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Ahead of the curve: Titanic awakening?

November 25, 2020

A commentary by Jürgen Lukasser, Chief Investment Officer of LGT Bank Österreich, on the newly created largest free trade zone the "Regional Comprehensive Economic Partnership" (RCEP) in Asia and its enormous impact on the whole world.

Ahead of the curve: Titanic awakening?

After eight years of tough negotiations, the "Regional Comprehensive Economic Partnership" (RCEP) of 15 countries in Asia and the Pacific was signed on November 15, 2020.

The long-term impact of the agreement could be truly tectonic. Subject of the agreement is a territory with a population of more than 2 billion people and a GDP of 26 trillion dollars, which could expand dramatically again if India were to join. This makes the RCEP the largest free trade zone in the world - the European Union has easily been overtaken - and it includes almost a third of the world's population and economic output. In concrete terms, this agreement provides for simplified rules of origin and will thus make life easier for companies operating in the region. This will naturally increase the pressure on multinational companies to relocate their production there in order to compete. In this context, regional trade agreements between China, South Korea and Japan will be concluded for the first time, which could have a significant impact on trade flows in the high-tech sector in particular. China's economic influence in the region will thus be significantly strengthened. Important for understanding in this context is the fact that the pact does not restrict support for state-owned enterprises and other aspects of the Chinese economic model. Overall, a platform was created through the RCEP to define trade conditions in the interests of the Asian participating states.

On the other hand, this trade agreement - despite a long lead time - is not necessarily the most far-reaching. It eliminates fewer customs duties than usual and some of them only after two decades. The coverage of services and agricultural goods is patchy. At least in the beginning India is not a member. Nevertheless, when the heads of state and government met virtually to celebrate the final act, they welcomed the pact as a triumph.

If one tries to assess the impact of this agreement, it can be said that RCEP is in stark contrast to the policy of the Trump administration. One of the first official acts of the President after he came to power in January 2017 was to pass a resolution to withdraw from the Transpacific Partnership, a free trade agreement involving the United States and 11 other Pacific states. Moreover, it goes without saying that China's attractiveness as a trading center in Asia will undoubtedly increase compared to the United States with the introduction of the RCEP.

However, the true strategic dimension lies in the institutional voice that the RCEP will give to China. One must look at the overall picture surrounding the launch of the RCEP to understand how this latest detail fits into China's overall strategic concept. And that means looking back at the events of the past decades.

China's remarkable economic growth in recent decades has not been accompanied by a corresponding increase in Beijing's political influence on an international level. This fact should not be underestimated, especially when it comes to defining standards or rules of the game in areas such as trade, finance and investment. Seen from this perspective, RCEP could prove to be a "game changer". For a long time, the US was the top dog not only as an economic power but also in terms of institutional influence, both at the regional and international level. The privilege that this role confers should in no way be underestimated. Access to markets - for goods or for investment and financial transactions - is one thing; creating the rules by which these markets operate is another. The final advantage that the United States enjoys in this respect is the "exorbitant privilege" of controlling the world's main international reserve currency.

In recent decades, the US has exercised effective control over the world's leading multilateral institutions (many of which were set up on US initiative). The Bretton Woods twins (the International Monetary Fund and the World Bank) regional development banks, as well as the World Trade Organization, the World Health Organization, etc., were established with strong U.S. support. While China has managed to gain more voting rights or "quotas" in some of these policy-making institutions, it has not yet been able to establish itself as a major player in the political process. It has not been possible to fill top positions in the past. The low institutional influence led to frustration in Beijing. Now Bejing sees undreamt-of strategic opportunities.

What remains as a conclusion? The question currently being asked is whether the foreseeable effects of the agreement have already been priced into the stock markets. Considering the strategic dimension described above, this could simply be the wrong question. In the medium to long term, it seems essential to be able to determine the practices and definitions in one of the world's most interesting economic zones. In the most important world stock indices, China currently only plays a role in the emerging markets segment. This circumstance could change in the medium term, if important pre-conditions - keyword governance - are established on the Chinese stock exchanges.

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