The RCEP is likely to strengthen Asia as the worldʼs growth engine

The US-China trade conflict still rages on. Meanwhile, China and other Asian-Pacific countries have created the world's largest free trade zone to date in the region. On November 15, the heads of state and government of China, Japan, South Korea, Australia and New Zealand made an agreement with the Southeast Asian community of states ASEAN, which includes emerging countries such as Laos, Thailand, Vietnam and Indonesia. The free trade zone, which comprises a total of 15 states and around 30 percent of global economic output, affects around 2.2 billion people and even exceeds the Economic Partnership Agreement (EPA) between the European Union and Japan, which came into force on February 1, 2019, and covers 35 percent of world trade.

With the RCEP, the focus of the global economy will shift further east. For China, the agreement represents an opportunity to further expand its economic influence. However, for companies from the USA and Europe, the conditions in the region are likely to become more competitive. Sven Schubert explains what effects the agreement could have on the global economic order.

Is the RCEP a strategic move by China to build a stronger foundation for its One Belt One Road initiative and to break away from a US-dependent global trade landscape?

Yes and no. China has recently rolled out its strategic priorities for the next five years on its 19th Central Committee of the Communist Party. Dual circulation (domestic and external) has become a top priority. Domestic circulation means that China wants to strengthen the domestic market by becoming self-sufficient and less dependent on the imports of goods that are critical for the Chinese economy. The trade war has shown that the Chinese economy still depends on goods like semiconductor technology – China produces only 30% of what it consumes – from abroad. This is just one dependency, which the Trump administration used as a lever against China. Therefore, China wants to reduce its dependency on the global economy by reducing the imports on critical goods over time.

However, external circulation is part of the strategy too. China will remain open to foreign investors and producers and is likely to liberalize its capital markets even further. In the second quarter – after heavy outflows in the first half – Asian capital inflows (equities and bonds) reached a 7-year high. This is thanks to the Chinese opening financial markets to foreigners (e.g. bond index inclusion). Going forward this trend will continue, as China will continue to rely on foreign capital if it wants to be successful in climbing up the value chain. Therefore, China has an interest to keep good trade relations, but it wants to reduce its dependence on critical goods for the economy, in particular from the US.

Could the RCEP help Asian economies, emerging market members in particular, to recover from the pandemic?

The RCEP is clearly a positive development from an economic point of view as a lot of trade is taking place within the region. Approximately 40% of Asian exports stay in the Asian region. However, the real economic impact is unlikely to be felt in the near term, as the implementation is to start in 2021 and the tariff reductions will only get into full swing in 2022. However, the economic recovery is a sure thing as many Asian countries handled the COVID-19 crisis better than European or American countries.

The impact of the agreement will be significant not only because it encourages intraregional trade but also because it could even out economic divergences of living standards among member states. We have low- (Myanmar, Cambodia, Laos, Vietnam and Philippines), middle- (Indonesia, Thailand, China and Malaysia) and high-income (Brunei, S. Korea, Japan and Singapore) countries in the union. Therefore, supply chain restructuring is most likely getting a fresh boost with some production facilities moving out of China to other South East Asian countries.

In sum, the RCEP has an uplifting effect on investors’ sentiment and will fortify Asia as the worldʼs growth engine.

India and the US are not part of RCEP. Does their absence mean that China will have significantly greater power in setting the terms for this trading bloc?

India decided not to be part of the RCEP because it would have been the country with the second highest tariffs (9.5% average of WTO and World Bank index) in the trading bloc. This would have put increased pressure to reduce tariffs on the country. The economic risk was simply too high for the Indian government. Another important factor in answering this question is the relationship between China and India. In 2020, tensions between China and India have increased. The border conflict caused human casualties on both sides and India banned TikTok from its domestic market. Because of these tensions and higher Indian tariffs within the trading bloc, Indian participation would probably have slowed down tariff reductions.

The non-participation of the US strengthens not only Chinaʼs but also the regionʼs bargaining power as a whole. A comparison with the EU illustrates this point: negotiations with third parties is easier as a bloc with uniform rules. However, from an economic perspective, US participation would have been a clear signal of easing trade frictions between China and the US, which is why a US participation would have been beneficial for China in economic terms. In sum, the disadvantages of US non-participation, however, weigh heavier on the US than on the RCEP.

What does the RCEP mean for US-China trade tensions – could it be part of China’s strategy to gain stronger influence in global trade?

Rather no. Already for a decade China has been pursuing the strategy of reducing its dependency on exports and strengthening the domestic market. And indeed, China became less dependent on exports in general, and exports to the US in particular, in recent years. Between 2006 and today, Chinaʼs exports to GDP decreased from 36% to 19% of GDP. Over the same time period exports to the US decreased from 7% to 3% of GDP.

On the other hand, Chinaʼs “dual circulation” policy means that China wants to open up more to attract foreign investors (“external circulation”). By giving foreign investors access to the Chinese market, China is better protected against foreign sanctions. The tech industry is a good example. As China is one of the most important export markets for US tech companies, any restrictions by US authorities on US technology exports to China will hurt the US corporate sector too. Therefore, China has a strong interest in opening its economy up further to foreign investors and producers over the next few years. The International Monetary Fund has demonstrated in numerous publications that global trade goes hand in hand with innovation. Shutting a country off from foreign investors would hence be a big mistake.

There are speculations that the US might re-join the Trans-Pacific-Partnerhsip (TPP) after Biden takes office. Could this change the power dynamics in the region again?

True, Biden may try to renegotiate the TTP. And China would probably be happy about negotiations with the US in general. However, the trade war has changed Chinaʼs attitude regarding trade relations with the US. China still wants good trade relations with the US but not at any cost. That is why China will reduce its dependency from the US further going forward. Trade tensions may ease under Biden but his presidency is unlikely to change the trend that the center of economic activity is gravitating towards Asia. However, this does not mean that China will break US economic and financial dominance in this decade. The depth of US financial markets, US military dominance and the importance of the US dollar are key assets in the struggle for supremacy. Moreover, global investors still tend to have more trust in US institutions than in Chinese institutions. Even Donald Trumpʼs presidency could do no harm here.