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Reconsidering RCEP’s Impact on Foreign Investment

The Diplomat - 25 June 2021

Reconsidering RCEP’s Impact on Foreign Investment
By Jean-Marc F. Blanchard and Wei Liang

On November 15, 2020, after almost a 10-year negotiating process, the member states of the Association of Southeast Asian Nations (ASEAN), Australia, China, Japan, New Zealand, and South Korea concluded the Regional Comprehensive Economic Partnership (RCEP) free trade agreement (FTA), which also contains many provisions covering areas beyond trade.

Among other things, RCEP eliminates and lowers tariffs, cuts red tape (for example, by standardizing customs procedures), simplifies and reduces rules of origin (ROOs) restrictions and paperwork, liberalizes a number of service sectors, improves the protection of intellectual property rights (IPR), enhances the transparency of government procurement processes, and facilitates mutual recognition of professional certifications such as for doctors and lawyers.

The conclusion of RCEP, described as a “game changer” by some, produced much excitement. Reasons for that excitement included its provisions; the involvement of China, Japan, and South Korea (Japan does not have bilateral FTAs with either South Korea or China); and the unification and consolidation of the “noodle bowl” of existing bilateral, subregional, and regional FTAs and bilateral investment treaties (BITs). Fueling the exhilaration was the participation of five of the world’s top 20 economies by GDP, RCEP’s massive, 2 billion people-plus market, and the conclusion of an FTA at a time of rising protectionism and the intensification of the China-U.S. trade war.

Despite RCEP’s limits — the FTA, for instance, deals little with agriculture, worker standards, state-owned enterprises (SOEs), and subsidies — many predict RCEP could increase trade by hundreds of billions of dollars and dramatically multiply regional GDP.

As for foreign direct investment (FDI), the United Nations Conference on Trade and Development (UNCTAD) proclaimed that RCEP “could give a significant boost to FDI in the region.”

One factor driving potentially higher FDI flows is the removal of various hindrances to business establishment and operations in signatory nations. Changes to ROOs merit special attention. Specifically, RCEP adopts the “cumulation rule.” This means all RCEP signatories are treated as one economic region, which allows goods originating from one member state used as inputs in the production of a new product in another member state to be considered as if originating in the second member state. For example, cotton from China that is processed in Vietnam will be regarded as originating in Vietnam when Vietnam exports the final product to another RCEP country. This should incentivize companies within the RCEP region to give new attention to lower-cost production venues like Vietnam.

The openings created by a new “negative list” system for FDI should spur greater FDI flows, too. As for non-service sectors, RCEP adopts a negative list approach for the manufacturing, agriculture, forestry, fishing and mining sectors. Regarding service sector liberalization, RCEP embraced a two-tier system with Australia, Brunei, Indonesia, Japan, Malaysia, Singapore, and South Korea committing to a negative list approach while Cambodia, China, Laos, Myanmar, New Zealand, the Philippines, Thailand, and Vietnam adopted a positive list approach (meaning a detailed commitment for liberalization).

Adding to the investment appeal of the RCEP region for multinational corporations, RCEP signatories will be undertaking numerous measures with respect to investment facilitation such as the easing of administrative procedures. Beyond this, commentators expect that multinational corporations inside and outside the RCEP region will pour more money into it to exploit the attractive opportunities created by growing economic integration, and the efficiencies flowing from increased competition.

Finally, RCEP contains some state-to-state dispute settlement mechanisms, though the emphasis is on consultation rather than the usage of adversarial dispute settlement options.

It is, of course, premature to make any definitive judgement about RCEP’s FDI effects given it was signed less than a year ago and many signatories have not yet ratified it. Moreover, global economic activity — particularly FDI flows — has been and continues to be severely disrupted by the COVID-19 pandemic. Nevertheless, we believe that expectations regarding dramatic shifts in FDI volumes and geographic destinations need to be tempered.

First, reduced trade barriers are a disincentive to FDI since escaping tariff and non-tariff barriers is an important rationale for FDI. Second, a very large proportion of FDI in RCEP region countries relates to investment drivers such as industrial and national agglomerations, market size, or natural resources. RCEP will do little to undercut such drivers.

Third, China’s successful control of COVID-19 within its borders and impressive production attributes — infrastructure, complete supply chains, and political and labor force tranquility — in conjunction with its immense national and sectoral markets will keep a large proportion of FDI centered on China. Surveys by business associations such as the American and European Chambers of Commerce in China repeatedly lend credence to such a view. It should be noted, too, that with the application of information and communication technology (ICT), it may be possible for China to remain a cost-efficient producer, which would blunt the appeal of shifting to other countries within the RCEP region.

Fourth, it is highly likely that major regional outward investors like Japan and South Korea will invest not in the RCEP region, but in other developed and developing regions in their quest to access markets, resources, and keep major partners satisfied. This last dynamic was witnessed when South Korean multinational corporations such as Hyundai and Samsung promised to invest tens of billions of dollars in the U.S. around the time of the summit between U.S. President Joe Biden and South Korean President Moon Jae-In.

Fifth, it is possible that the implementation of RCEP may not reach the ideal, with recent studies indicating many ASEAN countries are not making adequate progress in reducing non-tariff barriers. Beyond this, many RCEP commitments such as those relating to technical standards are not binding.

Lastly, while RCEP does provide for state-to-state dispute settlements, a RCEP Secretariat, and regular meetings designed to keep implementation on track and provide a foundation for improving RCEP, it remains to be seen how potent such mechanisms will be. Relatedly, RCEP does not provide for investors-state dispute settlement, which is more useful to businesses.

We do not feel, paraphrasing one analyst, that RCEP is “new wine in old bottles… wine without much alcoholic content… or may not even be wine at all.” However, it is important to assess RCEP’s implications dispassionately.

Based on our analysis, RCEP does not ensure a new world order for FDI. Countries wanting to attract FDI cannot rest on the laurels of RCEP or its changes in ROOs. They must continue to build, among other things, their markets, infrastructure, and supply chain clusters and reduce de jure and de facto barriers to flows of capital, goods, and people. For companies inside the region, there may be benefits to be gained from the shifting of production to lower cost venues, but exporting may be a more viable pathway to riches since it does not entail, in concept, all the cultural, operational, and political hassles that investors confront. As far as companies and countries outside the RCEP region are concerned, there may be advantages to investing in the RCEP region, but this likely will be less due to RCEP than the attractions of individual RCEP member countries. After all, entities outside the RCEP region already have numerous deals with countries in the region and RCEP does not dramatically change the tariff picture within the region.

In our next piece, we will reconsider the implications of RCEP for trade within and outside the region.


 source: The Diplomat