Why Lanka should care about the Trans-Pacific Partnership

by Dr. Nihal Pitigala

After 10 years of arduous negotiation, last week, the United States, Japan, Canada, Australia, and eight other nations, including Vietnam and Malaysia, concluded a ‘mega’ free trade agreement, dubbed Trans-Pacific Partnership (TPP). On some measures, this trade deal is the largest ever outside the World Trade Organization (WTO) - it is said to ‘cover’ 40% of the global economy.

The deal’s detailed terms, yet to emerge, go far beyond tariff and non-tariff barriers to trade (traditional mode), to encompass rules for trade-related issues such as intellectual property, investment and competition, and new themes such as the environment, climate change and labour regulations.

Silver lining

There are fears among businesses, policy-makers and analysts that countries based outside the TPP free trade zone will likely lose out. At this stage, it is not clear how large those losses will be. The analytical arms are just getting flexed as details emerge.

However, there are three reasons not to be too alarmed. First, TPP members may well account for 40% of the world’s economy, but much of their trade — 55% of the manufactured goods Japan imports and 47% of what the US imports — are already duty-free under their commitments under the WTO Agreement.

The amount of trade where competitive conditions change markedly is likely to be much smaller than the 40% headline figure implies. Second, TPP will have to be ratified by national parliaments and then implemented before it really starts having an impact.

There is already a growing resistance to the deal from US lawmakers, as it is becoming clear that gains to US are small and the US wage earner will probably lose from TPP. Third, a few details available suggest, according to some press reports, the US will phase out its tariffs on some products, such as imported cars, for example, over a 25-year time horizon, giving those outside the agreement time to devise programs and strategies to manage the impact.

Cutting into the market share

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 beneficiaries in the agreement. The first likely impact is from trade diversion.

Trade diversion happens when a member country imports from a partner (eg Vietnam) goods that are previously imported from a non-member (eg Sri Lanka). Although we do not know the exact magnitudes, a recent study shows that Vietnam is likely to be one of the biggest winners from the TPP.

Economic estimates show 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 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. In another article I stressed that Sri Lanka, in major product segments, has graduated up the value chain vis-à-vis other developing countries, enabling Sri Lankan producers to differentiate their main exports from other developing countries such as Vietnam.

While this can insulate Sri Lanka’s industry from immediate competition, the incentive provided by TPP, equivalent to current US import tariff rates, is likely to be between 8% and 23% an advantage will not only provide Vietnam an immediate cost advantage, it will provide a longer-term advantage to those in the agreement, as such large margins can be an incentive for technology driven investment and move up the value chain.

There are indications this process is under way. The Japanese FDI is helping the Vietnamese industry upgrade production in weaving, dyeing and textile production. Even before the Agreement, other countries, including China, have been eyeing investments in Vietnam’s apparel value chain.

A counter-argument can be made that benefits of preferences are undermined through ‘rules of origin’ provision 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 parties to the agreement limiting the freedom to choose from the most competitive source.

Vietnam’s final stage of clothing supply chains relies heavily on Chinese intermediates, the latter not a party to the TPP. If Vietnam has to buy its fabric and other components from the United States (or maybe Mexico) then ship them back across the Pacific to their American buyers, input and transportation costs would more often than not offset any lower costs for Vietnamese exports arising from tariff reductions, effectively capping the increase in clothing exports that Vietnam can expect as a result of the TPP.

There are likely to be second-order effects on outsiders, such as Sri Lanka, that arise from new sources of competitiveness advantage in TPP member countries. First, if countries within the TPP expand their scale of production and realize efficiency gains, this can exert downward pressure on market prices faced by non-members in TPP markets (terms of trade effect).

Second, the TPP provides a powerful incentive for countries such as Vietnam to readily attract investment and technology flows, diverted away from other developing countries such as 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.

Then there are other marginal residual impacts on non-members with whom Sri Lanka trades closely, be it India, China or the EU. Studies point out that the effects on their national incomes are small or non-disruptive. However, transitory effects may emerge that affect third countries such as Sri Lanka that export intermediate goods and services to other countries and industries that are affected by competitive pressures in TPP country markets.

What can be done?

What are the options available to Sri Lanka to withstand and counter these likely effects? Sri Lanka may do well to review its trade negotiation strategy — bilateral trade agendas with the US, Japan and EU (cementing GSP plus) may become a way to reduce the potentially negative impact 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 needed 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 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.