Hanns Günther Hilpert

New Trade Agreements in Asia

Liberalisation in Times of Geopolitical Rivalry

SWP Comment 2021/C 25, April 2021, 8 Pages

doi:10.18449/2021C25

With the signing of the Regional Comprehensive Economic Partnership (RCEP) on 15 November 2020, the announcement of the EU-China Comprehensive Agreement on Investment (CAI) on 30 December, and the prospects of enlarging the Compre­hensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), trade policy with and within Asia is gathering speed. In the greater East Asia region, consisting of Japan, South Korea, China and the Association of Southeast Asian nations (ASEAN), economic integration via trade, investment, supply chains and digital connectivity will accelerate. In contrast, regions that remain on the outside – i.e. North America, Europe and India – surely fear that trade flows will be diverted. At the same time, geo­politics have become a determining factor of trade policy. Any agreement also represents political positioning in the context of the Sino-American rivalry, or at least a reinsurance against the risks of economic or technological decoupling. What are the economic and political perspectives of these trade and investment agreements? What goals and strategies are the relevant actors pursuing? And what are the con­sequences for Europe’s trade policy?

The remarkable economic success that East Asia has achieved in the past five decades has not been built on isolation and autarky. On the contrary, such high growth rates, rapid industrialisation and regional wealth creation would hardly have been possible without foreign trade and trade-related direct investment. Intra-Asian trade is now greater than Asia’s trade with the rest of the world. In fact, Asia itself has become the world’s largest trading region, with China as its natural centre. However, the foreign trade environment has fundamentally changed since the turn of the millennium, and hence the continuation of the region’s decades-long upward trajectory is now less assured than before.

From Trade Policy to Geoeconomics

Whether, and if so, for how long the well-established Pax Americana security order can continue to secure Asia’s geopolitical stability has become uncertain. While the US’s role as a guarantor of regional peace continues to be highly esteemed by its local allies and trading partners, China is now the most important trade centre for all coun­tries in the region, and its share of the regional supply and sales markets con­tin­ues to grow. At the same time, the “Middle Kingdom” is increasingly acting as a revisionist superpower. Beijing’s aggressive foreign policy shows that its political supremacy and growing military clout have heightened China’s willingness to assert its interests in a conflictual manner – quite brutally, if necessary – through the use of economic and military threats.

In general, trade policy, which is osten­sibly oriented towards national economic interests, is increasingly dominated by foreign and security policy considerations. The USA is actively decoupling China in technologically sensitive areas and forcing allies and partner states to follow suit. The People’s Republic, in turn, is attempting to reduce its vulnerability as it strives for technological autonomy. Companies from third countries fear, with good reason, that they will be forced to choose sides in the course of this conflict. China and the USA aren’t shying away from using sanctions, boycotts and punitive tariffs as means of coercion in their foreign policies. Other countries, first and foremost Japan, are also shaping their trade policies strategically and are explicitly pursuing geopolitical agendas.

The shift towards geoeconomics is furthered by the progressive erosion of the multilateral framework espoused by the World Trade Organization (WTO). The WTO, founded in 1994, has so far only rudimentarily fulfilled its contractual obligation to liberalise multilateral trade. The Organization’s trade dispute settlement mechanisms have been on hold since December 2019, when the corresponding judges’ positions first went unfilled. What’s more, China con­tinuously disregards fundamental prin­ciples such as non-discrimination, most-favoured-nation (MFN) treatment and trans­parency while the USA (under Trump) has repeatedly violated the Organization’s treaty. Both countries’ transgressions con­tinue to be unaddressed by the WTO and its affected member states. At the same time, if trade law and liberalisation are not ad­vanced by the WTO, then it is hardly sur­prising that Asia’s trading states – which are so dependent on the global economy – are making their own bilateral and multi­lateral arrangements. Interest in trade and investment, which stimulate development and growth, continues unabated in the region. However, this is now increasingly supplemented by elements of geopolitics in a structure-building manner.

