Pursuit of Prosperity Amid Changes: Evolution of Trade Rules and Global Industry Chains

Abstract

Trade rules refer to a series of agreements by which countries must abide in international trade. Countries around the world are recognizing the need to enhance their security as their industry chains become globalized. This is occurring amid widespread change spurred by geopolitics. We believe trade rules may gradually evolve from being dominated by the World Trade Organization (WTO) to a new stage of parallel development of the WTO and preferential trade agreements (PTAs). Looking ahead, we expect the WTO and PTAs to put pressure on each other and evolve simultaneously to reshape the global trade landscape. We think the WTO will continue to play the basic function of adjudication and facilitate basic consensus in a wide range of fields, while PTAs will play a more obvious leading role in rule-making in emerging fields. This should drive in-depth integration of regional economies and trade.

The evolution of trade rules could increase uncertainty in global industry chains in the near term and affect changes in the global industry chains in the medium and long term. First, the transition from offshore outsourcing to nearshore and friendly-shore outsourcing may become increasingly prominent along the industry chains. Second, as the influence of major countries on the evolution of trade rules increases, regionalization of industry chains surrounding major countries should become more prevalent. Lastly, some emerging industries may see opportunities for further opening-up under new trade rules. We expect labor-intensive industries to be relatively less affected by the evolution of trade rules, while capital- and technology-intensive industries such as machinery and electronics industries may be more severely affected as the global development of their industry chains is more susceptible to far-reaching PTAs.

Currently, we think China’s trade rule system is yet to fully support the efficient and safe development of industry chains. First, China’s influence is comparatively modest in the global multilateral trade system, so it’s hard for the country to provide strong impetus for WTO reform. This means the development of China’s industry chains is subject to external pressure. Second, some regional trade agreements China initiated or participated in are still in the preliminary stage of development in terms of depth and breadth, and could play a limited role in facilitating in-depth industry chain integration in the short term. Third, China’s institutional arrangements for opening-up still have room for refinement, and the country’s ability to align itself to high-standard international economic and trade rules remains limited. We believe this may hinder its further integration into global industry chains to some extent.

Looking ahead, we think China could adapt to the evolution of trade rules and facilitate complementary and common development of multilateral trade, regional trade, and domestic market rules. Under the multilateral system, China can actively participate in the reform of the WTO, seek common ground while reserving differences, build consensus, and drive a multilateral cooperation platform. In regional markets, China could adopt a multi-level development strategy and upgrade regional trade agreements. In the domestic market, efforts could be made to advance a high-standard institutional opening-up with pilot free trade zones acting as test fields.

Authors of this chapter: WU Huimin, LIANG Dong, ZHANG Zhuoran, WU Aijing. Translator: WANG Qian. Editors: Kenneth HO, Grant SURRIDGE, LIANG Dong, LIU Xinran.

The wave of globalization since the 1980s has driven the rapid development of the global economy, an important manifestation of which is trade liberalization. Over the past 40 years, global merchandise trade grew at a CAGR of 6.3%, higher than the 4.1% CAGR of global GDP. However, in recent years, under pressure from the COVID-19 pandemic, geopolitical conflicts (e.g., the Russia-Ukraine conflict), and economic and technological competition among major countries, some economies have resumed trade protectionist policies to maintain the security of their industry chains. As such, deglobalization has gradually changed from thoughts and ideas into actions.

In retrospect, free trade has not always been the dominant theme of global trade over the past century. In the 30 years from 1914 to 1945, affected by the two world wars, the Spanish flu of 1918, and the Great Depression of the 1930s, various countries ramped up trade protectionist policies and tariffs, which led to a contraction in global trade. What are the differences between the current round of “deglobalization” and previous ones? Will countries become more closed off in industrial development, or will they continue to seek security amid opening-up policies? What are the opportunities and challenges faced by China and how can it cope with them? In this chapter, we will answer these questions from the perspective of international trade rules.

4.1 Trade Rules: A Perspective for Understanding Global Industry Chains

In the international trade system, the trade behavior of each country is not only affected by its own trade policies, but also trade rules—i.e., agreements, laws, practices, and models by which all countries need to abide. Written trade agreements are the most common trade rules. Trade rules can be divided into two types of trade agreements. First, WTO agreements, which are based on multilateral principles and characterized by inclusiveness. Second, PTAs are based on unilateral or plurilateral negotiations and can be discriminatory.¹ In addition, under the two types of trade agreements, it is possible to develop highly differentiated trade provisions such as specific tariffs, investment, and competition policies.

