Trade negotiations: which region has the best poker face?

Could there be more to the economics of Asia’s new trading bloc than meets the eye?

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The agreement has been made against the background of major demographic changes underway in China and the Association of Southeast Asian Nations (ASEAN) economies that will provide a powerful force for the expansion of trade in the region.

"Economists warn that the economic gains from Regional Comprehensive Economic Partnership will be only “incremental”.”

That and China’s natural desire to play a central role in the development of the East Asian community could make this a trade agreement like few others.

Admittedly, the Regional Comprehensive Economic Partnership (RCEP) is off to a modest start.

The new trading bloc has been welcomed for its large number of member states and its long-term potential at a time of populist protectionism.

But while the northern industrial giants – China, Japan and South Korea – have agreed to substantial cuts in their trade barriers, the ASEAN nations have been reluctant to let go of the tariffs that protect their largely assembly-level manufacturing. The trade barriers are scheduled to come down very slowly, with the implementation spread over 20 years.

Even with the rationalisation of the region’s “free trade” agreements and their varying rules-of-origin, economists warn the economic gains from RCEP will be only “incremental”.

But consider this: China is facing what British economists Charles Goodhart and Manoj Pradhan call a great demographic reversal. China’s working-age population is shrinking. It is expected to decline by 9 per cent by 2035 and 20 per cent by 2050. 

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At the same time, however, the ASEAN economies’ pre-1990 baby boom cohort is swelling the labour force, with the working age population projected to account for 68 per cent of region’s total population in 2025.

That alone has the potential to make this trading bloc different.

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Holding the cards

Usually countries enter trade negotiations in the hope of increasing their exports in return for agreeing to accept more imports at the necessary price. But, in this trade agreement, China’s demographic challenge is reversing the priority.

China is facing a labour shortage. It will need ASEAN’s surging working-age population to produce the components necessary to feed the Chinese industrial juggernaut. China wants imports, as do Japan and South Korea.

Hence the ability of ASEAN’s politicians to limit their concessions to the northern industrial giants. They hold the best cards.

However, as every ASEAN economist knows and Australia’s trade-reform example shows, the key to ASEAN’S prosperity includes the very imports ASEAN is reluctant to let in.

Like people, countries increase their incomes by specialising in what they do best. And the only way you can specialise in what you do best is by buying the things you don’t make so efficiently from the people who can.

For all their success as exporters, the three big upper-middle income ASEAN nations – Malaysia, Indonesia and Thailand - have been struggling to complete their climb from middle-income to high-income prosperity.

Even Malaysia, with a per capita income just short of the high-income threshold, has been stuck in the World Bank’s upper-middle category for almost 30 years. That’s twice as long as it took Taiwan and South Korea to climb through the upper-middle income range.

Indonesia is close to the bottom of the range. Thailand is sitting around the middle of the range but is impaired by political divisions. The Philippines and Vietnam are in the low-middle income range.

Avoiding the trap

Economists now talk about the “upper-middle income trap”, pointing to the difficulty of mastering the more sophisticated capitalism needed to make the transition from middle-income to high-income status.

That will come from specialisation, investment in skills, and a competitive culture that devours new ideas from everywhere and breeds its own, indigenous innovation. It is less likely to happen behind tariff walls that reduce the incentive for innovation and impose a hidden tax on exports.

Despite their export-oriented growth strategies, the ASEAN countries have found it difficult to specialise because their economies are similar. Specialisation through trade works best when the trading countries have different specialties.

But now the ASEAN nations are being offered the opportunity to expand their trade with the very different industrial giants in the north desperate to take the fruits of the ASEAN supply- chain and its workers. 

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Yet there are no guarantees of success. The slow tariff reduction negotiated by the ASEAN economies almost certainly reflects strong political resistance to trade liberalisation. It would be surprising if it were any other way: securing the economic gains from trade necessitates the contraction of uneconomic industries to make way for the new growth sector. It is a painful process.

Perhaps China, with its strong geopolitical interest in building a closer East Asian community, will help smooth the path. 

Looking back over the decade since it identified the middle-income trap, the World Bank points to the relative success of Europe’s middle-income economies.

“The economic success of countries integrating into the European Union has persuaded us that external commitments have a far more significant role to play than we thought,” it says.

“In fact, convergence within Europe has been one of the extraordinary stories of growth in this century.”

The World Bank’s economists talk about the European Union’s formidable “convergence machine”: “We neglected the value of regional institutions and organisations in pre-committing middle-income countries to a long-term reform trajectory and the impact this could have on economic development.”

The political and economic strength of China’s demand for ASEAN labour and what the World Bank calls ASEAN’s own neighbourhood effects might work some of the same kind of magic.

Memories of the promise of APEC’s Bogor declaration (free trade and investment), and of the success of Australia’s unilateral trade reform might also help accelerate the transition.

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Australia had its own formidable convergence machine in the form of the Industry Assistance Commission’s independent exposure of the true cost of industry protection.

It worked for us and, with China’s encouragement, it could work for ASEAN.

Alan Mitchell is a bluenotes columnist and former economics editor of the Australian Financial Review

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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