RCEP – Trade Liberalisation “the ASEAN Way”

With the Regional Comprehensive Eco­nomic Partnership (RCEP), the ten ASEAN countries together with Japan, China, South Korea, Australia and New Zealand will estab­lish the largest free trade area in the world. The agreement will come into force as soon as it has been ratified by at least six ASEAN countries and three other partners. In terms of its sheer dimensions – encompassing 2.2 billion people and around 30 percent of world’s production and trade – the agree­ment can hardly be understated. For the first time, through RCEP, the G20 countries of Northeast Asia – Japan, China and South Korea – will also be linked in a trade agree­ment.

RCEP documents the centrality of the ASEAN community’s foundational contri­bution to the agreement, for which it took the initiative and lead. The immediate motive of the negotiations was to consolidate the existing “ASEAN+1 Free Trade Agree­ment” framework by incorporating all relevant parties under one arrangement. As a result, RCEP should not be considered a deep, ambitious trade agreement. The agreed upon standards – for example on intellectual property rights, services, in­vest­ment and trade-related free movement of persons – are consistently weak and lack a future vision. Nonetheless, it was precisely this low level of ambition that made it pos­sible to include developing countries, which were also granted individualised elongated transition periods and differentiated adjust­ments. This approach was in line with the aspirations and objectives pursued by ASEAN, namely, to unite the states of the Indo-Pacific region in a large, open trade and investment area that promotes eco­nomic integration, growth and development while simultaneously integrating less developed states and counteracting the per­ceived divisive tendencies of the former Trans-Pacific Partnership (TPP) initiative. The signing of the agreement does not mark the end of negotiations. RCEP is to be open to accession by third countries, par­ticu­larly India, which dropped out of the agreement at the last moment. Further development of the agreement’s content is also planned. This is to be expected, as we know from past experience that ASEAN trade agree­ments start out weak, but then are suc­ces­sively improved upon and modernised. It is envisaged that an RCEP secretariat, which is yet to be established, will ensure that the agreement is continuously adapted and developed.

In terms of trade policy, liberalisation and facilitation of trade in goods are at the centre of the agreement. When it enters into force, 65 percent of RCEP’s intra-trade will be duty-free, and after twenty years this figure should be at least 92 percent. How­ever, liberalisation is not uniform. About half of the countries apply different tariff rates, depending on the RCEP trading part­ner. In addition, varying customs tariff sys­tems apply. Nonetheless, customs clearance will be much simpler. For example, a single document covering several processing stages and border crossings will suffice to prove the origin of goods. Documentation of data accompanying the trade will be able to occur centrally, in RCEP member coun­tries.

Tariff reductions outlined within the agreement mainly concern industrial, less agricultural, goods. While the ASEAN coun­tries are barely reducing their already low bilateral external tariffs, the tariff reduc­tions by China (and to a lesser extent South Korea) vis-à-vis Japan are quite substantial. This has caused some observers in Japan to even refer to RCEP as a “China-Japan free trade agreement”. An immense facilitator of trade will be seen in the uniform appli­cation of the comparatively easy-to-handle ASEAN rules of origin, which serve as proof that only goods from the RCEP free trade area, but not from third countries, benefit from tariff exemption.

With a reasonable amount of bureaucratic effort it will be possible to cumulate rules of origin over several stages of nation­al processing. As a rule, the minimum value-added share on a “Free On Board” (FOB) basis is set at a modest 40 percent, which means a maximum share for supplies from third countries of 60 percent. According to a forecast by Euler Hermes, harmonising the information requirements and setting a uni­form minimum value-added would save US$90 billion in costs per year in intra-RCEP goods trade.

