Analysis of RCEP (and CPTPP)

 BRIEFING

The return of free trade

THE FREE-TRADE DEAL SERVES PRESIDENT XI’S INTERESTS NICELY

While Britain and the EU struggle to come to terms, 15 Asia-Pacific countries quietly signed the biggest free-trade deal in history. That’s a welcome development, says Simon Wilson

WHAT’S HAPPENED?

In the middle of last month, as the UK and EU were struggling to nail down the world’s first free-trade agreement explicitly aimed at putting up fresh barriers to trade rather than tearing them down, 15 Asia-Pacific economies quietly signed the world’s biggest free-trade agreement. The Regional Comprehensive Economic Partnership (RCEP) has been signed by China, Japan, South Korea, Australia and New Zealand – along with ten southeast Asian countries, all members of the existing Asean trade bloc. The agreement covers almost a third of the world’s population and about 30% of global GDP – and is the first ever free-trade deal between China, Japan and South Korea, the biggest, second-biggest and fourth-biggest Asian economies. Of the major Asian economies, only India has opted out, over concerns over cheap Chinese imports. But as one of the original negotiating partners, it has an option to join at a later date.

WHEN DOES THE DEAL TAKE EFFECT?

It’s likely to be years rather than months, and some of its provisions may not take effect for up to 20 years. After eight years of tortuous on-off negotiations, the deal was concluded following a four-day international summit in the Vietnamese capital, Hanoi, in mid-November. But it must now be ratified by each country, and will not take effect until at least six of the ten Asean nations, and three of the five non-Asean nations, have done so. The key aim of the agreement is the progressive lowering of tariffs to allow more free movement of goods and encourage investment.

HOW IS THIS DIFFERENT FROM THE TPP?

RCEP represents a bigger bloc, but a less comprehensive deal. Since President Trump withdrew the US from the Trans-Pacific Partnership (TPP) trade deal in 2017, it has been renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and was ratified by its 11 remaining members in 2018-2019. The RCEP nations’ overall market size is nearly five times greater than that of the CPTPP, and the trade between them twice as big. Seven countries (notably Japan and Australia) are in both blocs. But crucially, the new bloc includes China and South Korea (and six southeast Asian economies that are not CPTPP signatories). It does not include the Americas members of the CPTPP (Canada, Mexico, Peru and Chile). However, compared with CPTPP, the RCEP is less comprehensive – and with much less emphasis on labour rights, environmental and intellectual property protections and dispute resolution mechanisms.

HOW IMPORTANT IS THE AGREEMENT?

RCEP was conceived as a grand “tidying-up exercise”, says The Economist, bringing together various smaller trade agreements in place between the Asean nations and Australia, China, Japan, New Zealand and South Korea. As such, only a limited amount of Asian trade is affected. Indeed, “of the $2.3trn in goods flowing between signatories in 2019, 83% passed between those that already had a trade deal”. The biggest benefits, in terms of trade liberalisation, will probably come of RCEP’s rules of origin – that is, the principles setting out how much regional content a product must have for it to enjoy lower tariffs. Currently, exports from an Asean state could face three different sets of rules when exported to China, South Korea or Japan. Now such companies will only need to comply with one and the rules are relatively liberal: many products will need just 40% of their value to be added within the region in order to  take advantage of lower tariffs”. 

WHO GAINS THE MOST?

The RCEP is not “China-led”, in the sense that it was the Asean nations that conceived the pact and have driven it forward. But it definitely serves China’s interests. The old TPP included provisions that reined in state-owned firms and included rules on labour and environmental standards. RCEP includes none of those constraints and is likely to strengthen China-centric supply chains. But a study by Peter Petri of the Peterson Institute and Michael Plummer of Johns Hopkins University estimates that Japan and South Korea will gain the most, with real incomes 1% higher by 2030 than they would have otherwise been.

SO A BIT OF DAMP SQUIB?

