RCEP: The consequences of the world’s largest free trade zone

The Regional Comprehensive Economic Partnership (RCEP), the largest free-trade zone in the world, is emerging in the Asia-Pacific region. On the 15th November 2020, the heads of state and government of China, Japan, South Korea, Australia and New Zealand signed the agreement with ASEAN, the Association of Southeast Asian Nations, which includes Thailand, Vietnam and Indonesia amongst others. According to Malaysia’s Trade Minister, it took ‘blood, sweat and tears’ to bring the record trade deal to a close, after more than eight years of tough negotiations. The trade pact encompassing a total of 15 states comprises around 30 percent of global economic output and a population of 2.2 billion.

 

Figure 1. The world’s largest free trade areas, measured by nominal 2019 GDP in billion USD. Lukas Wittman.

 

China’s Prime Minister Li Keqiang had recently praised the agreement as ‘a strong positive signal for the progress of regional integration and economic globalization.’ The government in Beijing promotes the free trade pact as an alternative to the Trans-Pacific Partnership (TTP), especially since President Trump withdrew the US from the TTP in 2016. Indeed, the deal offers China the opportunity to further expand its economic influence in Southeast Asia, which is China’s biggest trading partner with a trade volume of 1.058 billion USD in the first two quarters of 2020, followed by Europe with 396 billion USD and the US with 234 billion USD. RCEP, the very first trade deal between China, Japan and South Korea, also allows China to present itself as a pioneer of globalization in an era of waning multilateralism and rising populism.

Trade agreements in general can generate substantial gains. Empirical work by the International Monetary Fund finds that trade agreements are associated with an increase of exports by 80 percentage points over ten years, on average. The export gains are even higher when emerging markets have trade agreements with advanced markets. In the case of RECP, the presumed prosperity gains from this agreement are estimated to be 200 billion USD. While all participating countries will benefit, economists criticise the distribution of profits. It is estimated that half of the 200 billion profit goes to China, a quarter to Japan and the other quarter to the remaining states. To avoid opening up domestic Indian markets to a flood of Chinese goods, Narendra Modi refused to sign the deal.

For companies from the US and Europe, the competitive conditions in the region are likely to become more difficult. The trade pact puts China in a better position to significantly determine regional trade rules, so it will become more difficult to enforce European product standards. While standards will still apply to exports to the EU, they will no longer play a major role in the region itself. The new ‘rule of origin’ criteria of the deal determines that a product manufactured in the RCEP will work for all 15 countries, significantly reducing necessary paperwork. That might permanently disadvantage European firms competing in China. However, unlike the EU single market, the trade deal is not likely to lead to large overall tariff reductions.

In conclusion, RCEP will likely lead to welfare gains for all participating countries. However, doubts over the distribution of gains and the effect on competitive standards remain justified.

 

By Lukas Wittman

Sector Head: Jackson Philips

 

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