How RCEP will change the role of Asia in global trade

By Steven Guo, Senior Manager, Asia Operations, Global Trade Consulting

It’s difficult to imagine that it was only one year ago that the key concern amongst businesses engaged in trade was the rising tide of protectionism in the midst of a global pandemic and the impact it would have on the future of trade liberalization. 

Those concerns still exist and shouldn’t be discounted. But they have been overshadowed by months of supply chain crisis fuelled by congested ports, container shortages, a weeks-long blockage of the Suez Canal, pandemic lockdowns and China’s self-generated energy crisis. For much of 2021, fretting over trade policy seemed an untenable luxury against a backdrop of being unable to get goods to market. 

Those sentiments were just as prevalent in Asia as they were anywhere else. By most accounts, supply chain challenges – even if somewhat moderated – will remain well into the first half of 2022. Lurking in the background, however, is a new trade agreement that has received scant attention in North America, but that could ultimately change the nature of trade dynamics in Asia and globally. 

The Regional Comprehensive Economic Partnership (RCEP), a trade deal involving 15 countries in Asia-Pacific, including economic powerhouses China, Japan and South Korea, is creating a new bloc of liberalized trade where it hadn’t existed in the past. RCEP isn’t only a game changer for China, which organized and negotiated the deal in record speed to secure its economic leadership in the region. It has the potential to ultimately reset how businesses in Asia – including those headquartered in the U.S. – see the role of the region in the world. Rather than sustaining Asia’s long-held role as a source of low-cost production to satisfy consumer appetites in the West, RCEP could conceivably transform Asia into a much larger and more populated version of North America where supply chains are designed to service burgeoning middle classes across APAC’s many developing nations. 

A Market U.S. Firms Can’t Ignore

Since China’s ascendancy as an economic hegemon in the region and the proliferation of production by U.S. and European firms – coupled with the ballooning of the hi-tech sector – Asia’s middle class has been growing at rapid pace, far more rapid than that of North America. In fact, it is estimated that by 2030, Asia’s middle class – today approximately 2 billion – will reach 3.5 billion, representing 65% of the world’s middle-class population and 50% of the continent’s consumer spending. And it isn’t necessarily the region’s most populous countries that will lead the middle-class charge. Indonesia, a country with a population of less than 20% of China’s, is projected to have the fourth-largest middle class in the world by 2030.

These figures and trends aren’t lost on U.S. multinationals who have long realized the opportunity that lies in Asia and have been looking to court consumers across the continent while competing with regional players. Their inclination to do so will only accelerate as consumerism on the continent grows. In fact, a recent survey by the U.S.-China Business Council shows 94% of U.S. firms with a presence in China are channeling existing and future investments into servicing the market in China while only 15% are using their investments in China to serve as an export platform to service the U.S. market. 

Indeed, even in the wake of a global pandemic, U.S. investment in Asia was at an all-time high in 2020, reaching $969.6 billion dollars – a massive 358% increase from the $270 billion invested in 2002 when China was first invited into the World Trade Organization. The U.S. is the largest source of foreign direct investment (FDI) inflows into the 10 ASEAN countries, pouring $34.7 billion into the region in 2020, more than Hong Kong and Singapore (the second and third largest sources of FDI in the region) combined. U.S. services exports to the ASEAN group of $35.5 billion were 77% higher than they were just 10 years ago. 

How RCEP Will Change Trade Dynamics

RCEP’s impact on trade in the region will not occur overnight. The trade agreement is designed to eliminate 92% of tariffs over a 20-year period, though as much as 65% of tariffs on goods entering China will be eliminated immediately. The benefits of the trade agreement will be gradual and not equal for all member states. Indeed, there are a few countries that have yet to ratify the deal or fear it will create overpowering competition for their domestic industries.

To understand how the agreement will work to create regionally integrated supply chains, it’s critical to understand the composition of the agreement. Ultimately, RCEP is split between two groups – developed and developing countries. The first group is made up of economic powerhouses, such as Japan, South Korea and China (although, Beijing still classifies China as a developing market), as well as the advanced economies of Australia and New Zealand. The second group is comprised of the 10 countries that make up the Association of Southeast Asian Nations (ASEAN), which includes Brunei, Cambodia, Indonesia, Laos, Myanmar, the Philippines, Singapore, Thailand and Vietnam. 

Without question, the group of developed nations will be the biggest beneficiaries. Their businesses will now have the ability to set up production bases in countries with lower labor rates to supply critical raw materials and intermediate product inputs, enhancing productivity and efficiency of production and making their goods more competitive domestically and internationally. They will achieve this by leveraging duty-free imports from the ASEAN’s developing nations and the harmonized administration of using one trade agreement across the continent, rather than the more burdensome process of reconciling free trade certification across the multiple trade regimes that exist today. 

They will also establish satellite offices to service growing consumption in the digital and service sectors. In fact, the ASEAN countries are anticipated to have the fastest rates of growth for data centers, currently hosting 23% of all RCEP data centers, most of which are in Singapore, Malaysia and Indonesia.

A New Frontier

For U.S. firms to compete within Asia, they will need to make the same level of investment as their counterparts in South Korea, Japan and China. That means establishing supply chains designed specifically to service the Asian market by leveraging the cost efficiencies associated with RCEP and centralizing production within the continent without having to rely on inputs from locations in Mexico, India and other key sourcing markets. RCEP allows for the cumulation of goods across RCEP member states to qualify as originating goods, which allows U.S. firms to spread production across multiple RCEP member states in order to mitigate risk through redundancies and to optimize labor skill and/or availability. 

To be sure, the use of RCEP and Asia-centralized supply chains will not necessarily be a simple process and intra-RCEP transport may not be as seamless as some firms may be accustomed to with the USMCA. The customs procedures for RCEP are more onerous than those of the USMCA and other multilateral trade agreements. The agreement’s implementation occurred with the simultaneous update to Harmonized System classification codes by the World Customs Organization, creating the opportunity for misclassification of goods, particularly where RCEP’s HS codes have not been updated in a timely manner. Firms trading between RCEP countries will need to be scrupulous with the multitude of documentation required to claim preferential duty and expend the necessary time checking whether it is the RCEP or the ASEAN agreement which offers the lower preferential duty rates for each supply chain. Moreover, many of the RCEP countries still lack the port and roadway infrastructure to support high-volume movement of goods and – unlike the USMCA – movement between RCEP countries will often require ocean transport, which will eventually become easily accessible but remains challenging in today’s environment. 

The Near-Term View

While RCEP will usher in a new era and new regional dynamics, it could be some time before firms in the region can take full advantage. Four countries have yet to ratify the trade deal and among those that have, customs authorities have not yet put in place the mechanisms necessary to effectively process goods under the new trade regime. Many businesses across the continent continue to grapple with the challenges wrought by the pandemic – from on-again-off-again lockdowns and disrupted production to container shortages and soaring freight rates. Most firms will prioritize overcoming these challenges over studying the nuances of RCEP’s myriad provisions.  

Nevertheless, the region’s developed nations will waste little time to set in motion the efficiencies that will allow them to be more competitive within the region and in key consumer markets in the West where consumer demand remains insatiable and could further escalate should the omicron variant result in a return to lockdowns in America. 

U.S. firms should waste little time, not only in understanding the advantages RCEP may offer to them, but how it may change the competitive landscape in Asia and indeed around the world. 

Steven Guo is a Shanghai-based trade consultant with almost 20 years of experience helping businesses optimize their trade practices in Asia Pacific and navigate China’s increasingly complex trade environment.