International Trade CSQ — RCEP, Tariffs, Supply-Chain Resilience and Standard of Living

Case

Extract 4: India has good reason to reject the Regional Comprehensive Economic Partnership

India dropped out of the Regional Comprehensive Economic Partnership’s (RCEP) negotiations in November 2019 after participating in 28 of 31 rounds of talks over a six year period. India’s withdrawal, announced last year in a joint leader’s statement issued at the end of an Association of Southeast Asian Nations (ASEAN) summit in Bangkok, said that India had “significant outstanding issues which remain unresolved.”

Indian textiles, agriculture and dairy sectors, which employ hundreds of millions of workers, are seen as the most vulnerable to Chinese and other RCEP signatory imports. Under the pact, India would have been required to steadily drop tariff levels. China already enjoys a huge trade surplus with India, which hit US$48.6 billion in the 2019–2020 fiscal year period, according to Indian official statistics.

RCEP proponents say it will help signatory nations to emerge faster from the pandemic’s economic devastation including through greater participation in and access to regional supply chains. But Indian political leaders counter that they are protecting domestic interests from cheap and, in China’s case, often state-subsidised cheap imports.

Indian industry is already vexed by a sharp increase in imports from China that have adversely impacted small and medium-sized factories in particular. At the same time, India’s exports are often blocked by non-tariff barriers imposed by China, Indian trade groups and associations claim. Indian textile, steel and tire industries, all protected in varying degrees from foreign imports, would likewise face sudden stiff competition from RCEP nations.

Source: Asia Times, 15 November 2020

Table 2: Current account balance as % of GDP, 2016–2020

	2016	2017	2018	2019	2020
China	1.7	1.5	0.2	0.7	1.7
India	-0.5	-1.5	-2.4	-1.1	1.3
Singapore	17.7	17.3	15.2	14.5	17.1

Source: World Bank national accounts data, and OECD National Accounts data files

Extract 5: Easier, cheaper for Singapore companies to do business regionally with RCEP

Companies will soon find it easier and cheaper to conduct business in the region when the newly-inked, region-wide free trade pact takes effect, said Trade and Industry Minister Chan Chun Sing. Speaking to reporters after signing the RCEP, Mr. Chan said the agreement provides businesses with better intellectual property protection and enables them to consolidate their production across participating countries, which will lead to cost-savings and time-savings. Consumers, too, will see benefits with a more competitive range of products to choose from, as well as cost-savings passed down from the elimination of tariffs on most goods traded among participating countries, said Mr. Chan.

The RCEP was signed virtually by all ten ASEAN members and key partners Australia, China, Japan, South Korea and New Zealand on the last day of the annual year-end ASEAN Summit hosted by Vietnam, which also handed over the chairmanship of the grouping to Brunei. Together, the RCEP countries account for 30% of the global economy and one-third of the world’s population. Singapore’s trade value with the other 14 RCEP members has grown steadily over the years, reaching 50.4% or S$515.2 billion of the Republic’s global trade last year.

The agreement’s key benefits include tariff elimination for at least 92% of goods traded among members, and allowing businesses to invest in fellow RCEP countries without having to meet conditional performance requirements. As a result, businesses handling chemicals, plastics and processed food could see cost savings for their exports especially to China, Japan and South Korea. Express consignments and perishable goods also have to be cleared by customs within six hours of arrival.

There will also be greater clarity and transparency for firms seeking government projects, with members agreeing to publish laws, regulations and procedures on such opportunities. RCEP members are also obliged to share information that may be relevant to small and medium enterprises so that they can benefit from the agreement.

As for concerns some have raised about benefits being tilted in favour of larger economies, like China, Mr. Chan said the signing of the RCEP will bring about mutual benefits for both Chinese companies venturing beyond the domestic market, as well as for non-Chinese companies who want to enter China. It will also allow for both the Chinese and regional markets to be seen as an integrated market, which will make the grouping more attractive to global investors and enhance the competitiveness of its exports to the rest of the world, he added.

