Economic harms spillover from China to the surrounding region via a contagion effect.
The highly integrated nature of the global economy means trade disputes often cause third-party economic harms via contagion. A trade war between two of the world’s largest economies is particularly likely to cause contagion.
The week before the commencement of US tariffs saw a dive in investor confidence in Asia. 9 of the 10 worst-performing stock indexes in the world were from the region, including Tokyo and Vietnam . The trade war with China causes economic collateral damage to the region. One partial explanation is that China is a significant investor in the region. When Chinese businesses feel the squeeze from US tariffs, they are forced to scale back investments abroad, hurting regional growth. This is only part of the story, since the proportion of Chinese investment differs significantly across the reason – for example, while Chinese Greenfield FDI to Southeast Asia is on the rise, the largest share is still held by Japan. The broader reason is that regional economies tend to be tightly interlinked. Damage to the Chinese economy also hurts regional businesses with supply chains that flow through China. In turn, this diminishes market confidence in those regional economies, leading to a loss of investment. The loss of investment is harmful to the region. Foreign investment allows businesses to flourish and expand, creating employment and increasing government revenue.
Regional economies are sufficiently robust to withstand the effects of contagion. The economies of Japan and South Korea, for example, are strong and active investors in the region. This is especially true if the trade war is not long-lived; the scale of the effects depends on the length of the war. Furthermore, the claim of long-term loss of investor confidence assumes that China will fare poorly in the trade war, thus triggering contagion. This claim is evaluated elsewhere in this issue; should it be false, then investor confidence will be restored as China weathers the storm successfully.
P1. China’s economy is closely linked to Asian regional economies P2. If China’s economy is closely linked to Asian regional economies, then the trade war will cause regional contagion C1. The trade war will cause regional contagion P3. Regional contagion causes a loss in investor confidence P4. A loss in investor confidence is bad for the region C2. The trade war is bad for the region
Response to [P2]: The hidden premise within [P2] is that the trade war will harm the Chinese economy, thus triggering a contagion effect. If the trade war doesn’t damage the Chinese economy, then contagion doesn’t occur, even if regional economies are closely linked.