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China’s New ‘Free Trade’ Deal: Should We Worry?

November 18, 2020

By Kenneth Rapoza, CPA Industry Analyst

Free traders touted the China-led "Regional Comprehensive Economic Partnership" as the world's biggest free trade zone. It's not. We need to defend our interests as a country and avoid believing that sweeping, free trade agreements will help us.

China has a new trade pact with 14 nations in southeast Asia, including American allies like Japan, South Korea and Australia. It has not yet been ratified. In all, some 90% of tariffs will be lowered over a long period of time. Asian supply chains could become more entrenched. Are we dealing with one giant China now?

The trade pact is not new. The so-called Regional Comprehensive Economic Partnership (RCEP) has been in the works since November 2012 and was slated to be signed by 2015. Like all things China, it’s at least five years late. 

Concern over China leading an Asian trade bloc is what got the ball rolling on President Obama’s Trans Pacific Partnership. The TPP has many of the same member states. It was drafted in 2015. It’s gone nowhere once President Trump put it to bed in 2017. Should Joe Biden be named president by electors next month, would Biden resuscitate the TPP as a counter to RCEP?

We are sure calls to do so will be loud in a Biden White House. But we don’t need the TPP to do business in Asia and maintain strong ties.

“The countries near China need US support to protect them from China’s expansionist aims in the South China Sea, on the Indian border and elsewhere,” said CPA Chief Economist Jeff Ferry. “We should not use trade agreements for foreign policy aims. Trade agreements sacrifice US jobs and entire industries and they don’t directly impinge on the foreign policy aims we are trying to achieve.”

Ferry cites South Korea as an example. South Korea is a close ally of the US. Why? Because they are worried about an invasion from the North. In recent years, they’ve also become more worried about China’s expansionism. The US provides South Korea with troops, and a high-tech ballistic missile shield called THAAD. That’s an example of an alliance cemented by common interest, military cooperation, and great US technology. We estimate that the Korean trade agreement KORUS sacrificed over 50,000 US jobs and has little to do with our alliance with Korea.

Michael Pettis, a Senior Fellow at Carnegie-Tsinghua Center and author of “Trade Wars are Class Wars” said on his Twitter feed that RCEP is “nonsense” and won’t change the fact that most members of RCEP are persistent trade-surplus countries. Pettis points out that unless the 15 countries (including China, Vietnam and South Korea) in the trade bloc can no longer count on the US as their oversupply dumping ground, they will have to start consuming what they make.

RCEP countries have been running current account surpluses of more than 2% of their collective GDP, and with the exception of Australia and New Zealand, these surpluses are based on structural savings imbalances. They are hard to eliminate without politically-difficult domestic adjustments that none of them want to accept. Small southeast Asian nations don’t have the consumer base to absorb what they produce. China’s economy, up until a few years ago, has been almost entirely geared towards exports. While its consumer economy is gaining, China may benefit most by offshoring to southeast Asia to make things cheaper than at home, but even that will come with a price for Beijing – namely its full employment model.

“This means that the RCEP can only function as a trade bloc if some of its members are forced into running deficits,” Pettis said. “RCEP will fall apart as each surplus country tries to protect its all-important exports at the expense of imports and its trade partners.”

China will maintain its focus on key industries to be made at home – emerging energy sectors like long-life batteries for electric vehicles; robotics; biotech; and computer hardware, especially semiconductors.

No Chinese multinational will not dare offshore these supply chains. Take car parts for example. Most tariff cuts will occur slowly and take 16-20 years before getting to 0 percent, said Jennifer Hillman, a senior fellow at the Council on Foreign Relations.

In other words, this is not a free trade deal because the biggest economy in the bloc is not going to open itself up to Panasonic battery imports, Samsung smartphones, Toyota's and Hyundais. Also, who thinks the Chinese Communist Party will watch their biggest companies send their workforce to Vietnam in order to lower costs?

Yet, the Financial Times could barely hide its giddiness about RCEP, saying China signed “the largest free trade deal” in history. The Guardian blamed Trump, saying that the vacuum caused by his leadership was too easily filled by China.

The WSJ cited William Reinsch, a trade expert at the Center for Strategic and International Studies, who said in essence that an eventual Biden Administration would have to rethink Obama’s old Asia Pivot.

“The fact that you could reach an agreement with all those parties including China is a significant accomplishment,” he said, adding Washington will “need to give a lot more thought to what policy we want to maintain in the Pacific.”

News of the “biggest free trade deal in history” was the perfect way to end Trump’s first term. China poses as a multilateralist free trader and the world’s media eagerly lap up the fiction. Recall that Trump’s presidency began with Xi Jinping attending the World Economic Forum in January 2017. There, Xi called for open markets, and an end to nationalist protectionism. Davos Man heralded Xi as the new leader of the free trade world. Up was down. On was off.

This week, during the Bloomberg New Economy Forum, China’s Vice President Wang Qishan gave his summation of protectionism: “countries must rise above exclusive blocks and reject the zero-sum mentality. They should…reduce barriers. We must firmly safeguard the multilateral trading system under the WTO and unequivocally reject unilateralism and protectionism.”

We think that the US, like China, should protect its key industries rather than permit its biggest corporations search the world over for the cheapest labor, the lowest taxation and regulatory burden. “Until we figure out how to address the problem of many nations running large beggar-thy-neighbor trade surpluses and producing more than they consume, trade agreements are meaningless, and counterproductive for a rich country like the US, many of whose political leaders don’t mind if we run a $600 billion trade deficit and our manufacturing industry crumbles to dust,” said Ferry.

The trade deal is a victory for China, but China’s new partners will soon learn, if they don’t already know, that China will not open any markets it deems important.  Our response to the RCEP shouldn’t be dictated by the FT and WSJ. Their motto: “let’s just open our market, too” would be a disaster. Behind the scenes, the financial industry sees big profit potential in open international markets.

The smart leaders in Asia already understand China’s only concern is its own power. Japan is paying its manufacturers billions of dollars to move manufacturing out of China. India pulled out of the RCEP after it saw the potential damage to Indian industry. The US has built alliances in Asia, and should continue to do so, but we should never use trade giveaways to win friends. 

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