The American economists Peter Petri and Michael Plummer estimate that RCEP trade will increase by US$500 billion per year after treaty implementation and that trade-related income will amount to US$186 bil­lion per year, with China accounting for about half of these figures and Japan for just under a quarter. Accordingly, North­east Asia will benefit more from tariff reduc­tions than Southeast Asia, Australia, and New Zealand. There are two reasons for this: first, Northeast Asia hosts the larger economies in absolute terms, and second, China and South Korea are making the biggest cuts to their tariffs. At the same time, trade gains are offset by trade diver­sions. Thus, from a dynamic perspective, the intensification of trade and investment links in the RCEP region is at the expense of trans-Pacific and Eurasian trade and invest­ment flows, even if Asian branches of Euro­pean or American companies benefit from the facilitation and liberalisation of trade in goods just as much as local businesses.

Likely to be even more important than its direct effects on trade is the agreement’s im­­pact on investment and the configuration of value chains. The combination of reduced tariffs, facilitated cross-border trade and stand­ardised rules of origin will trigger a re­organisation of supply chains. This is all the more true as China – a major producer – is already under pressure due to costs and American punitive tariffs while Beijing purses a policy of economic and techno­logical upgrading. The poorer countries in Southeast Asia – including Cambodia, Myanmar, Indonesia and the Philippines – could benefit from this, as these investment destinations must now meet new and har­monised RCEP standards.

China Wins

The boost to economic integration provided by RCEP will benefit China in particular. RCEP and the complementary CPTPP agree­ment (see below) support national growth in the region and its external orientation towards the Chinese industrial core by enabl­ing trade integration in an enlarged East Asia, thereby increasing the competi­tive­ness of “Made in Asia” goods and ser­vices. The People’s Republic is thus likely to further expand its role as a regional centre of gravity and strength. Beijing’s Belt and Road Initiative further supports this trend because it creates economic dependencies that favour China. China’s position is also strengthened by the fact that the four-decade-long trend of higher economic growth in East Asia compared to other world regions will continue. This is all the more plausible considering that the region is cop­ing comparatively well with the COVID-19 pandemic in terms of health policy and the economy, and will have to work through fewer structural distortions after this crisis.

China is also the political winner of RCEP. Indeed, political motives are likely to have prompted the country’s willingness to com­promise. With the conclusion of the nego­tia­tions in the end of 2019, China proved that it could resist America’s efforts to con­tain and isolate it. The signing of the agree­ment in November 2020 represents regional accord, despite Beijing’s aggressive foreign policy towards some of its neighbours that same year.

India Loses

India ultimately refused the RCEP compro­mise in November 2019, after 31 rounds of negotiations and 18 ministerial meetings. By not participating in the agreement, India is missing out on US$60 billion in income annually, economists Petri and Plummer estimate. The country’s exclusion from Asia’s supply chains will have a lasting im­pact on the development and industrialisation of the Indian subcontinent. Politically, however, New Delhi’s decision is at least partly understandable. India’s federal gov­ern­ment feared import competition from China (industrial goods), from Australia (dairy products) and from Southeast Asia (spices) and was not prepared to accept free trade in digital data and source codes. On the other hand, India could not push through its own demands, such as those for a snapback mechanism in the face of excessive imports of goods, for more restrictive rules of origin – which would protect its industry – and for a wider opening of RCEP services mar­kets. Above all, liberalising trade in goods with China was and is politically unfeasible in the country. This is because India already has a high deficit here; the bilateral trade structure is perceived as colonialist, Chinese competition as unfair.

From the mid-1990s, New Delhi success­fully pursued a policy of foreign trade liber­alisation and global economic integration, but under Prime Minister Narendra Modi, a change of course has taken place. As the current economic policy guidelines “Make in India” and “Self-Reliant India” indicate, the development strategy is once again ori­ented inwards. Industrial policy has gained importance and external protections are increasing, especially vis-à-vis China.

