Philippines, RCEP and geo-economic fragmentation

Philippines, RCEP and geo-economic fragmentation

When the Senate failed to ratify the Regional Comprehensive Economic Partnership (RCEP) due to what some senators described as “lack of safeguards for the agriculture sector,” that signaled the country’s lost opportunity to join the world’s biggest trade agreement early. That Senate deliberation in June 2022 took all of five months since RCEP was enforced on Jan. 1 this year. At the time, both Indonesia and Myanmar were yet to ratify the regional trade pact, too.

RCEP involves 15 countries accounting for a third of the world’s gross domestic product (GDP) and nearly half of the world’s population. Some estimate that by 2050, RCEP’s share of the global economy could tip the scale at $0.5 quadrillion. The trade pact aims to form an integrated market to facilitate cross-border transactions in trade in goods and services, investment, intellectual property, dispute settlement, e-commerce, small and medium enterprises and economic cooperation. 

The benefits are definitely non-trivial. If global trade weakens, this regional agreement is a good fallback, if not a strong mitigant.

But the prognosis for quick Senate action turned for the worse when then President-elect Bongbong Marcos called for a review of RCEP in order to “determine whether the agriculture sector is adequately protected.”

For all his shortcomings in economic policy, then President Rodrigo Duterte actually approved the RCEP Agreement as early as September 2021. He realized and accepted that RCEP was trade and investment positive for us. Those issues of proper transitioning to free trade and appropriate safeguards for some industries were amply discussed in the nearly one decade of RCEP negotiations.

Safety nets, they call them, and they are well articulated in the RCEP Agreement. Foreign competition, in the first place, has been with us since we acceded to the World Trade Organization (WTO) in the 1990s and inked other free trade relations with ASEAN and other country groupings. The scope has just been broadened to the extent of the larger membership of RCEP. It must be the rules and disciplines that some quarters complain about. Agricultural products are excluded from tariff liberalization, yet they would still qualify for some other benefits coming from trade remedies including those provided by WTO global safeguards.

If burgeoning imports threaten a local industry, for instance, WTO safeguards continue to be available to the Philippines. RCEP also provides a transitional safeguard to address this possible situation by way of suspending further reduction of customs duties or increasing them should imports surge under the RCEP. Anti-dumping and countervailing measures which reaffirm the rights and obligations of various parties under relevant WTO agreements remain available.

The Department of Trade and Industry therefore assured that our local industries including agriculture should consider RCEP “as a platform of more and bigger opportunities ranging from improved market access in the RCEP region, cheaper access to raw materials, wider cumulation area, trade facilitative measures, and even investments in smart agriculture and research and development.”

It helped that the economic managers in the Philippines were in support of RCEP. For instance, both then NEDA Head Karl Chua and then Trade Secretary Ramon Lopez both testified in the Senate and dialogued with members of the Samahang Industriya ng Agrikultura (SINAG) in May 2021. As Chua stressed: “The best farmers who can mechanize, improve their productivity, and consolidate land operation, win and become more productive. However, the trade deficit is a real problem, it means we are not competitive. The solution there is not to stop RCEP but to address the root causes of the inefficiency of the agriculture sector.”

With a broad inclusion of free trade partners in RCEP, the Philippines could work out ways to expand the partners’ share of over 50% of the country’s exports, while shaping up to secure its imports from them, now at more than 67%.

If the Philippines fails to join RCEP early enough, therefore, the country is expected to lose on so many other opportunities in the region’s journey to economic recovery. RCEP is a timely tool to foster regional integration and economic growth.

Indonesia, though relatively late in the game, realized in a deeper way that while its exports would benefit directly from RCEP, its own downstream industries are also poised to reap higher investments. With rich natural endowment, Indonesia seeks to ascend the global value chain, from raw materials exporter to processed high-value global supplier. Some members of Indonesia’s parliament were also apprehensive that the elimination of some 92% of tariffs on goods traded with the other 14 RCEP members could result in excessive influx of imports. But its key ministers were smart enough to emphasize that there are indeed short-term costs like higher trade deficit. In due time, Indonesia expects some turnaround in its real output as well as trade surplus by nearly a billion dollars. The challenge is to diversify its manufacturing sector, incubate new and emerging value chains especially in the digital space. Infra projects are also critical and Indonesia is quite serious in pursuing them.

Why is RCEP imperative, and should have been ratified yesterday?

In its Regional Economic Outlook for Asia and Pacific, the International Monetary Fund (IMF) is beginning to see some harmful fragmentation scenarios recently. These scenarios derive from potential global trade disruption following geopolitical tensions in the last few years. The Fund calls this as trade fragmentation that comes in the form of rising trade restrictions and uncertainty.

Asia is crucial in this scenario because its value added in global production meets half of external demand in North America and 35% in Europe in 2018, up from 41% and 28%, respectively, in 2000. Asia is no less than a global production hub, accounting for about half of global demand in key commodities. Asia’s well-developed regional value chains fuel two-thirds of intra-Asian trade.

And there are dark clouds on the horizon.

There are rising geopolitical tensions that could impinge on global trade and multilateralism. The Fund points to these tensions being driven by strategic competition and national security issues at the expense of economic efficiency. Greater trade integration has led to higher productivity and living standards across the world in the last two decades, with Asia riding the trend. But Asia might be looking at a possible inflection point.

The Fund is now seeing increased trade restrictions actually imposed by countries based on its Global Trade Alert since 2018, “mirroring the increase in trade-related uncertainty.” The sectoral composition of trade restrictions shows that high-tech and energy sectors are up, presaging what could happen to them in economic competition and national security.

Keeping trade-related uncertainty at current level would be enough to affect economic activity. Uncertainty around trading relationships promotes “wait and see” attitude among business firms, holding them back from investment and exporting. Uncertainty could also drive inflation by jacking up import prices or importers’ markups.

In general, the Fund reports, trade policy uncertainty reduces investment and GDP, but expands unemployment. It could also motivate exchange rate depreciation via higher risk premium. If higher trade policy uncertainty is rolling out negative economic effects in the short run, the Fund is equally concerned with the long-term impact. The earlier US-China trade hostilities and lately, the Russia-Ukraine conflict have sent waves of trade policy uncertainty.

An illustrative sharp fragmentation scenario was assumed in which the world divides into separate trading blocs and in the process generates large, permanent output losses. The hit on Asia is expected to be largest, and most severe, given its big role in global manufacturing and trade. The resulting reduction in productivity is enough to shave off 3.3 percentage points from regional output. Admittedly, total losses could be higher due to the impact on investment as exporters lose their markets.

As expected, the Fund’s advice is to encourage greater international cooperation to roll back trade restrictions, avoid policy uncertainty and invariably foster open and stable global and regional trade.

But the story does not end there.

Trade fragmentation may be aggravated by financial fragmentation. There are early signs including capital flow measures imposed by several countries in the aftermath of the pandemic. In particular, some restrictions on foreign direct investment inflows have been most obvious. It would definitely hurt Asia, and the Philippines, too when we see foreign firms doing more “reshoring,” “nearshoring,” and “onshoring.”

Thus, an early accession of the Philippines to RCEP can be a good countervailing move against these observed signs of both trade and financial fragmentation. Given the country’s large external trade to GDP ratio of more than 60%, RCEP can keep our growth engine firing on all cylinders.

There is no time to lose.

 

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