Trade historian Douglas Irwin once spoke highly of trade rules. According to Irwin, the prosperity of the world economy over the last half century owes a great deal to the growth of world trade which, in turn, is partly the result of farsighted officials who created the General Agreement on Tariffs and Trade (GATT). They established a set of procedures which gave stability to the trade-policy environment and facilitated the rapid growth of world trade. With the long run in view, the original GATT conferees helped put the world economy on a sound foundation and improved the livelihood of hundreds of millions of people.² This comment affirms the contribution of trade rules and clarifies that they lay “a sound foundation” for improving economic efficiency and, ultimately, national welfare. They do so by creating a global environment with low trade barriers. The functions of trade rules are reflected in two ways:

The most direct function of trade rules is to act as an “accelerator” for promoting the development of industrial trade. Figure 4.1 reviews the overall impact of more than 220 trade agreements on international trade over the past 60 years, and we note that trade agreements played a significant role in promoting trade development. In particular, intra-regional trade creation (i.e., trade flows between members) increased by 24% on a net basis thanks to the facilitation of internal trade within the region. With the integration of regional trade, member countries’ external demand for imports shrank, and trade flows from the rest of the world to the agreement zone decreased by a net 32%. More importantly, trade agreements facilitate industrial agglomeration and economies of scale within regions, and enhance the region’s overall economic strength. This has driven a net increase of 39% in extra-regional trade creation (i.e., trade flows from the agreement zone to the rest of the world).

Trade rules can also act as a “stabilizer” for industry chains and alleviate pressure on industry chain operations, which is particularly important in the current international environment. Without adequate constraints from trade rules, international trade may face a so-called prisoner’s dilemma, leading to stagnated development of global industry chains. According to a study by economist Avinash Dixit, in a world without trade rules, in which countries could benefit from erecting trade barriers—e.g., by levying an import tariff to improve their terms of trade—and provide subsidies to large firms to help them capture profit in oligopoly situations, such behavior would distort free trade and provoke retaliation from other countries. The absence of trade rules to restrict and punish such behaviors would eventually bring global industry chains to a standstill.³ In reality, as shown in Fig. 4.2, uncertainty in trade policy rose significantly after the COVID-19 outbreak, becoming a drag on global supply chains.

Fig. 4.1

Note GVC refers to global value chain. Source François de Soyres et al., Regional Trade Agreements with Global Value Chains, FEDS Notes, February 2021, CGI

Trade rules can act as an “accelerator” for industry chains.

Fig. 4.2

Source New York Fed, Trade Policy Uncertainty Index, CGI

Trade rules can act as a “stabilizer” for industry chains.

By working as an “accelerator” and “stabilizer”, effective trade rules can increase economies of scale and form a larger, connected market on the basis of complementary advantages and free trade. First, the flow and agglomeration of factors within a region could become more efficient in a connected market, extending the boundaries of economies of scale. Second, building a connected market means that trade policies of different countries are unified and predictable, which should reduce the cost of trade frictions between different countries and enlarge the room for production and sales growth in member countries.

Over the past 40 years, the trend of globalization has given rise to three production and export hubs—the US, Germany, and China. Multiple markets of different sizes and with connected industry chains have been established around these three hub countries. In this process, member countries can significantly benefit from economies of scale brought about by trade rules, with large economies being the major beneficiaries. According to a study, the US has been estimated to have made US$127bn in additional gains each year thanks to “extra” trade growth fostered by the North American Free Trade Agreement (NAFTA), accounting for about 0.93% of its GDP.⁴

In fact, not only have trade rules evolved along with the development of industry chains, but they have also acted as a driving force in reshaping industry chains. For example, trade in intermediate goods has given rise to new terminology related to global industry chains, and the rapid development of the digital economy has driven countries to negotiate terms of digital trade. At the same time, the evolution of trade rules provides new impetus and constraints for the development of industry chains. For example, after the establishment of the WTO, some complex industry chains with long processes and that require cross-border assembly of components such as home appliances, automobiles and high-end equipment have benefited significantly from tariff cuts.