CAI – Prioritizing Market Access

Shortly before the end of 2020, the EU and China agreed on a Comprehensive Agree­ment on Investment (CAI) preceded by 34 tough rounds of negotiations over seven years. The prospect of a common Western trade front had forced China to make deci­sive concessions shortly before the Biden administration took office. As a result, the CAI will substantially improve European companies’ access to the Chinese market and make the playing field for investors in China a bit fairer and more rule-bound on an MFN-basis, while the EU’s internal mar­ket remains open to Chinese investors. With the CAI, China renounces forced tech­nology transfer and joint venture coercion, and promises transparency of state sub­sidies and state-owned enterprise regula­tions. In a sustainability chapter, Beijing also accepts best effort clauses to comply with environmental and labour standards. It has even promised to sign the conventions of the International Labour Organisation (ILO) on forced labour.

However, it is questionable whether, and if so, how stringently the CAI will be im­ple­mented. On the one hand, due to past nega­tive experiences, there is great scep­ticism as to whether China will actually keep the promises it has made. At the very least, it will require strong political efforts on the part of the EU to press for active implemen­tation in line with the agreement. On the other side of the coin, in view of fierce criti­cism of the CAI in Europe, it is uncertain whether the agreement will be signed at all during 2022’s French EU Presidency, let alone be ratified by the European Parlia­ment.

It is obvious that the EU is positioning itself as an autonomous trade policy actor that not only advocates for improved mar­ket access for European companies – ex­tracting considerable concessions from China in the process – but also for a rules-based trade order that enforces its own regulatory standards. With the CAI, the EU is sticking to its policy of integration and interdependence vis-à-vis China in principle and is not seeking to decouple itself from the People’s Republic, at least economically, even if political differences have grown in recent years.

However, this trade policy positioning comes at the cost of foreign policy credibility. Under Xi Jinping’s reign, China has hardened its authoritarian stance and, espe­cially in the past year, pursued aggres­sive foreign policies towards Hong Kong, Tai­wan, Australia, India and Sweden. In light of this, critics from European civil society, media and politics rightly see the EU’s agreement with Beijing as opportunistic acceptance of Chinese realpolitik. By con­sciously and visibly deciding to prioritize market access, the EU loses political per­suasiveness in claiming to represent the values of democracy, freedom, the rule of law and human rights vis-à-vis its “systemic rival” China. Moreover, the timing of the conclusion of the negotiations could hardly have been worse, immediately before the Democratic Biden administration took office and openly promoted a common China policy for the West. The CAI will not make it easy for Europe and the USA to find a unified position vis-à-vis Beijing. But this is most likely what China hoped to achieve with its concessions shortly before the end of Germany’s EU Council Presidency. Now China can present itself as a responsible great power committed to multilateralism. For Europe, the bitter realisation remains that the EU has yet to find the right balance between its foreign economic interests and foreign policy aspirations.

CPTPP – on the Way to Enlargement

In January 2017, under newly inaugurated President Donald Trump, the USA withdrew from the Trans-Pacific Partnership (TPP) agree­ment, which had been negotiated under American guidance and leadership. Nonetheless, the remaining eleven coun­tries agreed to pursue the initiative without Washington. Indeed, on 8 March 2018, Aus­tralia, Brunei, Canada, Chile, Japan, Malay­sia, Mexico, New Zealand, Peru, Singapore and Vietnam signed the agreement under a new name, the Comprehensive and Pro­gressive Agreement for Trans-Pacific Partner­ship (CPTPP, also TPP-11). 22 clauses were suspended – but not removed – from the original text of the agreement, mostly in the area of intellectual property rights. The CPTPP entered into force on 30 December 2018 for Australia, Japan, Canada, Mexico, New Zealand and Singapore, and on 14 January 2019 for Vietnam. Brunei, Chile, Malaysia and Peru have not yet ratified the CPTPP.

