29 March 2016
The Trans-Pacific Partnership Revisited
The 12-strong Trans-Pacific Partnership (TPP) group of countries – Australia, Brunei-Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the US and Vietnam – reached a landmark agreement to liberalise trade in nearly all goods and services on 5 October 2015. The text of it, containing 30 chapters, was released on 5 November 2015. This agreement, which was subsequently signed on 4 February 2016, is expected to enter into force on or around 4 April 2018, although further delays are very much a possibility. While TPP should bring huge economic benefits to its members, outsiders will likely be disadvantaged. Hong Kong, with its production and sourcing mainly undertaken across the border in mainland China, will be hurt by a deterioration in the competitiveness of made-in-China exports, especially of garments and footwear. However, Hong Kong, as a regional service hub, should thrive on the additional business and investment activities stemming from TPP.
Merchandise Trade and Related Issues
Trade in Goods
Under TPP, member countries will provide duty-free treatment to a broad range of “originating goods” (i.e., goods genuinely produced in the TPP countries) upon entry into force of the agreement. These products include, among others, most machinery, equipment and other products (under Harmonised System (HS) Chapters 84 and 85), all clocks, watches and parts thereof (under Chapter 91), most furniture, furnishings and fittings (under Chapter 94), most games and sports equipment (under Chapter 95), a broad range of textile, clothing and footwear products (under Chapters 50 through 64), the vast majority of precious and semi-precious stones and jewellery (under Chapter 71), a range of plastic articles (under Chapter 39), and most travel goods (under heading 4202).
Among the major TPP countries, the US will eliminate an estimated 91% of duties on industrial products upon entry into force of the agreement, with tariffs on the remaining 9% being phased out within 15 years or less. US duties on a broad range of apparel products will be removed immediately, while duties on sensitive apparel items will be completely eliminated by 1 January of years five, 11 or 13. Japan, for its part, will eliminate 75% of duties on industrial products upon entry into force of the agreement, while Canada will remove its duties within a decade and Mexico within 15 years.
China already has free trade agreements (FTAs) with eight of the 12 TPP countries, a fact that may help to lessen some adverse impacts of the mainland’s eroding export competitiveness in the TPP markets. China is expected to encounter intensified competition mainly in the four TPP countries that it currently does not have FTAs with, in particular the US, which is by far the mainland’s largest TPP market with an 18% share of its total exports in 2015, followed by Japan (6%). Mexico (1%) and Canada (1%) are some way behind. As such, it is particularly noteworthy that TPP benefits will boost the competitive edge of export-oriented members, not least Vietnam, which do not have FTAs with the US at present but will gain free access to the US market. This will pose challenges in product sectors that overlap with those of China.
That said, a brief analysis of the current most-favoured-nation (MFN) duty treatment and tariff phase-out commitments for the 20 largest US imports from China in 2015 suggests that the overall impact of TPP on those products is likely to be modest, albeit several products could be significantly impacted by the agreement. 15 of those items already benefit from duty-free treatment on an MFN basis, and hence will not be impacted from a duty treatment perspective when the agreement is implemented.
The US imported US$4,065 million worth of flat panel colour televisions incorporating a video recording or reproducing apparatus classified under the Harmonised Tariff Schedule of the US (HTSUS) 8528.72.64 from China last year, and the 3.9% MFN duty on that product will be removed with respect to originating goods from the TPP parties immediately upon entry into force of the agreement. Nevertheless, the largest TPP supplier of subject merchandise, Mexico, already benefits from duty-free treatment under the North American Free Trade Agreement (NAFTA), and other suppliers play a very minor role in the market.
Meanwhile, China is the largest US supplier of cotton knitted sweaters, pullovers, sweatshirts and vests classified under HTSUS 6110.20.20, with a 37% share or US$2,841 million in 2015. Vietnam ranks second with a 14% share. The 16.5% MFN duty on cotton sweaters will be eliminated immediately, while the duty on cotton pullovers, sweatshirts and vests will be reduced by 35% of the base rate (to 10.7%) upon entry into force of the agreement and will be maintained at that level until 31 December of year 10. Such goods will be duty-free effective from 1 January of year 11. Vietnam’s trade within this subheading is heavily focused on cotton pullovers, which are subject to the long duty phase-out period.
