Regional Comprehensive Economic Protectionism?

Earlier this week, headlines touted some seemingly good news on the trade front: Fifteen Asian nations had agreed in principle on key portions of a new trade deal, likely clearing the way for them to sign it next year. Even India’s decision to opt out couldn’t shake some pundits’ enthusiasm over a potential positive to offset all the new tariffs accompanying the Trump administration’s various trade spats. Far be it from us to pooh-pooh good news, but we think a little perspective is in order. One, big trade deals are seldom near-term economic drivers since they usually take effect gradually, over many years. Two, the deal in question—dubbed the Regional Comprehensive Economic Partnership (RCEP)—isn’t even a free-trade deal. We see many reasons for investors to be bullish today, but this isn’t one of them.

Generally speaking, RCEP will be a trade deal among China, Japan, South Korea, Australia, New Zealand and countries in the Association of Southeast Asian Nations (ASEAN)—Indonesia, Thailand, Singapore, Philippines, Malaysia, Vietnam, Brunei, Cambodia, Myanmar and Laos. Coverage eagerly pointed out that, if finalized, it will be the world’s largest trade deal, covering almost one-third of global GDP and nearly half the world’s population. This is bigger than the artist formerly known as the Trans-Pacific Partnership (now the CPTPP), which includes seven of these nations (notably, not China) as well as some North and South American countries (notably, not the US). But unlike CPTPP, RCEP isn’t a sweeping reduction of tariffs and non-tariff barriers. Nor does it foster freer markets—unlike CPTPP, which made liberalization of certain markets a requirement. CPTPP also sought to protect intellectual property rights—RCEP doesn’t. It also doesn’t take on thorny issues like state-owned enterprises. That last point is critical, considering some of the participants are still somewhat communist.

Instead, it aims to replace ASEAN’s bilateral trade agreements with the other participating nations, “harmonizing” market access among all. One omnibus deal to replace many small ones. The National Bureau of Asian Research sums it up as “a consensus on the lowest common denominator in standards for goods, services, investment and intellectual property rights,” which is not flattering. It essentially means RCEP isn’t trying to make trade freer, but rather ensuring all the countries have the same rules and barriers so they can reduce paperwork. Which helps! But it also codifies protectionism. Most believe it will also reduce RCEP participants’ trade with other nations, as the application of Chinese standards across the board amounts to creating new regulatory barriers around the bloc.

All big trade deals create winners and losers, and RCEP does have some winners. Its less-developed members (e.g., Vietnam, Laos, Cambodia and Myanmar) should benefit from easier access to China, Korea and Japan. This is also the first trade deal between China and Japan, the world’s second- and third-largest economies. That is nice! It would just be a lot nicer if it came with a meaningful reduction in trade barriers—which Japan pushed for but China blocked.

This saga underscores a pet theory we have had for a few years now: Trade deals are, very often, protectionist. They take eons to negotiate because participating nations try to carve out exemptions for local industries and agriculture. This is a big reason why RCEP has been in talks since 2012. Multilateral trade deals also tend to bind participants closer to each other economically while discouraging trade with other nations. The reason former Prime Minister Theresa May’s Brexit deal was so unpalatable to many Brexiteers was that it left the UK in the EU’s single market and thus prevented the country from being able to ink free-trade deals with other nations. In contrast, a big reason Hong Kong and Singapore have been so successful globally—despite their small geographic size—is unilateral free trade. The UK’s plans to adopt unilateral free trade if it left the EU without a deal were a big reason we weren’t (and still aren’t) bearish on a no-deal Brexit. Eradicating tariffs without requiring reciprocation from other nations is really what free trade is all about. The alternative—different rules for different blocs—prevents the optimal flow of goods and services globally, making supply chains more complex than they otherwise would be.

This is all textbook, theoretical stuff, though—not really meaningful for markets. The potential for trade barriers to slowly morph over time isn’t relevant to potential profits over the next 3 – 30 months, which is what stocks spend most of their energy pricing in. We see plenty of reasons to be bullish within this window, including the global economy’s underappreciated resilience and the prospect of falling political uncertainty in the US (election) and UK (Brexit) next year. But we wouldn’t add RCEP or any other big potential trade deal to this list.