Tariff cuts under the Regional Comprehensive Economic Partnership will generate import gains for ASEAN as it will reverse the negative trade-diversion effects caused by the existing bilateral and ASEAN+1 free trade agreements. But there will be firms in ASEAN that have to compete with their counterparts from RCEP countries.
Sithanonxay Suvannaphakdy
30 April 2020
The US-China trade war and the Covid-19 pandemic show that any disruption on imports in one country has negative consequences on the production and consumption in other countries. Will the Regional Comprehensive Economic Partnership (RCEP) improve the efficiency of imports for its partners? Notably, tariff reductions under RCEP generate trade reversion among its members, enabling ASEAN countries to reallocate their import sources towards more efficient RCEP trading partners.
Trade reversion of RCEP occurs when a country that was previously outside of a free trade agreement (FTA) of one or more ASEAN countries (and suffered from export losses) now becomes a member of RCEP. The RCEP overlaps with many other ASEAN FTAs. Presently, ASEAN countries already have FTAs with all of their major trading partners. The International Trade Center’s import data for 2018 reveals that all ASEAN countries will gain substantially from trade reversion because all of their top-rank import sources are members of RCEP. To demonstrate the trade-reversion effect of RCEP, I consider various scenarios, before and after the formation of RCEP, using the ASEAN-China FTA and ASEAN-Japan FTA as examples.
Pre-RCEP
Before the formation of RCEP, the bilateral trade relations between ASEAN and its trading partners (i.e. China and Japan) can be illustrated in Table 1. The consumer price of an imported product (C) is the sum of its import price (A) and associated tariffs (B). In this scenario, ASEAN did not have any FTA with China and Japan. Exports from China and Japan to ASEAN face the same most favoured nation (MFN) tariff rate. In Scenario 1.1, ASEAN imported goods from China at $105 per unit and from Japan at $100. At the same tariff rate of 10 per cent on imports from both sources, consumers in ASEAN paid $115.5 and $110 per imported unit from China and Japan, respectively. Meanwhile, governments in ASEAN gained from tariffs levied on each unit of imports from China ($10.5) and from Japan ($10). In this period, consumers preferred to purchase goods from Japanese exporters, which was cheaper than goods imported from China.
FTA with China
ASEAN as a group formed an FTA with China, which entered into force in goods in 2005. Under this FTA, exports from China to ASEAN countries enjoyed preferential tariff rates. Meanwhile, Japan also exported goods to ASEAN, but its exports faced higher MFN tariff rates imposed by most ASEAN countries because Japan did not have any FTA with them, except Singapore.[1] Given the higher MFN tariff rates, prices of imported goods from Japan to ASEAN were higher than those from China. In Scenario 1.2, the price that consumers paid for imports from China fell to $105 per unit, while imports from Japan still cost $110 per unit. As a result, consumers in ASEAN switched to the cheaper source of supply which is China. This diverted trade flows from Japan to China.
Table 1: Trade effects of tariff reductions
Importing from China instead of Japan means that ASEAN countries purchased goods at a higher cost, as Japan was the cheaper supplier. China as an exporter benefited from this change, but the ASEAN countries suffered losses due to the higher cost of imported goods. The loss to individual ASEAN countries as an importer was not visibly felt by consumers, who found that the consumer prices of Chinese imports were lower due to the absence of tariffs. But the governments in ASEAN lost tariff revenues. As shown in Scenario 1.2, governments in ASEAN lost $10 per unit (or D, the tariff revenue they would have received on each unit of import from Japan), while the consumers gained $5 per unit as the consumer price of the same imported good fell from $110 to $105 per unit. The net effect for ASEAN (i.e. consumers and governments) was a loss of $5 per imported unit. The adverse impact of trade diversion in ASEAN is even greater when one adds the loss in outputs of ASEAN’s local producers and Japanese exporters, which were diminished by having to compete with Chinese exporters.
FTA with Japan
Three years later, Japan formed an FTA with ASEAN, which entered into force in 2008. Under the ASEAN-Japan FTA, exports from Japan to ASEAN faced preferential tariff rates, which partially reversed the loss of its exports. The partial recovery of Japanese exports is due to the fact that on average, ASEAN countries committed to a lower degree of tariff liberalisation under the ASEAN-Japan FTA (92.9 per cent zero tariffs in total tariff lines) than that under ASEAN-China FTA (94.7 per cent zero tariffs). As a result, the trade-reversion effect of the ASEAN-Japan FTA might not be sufficiently strong to reverse the trade diversion from China. Hence, ASEAN countries as importers still suffered from importing higher cost goods. In our numerical example, this is illustrated in the Scenario 1.3, where ASEAN imposed tariff rate of zero on imports from China and a tariff rate of 5 per cent on imports from Japan.
The import gains for ASEAN are in the form of lower prices and greater variety of imported goods and intermediate inputs. This was the result of greater competition among RCEP partners.
RCEP
Now, consider the scenario when the RCEP is formed. ASEAN, Japan and China will face a second round of trade reversion. As a regional FTA, RCEP will reduce the trade-diversion effect caused by ASEAN-China FTA by eliminating all tariff lines. This is illustrated in Scenario 2. The price that consumers paid for imports from Japan fell to $100 per unit, while imports from China still cost $105 per unit. In this situation, consumers in ASEAN will switch to the cheaper source of supply which is Japan. Meanwhile, governments in ASEAN will not have any tariff revenue due to tariff liberalisation, and local producers will face tougher competition due to lower prices of imports.
In conclusion, tariff cuts under RCEP will generate import gains for ASEAN as it will reverse the negative trade-diversion effects caused by the existing bilateral and ASEAN+1 FTAs. The import gains for ASEAN are in the form of lower prices and greater variety of imported goods and intermediate inputs. This was the result of greater competition among RCEP partners. The flip side is that local firms in import-competing industries in ASEAN countries will face tougher competition from exporters in the RCEP partners. Only firms with high productivity will be able to continue competing in the market. Consequently, any policy aimed at establishing assistance programs on trade adjustment or strengthening existing programmes is essential to mitigate the negative impacts of trade liberalisation on firms and jobs in ASEAN countries.
[1] Japan-Singapore FTA entered into force in 2002.
Dr Sithanonxay Suvannaphakdy is a Lead Researcher (Economic Affairs) at the ASEAN Studies Centre, ISEAS – Yusof Ishak Institute.
ISEAS Commentary — 2020/56
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