It has certainly been over hyped, says Salvatore Babones in Foreign Policy. The RCEP is a “straight tariff-reduction agreement at a time when base tariffs are already low, and countries don’t hesitate to impose punitive tariffs whenever it suits their foreign-policy objectives”. Moreover, it avoids hard issues such as state subsidies, intellectual property theft and investor-state disputes. Yet it remains the biggest free-trade deal in history, says Petri and Plummer for the Brookings think-tank. Together, CPTPP and RCEP are the only major multilateral free-trade agreements signed in the Trump era. And as now configured (ie, without the US) both of them “forcefully stimulate intra-East Asian integration around China and Japan”. RCEP will “help China strengthen its relations with neighbours”, and accelerate northeast Asian economic integration. 

WHAT SHOULD AMERICA DO?

In terms of pushing back against China, and reasserting US leadership on trade, the “obvious move”, says the FT, would be for the Biden administration to take the US into the CPTPP. Alas, while “such a move would make sense in diplomatic and economic terms”, it is probably “politically impossible in the current US climate”. There is an interesting geostrategic dilemma for India, too, with its goal of emerging as this century’s second Asian superpower. The Modi government has stood aside from RCEP, but India “must take care it does not relapse into the defensive, inward-looking attitude that has served the country so badly in the past”. And for the Western world as a whole, RCEP presents a salutary reminder. Whatever the prevailing mood of scepticism towards economic liberalisation, “free trade is the best route to greater prosperity”.

MONEYWEEK

Where should UK turn for trade growth?

 

Asia is where Britain should look for growth

Brexit is all about doing trade deals and getting agreements with the 85pc of the world economy beyond the EU

LIAM HALLIGAN6 December 2020 • 6:00am

During this pandemic, the UK’s political class has rightly been absorbed with care home rules, test-and-trace and tiered restrictions. Meanwhile, by far the most important story of our time has gathered pace.

This weekend it’s all eyes on Brexit – clearly hugely important, involving several world-ranking economies, not least the UK. How our European Union departure pans out will affect the lives of several hundred million people.

Yet, deal-or-no-deal, Brexit is a footnote in history. Rows over “level playing fields” and renewed UK sovereignty won’t be major themes when historians look back a century from now.

For the really big development of our time, the utterly dominant geo-strategic mega-trend, is the on-going shift in the economic balance of power from West to East. And, over the last year, that shift has been both accelerated and accentuated by this pandemic.

This autumn, a surge in Covid-19 cases forced the US and most European nations back into lockdown. Yes, there are vaccines coming, but – with the best will in the world – there will likely be setbacks and national rollouts will anyway take time.

The UK, and much of Europe, will remain shuttered until Easter and probably beyond. The economic impact is mind-boggling.

The Government is spending around £1bn per day on furloughing and other support measures, as our stymied economy struggles to generate tax.

That’s why state debt is up £400bn this year – an annual budget deficit of 19pc of GDP, twice what we borrowed following the 2008 financial crisis.

Over the coming half-decade, national debt, at a post-war peak as entered into this pandemic, will balloon from roughly £2 trillion to £3 trillion – well over £100,000 per household. That’s why no-one wants to think seriously about the dangers of debt being absorbed by the Bank of England.

Astonishing monetary profligacy is happening across the Western world, of course, as panicked governments, cheered on by ambitious advisors with scant knowledge of economics, bury blatantly obvious lessons of history.

Across much of Asia, in contrast, anti-virus restrictions are becoming the stuff of distant memory.

In countries including China, India and South Korea life is returning to normal. With Covid-19 contained, bars and restaurants are bustling, buses and trains are crowded and cities are buzzing once again. The picture could hardly be more different.

So far during this pandemic, the US and Europe combined, home to 15pc of the global population, have endured almost half the world’s 1.6m Covid-related deaths. The often densely populated nations of Asia, though, while accounting for over a third of all people on earth, have registered less than a fifth of all fatalities linked to this virus.

Which brings us back to economics. Over the last three decades, since the Berlin Wall fell and economic liberalism was unleashed across the post-communist world, Western growth has clearly lagged Asia. And now, the highly uneven incidence of Covid-19, with the West suffering far worse, has widened those growth disparities even more.

Last year, pre-Covid, the “advanced” Western economies grew just 1.7pc on average. Prolonged and repeated lockdown means we’re heading for a collective 5.8pc GDP contraction this year, according to the International Monetary Fund - with the UK set for an 11pc drop, showing how badly lockdowns impact service-driven economies.

