Why It Matters That One of the Region’s Biggest Trade Deals is Being Upgraded

Economic activity is set to increase between Southeast Asia and the People’s Republic of China as a major trade deal is upgraded. Photo: ADB
Economic activity is set to increase between Southeast Asia and the People’s Republic of China as a major trade deal is upgraded. Photo: ADB

By Jayant Menon, Anna Cassandra Melendez

Important changes are underway for Southeast Asia’s relationship with its biggest trading partner, the People’s Republic of China.

In 2015, ASEAN and the People’s Republic of China (PRC) signed an upgraded protocol to improve the original Framework Agreement for the ASEAN-China Free Trade Area (ACFTA). The Upgrading Protocol entered into force in July 2016 and implementation will start from August 2019.

Since ACFTA was launched, the PRC’s share of ASEAN total merchandise trade increased from 8% in 2004 to 21% in 2018, making it ASEAN’s biggest trading partner with trade amounting to $591.1 billion. The PRC also rose to become the third largest source of FDI in 2017, with flows amounting to $11.3 billion.

But how will the upgrading of the agreement likely affect these flows? The key changes relate to: (i) simplifying Rules of Origin (RoOs) and Certificate of Origin procedures; (ii) improving services commitments from the PRC covering engineering, construction, securities, sporting, and tourism sectors; (iii) strengthening provisions for investment promotion and facilitation; and (iv) building e-commerce capabilities, especially for Micro, Small and Medium-sized Enterprises.

Interestingly, the Upgraded Protocol does not do much to address non-tariff barriers despite evidence that they continue to grow and suppress trade. Even for tariffs, studies point to low utilization rates for ACFTA tariff concessions. If low utilization rates are mainly due to difficulties in complying with RoOs, for instance, then the proposed simplification could see a significant increase in trade flows. But if it is mainly because margins of preference (or the difference between Most-Favored-Nation (MFN) and ACFTA preferential tariffs) are low, then the likely impacts are more complex.

Margins of preference are likely to be low, or even zero, for trade in parts and components and other intermediate goods, because of various tariff exemption schemes. For example, for trade in electronic parts and components that dominate supply chains in Southeast and East Asia, the WTO’s Information Technology Agreement provides duty exemption, even for countries that are not signatories.

For trade in other types of parts and components, various duty-drawback schemes like bonded warehouses or the location of multinational corporations in duty-exempt export processing zones also make these tariff preferences redundant. Even if this was not the case, it is very difficult to design RoOs for supply chain-driven trade, which by its nature involves limited value-addition or transformation. Therefore, simplification of RoOs and other related reforms in the upgraded ACFTA is likely to affect trade in final rather than intermediate goods, which constitute only about a third of ASEAN’s exports to the PRC, but more than two-thirds in the opposite direction. 

But improvements to the agreement on trade in services has the potential to significantly strengthen trade relations, since barriers remain high. This is also a rapidly growing area of trade. The trade dispute between the PRC and the US has already affected supply chains, with investment being diverted away from the PRC and towards some countries of the region. The strengthening of provisions that promote or facilitate investment between the PRC and ASEAN could increase flows from the former to the latter in an attempt to avoid punitive tariffs, especially if the dispute is viewed as being more than transitory. Even if the dispute is resolved anytime soon, the restructuring may continue in an attempt to diversify risk, including by PRC firms.

All of this assumes, however, that the agreements are implemented faithfully. This is no easy task when considering that domestic laws may have to be amended to accommodate these new accords.

  Southeast Asia and the People’s Republic of China are talking trade

Ever since ACFTA was first mooted, there has been concerns over the potential negative impacts on production and employment in sensitive sectors in ASEAN member states. Indonesian producers as an example, had requested a delay in the implementation of the original ACFTA tariff reductions for some 228 items, without success.

Although some of these fears may have since subsided, they have not been eliminated. For example, there have been delays in the enactment of national laws and regulations to implement the Upgraded Protocol. Domestic industry lobbies continue to push for protection, and some wield significant influence over governments. In this environment, the flexibility that characterises ASEAN cooperation and institutional arrangements, the so-called ASEAN Way, could hand members a convenient pretext for non-compliance. How to enforce the accords remains an issue.

If implementation issues can be overcome, these amendments present new opportunities for further increasing trade between ASEAN and the PRC. With uncertainty growing on the rules that govern global trade and commerce, it is more important than ever that the Upgraded ACFTA succeed in an increasingly and irrefutably second-best world.

This is an abridged version of an article that first appeared in the June 2019 issue of ASEANFocus, a publication of the ASEAN Studies Centre at ISEAS-Yusof Ishak Institute, Singapore.