China and 14 other countries have signed a free trade agreement that will serve as a powerful economic counterweight to the West. The pact aims to eliminate 90 per cent of tariffs in the medium term. The economic potential is immense – and enormously important in terms of strategic portfolio positioning.

The balance of power is shifting towards Asia-Pacific

China and 14 other countries have signed a free trade agreement that will serve as a powerful economic counterweight to the West. The pact aims to eliminate 90 per cent of tariffs in the medium term. The economic potential in the region is immense – and enormously important in terms of strategic portfolio positioning.

The world’s largest free trade zone is currently being created in the Asia-Pacific region. It will cover one third of the world’s population and a third of global economic output. On 15 November, 15 states signed up to the Regional Comprehensive Economic Partnership (RCEP) to create the largest free trade zone in the world – outstripping even North America and Europe. Membership comprises the ten ASEAN states plus China, Japan, South Korea, Australia and New Zealand. Notably, this is the first time that China and Japan have joined together in a free trade pact. India was originally involved but pulled out of negotiations in 2019, fearing the competition from its neighbours.

China has been the main driving force behind the alliance. One factor that should not be underestimated is that RCEP provides a counterweight to the Transpacific Partnership (TPP) free trade agreement. The withdrawal of the US from the TPP under the Trump administration opened up a vacuum, which China has now adroitly filled. China is currently in the ascendant, stepping into the power vacuum created by Trump’s withdrawal from agreements and alliances, and by the coronavirus crisis. The comprehensive regional economic partnership is further evidence of the shifting power balance between the world’s major blocs – to the benefit of China and Asia.

There are still some details to be finalised, but South Korea, Japan, Malaysia, Thailand and China look set to be the biggest beneficiaries. An analysis carried out by the Peterson Institute for International Economics (PIIE), a US think tank, estimates that by 2030 the agreement could add a further US$ 186 billion to global growth. The region will benefit from this stimulus even if the trade dispute between the US and China continues. RCEP still has to be ratified by all 15 national parliaments, however. The agreement will come into effect when either half of all member states or six ASEAN countries and half of the non-ASEAN countries have ratified it – so probably around the middle of 2021 (ASEAN: Association of Southeast Asian Nations).

RCEP-15: Anticipated positive income effects for member states

RCEP-15: Anticipated positive income effects for member states

Removal of tariff and non-tariff trade barriers

The most important objective of the alliance is the removal of duties and trade barriers, although the member states are also keen to intensify cooperation in many areas and to boost investment in the region’s economy. In the area of tariff barriers, customs duties and quotas will initially be removed on around 65 per cent of goods traded within the zone. Within 20 years that figure should rise to over 90 per cent. The agreement also covers non-tariff barriers in areas such as services, investment, e-commerce, the protection of intellectual property and the free movement of people.

Standardisation of the rules of origin for individual components in complex manufacturing processes is particularly important. This will strengthen regional supply chains, especially when the coronavirus pandemic is one day finally over.

RCEP as a growth driver for Asia-Pacific

In assessing the impact of the RCEP trade agreement, there are two levels to consider. From an economic perspective, it is to be noted that trade between the Asia-Pacific nations is already very buoyant with goods to the value of around US$ 12.4 trillion currently being traded. But the new agreements are a further important step towards strengthening supply chains and generally intensifying collaboration and investment between the states. This is likely to have a positive impact on growth and employment in the region in the near term.

In view of the geopolitical importance of RCEP, China has landed a real coup. Combined with its massive Belt and Road initiative, sometimes referred to as the New Silk Road, the new trade agreement will enable China to further expand its influence in the region. It provides a platform for the further development of trade relations in the region. From a strategic perspective, it gives greater strength to the Asia-Pacific region relative to the North American free trade agreement (United States-Mexico-Canada Agreement USMCA) and the European Economic Area (European Union plus Norway, Iceland and Liechtenstein).

The world's largest free trade agreement is being signed in Asia

The world's largest free trade agreement is being signed in Asia
Source: International Monetary Fund, Commerzbank Research, Union Investment; *USMCA: US/Mexico/Canada; as at 2 December 2020.

What does the RCEP mean for Europe?

The signing of the agreement is a wake-up call for the West, as the new alliance includes a number of countries with particularly fast-growing economies and also growing populations. If the agreement is implemented as planned, a substantial portion of global economic power will shift eastwards. Europe will have to decide whether to align itself more closely with China and its new allies, having been given the cold shoulder by the US under the Trump administration.

As far as the transatlantic partnership with the US is concerned, the experts at Union Investment expect the tone to improve under the newly elected US president Joe Biden. However, substantive differences will still remain on issues such as defence spending and the Nord Stream 2 pipeline being built to carry Russian gas to western Europe. A return to multilateralism is thus more likely. The coming decade is likely to be shaped by the superpower competition between the US and China and we can therefore expect blocs to be formed in strategically important technological areas, with geographically separate spheres of influence. The Chinese ‘New Silk Road mega project gives an indication of where the boundaries may be drawn.

Europe will have to choose whether to stick to its old friendship with the US, even though this has cooled noticeably, or turn towards China, already the most important trading partner for many EU states. Or is there perhaps a third way? The Union Investment experts believe that Europe runs the risk of slipping between the two economic blocs and falling into insignificance. But, conversely, the possibility of accelerated growth in the Asia-Pacific region also creates opportunities, even if the trade wars continue. To be able to exploit these opportunities more fully, an adjustment of the investment portfolio on a regional basis is worth considering.

  1. As at: 7 December 2020