Asia is set to embrace protectionism in face of China's overcapacity

Protectionism against low-cost Chinese imports has so far been a Western phenomenon, with Asia largely a bystander. This is about to change.

This year marks a further escalation of trade tensions between China and the West. U.S. President Joe Biden expanded Section 301 tariffs on imports from China to cover goods such as electric vehicles (EVs) and batteries, and the European Commission plans to impose additional tariffs on Chinese EVs.

Among emerging market economies, Turkey imposed a 40% additional tariff on imports of vehicles from China, while Brazil has reinstated import taxes on EVs this year. By contrast, Asia has not erected as many trade barriers against rising shipments from China, with its policy responses more subdued so far.

This hands-off approach looks unsustainable, considering the challenges faced by Asia's economies from China's industrial overcapacity across product categories.

At the low end of the spectrum, low-priced Chinese consumer goods are flooding into Thailand, Indonesia and South Korea, especially via e-commerce platforms. China's overcapacity and exports are squeezing domestic producers of metals and chemicals in India, Vietnam, Thailand and South Korea.

Asia is also at risk from the knock-on effects of tariffs erected across the rest of the world. As the U.S. and Europe impose additional duties on Chinese EVs or Latin America levies tariffs on Chinese steel products, some of this additional supply is bound to be redirected to Asia.

EV penetration is still low in many Asian economies, but it is on an uptrend, which makes Asian markets attractive to Chinese EV makers. This shift is already taking place.

In 2023, over 30% of Thailand's vehicle imports were sourced from China, up from 10% in 2013. According to data from the China Passenger Car Association, China has exported 312,000 EVs to Asia through May 2024, surpassing its exports to Europe at 266,000 EVs.

Asia's challenge from Chinese imports, therefore, spans both low-tech and high-tech manufactured products, with several economic implications.

Rising imports from China may hollow out the region's manufacturing. Production by micro, small and medium-size enterprises will be hit. Asia's auto sector is no match for China's EV juggernaut, as Chinese EV producers can lower export prices to capture market share, disrupting the development of fledgling industries across the rest of Asia.

Even stronger companies may experience profit margin pressures as China exports deflation to the rest of Asia. The Bank of Thailand believes competition from low-priced imported consumer goods from China may be a structural factor keeping Thailand's inflation low.

Some Asian economies like India, Vietnam and Malaysia are benefitting from the China plus one strategy, but a continued dependence on imported intermediate products from China will limit domestic value addition, constrain the development of domestic manufacturing ecosystems and limit the creation of local manufacturing jobs.

As U.S. and European tariffs hit China, and China redirects its overcapacity to newer markets, Asian exports will also find it more challenging to compete with China in these markets.

Faced with the challenge of protecting the domestic manufacturing sector and jobs, Asian policymakers cannot sit idle. They need to create a local level playing field versus China.

Some argue that raising protectionist barriers against Chinese imports is not easy, because Asia has less bargaining power with China, both economically and geopolitically, than the U.S. This is especially true for Association of Southeast Asian Nations, whose economies have developed closer links with China in both trade and investment.

For example, China is a key destination for Indonesia's metal and mining exports. Vietnam, Malaysia and Thailand depend on Chinese supplies of intermediate goods for trade. Chinese investments in new production facilities in ASEAN is enabling their integration into global value chains.

South Korea also depends on China for critical raw materials for semiconductors and batteries, and despite recent signs of decoupling, China is still an important market for South Korean companies in the consumer and semiconductor sectors.

All things considered, we still believe Asian policymakers have to more actively manage their trade and industrial policies to protect themselves, while balancing their economic and geopolitical priorities. This could take various forms.

First, developing economies in the region, especially those with large working-age populations that need to create jobs, can create a level playing field vis-a-vis Chinese imports by imposing taxes or tariffs. For example, Thailand recently approved the imposition of a 7% value-added tax on imported goods sold for less than 1,500 baht ($41).

Similarly, while protectionism is generally abhorred in trade policy circles, Asia should not shy away from higher import tariffs as an interim measure, while government policies work toward making local manufacturing more competitive. This can also take the form of tariffs being imposed above a certain import quota.

Second, it is important for countries that are benefitting from the China plus one strategy to develop their domestic ecosystems. Governments should have clear local content requirement rules, with a rising localization target each year. This will incentivize a switch from imports towards domestic sourcing and also encourage the growth of domestic factories.

Third, to promote the development of strategically important sectors, policymakers can offer local-content driven subsidies, and use fiscal policies such as tax incentives or expense deductions for domestically produced items over imported products.

Fourth, Asia should mitigate its own supply-chain risk by securing alternate sources of critical raw materials and minerals, and by entering into longer-term contracts. In December 2023, South Korea's Ministry of Trade, Industry and Energy announced its 3050 Strategy, under which it has identified 185 items for semiconductors, secondary batteries, cars and shipbuilding on which it plans to reduce South Korea's import dependence to 50% by 2030. More Asian countries can follow its example.

Finally, diversification is the name of the game. As G-7 countries seek to de-risk from China, there will be increased scrutiny of trade and investment routed through third countries. Asia should proactively aim to attract foreign direct investment from a diverse base of investors, and also diversify its trade partners to minimize concentration risk.

It is still early days, but the rise in Western protectionism against China, and China's continued challenge with its industrial overcapacity, is creating new economic challenges for Asia, which we believe are likely to trigger a protectionist domino effect across more countries.

In the end, it boils down to protecting domestic companies and jobs. While many Asian policymakers will face difficult decisions, the path is clear.

This article was first published by Nikkei Asia on Jul 2, 2024.