In the case of other footwear with outer soles and uppers of rubber or plastics classified under HTSUS 6402.99.31, the 6% MFN duty will be removed with respect to originating goods from the TPP parties immediately upon entry into force of the agreement, with the exception of goods from Mexico. China is by far the largest US supplier of this product, with an 83% share or US$2,510 million in 2015, but second-ranked Vietnam, which held a 9% share, could potentially challenge China’s dominance in the years to come.
Undoubtedly, TPP’s impact on China is likely to be greatest in products that face high duties, and where the mainland is currently the dominant US supplier and Vietnam is either a large or an up-and-coming supplier, including in particular apparel, textiles and footwear. In general, Vietnam is expected to increase its share of the US textile, apparel and footwear markets once TPP is implemented, potentially at the expense of China and other major suppliers.
Vietnam is currently the second largest US textile and apparel supplier in value terms, with 9% of total US imports in 2015, and its share of the market has grown steadily over the past decade. China remains the leading US textile and apparel supplier, with a 38% share in 2015, but demand for Chinese products is trending down modestly. Vietnam, often a cheaper alternative to China, could increase its shipments of products that face very high MFN duties in the US such as man-made fibre coats and jackets, trousers, t-shirts, sweaters, sweatshirts, pullovers, shirts and blouses. Vietnam would also be expected to excel in the market for cotton apparel products, which face lower but still substantial MFN duties in the US. However, the extent of Vietnam’s gains will be limited, at least initially, by a relatively strict yarn-forward origin rule requiring the use of TPP textile inputs in apparel production (see Rules of Origin section).
Vietnam also ranks behind China in the US import market for footwear, making up 16% of total US imports in 2015, compared with China’s 63% share. As in textiles and apparel, US demand for Vietnamese footwear is expanding briskly, while sales of Chinese footwear are decelerating. Notably, a sizable share of almost 40% of all footwear imports from the TPP partners will benefit from duty-free treatment immediately upon entry of the agreement, with the vast majority of those imports coming from Vietnam. Duties on the remaining 60% plus of trade will be phased out over a period of five, seven or 12 years.
In electronics, China is the US’ largest supplier, with a 46% share in 2015, followed by Mexico (with a 19% share), which already benefits from zero duties under NAFTA. Yet many electronic products, including parts and components, are subject to no or very low MFN tariff rates at present. Coupled with an expansion of the World Trade Organisation (WTO) Information Technology Agreement (ITA), which will phase out tariffs on a further 201 information and communication technology products from as early as 1 July 2016, relocation of electronic production and sourcing from the non-TPP countries to TPP countries will less likely to be driven by tariff considerations as is the case for clothing and footwear.
Conceivably, the remaining nuisance tariffs on non-TPP countries, along with an improving business environment stemming not only from the TPP provisions on investment, but also on technical barriers, regulatory coherence, intellectual property, etc., may still encourage the relocation of electronic production to TPP countries. However, such an impact would be more long-term. As such, the effect of TPP on the Asian supply chains of electronic products will likely be insignificant over the short and medium term.
This applies even more so to toys and games, which under HTSUS 9503 to 9505 are already duty-free when being imported into the US. Together with its dominant 87% share of total US imports last year, China is expected to continue to outperform TPP suppliers of toys and games by a big margin.
For fine jewellery, the mainland is currently the second largest US supplier, with a 19% share in 2015, competing closely with two non-TPP countries, India and Thailand (the largest and third largest suppliers, with shares of 20% and 15% respectively). Except under HTSUS 7116.20.50, which provides duty-free treatment, US tariff rates range from 2.1% to 13.5% for other items, and these duties will be removed with respect to originating goods from the TPP parties immediately upon entry into force of the agreement. However, Mexico, the largest TPP supplier of fine jewellery, with a 4% share, already benefits from duty-free treatment under NAFTA.
