Potential Responses to Mega-regionals by Excluded Countries

Author: Uri Dadush
Originally published by the World Economic Forum

The TPP and TTIP intend to reshape world trade rules for the 21st century. However, the negotiations exclude some 160 countries, which are home to over 80% of the world’s population. These countries typically grow 3% a year or so faster than those included in mega-regional negotiations and, on current trends, may well account for over half of world trade in the not distant future. Thus, how the excluded countries respond to the rise of the mega-regionals is an important question not only for their citizens, but also for the United States, the European Union, Japan and the other 10 countries that are participants in the negotiations.

Uncertainties and possible impact

Very large uncertainty is attached to the content and timing of the mega-regionals. Indeed, whether these enormously complex agreements will conclude at all, or whether they are reduced to a minimum common denominator outcome that does not commit the parties to much, is unknown. Even if the TPP, which is by far the most advanced, is agreed on in 2014, the confidence interval around the “bite” of its provisions is wide, ratification by the US Congress is uncertain and implementation of its more significant measures could take many years. Thus, even though their own policy response could require long lead times, many of the excluded countries may decide to adopt a wait-and-see posture. Furthermore, since any response requires commitment of negotiating resources and political capital, the excluded countries will be inclined to look for strategies that are robust to the many possible outcomes.

The starting point for formulating an appropriate response to the mega-regionals is how the agreements are likely to affect the excluded country’s defensive and offensive trade interests. One can already predict that the vast majority of export sectors will be little affected by the TPP and TTIP since tariffs among the contracting parties are already low, and the reduction of many non-tariff barriers (such as custom delays and red tape) are likely to have MFN effects. However, there will also be instances (garments, autos, sugar, cotton, etc.) where tariff peaks prevail and significant trade diversion could occur as a result of their reduction or elimination. And, while the adoption of common standards could open up new export opportunities, there will be instances, especially if the reforms take the form of mutual recognition, where the new standards provide a significant advantage to firms of the contracting parties. There will also be instances where import- competing firms in the excluded countries will be adversely affected, as firms of the contracting parties that compete with them will benefit from economies of scale, lower tariffs and improved cash flow. Many of the effects on both exports and imports will be indirect, as changes in the competitive position of one firm will resonate up and down the supply chain.

While much of the impact on excluded countries will occur in specific sectors and thus calls for careful monitoring of the provisions being negotiated at a micro level, one cannot lose sight of the systemic implications of the mega-regionals, especially as changing the global trade rules is set out as an explicit objective by US and European negotiators. If successful, the agreements could set up new benchmarks and approaches – for example in the life of patents or in policies governing exchange rates – which will either supersede WTO or eventually come to be integrated into WTO. Even if no attempt is made to broaden the reach of the new standards to other countries, their adoption by countries representing such a large share of global economic activity will be of great significance to exporters and import- competing firms around the world. In practice, this means that excluded countries will see their influence on the global trade architecture diminish. Moreover, even for the largest excluded countries, such as China, an individual response to the systemic effects of mega-regionals is unrealistic. It is instead likely to rest in coalition formation with like-minded countries who want to see different outcomes. A natural place to seek out such coalitions is in the WTO, but history shows that the pursuit of parallel or competing regional deals is the more likely path.

Response

How should excluded countries respond? The tendency is to think of countries as led by an all-knowing and independent expert who will choose the public interest. In practice, the response to the mega-regionals will reflect the weight of domestic political interests and how they see themselves affected by the new trends. One implication is that countries are unlikely to react until an important domestic constituency sees a clear threat or opportunity. Another implication is that the largest countries, especially those that see themselves as rising powers – such as China, India and Brazil – will probably react faster to the perceived systemic implications of the mega-regionals, including their geopolitical and security implications, than will many smaller countries who see themselves as little able to affect the system.

Following are the pure strategies that can be pursued, recognizing that they will sometimes be deployed in combination.

