Solving the global trade jigsaw puzzle - Jayant Menon

Op-Ed / Opinion | 12 June 2014

The rise of mega-free trade agreements (FTAs), the so-called mega-regionals such as the Regional Comprehensive Economic Partnership (RCEP) in East Asia and the US-led Trans-Pacific Partnership (TPP) suggest that the world trade system is fragmenting to appear more like a jigsaw puzzle than a spaghetti bowl. Carving up global trade in this way is far from ideal for members of the mega-regionals, and much worse for non-members.

How do we resolve the growing mess? One approach is to consolidate bilateral FTAs into regional blocs, a process similar to solving a regional jigsaw puzzle and then link them up globally. But both regional and global jigsaw puzzles need to be solved, and in that order, if this route is to work. But can it?

The short answer is no, while the longer answer starts with the challenges posed by solving the regional jigsaw puzzle followed by the global one. But from these answers we can consider an alternative way forward, which works.

RCEP is a useful example to illustrate the regional puzzle. RCEP aims to create an FTA amongst the ten ASEAN countries and its six dialogue partners — Australia, China, India, Japan, Korea, and New Zealand — by the end of 2015, the same deadline as the ASEAN Economic Community. Like any jigsaw puzzle, we begin with disarray. But the RCEP puzzle is more than just messy — there is no solution because the pieces do not fit. The so-called pieces — the ASEAN+1 and bilateral FTAs — come in different shapes and sizes. The only way to make the pieces fit is to reshape them: either to shave them down or to build them up.

Shaving down the bits can be thought of as a “race to the bottom”, where the lowest common denominator rules, making for an easier fit. Building them up is the opposite, where laggards lift their reform game to meet the standard set by the front-runner(s). The only example of successful consolidation is the European Union. In all likelihood, RCEP will emerge after a shave down given the difficulties involved and the lack of political will to overcome them.

Despite the difficulties, assume that RCEP and the other mega-regionals are concluded as intended. If this is the best case scenario, what does success look like? Not good, unfortunately — it has merely replaced the mess at the regional level with one at the global level.

To resolve the mess, how should the process of global consolidation occur? Should it proceed sequentially, or through a single undertaking where the blocs come together to negotiate a comprehensive deal? The former faces the same difficulties as regional consolidation but amplified by greater diversity, while the latter, like Doha, is currently improbable with a wide-ranging agenda. For these reasons, cross-regional link-ups of mega blocs have no precedent.

In this environment, a way forward is to return to the most widely used modality of trade liberalization — unilateral actions — but this time involving the multilateralization of preferences rather than unreciprocated reductions in tariffs. In Asia, ASEAN’s original members including Indonesia have done this with the ASEAN Free Trade Area, and RCEP countries could follow suit since more than three-quarters of most countries’ imports are already covered or soon to be covered by an FTA. About 70 percent of Indonesia’s trade is already covered by FTAs, while another 20 percent is subject to negotiation. There is little point in holding out to pursue reciprocity with the countries accounting for the small amount of trade that remains uncovered.

Further, the benefits from reciprocity fall short of multilateralization when preference utilization is as low as it is in Asia. It is not uncommon to find utilization rates of 25 percent or even lower. Political economy-wise, the resistance from FTA partners toward multilateralization decreases as the number of FTAs increase, due to preference erosion. After all, special treatment depends on some degree of exclusivity, and this is fading away with the proliferation of FTAs.

While multilateralization is easily applied to tariffs, it is also naturally suited to non-tariff barriers (NTBs) and difficult sectors such as services. The removal of many NTBs share public good characteristics. Unlike tariffs, it is either costly or impractical to exclude non-members once an NTB has been removed. Similarly, if services liberalization is pursued through harmonization of standards or regulatory convergence, rather than mutual recognition arrangements, non-members can easily accede later. Multilateralization of preferences, whether tariff or non-tariff, presents a practical way out of the current mega-mess. This is a strategy that might recommend itself to negotiators who are charged with the responsibility of delivering RCEP by 2015, or the TPP if it is to be concluded anytime soon.

The writer is lead economist at the Office of Regional Economic Integration, Asian Development Bank. The views expressed in this article are those of the author.