Even without American participation, the CPTPP is the most important trade agree­ment since the foundation of the WTO in 1994. Its achievements include far-reach­ing liberalisations, ground-breaking devel­op­ment of trade rules and its strategic posi­tion as a spearhead of global trade lib­er­alisation open to accession. For the EU, the CPTPP is equally partner, competitor and adversary in the international regulatory arena. The newly established United States-Mexico-Canada Agreement (USMCA) nego­tiated in 2017/2018 already used numerous CPTPP treaty clauses as a template.

The agreements reached in the CPTPP look to the future. Industrial and merchandise trade will be almost absolutely liber­alised. When the agreement enters into force, 86 percent of tariff lines will be duty-free; after fifteen years, this figure will be 99 percent. Non-discrimination, MFN treat­ment, freedom of establishment and trans­parency are comprehensively and legally guaranteed for analogue and digital ser­vices. All relevant protection standards apply to investments. In cases of expropriation and discrimination, investor-states can pursue arbitration. The agreement’s sus­tain­ability chapters commit signatories to ILO protection standards and relevant inter­national environmental accords. With regard to state-owned enterprises, CPTPP members commit to the principles of non-discrimination, non-subsidisation, trans­parency, neutral oversight and commercial orientation. Special technical committees will ensure that the agreement is implemented in accordance with the treaty and, if necessary, adjust its contents. Member states will be responsible for internal co­ordination and cooperation as well as exter­nal representation through annually rotat­ing chairmanships.

The CPTPP is also on the verge of enlarge­ment. Numerous countries have expressed interest in membership, including the United Kingdom, Colombia, South Korea, Taiwan, Thailand and even the People’s Republic of China. The sequence of future enlargements will largely determine how the CPTPP positions itself in the realms of trade and geopolitics.

Nonetheless, so far only the United Kingdom has formally applied for membership (on 1 February 2021). The British government hopes that CPTPP membership will help it achieve its desired post-Brexit new start in trade policy while also manifesting its dream of a “Global Britain” in an anglo­sphere world. The UK’s chances of acceding are good. From the CPTPP member per­spec­tive, the UK would be an economically attractive new member. Moreover, it should not be particularly difficult for the country to fulfil the obligations of the agreement. However, the character of the CPTPP would fundamentally change if a non-Pacific lit­toral state were to be admitted. The CPTPP would then be less of a Pacific regional free trade area and more of a free-trade-oriented globalisation club dominated by the Anglo­sphere. In this respect, Britain’s accession should not be regarded as a foregone con­clusion.

In principle, the return of the USA to the agreement is also possible. It is very likely that the CPTPP members would be willing to reinstate the 22 treaty clauses suspended during renegotiations in order to facilitate the country’s accession. Such would not only bring substantial revenue to the USA, but would also grant it an instrument with which it could contain China’s geopolitical ambitions. However, domestically, it would currently be difficult to negotiate the open­ing of the American market that the CPTPP requires. In view of America’s precarious domestic situation, the priorities of the Biden presidency do not lie in foreign eco­nomic policy, at least for the time being.

China’s desire to join, prominently voiced by Xi Jinping himself, has several motives. First, with CPTPP membership, the country could broaden its exports and imports, realis­ing significant income gains in the pro­cess. Second, similar to China’s WTO accession in 2001, the admission conditions could be used to push through politically difficult domestic reforms. Third, as a CPTPP member, the People’s Republic would be excellently positioned to help shape global trade rules in the future. Fourth, China’s participation in the agree­ment could defuse the Sino-American trade conflict. And fifth, joining would be seen as a diplomatic vic­tory over the USA. How­ever, it is ques­tion­able whether China would ever be able to fulfil the strictly worded treaty clauses on state-owned en­ter­prises, intellectual prop­erty rights, sus­tain­ability and freedom of establishment for foreign-controlled digital companies. For the country to join, CPTPP members would have to concede to less specific and less strict entry conditions. This is not expected however. After all, the un­spoken purpose of the CPTPP is to commit Beijing to a rules-based trade regime. Once it joins, however, China would no longer be forced to change its protectionist structures and discriminatory behaviour.