The West as a whole will rebound with 3.9pc growth next year, the IMF says, before returning to 1.7pc “steady state” annual expansion by 2025.

“Emerging and developing Asia”, in contrast, saw 5.5pc pre-Covid growth in 2019, over three times faster than the West. Most nations across the region then managed the pandemic either with shorter, more concentrated lockdowns, or avoided them altogether with far more effective “test and trace”.

Authoritarian government makes clampdown easier, of course – that, plus Asia’s broader recent experience of viral pandemics.

So Asian growth will contract just 1.7pc in 2020, on IMF estimates, before a huge 8pc GDP bounce-back in 2021. The region then returns to buoyant mid-decade trend growth of 5.9pc – again, well over three times faster than the West.

As Asia leaves Covid behind, the long shadow of this pandemic will remain over the West, even when the virus is long gone.

The quite extraordinary fiscal and monetary measures we’ve implemented to support businesses and households are not only ruinously expensive but extremely difficult fully to reverse.

This time last year, Western nations had an average national debt of 103pc of GDP. By the end of 2020, that figure will be 124pc.

Asian government debt has risen this year from 53pc to just 63pc of GDP – a stunning reversal over just a couple of decades. It used to be the grown-up Western nations that bailed-out recklessly-managed economies of the East.

For there must be a risk these massive Western policy interventions will normalise and intensify, sparking inflation spikes and sovereign debt crises. And while the dollar battles on as the global reserve currency, the heady brew of slow growth, spiralling debt and money-printing surely means other leading Western currencies will lose ground.

China is already a bigger economy than the US on some measures – and set to overtake America as the world’s biggest importer by 2025. The big Eastern nations are the economic superpowers of tomorrow and, increasingly, today.

Last month, after nearly a decade of talks, 13 Asian countries plus Australia and New Zealand signed the Regional Comprehensive Economic Partnership – the world’s largest free trade pact, covering a third of the global economy.

The Comprehensive and Progressive Agreement for Trans-Pacific Partnership similarly comprises 11 “Pacific Rim” nations with 13pc of global commerce. If Britain joined, that would make 16pc – more than the EU27. And, unlike Europe, CPTPP nations are primed for super-charged growth.

The EU has always struggled to sign really big trade deals, given the differing agendas of, and conflicts between, member states. That’s why the EU has no trade deal with either the US or China, the two largest economies, despite decades of trying.

The UK, alone, won’t have those problems.

Yet as a top-tier economy, we still have commercial clout. Brexit is all about doing deals and trading more with the 85pc of the world economy beyond the EU – because that’s where the growth is.

Always clear to some of us, this pandemic has made that blindingly obvious.

Follow Liam on Twitter @liamhalligan

Developing economies - Central Europe

 Useful material looking at interdependence, economic development etc. Some good context for essays:

ANALYSIS

Frederic Guirinec

The challenge for central Europe

PICTURESQUE POLAND HAS BECOME A MANUFACTURING POWERHOUSE

After years of being Europe’s fastest-growing region, the Visegrád Group’s economic model may be reaching its limit. But the region still offers rare value, says Frederic Guirinec

The Central European economies of Poland, the Czech Republic, Hungary and Slovakia – known as the Visegrád Group (see box) – have seen strong average annual growth of 5% since they joined the EU in 2004. The real GDP of the area has more than doubled over this time, driven by foreign investment in capital-intensive industrial production: in 2019, Poland was the leading destination for greenfield foreign direct investment (FDI) in the bloc, with $21.8bn (£17.4bn) invested, compared with $19.2bn in Germany and $15.7bn in France, according to fDi Intelligence.

However, this steady growth could soon be under threat due to dependence on western Europe’s capital and markets. The global economic recession may reveal structural issues with the region’s economic development and point to what must change if these countries want to become more than a destination for low-cost, high-quality manufacturing.