On the other hand, China’s competitive position with respect to watches and clocks, which are currently subject to a wide range of the US’ ad valorem, specific and compound duties, with a few exceptions, is expected to be seriously challenged by Japan. While China is now the second largest US supplier, with a 21% share in 2015 (significantly behind Switzerland, which is not a TPP member state), it is trailed closely by Japan, the largest TPP supplier, with a 17% share. With the removal of all tariffs on watches and clocks from TPP parties immediately upon entry into force of the agreement, Japan’s competitive edge will be further enhanced. However, China’s exports of watches and clocks to the US accounted for only 0.1% of the mainland’s total exports to the US in 2015, compared with 35% for electronics, 14% for textile, clothing and footwear, 3% for toys and games and 1% for fine jewellery.
Rules of Origin
The chapter on rules of origin creates a fundamental commitment that only originating goods will benefit from lower tariffs under the agreement. These rules are specific to each product, defining the operations it must undergo in order to be considered for lower tariffs. As in other FTAs, goods will be deemed to originate in the region if they are wholly obtained or produced in one or more TPP countries; are produced in one or more TPP countries exclusively from originating materials; or comply with a product-specific origin rule requiring certain production operations to take place in one or more TPP countries and limiting the type or amount of non-TPP materials that can be used.
The agreement includes relatively flexible product-specific origin rules for certain products and stricter provisions for others. For example, a change in tariff classification from a different HS chapter applies to footwear, although the use of non-originating footwear parts, other than uppers and parts thereof (under subheading 6406.10) and/or assemblies of uppers (under subheading 6409.99), is allowed provided that certain regional value content levels are met.
For apparel, the origin rule is generally yarn-forward. This requires the yarns and fabrics to be made and the apparel to be cut and/or knitted to shape, and sewn or otherwise assembled in the territory of one or more of the parties. The use of certain foreign yarns and fabrics is allowed, however: namely silk yarns, woven silk fabrics, flax yarn, jute yarns, yarns of other non-cotton vegetable fibres, woven fabrics of flax, woven fabrics of jute, woven fabrics of other non-cotton vegetable fibres, high tenacity yarns of viscose rayon (subheading 5403.10), other single yarns of viscose rayon (subheadings 5403.31 and 5403.32), and multiple or cabled yarns of viscose rayon (subheading 5403.41).
The agreement allows for full cumulation between the parties, which is expected to strengthen incentives for the TPP businesses to integrate production and supply chains within the region, making it more attractive to do business with producers in the TPP countries than with producers in other countries. In general, the fact that most apparel products will have to be made with TPP yarns and fabrics in order to qualify for preferential duty treatment under the agreement is expected to encourage (1) an expansion of the domestic yarn and fabric manufacturing sector in Vietnam and possibly Malaysia, partly through increased investment from Hong Kong and mainland companies, and (2) increased sourcing of yarn and fabric inputs by Vietnam and Malaysia from within the TPP region, including the US and Japan. This could possibly also lead to lower purchases by Vietnam and Malaysia of various types of yarns and fabrics from China, South Korea and Taiwan.
The trade remedy provisions are, in contrast, unlikely to have a significant effect on Hong Kong or the mainland. In the main, TPP will not affect the rights and obligations of its member states under the WTO agreements relevant to anti-dumping (AD) and countervailing (CV) duties, nor confer additional rights or obligations. It promotes certain well-recognised transparency and due process practices in trade remedy proceedings. These include notification to another party of receipt of an AD/CV application, transparency and due process notifications, maintenance of public files to provide access to all non-confidential documents in the administrative record, and disclosure of key facts on which decisions regarding whether to apply AD/CV measures are based.