4.2 Trend Amid Deglobalization: From a Multilateral Mechanism to a Multilateral Mechanism Plus Regional Mechanisms

4.2.1 Economic and Political Factors Dominate the Evolution of Trade Rules

International trade has a long history. International trade took shape as early as the Age of Discovery in the fifteenth and sixteenth centuries. However, before the end of the Second World War in 1945, there was no extensive global trade coordination mechanism.⁵ During that period, countries followed the traditional trading model of exchanging manufactured products and raw materials. Even during the first round of globalization from 1870 to 1914, the average global tariff rate did not decline, and trade flows were still reflected mainly in the movement of people rather than freight. For example, in the decade between 1896 and 1906 alone, the number of international migrants doubled.⁶ However, global exports as a percentage of GDP remained largely stable.

During the period encompassing the two world wars, pandemic outbreaks and geopolitics highlighted the disadvantages of a lack of coordination in international trade. After the First World War, which began in 1914, the wave of globalization gradually faded. With the outbreak of the Spanish flu of 1918 and the rise of trade wars and nationalism in 1920s and 1930s, the trend of deglobalization gradually intensified, as evidenced by the widespread adoption of protectionist trade policies in various countries, and substantial tariff increases aiming at protecting domestic “infant industries” and maintaining fiscal revenue. For example, in 1915, the British Parliament raised the import tariff on automobiles and watches to 33.3%,⁷ and in 1930, the Smoot-Hawley Tariff Act was passed in the US, which raised tariffs on all imported goods. These unilateral protectionist policies eventually led to a sharp contraction in global trade.

Driven by economic factors, developing international trade rules became a shared aspiration after the Second World War. The theory of free trade, which draws on work from economists such as Adam Smith and David Ricardo, went mainstream following the two world wars. As they reexamined the damage and destruction to the global economy and the international order caused by the Second World War, various countries started to show unanimous support for the establishment of a multilateral trading system and trade liberalization.⁸ Led by the US, 23 member countries, including the UK, Canada, and Australia, signed GATT, which drove a significant decline in the global average tariff and opened a new chapter of globalization. GATT, which gradually morphed into the WTO, laid a solid foundation for the current multilateral trade system.

As the rise of Japan and Europe led to changes in the international economic and trade landscape, trade rules also underwent changes again driven by economic and political factors. From the end of the Second World War to the 1960s, the US remained the world’s most powerful country in terms of industrial production, accounting for about 50% of the world’s manufacturing output,⁹ and it was also the world’s largest exporting country. In the meantime, Japan and Europe recovered rapidly after the war. In 1965, the US recorded a bilateral trade deficit with Japan for the first time, and the trade deficit gradually widened, posing challenges to the US’s economic status. In order to eliminate the trade deficit and protect its position in the international market, the US then imposed sanctions on Japan’s textile, TV, steel, automobile, and semiconductor industries, and put further pressure on Japan through the Plaza Accord in 1985 and the Japan-United States Structural Impediments Initiative in 1989. Overall, trade rules during that period were affected by both economic and political factors and were designed to serve the interests of major countries; for example, the US leveraged its dominant position in GATT to sign the Multifiber Arrangement with 40 countries and regions, which saw these countries voluntarily limit exports to the US.

With the rise of developing countries, economic factors once again dominated the evolution of trade rules, and the world entered a trade boom. In the 1990s, industrialization accelerated in developing countries such as China and Vietnam, setting stage for the formation of global industry chains. Driven by the offshoring and outsourcing activities of multinational companies in developed countries, developing countries benefited notably from industrial transfers by leveraging their low labor costs. The pattern of the international division of labor changed from an inter-industry division of labor to an intra-industry division of labor. The determining factor for division of labor in various countries changed from a comparative advantage in products to a comparative advantage in factors. Driven by economic benefits, the Tokyo Round (from 1973 to 1979) and the Uruguay Round (from 1986 to 1993) of multilateral trade negotiations (MTN) resulted in average tariff reductions of 35% and 39%,¹⁰ respectively, driving a sharp drop in the average global tariff rate to around 3.5%.¹¹ Against such a background, international trade witnessed an unprecedented boom over 1990–2007, with global exports growing at a CAGR of 6.2%, much faster than the 3.2% GDP growth over the same period.¹²

