China to Adapt as TPP Deal Spells Opportunities for the United States & Asia

China is set to lose out as the United States Senate voted on June 23rd to allow the much-vaunted Trans-Pacific Partnership free trade deal to go ahead. That senate deal effectively paved the way for the TPP to progress unimpeded and prevents Congress from interfering with negotiated trade agreements. 

It’s been a long time coming. It is now ten years since the TPP was first mooted as a Free Trade area, and it is a significant one at that. The United States, in conjunction with Canada, Chile, Mexico and Peru on the Eastern Pacific, and with Australia, Brunei, Japan, Malaysia, New Zealand, Singapore and Vietnam on the Asian side, represents 40 percent of global GDP and a combined economic strength of US$28 trillion.  China, however, is not part of the TPP negotiations and has understandably been somewhat critical about them.

The TPP sets the terms for trade between the participating members, and includes several major areas where competition will undoubtedly increase, making it a good deal for consumers. But not all businesses will benefit – it depends largely upon which side of the deal you are on.

Critics of the TPP state that it will cost American jobs in terms of leeching production to cheaper TPP members such as Vietnam and Mexico. The same critics also suggest that it will result in higher U.S. consumer prices for certain consumables, products and especially pharmaceuticals, as the TPP includes provisions for upholding American patent laws. That, critics suggest, will raise production costs overseas, and impact upon imported goods to the U.S. domestic market. Those in favor view it as a counterweight to the rise of China as a global manufacturing hub, and providing a platform from which to better encourage industries that the U.S. is typically strong in, such as e-commerce, cross-border internet access and financial services. The TPP is also expected to lead the way to the United States strengthening its existing trade agreements – some of the American Double Tax Treaties are seriously out of date – and in particular with Japan, Malaysia, Brunei, New Zealand and Vietnam.

Such a platform, if proven to work, could lay the foundations for a later expansion of the TPP itself. Key to that would be potential future partnerships with Myanmar and India – and possibly China as a longer goal. In this regard, the TPP needs to be seen to work in order to persuade China that freeing up certain aspects of its political and commercial environment would be beneficial.

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Open Internet & Scaling Back on SOE Favoritism

To illustrate this, much can be made of the agreement to open up the Internet, something that China itself would currently have great difficulties with. The TPP requests that member countries agree not to block cross-border transfers of data over the Internet, and also not require that servers be located in the country in order to conduct business in that country.

In addition to this, the TPP places SOEs as an area for reform, and imposes restrictions on trade sops often granted to state-owned businesses. Malaysia and Vietnam will be most impacted by this, and although China also faces problems with favoritism by senior officials with vested interests in SOEs, it is an area where at the highest levels, Washington and Beijing probably see eye to eye.

American Services for Asian Consumers

The TPP is also heavily geared towards the services industry. The key point here is that while services are not subject to cross border tariffs, nationality requirements and investment restrictions are actively used by many developing countries – including China – to protect local businesses. However, the United States’ services industry now comprises most private sector jobs in the country, and has a competitive edge across the board in this sector, including finance, engineering, software, education, legal services and IT.

Market Opportunities

It’s a fairly simple divide. Asia will generate more manufacturing work, and the United States will generate more services work. It should create a platform that makes it easier for American companies to sell services, and for Asian based companies to manufacture and sell to the U.S. Naturally, part of the latter will include American owned manufacturing businesses who will find it advantageous to relocate their production facilities to Asia, and Malaysia and Vietnam in particular. American services companies looking to sell products to Asia have a natural ally in Singapore, which is part of the TPP and also has a highly preferential employment and tax relationship through the extensive United States-Singapore Free Trade Agreement.

What Will China Do?

It’s not all doom and gloom for China, but the TPP is a deal that will make the CCP think long and hard about reforms. On the one side, they would welcome any agreement that opens up doors to the wealthy U.S. market. But in order to do that, they will need to make several concessions, not least over the Internet firewall, which is already noted in some quarters as damaging for the Chinese economy. Whether the CCP is prepared to negotiate issues of what are perceived as critical national security concerns remains to be seen. On the other hand, becoming less competitive to U.S. consumers is a bitter pill. Not all Chinese manufacturers can relocate to Vietnam to get around this barrier. China will probably do what China does best – wait and see. Much will depend on how badly the Chinese economy starts to hurt over the coming five years. If it tanks, then a sudden lurch to reform, including taking down Internet barriers and providing access to its own large services industry may yet be on the cards.

Meanwhile, it has its own development plans that lead towards the EU. As I have previously discussed, should China agree a Free Trade deal with the Eurasian Economic Union, this will be a clear sign of its intentions to look towards Russia and Eurasia and develop ties and infrastructure across the Eurasian Continent. It will cost a huge amount of time and money to accomplish, but would also wean China off dependence from the American market. That may well fit in with China’s longer term policy.

One to Watch: Vietnam

Vietnam is expected to meet most of its tariff reductions at the end of this year when it is due to be in ASEAN Economic Community compliance. It may not meet all its obligations, but tariffs will probably be amongst the initial trench of reforms it will enact, resulting in Vietnam being in complete free trade synchronization with ASEAN in addition to its own Free Trade Agreement with China. That means zero tariffs on Vietnamese exports to China.

The TPP agreement will also impact upon Vietnam’s reliance on Chinese textiles and make sourcing from Vietnam a rather more tariff comparative, yet cost effective solution than was previously the case.

In addition to this, it should be noted that while Vietnam is part of the TPP agreement with the United States, and has, via its membership of ASEAN, a free trade agreement with China, it is also currently the only country within all of these agreements to possess a free trade agreement with the Eurasian Economic Union. That neatly provides a sanctions loophole whereby entrepreneurial Russian businesses can invest in Vietnam and sell products to the United States.

Conclusion

It is clear that China is going to need to adapt if it wishes to make further inroads into the American market. It could do so, but only after some studying of the effects on the TPP upon other Asian members, and Vietnam and Malaysia in particular. If their trade with the US increases in their favor, China will be aware it may have missed an opportunity. That realization would only become more acute should the Chinese economy begin to stagnate or flounder. The CCP needs to keep its citizens happy, and will relax trade barriers should it feel its governance of the country could be criticized or a feeling develops that the nation is being left behind.

In the meantime, China has its own political trade ball to play with, and seems intent on opening up the Silk Road Economic Belt. Of the two, the TPP is expected to create an almost immediate return, yet China is not part of that agreement. The CCP will have to get used to a carrot & stick approach from the United States when it comes to increasing any further trade access. It remains to be seen quite how that will manifest itself. However, my view is that it will be the future performance of the Chinese economy that would dictate whether China will later be part of the TPP group.

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