1. Do nothing—This is often a bad strategy but one to which many political systems naturally converge. In this case, the uncertainties are so big that it may make sense to wait and see, especially for small countries that cannot hope to affect the negotiations or to realistically craft a systemic response. Even then, countries will want to monitor developments closely and analyse the impact of alternative scenarios or outcomes on their most important trade interests. They may begin to devise strategies and send out feelers to trading partners.
2.  Reject, withdraw, obstruct—This is the worst response. Countries are not likely to retreat into protectionism or obstruct WTO negotiations just because they do not like being excluded from mega-regionals. However, where influential domestic constituencies are hostile to trade anyway, the disappointments with multilateral approaches and exclusion from the most vital parts of world trade negotiations can play into the hands of anti- globalization lobbies and of those who argue that the dice are loaded. Although the modest progress made in Bali may have mitigated this risk, the shift of focus by the major trading powers onto mega-regionals will discourage countries that tend to be inward-looking, such as India, Brazil, Russia and South Africa, from adopting a more liberal stance.
3. Enact autonomous reforms—This is the best response to mega-regionals but also the least likely course politically. The mega-regionals do little to change the political economy of autonomous trade reforms in the excluded countries, and, if anything, strengthen the hand of protectionists. Still, if done at the right pace and with adequate companion measures, unilateral regulatory reform and trade liberalization can induce a supply response and reduce distortions, and are an effective way to prepare firms for the increased competition, tougher standards and bigger markets that successful mega-regionals would bring. Moreover, these reforms are robust – worth pursuing regardless of the shape that mega-regional may take.
4. Join them—One strategy, most likely to appeal to smaller countries eager to join the TPP, is to use the available “docking stations”. The downside of this approach for a small country is that it will mean being subjected to one of the most lopsided trade negotiation in history. Moreover, this path is very unlikely to be pursued by large countries, not only because the likes of China or Indonesia will not accept unconditional adoption of the TPP “acquis”, but also because the incumbents will be reluctant to open their doors so wide to a big, new source of competition without imposing additional conditions.Given the complexities of joining a mega-regional after their conclusion has been reached, a more realistic approach is to enter into a bilateral negotiation with both the US, which is a way to get a large chunk of the market access under the TPP and TTIP, and the EU. Such an approach would provide a window to the regulatory reforms and tougher standards both trading powers are aiming for. Many smaller countries will be attracted by this option, even though the negotiations are likely to be lopsided. Larger countries, with greater bargaining power, may also pursue this route – as in the Brazil-EU and India-EU negotiations at present.
5. Compete with them—This strategy consists of joining competing regional arrangements or forming new ones. There is, however, nothing on offer that is likely to compare in terms of ambition or scope with the TPP and TTIP. The prospect of RCEP, which includes China, India and Japan – geopolitical rivals with very divergent trade agendas – resulting in a high ambition agreement is, to say the least, distant. Any number of other opportunities exist for countries to enter into far- reaching trade agreements with neighbours or with their most important trading partners in other regions, including those that are set to join the TPP (those joining TTIP are part of the EU Customs Union) and from whom one can “learn” the new standards. However, these agreements would be limited in their reach (proportion of trade covered). They would only be a very partial response to the mega-regionals and are best seen as a complement to autonomous trade reforms.
6. Re-engage in the WTO—This strategy could have been considered as pure wishful thinking before Bali. After the modest success in Bali, and given the growing realization that successfully negotiating the TPP and TTIP also presents great challenges, WTO re- engagement is perhaps a less far-fetched option for many countries, including those engaged in the mega-regionals. Adopting a realistic post-Bali agenda in Geneva is not going to stop the TPP and TTIP train, but, if done right, could create a positive dynamic between the regional and multilateral negotiations. Indeed, the constructive role played in Bali by many, from the US to China, the LDCs and even India, may reflect concerns that the mega-regionals could render the WTO irrelevant and ultimately undermine its acquis. In some aspects of the mega-regional negotiations, for example on trade facilitation, the Bali agreement could represent the minimum denominator starting point, and advances in regional negotiations could eventually feed back into the multilateral sphere.What appears unrealistic after Bali is the pursuit of far-reaching WTO agreements based mainly or exclusively on the single undertaking/consensus rule. To revitalize the multilateral system, countries involved in TPP and TTIP negotiations and those excluded will probably have to accept slicing up the Doha agenda (and the many issues which Doha did not address) into manageable pieces involving a critical-mass subset of countries willing to move faster and farther than the rest.

Conclusion

For the countries excluded from mega-regionals and worried about the systemic implications for the global trade system, “plurilateral” or flexible geometry approaches within the WTO probably represent the only realistic response. Such approaches would form an important part of their overall national response to mega-regionals, which could also include autonomous trade reforms and the initiation of new bilateral or regional negotiations with the contracting parties to the TPP and TTIP, as well as with other important trading partners, enabling them to raise the competitiveness of their productive apparatus.

This article was originally published as part of a paper by the World Economic Forum entitled Mega-regional Trade Agreements: Game-Changers or Costly Distractions for the World Trading System?