entered a new development stage, its position in GVC is moving up, and its comparative advantage is in transformation. Such a shift is to a large extent the normal adjustment of multinationals’ production layouts.
Moreover, it is important to note that most of the undergoing industrial shifts usually means the enterprises are simply moving assembly lines rather than the full industrial networks to other countries or regions, since China possesses huge advantages in integrity of domestic supply chains and economy of scale generated by such an integrity.
Proactive measures
Economic globalization will continue despite the current adjustments. Since the Chinese economy is now undergoing structural transformation, in which the principal growth momentum is shifting from traditional drivers to new ones, we must fully evaluate the shocks possibly triggered by the COVID-19 pandemic and external environments deterioration on China’s participation in GVC restructuring. In this regard, China should take the initiative to come up with countermeasures.
Though the overall technological gap between China and developed countries is narrowing, the absolute gap is still significant. China has gained improvement in its GVC position, but such improvement only holds in comparison to countries and regions other than the United States, it is not a direct challenge to the United States’ leading role in GVC. China's move from the low end of GVC to the medium-high end will be a long-term and gradual process.
In this process, the competition between China and major developed countries in core technology research and development, brand promotion, and other aspects will inevitably intensify, which means other countries will be wary of China's development and frictions will emerge.
In this light, China should strengthen basic scientific research and human capital accumulation, promote independent technological innovation, and improve the innovation environment through reform to enhance China's overall technological competitiveness. 
In line with the trend of GVC's contraction toward certain hub regions, we should take concrete steps, including reducing taxes and fees to lighten the burden on firms and help them tide over difficulties, so as to consolidate China's role in the Asian regional production networks. Meanwhile, China should embrace the undergoing digital transformation in global economy, and take active part in the GVC reconstruction.
In the long run, we should continue to push forward the supply-side reform and opening up, improve the business environment to make China more adaptable to high-standard economic and trade rules and more attractive to worldwide high-level production factors, and create favorable institutional conditions for facilitating domestic supply chains and industrial upgrading.
China is devoted to deepen its reform to create a "dual circulation" development pattern. A prerequisite for smooth domestic economic circulation lies in a continuous growing domestic market, which depends principally on growth of residents' disposable income. At present, there are still 600 million people with a monthly income of less than 1,000 yuan (roughly $154.6) in China, and regional economic and development disparities are alarming. This requires China to improve its pattern of income distribution, narrow the income gap between different groups while uplifting the proportion of household income in GDP. Meanwhile, reinforcement between international and domestic circulations should not be underestimated. 
Peng Zhiwei is an associate professor from the School of Economics at Nankai University. 
Edited by MA YUHONG