Untangling the knots: The consolidation of FTAs could provide a spur to liberalisation efforts

The Philippines is party to a number of free trade agreements (FTAs), many of which are overlapping, and some of which have become redundant. It is part of ASEAN’s Free Trade Area and is a signatory to many FTAs between ASEAN and other countries, such as Australia, China, India, Japan, New Zealand and South Korea. The country also has a bilateral FTA with Japan and is discussing additional FTA deals with Switzerland, Taiwan, Iceland, Norway, Lichtenstein, the EU and the US.

THE NOODLE BOWL: Many of the Philippines’ trading partners have conducted their own agreements, complicating the landscape and further muddying the free trade waters. Singapore has an FTA with the US. Brunei Darussalam has signed the Trans-Pacific Strategic Economic Partnership Agreement (TPP) with Singapore, Australia and New Zealand. China, Japan and South Korea are negotiating their own free trade deal, while Thailand has bilateral FTAs with Japan, China, Australia and New Zealand. The result is a complex web of dotted and dash lines with the potential, according to some observers, to increase transaction costs as well as systemic risk, as various rules of origin and tariff rates interact with each other. Confusion and chaos at the enterprise and Customs department level are possible, and considerable sums might have to be spent all along the value chain to make sure that the best rates are paid and that the appropriate rates are properly applied.

This is known as the spaghetti bowl phenomenon – and in Asia specifically as the noodle bowl phenomenon. The WTO notes that 379 free trade and related agreements are currently in force globally, with an estimated 109 of these involving at least one Asian country. ASEAN has been particularly active, with 67 FTAs in effect. These numbers are set to grow. According to the Asian Economic Integration Monitor, if all FTAs are considered – those proposed, those with a framework agreement signed, and those signed and already in effect – the total would be 257 for Asia and 179 for ASEAN. The report also notes that Singapore has the most FTAs globally, while the Philippines ranks at 15th.

CONSOLIDATION: Partly in response to this growing confusion is a push to consolidate FTAs. Precedents exist, most notably in NAFTA which took over from the Canada-US FTA, or in the Central European Free Trade Area, which replaced 32 existing FTAs. One possible vehicle for cleaning up the FTA field among ASEAN member states is the Regional Comprehensive Economic Partnership (RCEP). The basic idea behind the RCEP is to bring together ASEAN and its six FTA partners, creating one umbrella agreement that includes all 16 countries. This would help to untangle ASEAN's many trading relationships, and so could constitute a first step in dealing with the noodle bowl phenomenon.

It would also create a large group and an impressive economic unit, comprising 3bn people, making up more than 45% of the world's total population and 26% of its FDI flows. It would also conduct more than a quarter of total global trade and have a GDP of $17trn, equal to about one-third of the world's total. In short, it will become the world's largest trading bloc. Importantly, the RCEP contemplates a deeper level of cooperation than the FTAs it intends to replace. Negotiations to create the grouping began in 2011, and it is hoped that they can be concluded by 2015.

The main concern about the RCEP is that it is both too ambitious and not ambitious enough. It aims to bring together a highly diverse set of countries in a giant conglomeration that spans from India to Japan, but in order to achieve that it is going to have to make a number of compromises. Indeed, such compromises are built into the agreement in the first place. The communiqué from the first meeting of the RCEP trade negotiating committee contains a flexibility clause, allowing some of the lesser developed countries to opt out. If these are used too often, and past experience suggests they may well be, the bloc will be something other than a true free trade area, with individual nations within the group retaining trade barriers to suit economic circumstances.

STOPPING SHORT: While the RCEP is more ambitious than existing FTAs, it remains relatively conservative. It calls for significant reforms, but stops short of tackling more complex and fundamental issues such as intellectual property rights. The origins of the grouping suggest that it will by definition be conservative. The ends are to create a bloc, so the rules will be set to achieve those ends. That is rather different from a free trade area where the ends are to bring together like-minded open economies – where rules are set in advance and those who want to enter must meet them.

The inadequacy of FTAs is well known in Asia. According to Josef Yap, president of the Philippine Institute for Development Studies, FTAs are more political than economic. They are, he says, trade-light, filled with so many exemptions as to be all but meaningless in terms of truly substantive reforms. He argues, however, they should be signed, as they do no harm and do offer some significant benefits, such as technical cooperation.

As a political effort, the RCEP could be quite successful. Because of its willingness to compromise for the sake of unity, it could very well become a reality in a short space of time and make a bold statement about regional cooperation. The most difficult liberalisations could be pushed into the future and dealt with when the time is right and each country is ready. The fact that a country like India, with relatively high tariffs and problematic non-tariff barriers, could be placed within the same trading group as Singapore, which is a free port, is an impressive achievement in and of itself.

TIME TO DECIDE: For the Philippines, joining will be an easy decision. It will not likely have to undertake any of the most difficult reforms, such as those involving foreign ownership or intellectual property rights, and will instead be able to focus on achievable goals. As a result, the RCEP could be a productive endeavour. While it will not examine the inner workings of member states, it will nevertheless ask more from signatories than has been asked to date. Small gains in terms of reform will be made and the trade and investment environment will improve to a certain extent. Most significantly, a platform will be created to push for further liberalisation. Constructive dialogue will be established.

The question is how the RCEP will work with other agreements. Clearly, it is set to supersede or nullify many existing FTAs. But as it does so, others will likely be signed and the problem of the noodle bowl will remain present. One possible solution is for other FTAs to be rolled into the RCEP over time, so that rather than conflicting, the competing groupings could be merged. This might be the wave of the future, as an increasing number of states demonstrate a willingness to cooperate across great distances and with countries at very different levels of economic and political development.

However, this may not be the case with the TPP. This is a very different type of FTA, with far more stringent conditions and less tolerance for exceptions. New members have to show that they can make the grade. Because of this, the TPP is likely to lag in terms of adding further Asian economies. The Philippines, for instance, will find it difficult to join given its constitutional restrictions on foreign investment (see Economy chapter). In that case, RCEP is likely to win the country count at first.

What happens after that is harder to predict. Some see the two coexisting peacefully, with a few countries part of both groupings simultaneously. However, others forecast that the TPP may split ASEAN into a two-tiered community, with the more economically open countries – Singapore, Malaysia, Vietnam and Brunei Darussalam – opting for the TPP and thus putting the RCEP project at risk. The Philippines, with its current territorial disputes with China, might in the end choose to join the TPP regardless of what that would involve.

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The Report: The Philippines 2014

Trade & Investment chapter from The Report: The Philippines 2014

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