While the global financial crisis put a pause on the second round of globalization, competition among major countries for international status and influence once again drove international trade rules to a new stage of development oriented by political considerations. Global trade and value chain expansion plateaued after the financial crisis, and participation in the global value chain declined notably over 2010–2016.¹³ WTO reform stalled, with the US, China, and the EU at odds with each other on reforms in key areas such as dispute settlement, SOE protection, and industrial subsidies.¹⁴ Regional trade agreements (RTAs) among countries and regions with close economic and trade ties and consistent political stances, as represented by PTA, began to emerge in large numbers. In 2009 alone, 21 PTAs took effect, showing a clear domino effect. Intensifying competition among major countries and various geopolitical factors shifted the basis for international trade rules from efficiency to security. Developed countries such as the US shifted the focus of international trade negotiations from multilateral negotiations to regional ones. It launched negotiations related to the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP), and built alliances in Asia through the Indo-Pacific Economic Framework for Prosperity (IPEF). Such a shift also meant that international trade rules gradually evolved from being dominated by multilateral mechanisms to both multilateral and regional mechanisms.

4.2.2 Global Trade Rules: Towards a New Stage of Development Driven by Both Multilateral and Regional Mechanisms

In recent years, trade liberalization has faced unprecedented challenges under the pressure of global public health crisis, geopolitical conflicts, and competition among major countries. However, unlike in 1914–1945, when globalization ebbed for the first time, industry chains of different countries are now deeply integrated and trade in intermediate goods is developing rapidly. It is now difficult for individual countries to cut international ties and adopt independent trade protectionist measures. Countries are more inclined to build alliances to enhance security while maintaining openness. Therefore, demand for openness is not weakening. However, we think the key for individual countries is to determine with whom they should cooperate and how to achieve openness. This also means international trade rules will likely move towards higher levels of flexibility and autonomy under the influence of political factors. Both WTO-based multilateral mechanisms and PTA-based regional or group agreements will likely play important roles in their respective fields.

Of course, WTO and PTAs are not separate from each other. The two put pressure on each other and jointly drive the continuous evolution of international trade rules. PTAs put pressure on the WTO, and drive the WTO to carry out reforms by playing experimental and exemplary roles. For example, in the 1990s, the US launched NAFTA negotiations during the Uruguay Round of negotiations, and introduced the higher-standard investment and intellectual property protection provisions in NAFTA into the drafting of the WTO Agreement on Trade-Related Investment Measures (TRIMS) and the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).¹⁵ The multilateral rules laid down by the WTO also drove regional cooperation to a deeper level. For example, the 12th Ministerial Conference (MC12) of the WTO adopted the Ministerial Draft Agreement on TRIPS in June 2022, allowing countries to use patents necessary for the production and supply of COVID-19 vaccines without the patent owner’s permission in response to the COVID-19 pandemic. This move may significantly affect PTA rules on public health crisis response in the future.

Looking ahead, we believe the inclusiveness of economic development and national security among major countries will determine future development of international trade rules. It is possible that countries will reach a multilateral consensus, WTO reform resolves its impasse, PTAs become more inclusive, countries integrate more deeply in institutional arrangements, and the WTO and PTAs drive globalization forward. Such a trend occurred in the 1990s, most notably in the negotiations of the Information Technology Agreement (ITA), which was initiated by Europe and the US in the TransAtlantic Business Dialogue (TABD) in 1995. After gaining the support of APEC members, the initiative was submitted to the WTO. Negotiations concluded in 1997, and ITA became a plurilateral agreement. On the contrary, it is also possible that competition between major countries will intensify, WTO reform will stagnate, and PTAs will become tools for core countries to form opposing alliances. In this scenario, deglobalization could intensify.

At the same time, with the development of the global economy, the wide application of new technologies, and the emergence of new challenges, we think the development of WTO and PTAs will show new characteristics. Specifically, the WTO may exhibit three trends involving its adjudication function, negotiations in specific areas, and its operating mechanism.

First, the multilateral trading regime with the WTO at its core has been the cornerstone of international trade, and we believe the WTO will continue to play a basic adjudicative function. Despite criticism of its dispute settlement mechanism, the WTO’s international judicial mechanism handles the most cases of any such body in the world. Dispute settlement bodies became increasingly active over 2014–2018, before the US began influencing the selection of justices on WTO Appellate Body.¹⁶ And despite its discontent, the US has filed 124 dispute cases at the WTO to address trade subsidies, anti-dumping, and intellectual property protection.¹⁷ Looking ahead, the rules-based multilateral trading system could remain the cornerstone of international trade and negotiations. As the guardian of the multilateral system, the WTO could still provide a platform for exchanges and opportunities for consultation among heads of state. As such, it could resist pressure from protectionist policies and provide a high degree of certainty for trade policies.¹⁸

