Developing countries have been busy forging trade agreements — with one another Supply chains in a post-pandemic world might revolve far less around China

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Supply chains in a post-pandemic world might revolve far less around China

Are we now in a “new Cold War,” as headlines in recent months suggest? As the covid-19 pandemic rages on, relations between the United States and China have reached new lows, and President Trump threatened to “cut off the whole relationship.”

This leaves economists and policymakers considering a question that once seemed unthinkable: What would happen to global supply chains if this decoupling should occur? Which countries can step into the vacuum created by this superpower conflict?

Our recent study gives some answers. We show the building blocks are already emerging for a new international trade order — with a rapidly increasing number of poorer countries navigating this system. This has happened largely without the direction of global superpowers like the United States and China. Here is what you need to know.

The ‘China shock’ has hit poor countries

Like the United States, many poor countries have struggled with the economic and political effects of a “China shock” since the 1990s. As China’s export dominance in manufactured goods satisfied much of the demand from wealthier nations, developing countries saw a sharp decline in trade with the global north, as the figure below indicates. These countries have also been shut out of lucrative trade agreements with Europe and the United States, which concentrated primarily on deals with the larger “BRICS” (Brazil, Russia, India, China, South Africa).

Our study explores what this shock has meant for poor countries with large populations of unemployed or underemployed workers — what economists call “surplus” labor. Countries like Pakistan, Peru, Zambia, Uganda and Nigeria are rich in labor, but many young people, and particularly women, work in the precarious informal economy. What’s missing in these countries are enough industries plugged into global supply chains — which could provide far superior formal employment opportunities and better working conditions for large populations of underemployed workers.

Here’s the surprising fallout of this decline in exports

How have these “surplus labor” nations responded to the challenges posed by China’s export juggernaut? We find they have been engaging in a surprising strategy: They’ve been banding together and attempting to forge their own path toward global economic integration.

Classic economic theory doesn’t expect developing countries with similar economic profiles to strike many trade agreements among themselves. Put simply, they are rich in labor and poor in capital. But these “South-South” trade agreements have some overlooked benefits that may be relevant for rich-country firms. These agreements, most importantly, enable firms in poor countries to “learn by export” — they start small by exporting to neighbors and gradually build the ability to export to larger and more distant markets.

Not surprisingly, supply chains among poor countries have grown rapidly in recent years. This includes trade in a range of goods from apparel, leather, toys, office equipment and food products. As small countries ramp up trade with one another, they increase scale and product quality, which serve as steppingstones toward integration with even larger markets outside the region.

These networks don’t include China

We document a sharp increase in South-South trade agreements among non-BRIC developing countries during the past 20 years, as shown in the next figure. To take this point even further, we show these agreements are mainly being forged by countries facing steep competition from China. For some countries, controversy and suspicions in recent years over China’s Belt and Road initiative have given them added reasons to do so. Trade networks in East Africa, Southeast Asia and the Americas have been actively seeking to strengthen regional export capacity.

Consider the evolving trade network in East Africa. Companies like Mukwano Group, a Ugandan conglomerate that produces low-skilled manufactured goods, took the lead in arguing that an East African free trade agreement (FTA) would help them compete with countries like China. The Ugandan Manufacturers Association supported the creation of an FTA in 2000, as a bid to avoid a return to the era of exporting unprocessed raw materials and importing finished products.

Similarly, in Kenya, local manufacturers are incentivized to support preferential trade agreements as a way to give regional businesses to stave off competition from Indian and Chinese exporters. The Kenyan High Commission endorsed the FTA’s simplified “certificate of origin” rules, with the specific goal of promoting “small-scale cross border traders.”

What does this mean for the post-pandemic global economy, as companies take a long, hard look at overall strategies and supply chains? This could be good news for firms looking to diversify their supply chain partners as a way to boost economic resilience. As a recent Economist article sums up, the pandemic has exposed the simple truth that “… what people thought was a global supply chain was a Chinese supply chain. … Companies do not just need suppliers outside China. They need to build out their choice of suppliers, even if doing so raises costs and reduces efficiency.”

For companies in industrialized nations, this diversification may involve some simple steps to boost the capacity of new suppliers from developing nations. These steps might include increasing on-the-job product quality and skills training, for instance.

For governments in industrialized countries, supporting nascent trade networks in the developing world is also a win-win strategy because it may counter China’s influence while simultaneously helping to develop markets in poorer countries. This is certainly not news in Europe, which has long encouraged regional trade agreements in Africa — but analysts point out the E.U.’s trade agreements need some renewed energy.

With international institutions like the WTO seemingly adrift, new South-South trade agreements and closer links with these new markets would appear to be a no-brainer for the U.S. and Europe. As the aftershocks and disruptions of the 2020 pandemic play out, the future of global trade might depend as much on “the rest” of the world as on the U.S. and China.

Time will tell if this new crop of international networks — forged by small countries, not big powers — will prove their worth by providing firms with opportunities to engage in a more diversified, vibrant and participatory global economy. The result may be a global economy that is quite different from how we started out in January 2020.