China, Tariffs, and Geopolitical Fragmentation

For more than a decade, the neoliberal global trading system has been slowly disintegrating under the pressure of a process best described as "geopolitical fragmentation," in which patterns of trade determined by "dynamic comparative advantage," which have brought unparalleled poverty reduction and technological breakthroughs, are being undermined by both an accelerating U.S./China contest for hegemony and, more recently, by a misguided U.S. move toward autarky behind high tariff walls. The neoliberal era started with the liberalization of global finance in the 1970s and 1980s and was deepened by the entry of the post-Soviet states, China, and India into trade and capital flow networks. For a brief moment, the term "Chimerica" flourished as a signal of a mutual search for economic gains.

Alas, it was not fated to endure. Xi Jinping took China into a period of enhanced state control of the economy and a push for self-reliance and strategic advantage. Russia's invasion of Ukraine shattered European peace and Russia moved into a position of subordination and dependence on China. Europe found itself increasingly squeezed into painful economic tradeoffs between the U.S. and China. The U.S. response to the China challenge initially focused on export controls on semiconductor chips and other advanced technologies central to the growing contest to develop AI. Now, Trump has taken fragmentation to a new level, with a tariff push, directed most strongly against China, that spills over to harm every country in the world.

1) The first stages of a changing Chinese relationship with the rest of the world date from the trade war of 2018, which accelerated several pre-existing domestic trends: A decline in China's reliance on imports, a focus on the auto sector, and, most recently, a decline in inward foreign direct investment (FDI). The process is described in papers by economists at the Federal Reserve, as summarized in three posts at the VoxEU website. Interestingly, while China and the U.S. have been decoupling, China's trade with the rest of the world remained at high levels, i.e., "fragmentation" was partial.

Since 2018, China has pursued its clear, stated objective of self-reliance, and seems to have made progress in several key sectors. As geopolitical tensions rise, domestic and foreign restrictions on cross-border trade and investment have also intensified, potentially increasing China’s urgency in pursuing its self-reliance goals. China’s declining reliance on imports, particularly in critical sectors like high tech and electrical products, demonstrates the progress that the country has made in just a few years.

At the same time, production linkages between China and the western bloc remain high. According to the OECD, China’s contribution to foreign value added in world domestic final demand has grown significantly throughout the 2010s, reaching 39% in 2020. A fragmentation of global production processes is not in sight, and China’s pursuit of self-reliance is likely to continue having global ramifications.

https://cepr.org/voxeu/columns/assessing-chinas-efforts-increase-self-reliance

A second post emphasized how China is moving up the global value chain as the sectoral composition of its exports changes. It is no longer exporting low-cost goods, production of which has moved to many other countries, including Bangladesh, Vietnam, Mexico, and several countries of South America. Instead it is producing more advanced goods similar to those produced in countries from which it used to buy. It is becoming more of a "rival" than a "partner."

These changes have far-reaching implications. As China’s exports become more similar to those of advanced economies, competition intensifies in third markets. Traditional exporters risk losing market share in industries where China is gaining strength, such as automotive and high-tech goods. This shift could exacerbate trade tensions and lead to protective measures by advanced economies seeking to safeguard domestic industries.

https://cepr.org/voxeu/columns/partner-rival-sectoral-evolution-chinas-trade

Another contribution from Fed researchers takes the story one step further by showing how China's shifting priorities have caused a broader geopolitical realignment that is creating new risks for all participants in the global trading system. The "economic" logic fueling global trade, with its emphasis on "win-win" situations of mutual gains from trade is being challenged by a logic much more amenable to analysis in the framework of the Realist theory of international relations, in which national security considerations deriving from the rivalry between an existing hegemon and a rising challenger more and more determine patterns of trade and capital =movements.

Global trade is entering a new era shaped by geopolitical alignment and China’s evolving role. China has become a direct competitor in high-tech sectors while dominating critical input markets, creating dual risks for advanced economies in the form of supply dependence and industrial displacement. These risks increasingly reinforce one another, challenging traditional trade logic. This column documents these shifts using new data on trade flows, technological overlap, and input concentration – highlighting the strategic vulnerabilities facing advanced economies, particularly in Europe, as trade becomes more politicised.

https://cepr.org/voxeu/columns/risks-new-international-trade-landscape

Generalizing the above empirical changes within an even broader analytical framework, four European economists argue that globalization proceeds most rapidly when there is a single global hegemon.

There is a growing concern that tensions between China and the US may lead to an unravelling of globalisation. This column discusses how rivalry between great powers can be detrimental to global trade and welfare and introduces the theory of hegemonic globalisation. Analysis of bilateral and multilateral treaties since 1800 shows that a dominant global power (a hegemon) promotes international policy alignment and global trade integration. Transitioning from a unipolar to a multipolar world can lead to fragmentation, which is especially costly for the incumbent hegemon and its allies.

If the U.S. declines as a hegemon and China does not succeed in developing quickly enough to replace it -- China is facing serious demographic headwinds and its state-dominated system may not be flexible enough to escape the "middle-income trap -- then the world economy might enter a period without a hegemon, which this research claims will lead to further deglobalization.

https://cepr.org/voxeu/columns/why-globalisation-needs-leader-hegemons-alignment-and-trade

2) China is not the only factor threatening the

neoliberal international order. Mistaken notions in the U.S. about this system have led to a reaction against it, with several consequences, one of which is support for a high level of tariff protection. One of the pillars of support for tariffs is the idea that the international system "forces" trade deficits on the U.S., since the dominance of the dollar requires foreign central banks to send capital into the U.S. to accumulate the reserves they need. Michael Bordo and Robert McCauley show that, while that may not have been a bad description until 2008, it has not been valid ever since.

https://cepr.org/voxeu/columns/miran-were-not-triffin-land-anymore

And a Deputy-Governor of the Banque de France argues that the system is in no way "unfair" to either the U.S. or its trading partners. If there have been problems at times created for selected regions and working populations in the U.S., they are the result of domestic forces, such as rapid technological change in manufacturing and fiscal deficits causing a low saving rate.

https://www.banque-france.fr/en/governors-interventions/international-monetary-system-unfair