Second, despite the slow progress of the Doha Round of negotiations, efforts have also been made under the multilateral mechanism to explore new ways to provide basic consensus for the formulation of trade rules. Why has no important WTO framework agreement emerged since the end of the Uruguay Round of negotiations? The core reason lies in the WTO’s negotiation system—under the traditional principle of reaching decisions by consensus, all 164 member states must reach consensus on any proposals. However, countries’ aspirations and stages of development often vary widely, making it difficult to achieve results under this way of negotiation. The Open Plurilateral Agreement (OPA) under the WTO framework provides a possible solution. It was negotiated, adopted, and operated by WTO members. The results of the negotiations can be used only among participating countries or extended to nonmembers on a most favored nation (MFN) basis.¹⁹ This means that if differences between countries cannot be addressed in the short term, agreements can be formed among countries with a high degree of consensus before gradually evolving to multilateral rules. For example, the Environmental Goods Agreement (EGA) launched in 2014 has gone through 18 rounds of negotiation. It has 28 participating members and covers about 54 environmental products. In terms of digital trade, 71 member states issued the Joint Statement Initiative (JSI) on future negotiations on e-commerce in 2017, and the 2021 plurilateral agreement negotiations on e-commerce have made progress on eight articles, including consumer protection, electronic signatures and authentication, and paperless trading.²⁰

Finally, major countries will play an increasingly important role in the operation of multilateral mechanisms. From the establishment of GATT to that of the WTO, the operation of the multilateral trading system has been inseparable from the leading roles of major countries in global governance.²¹ Major WTO negotiations have stalled since 2018. During that time, the EU, China, and the US have released documents in an effort to advance WTO reform. However, there are still disagreements on key issues such as reform of the dispute mechanism, recognition of developing country status, and industrial subsidies. While the necessity of WTO reform is widely recognized at present against a background of “governance deficit”, the pace of reform may depend on major countries’ willingness to reform and whether they can reach consensus. Progress in reforms has been limited so far.

On the basis of the multilateral system, we think PTAs could play a more important role in three aspects, i.e., playing a leading and exemplary role in rule-making, integrating regional economies, and focusing on industrial policies.

First, PTAs could play a leading role in rule-making in emerging fields. As the number of PTA member countries is much smaller than that of WTO member countries, negotiations face fewer obstacles and could be more focused, as reflected by in-depth PTA clauses, faster pace of upgrading, and better implementation. For example, based on the WTO Agreement on TRIPS, PTAs in various countries have expanded the scope of intellectual property protection based on their own characteristics. Specifically, Japan and South Korea emphasize extended patent protection, the US pays attention to copyright protection, and the EU attaches importance to geographical indications.²² In addition, PTAs have clearer and more targeted standards and implementation procedures than TRIPS. As digital and green topics become increasingly important, we expect PTAs to play a bigger role in leading the upgrading of rules. For example, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), the United States-Mexico-Canada Agreement (USMCA), and the Regional Comprehensive Economic Partnership (RCEP) all contain rules on digital trade. The USMCA adopts more aggressive digital trade provisions, requiring that platforms are not held liable for third party content and banning customs duties on digital services.²³ We believe the contents of these agreements provide a reference and guidance for defining, standardizing, and identifying fulfillment risks in digital trade under future PTAs. In addition, compared with OPA negotiations under the WTO framework, which usually focus on a specific topic, PTAs cover a wide range of topics and can innovate and upgrade provisions in many emerging fields, making them a bellwether for reforming trade rules.

Second, a number of large regional trade agreements have emerged to create a new pattern of regional integration. In recent years, large regional trade agreements such as CPTPP and RCEP have emerged, facilitating the formation of a new pattern of regional integration by integrating regional economic and trade ties and rules and systems. First, integration of scale: Large-scale regional trade agreements cover a large number of countries and economies, delivering strong trade creation and trade diversion effects. For example, the United Nations Conference on Trade and Development (UNCTAD) estimates that RCEP’s trade creation effect would stimulate trade between members by US$17bn, while its trade diversion effect could total US$25bn; the sum of these two figures is equivalent to 18.3% of intra RCEP-trade in 2019.²⁴ Second, integration of rules: Large regional trade agreements could unify higher-standard rules in a larger scope. For example, the TPP has 26 provisions, nearly half of which are not found in other free trade agreements implemented in the Asia–Pacific region, including those involving agriculture, labor standards, environment, and small and medium-sized enterprise (SME) subsidies. The Transatlantic Trade and Investment Partnership (T-TIP) echoes the TPP in several ways,²⁵ reflecting the US and EU’s intention to achieve unification in rule-making with the Asia–Pacific region through trade agreements.