Source: The Straits Times, 15 November 2020

Extract 6: Singapore to be a reliable node in global supply chain and build internal resilience

Singapore has to build its reliability as a node in the global supply chain, while also keeping an eye on the resilience of its own internal supply networks, said Senior Minister of State for Trade and Industry Chee Hong Tat. This is especially so since the coronavirus pandemic has affected many businesses and employees around the world.

“The global economy is experiencing both a supply and demand shock. Supply chains have been disrupted, as countries imposed lockdowns and export bans. Even as countries are gradually reopening their economies, travel restrictions remain,” Mr. Chee said. “To enhance supply chain resilience, some countries may respond by restricting exports — especially for essentials, such as food and medical items — while others will strengthen their interdependence with other economies. As a small and open economy, Singapore’s response cannot be the former. We must continue to look outward and find our relevance in the new world.”

He added that Singapore is keeping its ports and production lines open to ensure that trade flows unimpeded, which shows that it is reliant in times of crisis. He brought up the example of mask manufacturer Medicom, which is headquartered in Montreal. It announced in June that it would locate its new surgical mask manufacturing facility here. Mr. Chee said: “These investments will create a diversity of good jobs in research, product development, manufacturing and commercial functions.”

But internally, Singapore also needs to constantly review its sources for essential items, he added. For instance, it is establishing new networks and diversifying supply sources and markets in food to ensure long-term food security. Singapore is also working on building local capabilities, such as in urban farming and agri-food technology, he added.

But ultimately, workers and companies have to prepare for changes in the global supply chain by taking advantage of opportunities in the digital economy. Businesses can go overseas through e-commerce platforms, for instance. Workers can also upskill themselves through continual training.

Source: The Straits Times, 2 July 2020

Questions

(a) With reference to Extract 4 and Table 2, explain two reasons why India is against the removal of import tariffs. [4]

(b) Using a diagram and Extract 5, explain how the removal of import tariffs would impact consumer surplus. [3]

(c) Discuss the relative benefits of diversification for a resilient supply chain as compared to specialisation of exports to an economy engaging in international trade. [8]

(d) Discuss whether participation in the RCEP would likely enhance the standards of living in an economy. [10]

[Total: 25]

Answers

(a) — explain [4]

Import tariffs raise the domestic price of imports and so curb import volumes. Removing them does the reverse: tariff-free imports from countries such as China become cheaper, and with substitutes widely available these goods have price-elastic demand, so quantity demanded rises more than proportionately. Consumers also switch away from domestically produced goods. Import expenditure (M) rises and domestic consumption (C) falls, so ceteris paribus aggregate demand falls. India resists removal for two reasons:

• Reason 1 — protect employment. Extract 4 notes India’s textiles, agriculture and dairy sectors “employ hundreds of millions of workers”. Removing tariffs would expose these sectors to cheap RCEP imports, cutting demand for domestic output and raising demand-deficient unemployment. Keeping tariffs protects these jobs.

• Reason 2 — protect the balance of payments. Table 2 shows India running a current account deficit through 2019 (−2.4% of GDP in 2018, −1.1% in 2019). Removing tariffs raises import expenditure, worsening the balance of trade and hence the current account and balance of payments. Retaining tariffs keeps the BOP more favourable.

Marks: explain how import tariffs work [2]; link to reducing demand-deficient unemployment [1]; link to protecting the BOP [1].

(b) — explain with diagram [3]

Consumer surplus is the difference between the price consumers are willing and able to pay and the price actually paid.

With an import tariff in place the price is P₁ and quantity demanded is Q3 (Figure 1). Removing the tariff lowers the price from P₁ to the world price P_W and raises quantity demanded from Q3 to Q4. The gap between what consumers are willing to pay and what they actually pay widens, so consumer surplus increases from area ABP₁ to the larger area ACP_W.

Marks: analyse the impact of the tariff removal on price and quantity [1]; link to the impact on consumer surplus [1]; correct diagram [1].

(c) — discuss [8]

Thesis. Diversifying supply sources for a resilient supply chain shields an economy from supply shocks, while specialising exports lets it exploit cost advantages from comparative advantage. Which dominates depends on the economy; for an import-dependent economy diversification matters more, but in a globalised world specialisation generally brings the larger benefits.