COPING WITH COVID-19

Central and eastern Europe have coped well with the pandemic. Governments had time to observe the spread in western Europe and learn from other countries, closing their borders early to significantly limit the pandemic. Now lockdowns are being lifted and activity is increasing steadily. Google’s Covid-19 community mobility reports indicate that life is returning to normal: by the end of June, retail and recreation mobility was back to pre-lockdown levels, especially in the Czech Republic (compared with 48% below normal in the UK) and transit and work mobility is crawling back up (-20% versus -50% in the UK). 

The Polish economy, which represents more than half of the GDP of this region, contracted by 0.5% during the first quarter – a better outcome than in most large European economies. The damage was obviously greater in the second quarter and overall the economy is forecast to contract by 4.6% in 2020, according to the IMF. This would be the first recession in Poland since 1994. Still, the government has designed a very large support programme worth PLN212bn (£42.5bn or 9% of GDP) and hence the country is likely to see one of the smallest peak-to-trough falls in GDP in Europe. The strong challenge that Warsaw’s mayor Rafal Trzaskowski posed to incumbent president Andrzej Duda in the presidential election was much more about social values than the government’s handling of the pandemic and its related economic impact (see politics & economics).

RELYING TOO MUCH ON THE NEIGHBOURS

The Achilles’ heel of central Europe is its dependence on Germany. The region is often seen as the German hinterland – it generates between 25% and 30% of trade with its larger neighbour. This means that in this crisis it will benefit indirectly from the massive economic stimulus in Germany, which amounts to €1.1trn (30% of German GDP) when including guaranteed loans. However, being so closely linked to one neighbouring economy raises the area’s vulnerability to external shocks and also risks restricting its long-term development too closely to what suits Germany’s needs.

The Visegrád economies offer skilled labour at much lower cost than western Europe. Despite a 35% increase since 2012, total labour costs in the manufacturing sector stand at €11 per hour on average, well below the average of €32 per hour in the eurozone, according to Rexecode, an economic research institute. That said, the declining supply of skilled labour is becoming a significant bottleneck. Since joining the EU, two million Poles have emigrated, forcing the country to rely on more low-skilled immigration from Ukraine. Indeed, Poland has welcomed a record number of migrants in recent years.

“THE ACHILLES’ HEEL OF CENTRAL EUROPE IS ITS DEPENDENCE ON GERMANY”

The vehicle industry is an outstanding example of the strengths and limitations of this growth model. These four countries produce 3.3 million cars a year, equivalent to British and French car production combined: car manufacturing represents 40% of Hungary’s exports. The factories are not simply assembly facilities that put together parts made elsewhere: large investments by firms such as Audi and BMW also ensure integration into the global supply chains of multinationals and contribute to technological transfer and an upgrade of physical infrastructure. But foreign ownership of these facilities means that key decisions are still made elsewhere. 

OPPORTUNITIES FOR INNOVATION

So the region needs to develop its research and development (R&D) capacity if it is to become more than a convenient location for manufacturers. Unfortunately, R&D spending remains very low in the region, at under 1% of GDP in Poland and Slovakia. Only the Czech Republic has achieved more, at 1.7% – in line with the UK, but well below Germany’s 2.9%. On the plus side, the Visegrád economies have avoided falling into what economists call the middle-income trap, where rising living standards and wages in fast-developing countries mean that they lose their competitive edge (low labour costs) without developing the skills needed to move up the value chain. Instead, the region can draw on a rich and robust industrial heritage that leaves it capable of innovation. Its advantages include a long tradition in education of technical universities and a multilingual workforce, similar to Switzerland and Germany.

The limited size of local economies encourages firms to roll out products and services to global markets quickly. Hence central Europe has become Europe’s fastest emerging start-up ecosystem, raising $1.8bn in 2019 compared with $1bn in 2018, according to PFR Ventures, a venture-capital investor backed by the Polish government. This has so far created eight unicorns (start-ups valued at more than $1bn), including GitLab, Grammarly, Bitfury and Bolt. With dynamic hubs such as The Heart and Google Campus Warsaw, Poland has been ranked as the seventh most-attractive country for start-ups globally by Ceoworld magazine – just behind Germany. This environment is drawing heavyweight foreign direct investment: Microsoft announced a $1bn investment in a new data centre in Poland, Google is planning a similar $2bn project and SK Innovation – part of one of South Korea’s largest business groups– is to invest €335m in producing components for lithium-ion batteries.

