# 3. **THE IMPLICATIONS OF AND THE POLICY RESPONSE TO THE CHANGING TRADE PATTERN**

This section addresses four questions associated with the changing trade trends outlined in Section 2. The first pair of questions relates to China’s emergence and the appropriate national policy response. What are the trade effects of the growth of China on other developing East Asian countries? And how has the asymmetric opening of goods and services trade affected the productivity and comparative advantage of developing East Asian economies? The second pair relates to the emergence of GVCs and the appropriate response in terms of international cooperation. How does the increasing fragmentation of production across borders affect developing East Asian countries’ productivity? And how far are the international agreements negotiated by developing East Asia fostering the growth of GVCs and deeper international integration? We will investigate these issues in turn.

# **a. The heterogeneous impact of China**

The inclusion of China in the global trade system has had a significant impact on developing East Asian countries. This section provides an assessment of the effect on trade flows. As discussed in Section 2, the rise of China as a major player in world trade has changed the nature of intra‐ regional and extra‐regional trade for developing East Asian countries. China’s share of world exports increased between 1995 and 2015 from about 2 percent to 11 percent. In light of this change, a number of studies (most notably, Autor et al., 2013) have investigated the impact of the China (supply) shock on other countries. At the same time, China grew as an importer, notably of agricultural and mining products where its share of world imports increased from 2 percent in 1995 to 10 percent in 2015. This China (demand) shock also affected its trade partners, altering their trade patterns. China’s supply and demand shocks have contrasting effects on East Asian developing countries that ultimately depend on their production and trade structures and the similarity of their export destinations with China. An empirical investigation is required to quantify these various channels.

Econometric analysis points to a heterogeneous impact of China‐related trade shocks on exports of developing East Asian countries. Bastos (2018) examines empirically the effect of supply and demand shocks associated with China’s trade dynamics on multilateral exports of the Belt and Road Initiative (BRI) countries – a group that includes, but is not limited to developing East Asian countries ‐ and finds a significant overall effect and heterogeneous impacts by country and period, for both types of trade shocks.<sup>8,9</sup> Table 1 presents the estimated coefficients obtained in

> 8 Intuitively, China‐related supply or competition shocks are associated with China’s rising global exports, and may pose a competition challenge especially for countries with an initial export structure that is similar to China’s. In contrast, China‐related demand shocks are associated with China’s rising imports, and may represent an opportunity for countries with initial export profiles matching China’s import structure.

> 9 The methodological approach in Bastos (2018) is built on insights by Autor et al. (2013). The estimation equation relates multilateral exports by country, sector and period to the China‐related supply and demand shocks, where the supply shock is computed as the product of the change in log of multilateral exports of China in a sector and period and the export similarity index between China and the exporting country and the same sector in 1995, while the demand shock is computed by the product of the change in log of multilateral imports of China in a sector and period and the similarity index between China’s imports and the country’s exports in the same sector in

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