Lastly, coordination between PTAs, one of the core foreign trade policy tools of major countries, and these countries’ domestic industrial policies could be strengthened. For example, in the past decade, the US has focused on emerging industries such as chips, biomedicine, big data, AI, IT, and finance in CPTPP and TTIP negotiations and in USMCA documents in an attempt to strengthen its domestic industries.²⁶ At the same time, the US’s industrial policies and national security policies also emphasize its leadership in strategic emerging industries and the importance of fending off competition from external parties. Specifically, the rules of origin clause in PTAs may become a restrictive measure, and PTAs themselves can also be used to extend industrial policies to the trade area. For example, the US recently introduced the Inflation Reduction Act, which states automobile manufacturers should source at least 40% of critical battery minerals domestically or with free trade partners starting in 2023.²⁷

4.3 Global Industry Chain: Regionalization Gathering Momentum Amid a Rising Level of Uncertainty

On the surface, trade rules have evolved from being dominated by the WTO towards a spiral pattern development amid interaction between the WTO and PTAs. In essence, the evolution of trade rules has brought about changes on multiple fronts, e.g., the development of global industry chains and cooperation. When trade rules were driven by economic factors, efficiency was the core development goal of industry chains. However, as political considerations are increasingly reflected in trade rules, more importance will be attached to the security of industry chains. This is reflected by the growing trend of regionalization and diversification of industry chains, the possible shortening of some industry chains, and the transformation from shallow integration of industry chains to deep integration.²⁸ So specifically, how do trade rules affect industry chains? How does their impact differ for different industry chains? We answer these questions in the following section.

4.3.1 Reshaping Global Industry Chains: Transfer of Industry Chains, Regional Agglomeration, and a New Opening-Up

We think uncertainties about the development of global industry chains will increase as reforms of multilateral rules stall. The operation of global industry chains is inevitably subject to disputes, and the settlement of such disputes needs to rely on WTO dispute settlement mechanisms. For example, China won the DS437 case (China challenged US countervailing duty measures against Chinese exports of oil well pipes and other products to the US on the grounds they violated WTO-covered agreements) and was authorized to impose tariffs on imports from the US totaling up to US$645 mn a year to maintain normal competition in the industry chain. We believe the stable operation of global industry chains is in urgent need of protection from multilateral rules. For example, during the COVID-19 pandemic, many countries took trade protectionist measures to serve their own needs for industrial security, which hindered the free development of global industry chains, and even severed or disrupted some chains. We think the evolution of trade rules on global industry chains will be reflected in three ways.

First, policies that are not conducive to free trade could increase substantially, and the transition from offshore outsourcing to nearshore and friendly-shore outsourcing may ramp up along the industry chains. According to Global Trade Alert, the number of policies that are not conducive to free trade rose from 217 in 2012 to 2,137 in 2022, implying a CAGR of 23.1%, and posing two challenges to traditional offshore outsourcing. Against a background of increasing emphasis on the security of industry chains, major countries are more inclined to locate their industry chains in neighboring areas within closer geographical proximity, i.e., nearshore or backshore outsourcing. According to a Kearney survey, in 2021, about 70% of US CEOs planned to relocate partial manufacturing operations to Mexico to strengthen their control.²⁹ In addition, it could be more difficult to reach new PTAs amid uncertainties over the trade environment and policies.³⁰ This is illustrated by increased average distance between member countries of newly signed PTAs and increased cooperation between countries with shared values, i.e., the so-called friendly-shore outsourcing.

Second, as major countries’ influence on the evolution of trade rules increases, the effect of regional industry chains surrounding major countries may become more prominent. Studies show that the effectiveness of trade agreements on industry chains increases as the number of member countries increases and the trade provisions go deeper.³¹ Reaching PTAs with such characteristics requires increased participation of great powers as major countries exhibit more obvious advantages in negotiations in areas such as scale, market access, and politics.³² Against such a background, regional industry chains with major countries at the core may become increasingly influential. For example, mega-regional trade agreements such as the EU, NAFTA, and RCEP all set specific regional development provisions targeting the automobile industry chain. NAFTA stipulates that only products with a minimum regional value content (RVC) of 62.5% can enjoy preferential tax treatment, and the USMCA required an upwards adjustment to the RVC requirement from 62.5% under NAFTA to 75% under the USMCA to strengthen PTAs’ binding effect on regional industry chains.