Technical Barriers to Trade
The TPP parties will co-operate to ensure that international standards and recommendations likely to form the basis for technical regulations do not create unnecessary barriers to trade. They will provide national treatment to one another’s conformity assessment bodies, i.e., testing and certification performed by another party’s qualified conformity assessment body will be accepted as confirmation that its products, services or systems meet the requirements of the other party. Stakeholders and interested parties from the TPP countries will have the opportunity to participate in the development of technical regulations, standards and conformity assessment procedures by government bodies, reflecting the US approach to standards-setting.
The technical barriers to trade (TBT) chapter ensures a reasonable interval between publication of regulations and entry into force so that stakeholders have sufficient time to meet the new requirements. Similarly, the TPP countries have committed to give producers a reasonable amount of time to demonstrate the conformity of their goods with any relevant requirements. It includes sector-specific annexes to promote common regulatory approaches across the region, covering (1) cosmetics, medical devices and pharmaceuticals, (2) information and communications technology products, (3) wine and distilled spirits, (4) formulas for food products, and (5) organic products.
Through TPP, the US approach to standards-setting, which places high value on transparency and stakeholder participation, is promoted. It is believed that the public sector should set technical regulations mainly in areas that could involve public health or safety risks, while other standards-setting activities should be left to the private sector. By promoting this way of how standards should be set, TPP contests a competing approach embraced by some major economies in the Asia-Pacific region, including China, that relies heavily on a government-mandated approach.
The regulatory coherence chapter seeks to facilitate regulatory coherence in each TPP country by promoting mechanisms for effective interagency consultation and coordination. It encourages widely-accepted regulatory practices for goods, including provisions to help ensure regulations are written clearly and concisely, that the public has access to information on new regulatory measures, and that existing regulatory measures are periodically reviewed to determine if they remain the most effective means of achieving the desired objective. Rather than having to fulfil different national obligations, Hong Kong and mainland exporters should benefit from regulatory coherence – they will only need to satisfy a single set of harmonised requirements for the TPP markets.
Sanitary and Phytosanitary Measures
This chapter designs new rules that will ensure science-based sanitary and phytosanitary (SPS) measures are developed and implemented in a transparent, predictable and non-discriminatory manner, while at the same time preserving the ability of TPP regulatory agencies to take necessary steps to ensure food safety and protect plant and animal health. It includes commitments to ensure that the public can comment on proposed measures and that producers understand the requirements they must meet in each country. The TPP parties will also have to ensure that import checks for SPS requirements are based on the actual potential risk posed by the imports. In addition, the chapter requires the parties to inform importers or exporters within seven days if a shipment is being denied entry for a reason related to food safety or animal or plant health.
Customs Administration and Trade Facilitation
The customs administration and trade facilitation chapter seeks to ensure that goods traded among the TPP countries move quickly across borders, with facilitative and transparent procedures that require customs authorities to treat goods fairly and reduce opportunities for conflicts of interest in customs administration. This is particularly important to small- and medium-sized enterprises (SMEs), which often find complex customs and border procedures among the most serious obstacles to increasing their exports and are particularly reliant on the quick movement of goods, through services such as express delivery, to reach individual customers as fast as possible.
This chapter is seen as complementary to the WTO Trade Facilitation Agreement (TFA). In many areas, the two arrangements deal with similar issues and have similar provisions, but TPP includes more detailed requirements such as specific time limits. For example, TPP provides that under normal circumstances express shipments should be released within six hours after submission of the necessary customs documents, provided the shipment has arrived, while the TFA simply states that express shipments should be released under normal circumstances as rapidly as possible after arrival, provided the information required for release has been submitted. That said, while the TPP provisions will be implemented on an MFN basis, they are basically in line with the TFA and so no significant additional benefits are anticipated.
Investment, Services and Other Major Issues
The investment chapter provides the basic investment protections found in other investment-related agreements. These include national treatment, MFN treatment, minimum standard of treatment, prohibition of expropriation, prohibition on performance requirements such as local content or technology localisation requirements, free transfer of funds, and freedom to appoint senior management of any nationality. The TPP parties have adopted a negative list approach to investment, meaning that their markets are fully open to foreign investors, except where they have made country-specific exceptions.