“STOCKMARKET VALUATIONS FOR THESE COUNTRIES ARE AMONG THE LOWEST IN THE WORLD”

The four countries may also be able to decrease their dependence on Germany if they integrate their economies more closely with each other. Trade within the region currently represents less than 60% of trade with Germany. However, since 1990 growth has been encouragingly inclusive: unemployment fell sharply and wages increased. So economic growth is increasingly driven by domestic demand as households benefit from these favourable trends in the labour market. The Visegrád economies are also coordinating more closely with their neighbours through the Three Seas Initiative (which includes 12 countries that link the Baltic Sea, the Adriatic Sea and the Black Sea), as well as pursuing major regional infrastructure upgrades such as a 1,800km link from Gdansk on the Polish coast via Vienna in Austria to Bologna in Italy.

CHEAP WHATEVER HAPPENS

Importantly, even if these economies do not evolve as much as they should, their stockmarkets are cheap enough to be compelling. Valuations are among some of the lowest in the world: the cyclically adjusted price/earnings (p/e) ratio (Cape – see page 15) for the Czech Republic is eight, Poland 8.5 and Hungary 12.5. Poland is the largest of the four and is the one that attracts the most attention from investors. CD Projekt is the current darling of its exchange: this video-game publisher has seen its share price rise 350% over the last three years following the huge success of The Witcher 3 and there are high hopes for its upcoming release Cyberpunk 2077. Last month, its market capitalisation passed that of Ubisoft, Europe’s biggest games firm. CD Projekt now looks pricey on a p/e of 154, but is an encouraging example of Poland’s ability to produce successful tech firms. A cheaper play in the IT sector is banking software provider Asseco Poland (Warsaw: ACP), on a p/e of 17.5. I first recommended this in MoneyWeek in 2017; its shares had failed to impress until recently, but have done better in the last few months.

The Czech electricity producer CEZ (Prague: CEZ) is one of the ten largest energy firms in Europe. It generates good cash flows and offers a decent dividend yield of 7% (6% net of dividend withholding tax). In Hungary, pharmaceutical firm Gedeon Richter (Budapest: RICHTER) enjoys a 17.8% operating margin and carries no net debt. London-listed regional drinks firm Stock Spirits (LSE: STCK) is performing well and remains relatively good value compared with multinationals such as Diageo or Pernod Ricard, on a p/e ratio of around 17.5. 

Fund investors should be aware that eastern Europe funds often include (and are dominated by) Russia, but the Amundi MSCI Eastern Europe ex Russia (Paris: CE9) is an exception. It has around 68% in Poland, 22% in Hungary and 10% in the Czech Republic. Poland is the only market large enough to have a dedicated ETF, iShares MSCI Poland (LSE: SPOL).

A brief history of the Visegrád Group

The Visegrád Group is an alliance of four central European states sharing common values and economic interests: Poland, the Czech Republic, Hungary and Slovakia. The group was created in Visegrád, Hungary, in 1991, to strengthen military, cultural, economic and energy cooperation among its members, including pursuing membership of Nato and the EU. The choice of name refers to the congress of Visegrád in 1335 between John I of Bohemia (in what is now the Czech Republic), Charles I of Hungary and Kazimierz III of Poland. Their main purpose was to settle the dispute over the Polish throne limiting the armed conflicts, encouraging diplomatic custom and to create new commercial routes to bypass the Habsburg empire in Vienna.

All four countries joined the EU at the same time in May 2004 and the region has since become a major economic centre. Together, the Visegrád Four have a population of 64 million inhabitants – similar to Italy, France or the UK – and a GDP of $2.13bn in purchasing power parity (PPP) terms (which accounts for differences in the cost of living), similar to the $2.24bn GDP of Italy.

All four countries have a PPP GDP per capita greater than Portugal and Greece. The figure for the Czech Republic, the wealthiest, is $40,585 according to IMF estimates, putting it broadly in line with Italy ($41,582). But GDP per capita at market exchange rates remains much lower, ranging from $14,900 for Poland to $23,200 for the Czech Republic, providing further room for catch-up growth.