Lastly, there may be opportunities for some industry chains for further opening-up as the WTO and PTAs put pressure on each other and jointly drive the continuous evolution of international trade rules. The WTO tends to seek greater depth through innovation of mechanisms such as OPAs, while PTAs seek greater influence through the “extension” of rules. The interaction between the two may promote the opening-up and development of some industry chains, especially global necessities or emerging industries with no well-established rules in place, e.g., the aforementioned TRIPS waiver decision for COVID-19 vaccines authorizing developing countries to produce and export COVID-19 vaccines to other developing countries without the patent owners’ consent.³³ In addition, driven by PTAs, some provisions have been gradually introduced in areas such as the digital economy and green economy, boding well for opening-up in these areas. For example, before 2020, there was considerable disparity among countries on digital taxes, and countries generally imposed unilateral taxes on digital companies, triggering trade protectionism. After multilateral organizations such as the G7 and the OECD came to an agreement with an approach to taxing the digital economy and set the minimum tax threshold for multinational companies at 15%, this agreement has gradually gained support under multilateral rules. We think this bodes well for improving the operation of the digital industry chains.

4.3.2 Impacts on Different Industrial Sectors Could Also Vary Notably

The evolution of trade rules impacts industry chains mainly through two channels—trade cost and production cost, and different industries may be affected and impacted to varying degrees due to different levels of sensitivity. We select four industries—i.e., textile & clothing, machinery manufacturing, electronic information, and coal & oil—to represent labor-, capital-, technology-, and resource-intensive industries, and analyze the differentiated impacts of the evolution of trade rules on different industries. Overall, “shallow” rules such as tariffs have a relatively large impact on labor-intensive industry chains such as textiles and apparel. Capital- and technology-intensive industries such as machinery and electronics are more susceptible to non-tariff barriers, implying that they could be more severely affected by the evolution of trade rules. The energy industry may also face higher trade risks due to its inherent characteristics and important influence on the economy.

As textiles and apparel is a typical labor-intensive industry, cost is at the core of its development, and the industry features limited intermediate inputs, relatively mature technologies, and high susceptibility to shallow trade rules such as tariffs. In retrospect, the Multifiber Arrangement (MFA) in the 1970s stipulated the proportion of textile and apparel exports of various countries in the form of quotas, which forced late movers to upgrade their industries. PTAs such as NAFTA, the African Growth and Opportunity Act (AGOA), and the Dominican Republic-Central American Free Trade Agreement (CAFTA-DR) strengthened regional textiles and apparel industry chains, and promoted the development of the textiles and apparel industries in East Asia and Southeast Asia, which now constitute the main hub of the textiles and apparel industry.³⁴ At present, although the textiles and apparel industry chain is relatively unstable and vulnerable to direct trade policies such as tariffs, it shows higher resilience than other industries in terms of its ability to recover from trade shocks.

In contrast, capital- and technology-intensive industries such as machinery and electronics are mainly subject to constraints from non-tariff barriers and may face more challenges. Capital- and technology-intensive industries are often characterized by high product complexity, abundant intermediate inputs, and strong economies of scale, and have formed relatively complex global production networks. Taking the chip industry chain as an example, major countries in Europe, the US, and the Asia–Pacific region all produce some key intermediate products, leading to autonomous and controllable risks for various countries. In the context of deglobalization, these industries may face more trade barriers. For example, some countries have disrupted global industry chains and accelerated the localization of so-called key products through trade protectionist measures such as export controls. As political factors and industry chain security become increasingly important, these two types of industries may be more severely affected by adjusted trade rules. This could manifest itself in an accelerated return of industry chains to their home countries and reduced cooperation across regions.

Although the impact of trade rules on the energy industry are relatively limited, the industry plays an important role in competition among great powers given its significant influence on the economic system; this could magnify the challenges and risks faced by the industry. Unlike the other three types of industries, the energy industry has been less affected by trade rules in the past, with both tariff and non-tariff barriers having a limited impact. Energy industry considerations may not be a main factor when countries sign PTAs.³⁵ However, the energy industry is highly dependent on geography, and it is vital to economic development (especially against the backdrop of the European energy crisis triggered by the Russia-Ukraine conflict). This means that the potential impact from geopolitics and competition among major countries on the energy industry cannot be ignored.

