How Mega-Regional Trade Deals Affect China

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German Chancellor Angela Merkel travels to China on June 12th for the fourth Sino-German government consultations. Trade and investment between China and Germany will surely be on top of the agenda. Merkel’s visit is bound to receive a great deal of public attention, nationally and internationally. At the same time, Beijing’s talks on trade and investment with a number of other countries have so far been given much less attention, although their economic impact on China will be felt in Germany and beyond.

Figure1: China’s trade relations with three of it’s major trading partners, the United States, Germany and Japan, 2013

Currently, three mega-regional trade agreements are being negotiated in the Asia-Pacific region: the Trans-Pacific Partnership (TPP), the Regional Comprehensive Economic Partnership (RCEP) and the Free Trade Area of the Asia-Pacific (FTAAP). They differ in their composition and regional outreach and thus also in their economic impact on different countries, on which our latest infographic provides a more detailed overview.

China, albeit being the world’s largest trading nation, is excluded from the TPP. This could be regarded as deliberate containment, since the TPP is backed by the United States. A statement from the White House also points into this direction:

“With the TPP, we can rewrite the rules of trade to benefit America’s middle class. Because if we don’t, competitors who don’t share our values, like China, will step in to fill that void.”

China has therefore started to favor the FTAAP, which like the TPP connects the Asia-Pacific region, but includes all 21 member states of the Asia-Pacific Economic Community (APEC), as compared to only 12 TPP members. China is also a member of the RCEP, which is promoted by the Association of Southeast Asian Nations (ASEAN) and strives for closer integration between Asia and Oceania.

China need not fear the TPP…

Our analysis of the potential economic effects of these agreements shows that under the most likely shallow TPP scenario, China experiences a loss in real income (-0.08 percent) and a decline in total value added (-0.23 percent). These effects stay within very narrow limits. Effects on value added in the 10 main sectors are well below one percent. The overall structure of China’s most important trading partners hardly changes under the TPP. Nor is a general trend in trade with TPP members evident – positive or negative. China imports less from Japan, but more from the United States, while Chinese exports to Japan increase and Chinese exports to the United States decline. The latter is mainly due to the electronics sector and textiles, where TPP members seem to gain competitiveness on the US market vis-à-vis China. Since these are core sectors in China’s trade, this could be a development with a more long-term impact. Germany, as China’s most important European trading partner, retains this position under the TPP and can even slightly increase its exports to China.

…but would be far better off with the FTAAP

The situation is very much different with the FTAAP, in which China participates. In the most likely shallow FTAAP scenario, China experiences considerable welfare gains (+5.89 percent). Especially the reduction of non-tariff barriers gives China a real boost, which may be ascribed to China’s most important trading partner, the United States, being part of the pact. Moreover, the reduction of trade cost leads to considerable trade creation among FTAAP members. While most European countries suffer from trade diversion effects, Germany remains the only European country among China’s Top 10 importers and can chalk up significant gains. So the competitiveness of German products in China would not be sustainably affected by the FTAAP.

Figure 2: Change in China’s real income in the most likely shallow scenarios of TPP, FTAAP and RCEP
Source: Calculation ifo

On the sectoral level, the FTAAP clearly increases total value added in China (+3.66 percent). Eight of 10 main sectors show an increase in value added. Only two of them are negatively affected: The chemical industry has to accept a loss of -0.24 percent. The mining sector even loses in the double-digits, with -24.97 percent. This may be explained by the fact that these industries are classified as strategic sectors in China and are consequently still state-dominated. With further trade liberalization, an at least partial removal of privileges would be necessary.

The RCEP further deepens China’s ties with Asian countries

Under the ASEAN-initiated RCEP, which does not include the United States, China experiences fewer welfare gains than with the FTAAP, but they still are considerable in the most likely shallow scenario (+2.26 percent). Total value added increases by only +0.66 percent, with some sectors reaping considerable gains, while the impact on others is close to zero or negative. Of the 10 main sectors, the electronics industry would benefit most with an increase in value added by 2.49 percent. It may be assumed that the intermediate products traded among RCEP members in this sector are burdened by non-tariff trade barriers, which are partially removed in the most likely shallow scenario, leading to price reductions. China’s chemical industry endures a loss in value added under the RCEP, too (-1.76 percent). As mentioned above, this could be due to the state monopoly, which would have to be softened by the agreement.

Figure 3: Change in China’s total value added (32 sectors) in the most likely shallow scenario of TPP, FTAAP and RCEP
Source: Calculation ifo

The biggest changes in China’s trade spread only to RCEP members, with three-digit increases for some countries. In terms of exports to China, this could be due to a rise in Chinese demand for intermediate products from the region among other things. India is at the top in increasing its imports from China. The demand for Chinese products in India, for example, in mechanical engineering or the automotive industry, has already increased continuously in recent years. It is assumed that an elimination of trade barriers between the two countries would further promote this development. Under the RCEP, Germany would export less to China in absolute terms, but its position in the Top 10 hardly changes.

For China, inclusion matters

Our analysis shows that China profits most from those mega-regional trade deals in which it participates. The effects of the FTAAP with China and the United States as members clearly exceeds those of the RCEP in terms of welfare gains and increase in total value added. Regarding the TPP, China need not fear any significant adverse effects for now, despite not being a member. The impact of the agreement on Chinese welfare and value added is comparatively manageable. However, the political dimension of these agreements should not be neglected: In the 21st century, trade negotiations are not only about economic issues, but at least as much about the question: Who makes the rules governing international trade in the future? In this regard, as the US statement quoted above shows very well, only those who are part of the game will have a say. If China does not want to be kept out, it needs to push those trade deals in which it is included. Also, the Chinese government could consider – further institutionalizing its “One belt, one road” (OBOR) initiative, which aims at trade integration, but currently is not intended to become a fixed agreement.

Turning back to Germany, both dimensions matter: a globally well-integrated China, and a China that plays by international rules. So from a German perspective, it makes sense to act inclusively vis-à-vis China and thus it ought to appear questionable to exclude the world’s most important trading nation from trade agreements in its very own neighborhood.