Sunday Times 2
The Trans-Pacific Partnership: What’s at Stake for Sri Lanka?
On October 5, 12 Pacific-Rim nations, including Vietnam and Malaysia, along with the US and Japan, announced the successful conclusion of the Trans-Pacific Partnership (TPP) trade agreement. The TPP is the largest ever trade agreement outside of the World Trade Organisation (WTO) – it is said to “cover” 40% of the global economy.
Dr. Nihal Pitigala
The deal’s detailed terms, yet to emerge, cover commitments to eliminate most tariffs on industrial goods and, progressively, on agricultural products. Besides tariff concessions, the TPP sets standards higher than previously negotiated “mega trade agreements” by including trade in services, investment and other policy areas that extend well beyond trade, such as intellectual property protection, competition policy, operations of state-owned enterprises (SOEs), labour law and conditions, environmental protection, e-commerce facilitation, rules on telecommunications and development with regional integration.
What is at stake?
As with any such mega trade agreement in an interconnected world, there’s likely to be winners and losers, especially for those “inside” the TPP versus “outsiders”. Of immediate concern to those outside the TPP, like Sri Lanka, is how this agreement could affect trade and investment prospects in the near term and in the long run. Since details of the agreement are still emerging, there are likely to be a number of both direct and indirect impacts.
Available estimates suggest that the TPP’s largest beneficiary is likely to be Vietnam, an exporter of apparel to the US market. For Sri Lanka, a small global player, there’s likely to be direct, first-order trade-deviation effects on exports and imports of goods and services, from preferences acquired by Vietnam and other beneficiaries inside the agreement. The first likely impact is from trade diversion. Trade diversion happens when a member country imports a good from a partner (e.g. Vietnam) that was previously imported from a non-member (e.g. Sri Lanka). Economic estimates shows that the TPP would help Vietnam’s apparel and footwear exports reach $165 billion by 2025; without the TPP, this figure would have been $113 billion. This additional growth is expected to cut into the market share of its competitors.
Although it is not clear how much would be diverted away from Sri Lanka, a cursory observation shows that Vietnam is a prolific exporter of “similar” categories of apparel to Sri Lanka. Through concerted efforts by leading manufacturers, Sri Lanka has been able to move up the value chain in a number of key product segments, enabling them to differentiate themselves from Vietnam and other developing country competitors. While this can insulate Sri Lanka’s industry from immediate competition, the 8% to 23% preference margin on tariffs offered under TPP will not only provide Vietnam an immediate cost advantage, it will also provide an incentive for technology-driven investment into the sector to increase its scale and competitiveness. There are indications this process is already underway. Japanese investment is helping Vietnam’s industry to upgrade production in weaving, dying and textiles, while Chinese firms are hinting at significant investments in Vietnam’s apparel value chain.
There are also likely to be second-order effects on outsiders, like Sri Lanka, that arise from new sources of competitive advantage in TPP member countries. First, if countries within the TPP are able to expand their scale of production and realise efficiency gains, this can exert downward pressure on market prices faced by non-members in TPP export markets (terms of trade effect).
Second, as noted above, the TPP provides a powerful incentive for countries like Vietnam to readily attract investment and technology flows, diverted away from other developing countries like Sri Lanka.
Third, the impact of the reduction of so-called “non-tariff barriers” will increase the efficiency of supply chains in the participating countries — while some of the benefits are likely to also benefit non-members, such as trade facilitation measures that make importing to the US easier, others will accrue only to TPP members, such as those related to mutual recognition of standards. Finally, there are other marginal residual impacts on non-members with whom Sri Lanka trades closely, be it India, China or the EU. Existing studies point out that the TPP’s effect on their national incomes are likely to be small or non-disruptive. However, transitory effects may emerge that affect third countries such as Sri Lanka that export intermediate goods and services to these non-members which rely on TPP members as final markets.
Finally, an additional point with regard to investment liberalisation; TPP intends to pursue liberalising inward through a negative list approach. The effect of a deep agreement on investment provisions could open up important sectors in the TPP region that was previously restricted such as air transport and telecommunication. If the result of the TPP is ambitious in terms of increased flexibility on investment, in the short run, flows normally going to developing countries might be redirected to the TPP countries with the objective of taking advantage of the new market opportunities created. It may also depend on whether the negative lists are preferential to TPP members or erga omnes (applicable to all).
It’s not all doom and gloom
There are several silver linings for those outside the TPP. First, the benefits of preferences are undermined through “rules of origin” provisions of the TPP. Specifically, the “yarn forward” rule of origin stipulates the components, from the yarn to the fabric to the final item, be produced in one of the member countries to the agreement, limiting the freedom to choose from the most competitive sources. Vietnam’s final stage of clothing supply chain currently relies heavily on Chinese intermediates, but the latter is not a party to the TPP. If Vietnam must instead buy their fabric and other components from the US (or maybe Mexico) then ship them back across the Pacific to their American buyers, input and transportation costs would likely more than offset any cost advantage to Vietnamese exports arising from tariff reductions, effectively capping the increase in clothing exports that Vietnam can expect as a result of the TPP.
Second, though the TPP members account for 40% of world’s economy, much of their trade-55% of the manufactured goods that Japan imports and 47% of what the US imports — are already duty-free due to commitments made under the WTO and some TPP members have previously entered preferential agreements (US and Mexico under NAFTA; Japan and ASEAN) means minimum additional tariff reductions under TPP for those partnerships. The amount of trade where competitive conditions change markedly is likely to be much smaller than the 40% implies.
Third, TPP will have to be ratified by national parliaments and then implemented before it really starts having an impact. In the US, the TPP deal is already running into criticism from US lawmakers and politicians, including the leading democratic contender for the 2016 presidential race, Hillary Clinton, as it is becoming clear that gains to the US, in terms of GDP, are expected to be small and US wage earners will likely lose out from TPP. Fourth, the few details available suggest, according to some press reports, the US will phase out its tariffs on some products including agriculture, textile and apparel products deemed sensitive by US producers, giving those outside the agreement time to devise programs and strategies to manage the impacts.
So what are Sri Lanka’s options?
What are the options available to Sri Lanka to withstand and counter these likely effects? Sri Lanka may do well to review its prevailing trade negotiation strategy — bilateral trade agendas with the US, Japan and EU (cementing GSP plus) may become a way to mitigate the potentially negative impacts of the TPP, particularly with respect to preference margins. More importantly, these mega-trade deals provide an excellent opportunity to revisit economic reform plans for the national business environment, a well-established and sustainable path to increase export competitiveness, attract new investment, and promote industry upgrading — all of which will benefit Sri Lanka over the longer term, irrespective of various trade deals.
In addition to broad business environment reforms, a tailored strategy is required to promote the upward differentiation of Sri Lankan products — through innovation, R&D and knowledge accumulation — which can provide Sri Lankan export sectors with a competitive foundation that promotes competition based on quality rather than price.
(The writer is a former Advisor to the BOI and is currently a consultant to the World Bank on trade and development. The views expressed herein are the author’s own and do not necessarily reflect those of the World Bank.)