China and free trade's complex step two

The tariffs are down; next the free traders need to establish standardised production chain settings – such as rules and infrastructure – between nations. They will be hard agreements to forge, and China is critical.

Lowy Interpreter

For half a century the focus of international economic integration has been on reducing border restrictions to trade, mainly through tariff reductions. This task is not complete, but where there are substantial remaining barriers, as with agriculture, the domestic opposition is just too powerful. The Doha Round has also ground to a halt.

As a result, a different type of international integration is attracting attention, especially in East Asia.

This new form of integration emerges from the idea of the 'second unbundling' of international trade. The first unbundling was the geographic separation of production and consumption: one country produces wine and swaps it for the cloth produced by another country, with each country benefitting by producing according to its comparative advantage. The second unbundling is the division of production itself, so that each stage of the production process is done in the most efficient location.

Examples abound: call centres and back offices are elements of the production process routinely geographically separated from production itself. East Asia has taken this concept furthest. Apple iPhones are recorded as part of China's exports, but most of the value (not just high-tech components, but a big chunk of intellectual property) comes from outside China.

To reap the full benefits from this sort of unbundling, there needs to be not just a dismantling of 'behind-the-border' restrictions but also a consistency of rules, standards, methods of operation and physical infrastructure to smooth the complexity of this production chain. This is much more subtle than the conceptually straightforward task of lowering tariffs. (Free trade is also a universally accepted principle; just about everyone accepts that lower tariffs are a good idea, even if it's not easy to implement this in practice.)

There will be much disagreement about these rules. Some differentiation in standards is the basis of comparative advantage: different labour, safety or environmental standards may in fact be appropriate. With intellectual property rights, there has to be a balance between the rights of those who thought up the ideas and the rights of users to copy: handing out monopolies to patent-holders never made good economic sense. Simple technical standards should be the same universally, but whose standards will prevail (whose electric plugs will become the international norm)?

The key issue is that a set of rules to foster the 'second unbundling' can't be established and enforced in the same way free trade is enforced within a forum like the WTO. Even less appropriate will be the 'platinum standards' the US is pushing for in the Trans Pacific Partnership, which demand stronger intellectual property rights, stronger labour and environmental standards and regulatory discipline of state-owned enterprises.

Hence the two radical ideas currently under discussion. First, that there is way forward from the noodle bowl of overlapping and conflicting preferential trade agreements. Whatever damage these PTAs do to the multilateral system, some of them are potentially valuable as the framework for negotiating 'second unbundling' issues. 

Second, that the ASEAN framework, lumbering along under the need for consensus and often held back by the lowest common denominator, may actually be a better approach to the sensitive issues of the 'second unbundling'. Connectivity – smoothing the physical infrastructure connecting the production units – is the sort of issue where progress is made in ASEAN.

What seems pretty clear is that the platinum standard envisaged in the Trans Pacific Partnership, which imposes self-interested US intellectual property objectives and which sees abnormality in state-owned enterprises, is not going to get Chinese participation. Any set of international rule making which excludes the Chinese will not be a relevant basis for the 'second unbundling'.

Originally published by The Lowy Institute publication The Interpreter. Reproduced with permission.

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