Trumponomics: Trans-Pacific Partnership is the first trade victim

On his first day in office on Monday the 23-rd, United States President Donald Trump signed an executive order formally ordering the withdrawal of the US from the 12-nation Trans-Pacific Partnership (TPP) trade deal. Although this had been expected based on his promises during the campaign trail, it is regarded as an historical break given that the US has never before failed to ratify a negotiated trade agreement. In this piece, we briefly look at which region is expected to lose out most because of TPP not happening and what the broader implication is of this move by Trump.

The Trans-Pacific Partnership trade agreement, which was initiated by the US, included the US and 11 other nations bordering the Pacific, covering roughly 40% of global GDP and 20% of world trade: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam (Figures 1 and 2). TPP thus would have involved a diverse group of countries, varying from advanced economies such as the US, Canada, Australia and Singapore to emerging markets like Malaysia, Mexico and Peru.

Although TPP would likely have benefited all these countries, the latter group (emerging markets) would have benefited disproportionally. The reason for this is that the intellectual property rights framework is less developed and the respect for international labor standards is lower across this group. That is why TPP, next to tariff measures, includes provisions on state-owned enterprises (SOEs), labor protection standards and the protection of (intellectual) property rights. These provisions were an important long term benefit of TPP because adhering to them requires passing, in some cases much needed, institutional reforms.

The failure of TPP does not impact existing trade flows directly, since it simply had not yet been implemented. But its failure means a missed opportunity for its participants to increase welfare (Table 1). Moreover, it could have considerable negative spillover effects, since these countries wanted to achieve bigger national objectives next to increasing welfare, such as lower tariffs and improving compliance with international standards for labor and intellectual property rights. We note that the pain will be felt most by Asian countries and less by Latin American countries such as Mexico, Chile and Peru. The potential long term benefits of TPP for Latin American countries were likely to be limited since they already face low tariffs when exporting to the TPP countries and in some cases also have less to gain from TPP’s non-tariff provisions.

The US withdrawal has given China, which was excluded from TPP, opportunities to fill a void and to further expand its influence in Asia. It has already been in negotiations on a different regional free trade deal, the Regional Comprehensive Economic Partnership (RCEP), which includes a number of Southeast Asian countries, Japan, India and Korea, but excludes the US (Figure 1), directing Asian trade towards China. But whereas the TPP was focused on the reduction of tariff and non-tariff barriers, the RCEP focuses primarily on tariff barriers alone, and most countries in (Southeast) Asia already have trade agreements with China. Thus the economic benefits from RCEP are not to be as large as those from TPP.

The TPP collapse is beneficial for South Korea, as this country was not included in potential TPP benefits, but less beneficial for Japan: it undermines premier Abe’s ability to make progress on structural reforms (e.g. third pillar of Abenomics), such as agriculture, energy and healthcare. The potential benefits for Japan from the proposed RCEP trade deal are similar in scale to those that might have been achieved under the TPP. But they are not substitutes for each other: the more important areas of the agreement for Japan relate to non-tariff barriers, government procurement and state-owned firms. As such, TPP’s failure could harm Japan’s long-term prospects and deprive it from necessary foreign direct investments (FDI) into the country in order to raise its productivity levels.

Within Southeast Asia, Malaysia and Vietnam stand to lose most from Trump’s withdrawal of TPP since they would have gained significantly from tariff and non-tariff related provisions of TPP. Regarding the former, Vietnam and Malaysia will be hurt through the absence of reduced tariffs. The potential benefit of such reduced tariffs could have been significant since Vietnam’s and Malaysia’s exports to the US are significant, representing 18% and 6% respectively of these countries’ GDP (Figure 3). On the other hand, as was the case for South Korea, the Philippines indirectly benefit from TPP withdrawal since they were not included in the first place.

Regarding non-tariff related benefits, as we already mentioned, a major long term benefit of TPP were its provisions on SOEs, labor protection standards and the protection of (intellectual) property rights. Effectively, participating in TPP is a way of passing reforms (which will structurally benefit the economy) without upsetting vested interests. For example in Malaysia, stronger intellectual property laws required by TPP would have helped the country to attract FDI to further develop its electrical and electronics sector, which in 2015 comprised more than 30% of Malaysia’s exports. In Vietnam, TPP could have driven reform of the country’s inefficient SOEs, which account for 30% of GDP and employ 14% of the labor force. The Vietnamese government has been trying to pass such reforms for years, but has been unable to do so due to vested interests.

Further south, in Australia and New Zealand, TPP’s demise has negative implications for exports. The TPP countries represent about 40% and 30% of the total exports of Australia and New Zealand respectively. More structurally, without TPP, the ambition of these countries to diversify their economies away from its dependence on China will stall.

In terms of sectors, the ones that depend heavily on foreign trade will lose out most. For example the electronics sector in Malaysia, the textile sector in Vietnam, the dairy sector in New Zealand, and the agricultural sector in Australia.

On a broader scale, Trumps’ actual withdrawal of TPP indicates that he is serious about his protectionist agenda. At a minimum this raises the risk that world trade growth is not going to make much of a headway in the coming years – a point that we also made in a recent Special.

Moreover, if his actions result in protectionist retaliations (for example by China), this would stifle trade and, in a bleak scenario, could even lead to a trade war (a scenario we discussed in our US Special: The Trump Trade War Game). The chance of this happening seems to have slightly increased, although it is too early to say by how much. Should such a scenario take place, and China’s economic growth takes a big hit as a result, there will undoubtedly be knock on effects for countries that export heavily to China. Here Taiwan and Malaysia are likely to take a hit since they are relatively large suppliers of intermediate goods to China (intermediate exports are about 1.5% and 1% of Taiwanese and Malaysian GDP’s respectively), particularly of electronics.