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Analysis
Why the TPP matters

Why the TPP matters

New mega-regional deal modernises trade rules

by Ben Robinson

Tue 13 Oct 2015

The Trans-Pacific Partnership, a mega-regional free trade deal encompassing 12 Asian and American countries which account for 40% of global GDP, opens up a new chapter in world trade. The deal, announced on 5 October, remains subject to ratification by the constituent governments, which could prove troublesome given significant public opposition to the deal and electoral cycles in several countries, including the US.

Nonetheless, if approved, the agreement will reduce tariffs on 18,000 items and eliminate them completely in some areas, lowering trade costs for members and opening up previously protected industries, including agriculture and automobiles.

While this is a welcome move for supporters of free trade, the direct economic impact of tariff reductions will be rather muted. After successive rounds of trade liberalisation under the General Agreement on Tariffs and Trade and the Bali package of the World Trade Organisation, global tariffs are already low and contribute only a small share of total trade costs. Moreover the currently protected areas such as agriculture that the TPP will liberalise contribute only a small share of global GDP.

The true significance of the TPP lies beyond tariff liberalisation. Most importantly, the deal modernises trade rules and brings them up to speed with changes in the global economy, in which intellectual property, knowledge-based capital, and other service-related activities are increasingly important.

Since the 1970s the manufacturing sector has fallen as a share of global GDP from around 27% to 16% (and is still declining), while services have grown from 53% of GDP to over 70%, and are still rising. In developed economies services contribute up to 85% of GDP.

Encouraging global trade and increasing economic growth therefore depends on lowering barriers and increasing trade in the service sector, more than on liberalising goods tariffs. So far these issues have eluded global free trade agreements, with the 15-year-old negotiations under the WTO Doha round yet to reach a conclusion.

As a result of the failure to liberalise services trade, the amount of services in global trade has remained remarkably low over the last few decades, at around 20%, despite contributing a growing share of global GDP. Manufacturing and goods trade still accounts for 70% of total trade, despite contributing a low (16%) and declining share of global GDP.

This imbalance has been a big factor behind slowing global trade growth over the past decade, with trade growth rates now below 3%, less than half their previous decades-long rate of 7%.

Increasing economic growth and reinvigorating global trade requires addressing this imbalance and raising the share of services in total trade. The TPP lives up to this challenge. Its chapters on investment, cross-border trade in services, financial services, telecommunications, electronic commerce and intellectual property significantly reduce behind-the-border impediments to cross-border services trade and services-based foreign direct investment.

The combined economic size of the TPP participants (Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the US, and Vietnam) means the new rules will effectively establish global standards for the service sector. Already countries such as South Korea are vying to join, adding momentum for worldwide standard-setting.

Although politically unlikely at the moment, the prospect also remains open for China to join as a full member. Whether or not it does, Beijing too will face pressure to adopt the TPP’s standards, given that China trades heavily with TPP member states. This harmonisation of service trade rules can help simplify the 'spaghetti bowl' of overlapping trade rules on services, investment and intellectual property, which have resulted from the previous lack of global agreement on such issues, and which add costs and hinder service trade flows.

By establishing multilateral rules on the issues on which services depend, the TPP provides a welcome coordination of service trade policy – filling an important gap left by the WTO in global service trade facilitation, on which 70% of global GDP depends.

Ben Robinson is the Economist at OMFIF.

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