4.4 China’s Trade Rules: Progress and Shortcomings

In retrospect, the multilateral trade system facilitated the rapid development of China’s industry chains. Since its accession to the WTO, China has played an increasingly important role in international trade and coordination of production. It has become more deeply involved in the global division of labor. After 2001, China’s global value chain (GVC) trade rose rapidly, having recorded an average annual growth rate of 27.3% before the 2008 financial crisis. Although the growth rate has slowed since 2010, the overall upward trend has remained intact. China’s backward GVC participation³⁶ has declined, indicating falling reliance on imported intermediate goods and a rising position in the global value chain. This reflects China’s efforts to attract capital and improve technologies to gradually replace foreign products in upstream and midstream markets with domestically-produced ones, while opening its domestic market to the world.

Looking ahead, China’s industry chains face new opportunities and challenges. Bottlenecks faced by the WTO and an increase in trade frictions should accelerate the restructuring of industry chains in the Asia–Pacific region. As a major destination for offshore outsourcing, China’s share of global trade in intermediate goods has been increasing over the past 20 years, having peaked at 10.3% in exports and 10.1% in imports in 2015. However, in recent years, the level of tariffs faced by China’s goods exports has rebounded amid trade frictions, and corporate trade costs and industry chain risks in China have also increased. Such a change has driven the relocation of industries (the textiles and apparel, electronics, etc.) industries from China to Southeast Asia and India as these regions feature lower factor costs and are less affected by developed countries’ tariff policies.

At present, we think China’s trade rule system is yet to support the efficient and safe development of industry chains. First, China’s influence is relatively modest in the multilateral system, and the country is not fully familiar with the application of international economic and trade rules. Since 2001, China has only filed 22 dispute cases with the WTO up to 2022, accounting for less than half of the cases filed against it, and most were cases against the anti-dumping and countervailing duties imposed by developed members against Chinese exports. In comparison, the US has filed 124 dispute cases since 1996, accounting for 80% of the total number of the cases filed against the country.³⁷ We see this as evidence that China is not using multilateral trade rules to effectively deal with disputes initiated by developed countries. Developed countries have instead used these trade rules to justify their unilateral sanctions against China.

Second, China’s regional trade agreements still have room for improvement in terms of contracting parties, depth of rules, and level of openness. First, China signed PTAs³⁸ mostly with Asian countries and developing countries, and economic factors often give way to diplomatic considerations in the choice of contracting parties.³⁹ Second, China’s PTAs generally feature narrow coverage and shallow contents. For example, China’s bilateral free trade agreements usually focus on market access and tariff reduction, while there is a lack of behind-the-border measures such as policy cooperation and dispute settlement. China’s RCEP mainly focuses on traditional topics such as trade in goods and investment facilitation, with no significant progress made on the basis of the WTO framework.⁴⁰ In addition, the Belt and Road Initiative is based on “soft rules” such as memorandums of understanding (MOU), which have weak legal effect. China also has room for improvement in terms of the level of openness of trade agreements. For example, according to the China–South Korea Free Trade Agreement, the tariffs of 90% of goods will eventually be reduced to zero within a transition period of 20 years. In contrast, pursuant to the US-South Korea FTA, 95% of bilateral trade in consumer and industrial products would become duty free, with a transition period of no more than five years.

Third, China’s domestic market still needs to be improved to support the development of a high-level trade system. The level of openness still needs to be improved—e.g., by enhancing service trade and investment liberalization—and issues related to SOEs, technology transfer, and industrial subsidies have yet to be fully resolved. Issues with the domestic market have restricted China’s ability to align itself with and formulate high-standard international economic and trade rules, thus exacerbating issues faced by China such as the lack of voice in the multilateral system and the low complexity of its regional trade agreements.

International trade rules and global industry chains are undergoing a new round of reshaping amid deglobalization, presenting both new opportunities and challenges for China. Against such a background, a favorable international environment and trade partnerships can help stabilize corporate expectations, drive effective resource allocation, and increase the level of security and efficiency of industry chains. In view of these developments, we think China can actively participate in the reform of the WTO and drive multilateral cooperation platforms to keep pace with the times, adopt a multi-level development strategy to upgrade the level of regional trade agreements, and advance high-standard institutional opening-up using pilot free trade zones. The goal would be to create a concentric circle of multilateral, regional, and domestic markets, and establish a new system for a higher-level open economy.