China's ascension leaves rest of Asia behind

China’s vertical integration leads to less dependence on Asian regional value chain

GLOBAL value chains have been declining since the global financial crisis, and a recent report by Natixis: China’s vertical integration leads to less dependence on Asian regional value chain, released on October 21, delves in to whether the decline of China’s global value chain participation is driven by the shortening of the supply chain or rising regional integration.

China is becoming less integrated with the world as it increasingly relies on fewer foreign inputs for production of exports. However, the world is becoming more integrated with China as other countries increasingly import more intermediate goods from China for their exports.

Such asymmetric evolution in China’s participation in the global value chain, with China less dependent on the rest of the world but the world more dependent on China for its exports, may be behind some of the actions that the US has taken against China on the trade front.

For the report the sub-regions were grouped by Natixis as follows: North Asia - South Korea, Taiwan and Japan; Southeast Asia - Singapore, Malaysia, the Philippines, Vietnam, Indonesia and Thailand; and South Asia - Nepal, Pakistan, India, Sri Lanka and Bangladesh.

The report notes that with the clear exception of Pakistan, and to a lesser extent Taiwan and Nepal, all Asian countries seem to have reduced their participation in the global value chain.

The same applies to the Asian value chain - although a few countries have increased their participation such as Singapore and Nepal, many more have reduced it.

For Thailand, Indonesia and Malaysia, their participation in the Asian value chain has simply stagnated.

As such, trade deglobalization for China, defined by a declining participation in the global value chain, cannot be explained by increasing regionalization.

“In 2001, before China joined the World Trade Organization, Asean’s share in global manufacturing was close to China’s, and North Asia’s was roughly two times larger than China’s manufacturing export. Today, China alone has a larger share of global manufacturing than the rest of Asia combined,” says Alicia Garcia Herrero, chief economist, Asia Pacific, Natixis Asia Research.

Clearly, China’s emergence in manufacturing capability, with less reliance on foreign inputs for exports and higher increase of domestic exports of intermediates for other countries’ export, has impacted the region.

What is also clear from the report is that China’s rise of domestic value-added exports is not due to its integration with Asia but rather with the rest of world. Asia has the sharpest decline of regional value chain participation, which means that integration within the region has declined.

Remove China from Asia to have Asia ex China, then the degree of Asia ex China value chain participation increased. This also reflects a pronounced decline of China’s integration with the region.

It is clear that the rise of integration of the Asia ex China region is due to the rise of value chain participation within Asean, with a small increase in regional value chain participation, and to a lesser extent North Asia.

“South Asia as a sub-region is declining in its value chain participation with each other. In other words, the decline of regional integration is driven by China and to a lesser extent South Asia. Meanwhile, both Asean and North Asia are more sub-regionally integrated,” says Trinh Nguyen, economist, Emerging Asia, Natixis Asia Research. China’s declining integration with Asia is primarily driven by the reduction of foreign value-added exports while China’s domestic value-added exports within the Asian region increased. The trend is the same with China’s participation in the global value chain.

While China is exporting slightly more intermediates to regional counterparts as reflected in a 0.5% rise of domestic value-added exports, the decrease of 1.2% in China’s reliance on inputs from the rest of the region outweighs the increase of domestic value-added exports, which leaves the net integration down 0.7%.

As such, the region is clearly less integrated with China - all major economies in Asia show a decline in value chain integration with China, except Singapore, Vietnam and Bangladesh.

However, while Taiwan is increasingly participating in the global, regional and sub-regional supply chain, it is becoming less integrated in the supply chain of China. This may be partly explained by the reshoring of production back to Taiwan from China amid escalating US-China trade tensions.

“The decline of regional counterparts in participation of China’s supply chain is consistent with China’s increasingly high vertical integration of China’s supply chain by reducing its reliance of foreign inputs for exports,” says Herrero.

“Nonetheless, while China also sharply increased its exports of intermediate goods to the rest of the world for other countries’ production of exports, the decrease in integration with China shows that most of the regional counterparts are not participating more with China’s value chain,” she adds.

In short, the report finds that the trade deglobalization trend of Asian countries cannot be explained by the rise of regionalization. In fact, for some countries such as China, their reduced participation in the Asian regional value chain is much faster than elsewhere.

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