Benefits of diversification. The COVID-19 pandemic delivered “both a supply and demand shock” (Extract 6), disrupting supply chains as countries imposed “lockdowns and export bans”. An economy that diversifies supply sources is less exposed: if one source of imported inputs is cut off, it can fall back on others (or domestic supply), avoiding imported cost-push inflation from a negative supply shock. An undiversified economy instead suffers rising input costs — short-run aggregate supply shifts up and to the left and the price level rises — whereas a diversified one preserves price stability.

Benefits of specialisation. Under the theory of comparative advantage, if each country specialises in the goods it produces at lower opportunity cost, all gain from trade. A specialising producer prices lower, raising export competitiveness and export revenue (X). Ceteris paribus, aggregate demand shifts right from AD₀ to AD₁; via the multiplier, national income rises more than proportionately — actual economic growth (output Y₀ to Y₁).

The higher AD also draws producers to hire more factors of production, cutting demand-deficient unemployment; and the rise in X improves the balance of trade and hence the balance of payments.

Evaluation and judgement. Specialisation generally brings more benefits. Because globalisation means most economies already hold many FTAs and so already have multiple input sources, the marginal benefit of further internal diversification is low, while export-orientation makes the gains from specialisation larger. The verdict, though, is conditional on the nature of the economy: an export-dependent (e.g. developing) economy reaps higher marginal benefits from specialisation, whereas an economy heavily dependent on imports for want of natural resources should weight diversification for supply-chain resilience more heavily.

(d) — discuss [10]

Thesis. Standard of living has a material dimension (mSOL — the quantity and quality of goods and services available for consumption) and a non-material dimension (nmSOL — intangible quality of life). RCEP participation boosts trade and FDI, raising mSOL, but can also raise import expenditure and structural unemployment, which can offset the gains. On balance it is beneficial.

Improvement to mSOL — trade and FDI. RCEP delivers “tariff elimination for at least 92 per cent of goods traded among members” (Extract 5), improving members’ export price competitiveness. For exporters of price-elastic goods, the lower export price raises quantity demanded more than proportionately, lifting export revenue (X) and so aggregate demand. RCEP also facilitates FDI — members can “invest in fellow RCEP countries without having to meet conditional performance requirements” and share information, raising the marginal efficiency of investment and so investment (I), lifting AD further. FDI also brings new capital and technology, raising productive capacity and shifting LRAS right. The combined AD and AS expansion yields sustained growth; household disposable income and real purchasing power rise, so households consume a greater quantity and quality of goods and services — mSOL rises.

Worsening of mSOL — import leakage. RCEP’s tariff cuts also lower the price of foreign imports relative to domestic currency, raising the quantity of imports demanded and so import expenditure (M). If the rise in M exceeds the rise in X, AD falls instead, lowering national income and mSOL. This is especially likely for developing economies lacking developed industries and economies of scale to compete with more developed members.

Worsening of nmSOL — structural unemployment. FDI introduces new technology and higher-quality capital that can render low-skilled workers obsolete, causing structural unemployment. In Singapore, restructuring around the “digital economy” can see low-skilled labour displaced by technology. The structurally unemployed face stress and, in some cases, crime; income inequality and weaker social cohesion follow — nmSOL falls.

Evaluation and judgement. RCEP is generally beneficial. Although it can cause structural unemployment, the trade- and FDI-driven rise in AD reduces demand-deficient unemployment, and retraining and reskilling schemes can mitigate the structural component. As the world globalises, export revenue is a growing share of most economies’ AD and GDP, so RCEP participation is beneficial for most members. The outcome is conditional on the economy: those more reliant on external trade and FDI for growth gain more in mSOL. Singapore — a small, open economy where trade is a large share of GDP, and which runs the large current-account surpluses shown in Table 2 (15–18% of GDP) — stands to benefit most from RCEP participation. This places RCEP within Singapore’s broader strategy of managing globalisation by remaining outward-facing.