Currently, maritime trade is regulated by the United Nations Convention on the Law of the Sea (UNCLOS). This regime was established after the First World War under the premise that taxes and blockages to free trade interfere with world peace.

This means that, except for a certain number of nautical miles that gives countries exclusive economic rights over their seas, the seas are international waters in which no State exercises sovereignty. This regime promotes cooperation between governments to protect merchant ships and guarantees the right of way. If there is less uncertainty, the risks are lower, which encourages the creation of more exchange networks and cheapens international trade.

However, since 1947, China has declared that it has right over waters in the “Line of the nine points”. This line demarcates most of the South China Sea, a sea in which the exclusive economic zones of six countries adjoin and through which approximately one third of international trade flows, valued at 3.4 billion dollars annually, according to a study of the Center for Strategic and International Studies.

The Chinese government argues that it has the historical right over these waters. This means that, if it manages to impose its own regime above the UNCLOS, it could impose taxes on merchant ships. In this sense, it is known that China is building artificial islands with military infrastructure in the South China Sea.

China’s claims present a risk because, if implemented, they constitute a precedent for other coastal countries that are highly dependent on trade to seek to increase their profits by imposing controls on the passage of ships in strategic ports or ports. This in turn entails the risk of militarization since, in the absence of a shared protection regime, each country and each transport company must ensure the protection of their vessels.

These are global risks, but there are also risks that affect companies in the short term. An example is the risk of raising transport costs. The main reason why trade in the South China Sea transits is because it has natural narrows that facilitate intercontinental trade. The busiest is the Strait of Malacca, since it is the fastest route to connect the Pacific and Indian oceans. This strait is the most economical route to move goods between Asia, India, Africa and the Arabian Peninsula. If a military or political event forced merchant ships to look for new routes, transport costs and piracy risks would increase considerably.

It is estimated that taking the second cheapest route (through the Sunda Strait) would raise transportation costs by approximately 65 million dollars, which would represent huge losses for companies that trade via this route. Any eventuality that forces ships to encircle Indonesia or even Australia would raise costs even more. In addition, these disruptions to trade in the short term can translate into uncertainty for financial markets in the medium and long term.

There is evidence that, since 2015, China is interested in maintaining a military presence in the South China Sea. And, in 2016, an international arbitration between China and the Philippines determined, under UNCLOS, that China’s historical claim has no basis in international law. These two contrasting cases show that the tension in the region is rising and there seems to be no middle ground between China’s historical claims and the prevailing trade regime.


Do you need advice on the possible effects on world trade and how would it impact the business objectives of your company? Write to info@riesgospoliticos.com.mx to help you.


Photo by Kyle Ryan on Unsplash

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