Taiwan would have comparatively few prob­lems meeting the CPTPP accession criteria. Admittedly, the country’s politically well-connected agricultural lobby would fiercely resist a market opening, but it would probably have little domestic po­liti­cal clout if the agreement’s proponents were to point to the upgrade to Taiwan’s international political profile should it join. Unsurprisingly, however, China has already declared its opposition to Taiwan’s admis­sion even though, as a non-member, it can­not block the potential process. Still, China would likely brand such a move as inter­ference in its internal affairs and exert political pressure on all CPTPP members to oppose Taiwan’s admission.

Japan will play a central role in upcom­ing accession negotiations. The country is the de facto leader of the CPTPP and holds this year’s chairmanship. The transfer of the TPP initiative to the CPTPP would not have been possible without Tokyo’s decisive action. For beyond liberalisation, trade policy has been a strategic instrument of foreign policy for both the administrations of Shinzo Abe (2012-2020) and Yoshihide Suga (since September 2020). In congruence with Japan’s “Free and Open Indo-Pacific” (FOIP) strategy, officially announced in 2016, the CPTPP is meant to contain China’s economic offensives. Against this backdrop, the Japanese trade bureaucracy has already made it clear that it will insist on rigorous liberalisation and regulatory standards and will not accept watering down the content of the agreement to make a major (i.e. Chi­na’s) accession possible. In this context, liberal UK’s application for membership comes in handy for Tokyo. London could be used as a model for accession, setting a standard that China would certainly not be able to meet.

Conclusions for Europe

The new EU strategy for an open, sustain­able and assertive trade policy sets the neces­sary groundwork to be able to deal with the Chinese challenge in a realistic and defensive manner. However, aside from China, Asia remains virtually unmentioned in the strategy despite being the most dy­nam­ic and, in terms of its volume, the most important economic region in the world. Moreover, if the EU is to maintain and strengthen the rules-based trade order, espe­cially in the face of Beijing’s offensives, close cooperation with like-minded actors in the Indo-Pacific region, including Japan, South Korea, Australia, Singapore and Canada, is indispensable.

European trade policy should do two things. First, it should expand Indo-Pacific trade and investment links beyond China, or at least mitigate existing dependencies on the Chinese market. Bi- and multilateral agreements can be useful to this end. In par­ticular, the negotiations for EU-Australia and EU-New Zealand free trade agreements, which have been ongoing since mid-2018, should be brought to a swift conclusion.

Second, the EU should also enter into free trade negotiations with the CPTPP as a group. At the very least, the EU and the CPTPP should mutually agree on further developing and modernising global trade rules, especially in the areas of intellectual property rights, sustainability, safeguards, subsidies, state-owned enterprises, digital trade and the settlement of investor-state disputes. Should a deal be reached with Australia and New Zealand, the EU would be linked in a free trade agreement with all those states that have ratified the CPTPP. This would provide an excellent political and legal basis for a Euro-Indo-Pacific part­nership that would extend beyond trade policy to foreign policy.

EU-China trade and foreign relations wit­ness both sides pursuing analogous inter­ests that overlap in most areas. Seeing that far-reaching convergence on regulatory issues already exists (or has been achieved in individual free trade agreements), co­operation with the CPTPP would also im­prove the chances that EU standards are enforced globally. Finally, a Euro-Indo-Pacific partnership would also be important when looking to the USA. Such could help counter the recurring trend towards pro­tec­tionism and unilateralism in America with much more persuasive and assertive power.

Dr Hanns Günther Hilpert is Head of the Asia Research Division at SWP.

© Stiftung Wissenschaft und Politik, 2021

SWP

Stiftung Wissenschaft und Politik

ISSN (Print) 1861-1761

ISSN (Online) 2747-5107

(English version of SWP‑Aktuell 23/2021)

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