Trade as geopolitics
Trade flows capture changes in the geopolitical context: global economic fragmentation continues to sharpen, driven by geopolitical rivalry
Economic relations are increasingly contingent on the geopolitical environment. Indeed, changes in patterns of cross-border trade and investment flows are the ‘revealed preference’ of geopolitical alignment, often capturing the impact of geopolitical rivalry more accurately than diplomatic statements.
The post-Cold War regime of relative geopolitical calm supported intense globalisation and a process of deep US/China economic integration through strengthened trade and investment flows. This is now changing, with growing strategic competition between China, the US, and others. Previous notes have discussed the growing evidence of global economic fragmentation driven by geopolitical rivalry.
Globalisation is not ending: trade, capital, knowledge, and people flows, remain robust. But a new model of globalisation is emerging: trade and investment flows are being increasingly shaped by geopolitical alignment. This note considers five notable developments in trade flows to provide a perspective on geopolitical dynamics.
1. US/China high-water mark
There has been a marked reduction in US imports from China over the past 18 months. Some of this reflects normalisation after a Covid-era surge, as well as the impact of trade diversion with Chinese exports to the US increasingly coming through other economies (ASEAN, Mexico). But it also reflects a rotation of US import preferences away from China.
The weakness in direct imports from China will likely continue, as the US continues to implement tariffs and other restrictions: President Biden raised tariffs on selected goods earlier this month, and Mr Trump has committed to high tariffs on Chinese imports if he wins a second term. I did not think that the ‘small yard, high fence’ approach to US trade restrictions sketched out by Jake Sullivan last year would be politically sustainable, and so it has proved (the yard is getting bigger).
On the other side, US exports to China have softened but remain close to record highs. There is an increasing array of US export restrictions on technology and other sensitive goods; but trade in many goods remains untouched. Over time though, US exports to China will likely continue to soften as China imposes more restrictions (from Boeing to Microsoft) and engages in more import substitution activity. China is looking to reduce its exposure to the US.
Similar dynamics can be seen in trade flows between the EU and China. EU exports to China have reduced slightly over the past year, but remain near record highs. The EU’s large trade deficit with China is reducing after a fall in the value of imports from China. Looking forward, the EU is nervous about a surge in Chinese imports (in autos, renewables) supported by Chinese subsidies – and is imposing various import restrictions. And the communique from the G7 Finance Ministers’ summit in Italy last weekend proposed new measures to push back on Chinese exports of industrial over-capacity.
2. Asia’s US tilt
Economic and geopolitical choices are being forced in Asian countries, on the front lines of strategic competition. Countries in North Asia (Japan, South Korea, Taiwan) are reducing their economic exposure to China, as part of a shift in strategic posture. Despite diplomatic efforts like this week’s China/Japan/South Korea leaders’ summit, these countries are increasingly shifting their economic exposure towards the US.
Geographic proximity to the large Chinese market favours exports to China, but exports to the US from Taiwan and South Korea have just overtaken those to China. And the US has recently become the larger export market for Japan as well. This rapid rotation in market exposure has been shaped by geopolitical factors: firms and governments are managing down their geopolitical risk exposure to China. This shift is also propelled by strong US demand for technology exports from these markets (e.g. semiconductors).
Despite the US withdrawal from the CPTPP and its unwillingness to engage seriously in regional trade architecture, the US is growing its economic presence in Asia. The US value proposition to Asian economies is not just a security guarantee.
3. China and the global south
China is reorienting its trade flows in response to geopolitical dynamics. Most obviously, exports/imports to/from Russia have surged since the invasion of Ukraine. However, there are limits (e.g. on Russian gas imports) and the relationship is asymmetric in China’s favour. There is talk of a ‘New Axis’ of anti-Western states (China, Russia, Iran, North Korea, and so on). But from an economic perspective, these trade flows are small and with limited growth potential.
More broadly however, there is increasing intensity of trade flows between China and other BRICS+ countries as well as with Africa and Latin America. The wide variation in interests across the BRICS+ countries mean that it will not be a coherent organisation, but BRICS+ is important as a symbol of shifting economic and geopolitical geography. Much of the global south wants to remain non-aligned, and will remain open to engaging with China. As China’s trade and investment relations with Western economies are challenged, there will be a rotation in China’s trade flows to the global south.
4. The geopolitics of trade diversion
The trade restrictions associated with geopolitical rivalry is also leading to trade diversion, as trade flows move around various frictions. For example, Mexico has recently overtaken China as the largest source of imports into the US. Some of this is due to the commercial incentives associated with strengthening global supply chain resilience, bringing production closer to US consumers. But some of this is also due to Chinese firms using Mexico to access the US market,
Similar dynamics can be seen elsewhere. Exports from ASEAN economies to the US have also increased strongly, as production has located out of China (including by Chinese firms). There is a well-documented phenomenon of ‘Singapore-washing’ where Chinese firms domicile in Singapore to present as ‘safe’ to Western markets. And Chinese firms have been investing into friendly countries in and around the EU (Hungary, Serbia) to better access the European market: Mr Xi’s recent European itinerary reflected this.
These dynamics will create some new winners in ‘connector’ economies.
5. The Australian exception
The relationship between geopolitical alignment and trade intensity is not deterministic: as noted above, exports from US and the EU to China remain at high levels despite tensions. Australia provides another example of this.
Bilateral political relations between Australia and China have been tense over the past several years: Australia’s calls for a Covid enquiry, a strengthening strategic relationship with the US in the Indo Pacific, and being a founding member of AUKUS. In response, China imposed a series of export bans from 2020 on Australian exports of goods such as barley, wine, and beef (these are now being eased/lifted).
Despite this, Australian exports to China have increased strongly over the past several years (moving broadly in line with New Zealand’s exports to China, despite New Zealand’s less challenged political relationship with China).
This was importantly driven by Australia’s exports of iron ore to China. From a Chinese perspective, iron ore is a critical economic input - and Australian ore is high quality and proximate. The extent to which geopolitics shapes trade flows partly depends on the characteristics of the goods: economic imperatives can trump geopolitical preferences, at least to a point. At >35% of total goods exports, China remains Australia’s largest export market by a margin.
In the reverse direction, China’s dominance of rare earth production and other commodities/goods that are essential to the net zero transition will constrain the ability of geopolitical rivals to decouple/derisk from China – at least in the near term.
Overall, a more fragmented global economy is emerging as trade (and investment, technology) flows are reshaped by geopolitical rivalry. This rewiring of the global economy will lead to structurally - and materially - different patterns of world trade and investment flows. To understand the emerging shape of globalisation, and the winners and losers in this new world, understand geopolitical dynamics.
If you find these notes valuable, you might be interested in accessing the unique insights and advice we deliver to our clients. We provide regular briefings to firms, investors, and governments on critical issues at the intersection of global economic and geopolitical dynamics; deliver presentations on global macro, geopolitical, and policy developments; and undertake commissioned analysis.
Please feel free to reach out via reply email or at contact@landfallstrategy.com to schedule an introductory call. We would be pleased to share some perspectives on global economic and geopolitical issues and discuss how our services can benefit you.
Related insights:
The great reindustrialisation, 24 May 2024
Geopolitical shocks & shifts, 22 March 2024.
China shakes the world, 8 March 2024.
If you liked this note, do forward it - or share it with your network:
Previous small world notes are available here:
You can also connect with me on LinkedIn.
Well written. International trade and arraignments between states and private sector actors that cross borders have been around since the Bronze Age, all that’s not going anywhere. But the transnational business and international finance (and their symbiotic security services and international NGOs) may soo become greatly diminished, possibly to the point where, as an empire, it won’t much exist at all.