These provisions, in combination with the tariff benefits included in the agreement, could lead to an acceleration in foreign direct investment (FDI) flows into the TPP region, potentially at the expense of China and other economies. However, Hong Kong, with its entrenched role as a business hub in Asia-Pacific, is well poised to benefit from rising investment activity in the region, particularly with respect to the migration of textile, clothing and footwear factories from the mainland and other production bases to Vietnam, as well as FDI flows into Vietnam to develop that country’s industrial and infrastructure base. Hong Kong investors will also benefit from the MFN treatment under TPP.
Trade in Services
TPP includes core obligations, found in the WTO and other trade agreements, covering national treatment, MFN treatment and market access. In terms of the latter, no TPP country may impose quantitative restrictions on the supply of services (e.g., a limit on the number of suppliers or number of transactions) or require a specific type of legal entity or joint venture. Meanwhile, local presence obligations mean no country can require a supplier from another country to establish an office or affiliate, or to be resident in its territory, in order to supply a service. The TPP parties accept these obligations on a negative list basis. There is a professional services annex encouraging cooperative work on licensing recognition and other regulatory issues, as well as an annex on express delivery services.
Regarding financial services, the chapter includes commitments relating to regulated financial institutions, any investors or investments in financial institutions, and cross-border trade in financial services. It does not apply to public retirement plans or social security systems. Core obligations include national treatment for investors and investment in financial institutions, MFN treatment and market access. Other important provisions involve minimum standards of treatment, allowing for claims for denial of justice or failure to provide police protection, bounded by customary international law, as well as claims for damages due to civil strife. The chapter also includes rules that would allow the financial institution of one party to supply a new financial service in the territory of another party when that party already permits the supply of that service by its local financial institutions. If anything, the MFN treatment of relevant provisions will likewise be a boon to service suppliers and financial institutions from non-TPP signatories, including Hong Kong and the mainland.
The chapter on intellectual property (IP) establishes standards for patents based on the WTO’s Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement and international best practices. It provides trademark protection for brand names and other markings that businesses and individuals use to distinguish their products in the marketplace. In addition, certain transparency and due process safeguards are included for the protection of new geographical indications.
Regarding copyright, it establishes commitments for the protection of works, performances and phonograms such as songs, movies, books and software. It also includes an obligation for parties to continuously seek to achieve balance in copyright systems through, among other things, exceptions and limitations for legitimate purposes, including in the digital environment.
In the meantime, the TPP countries have agreed to provide strong enforcement systems (e.g., civil procedures, provisional measures, border measures, and criminal procedures and penalties) for commercial-scale trademark counterfeiting and copyright or related rights piracy. It is conceivable that the adoption of rigorous IP rules and requirements throughout the Asia-Pacific region will compel China to take further steps in improving its IP regulatory and enforcement regimes. Meanwhile, Hong Kong, as the premier IP trading hub in Asia, will continue to flourish as an IP intermediary connecting the mainland and the TPP countries.
The TPP parties are committed to ensuring the free flow of information and data subject to legitimate public policy objectives – for example to protect privacy, prevent spam and fight cyber-crime. There are provisions encouraging signatories to promote paperless trading between businesses and government, including via electronic customs forms and electronic authentication systems for commercial transactions. The parties are also required to work together to help SMEs to overcome obstacles to adopting e-commerce, share information and experiences relating to e-commerce regulations and policies, participate actively in regional and multilateral fora to promote the development of e-commerce, and encourage the private sector to develop self-regulation that fosters e-commerce.
While these provisions are not expected to have a substantial direct impact on Hong Kong and the mainland, the development of a more favourable e-commerce environment may facilitate the penetration of exporters, retailers and other relevant service providers into TPP markets.
Small and Medium-Sized Enterprises
Complementing the commitments throughout other chapters on market access, trade facilitation, e-commerce and other areas, the SME chapter includes commitments by each TPP party to create user-friendly websites providing easily accessible information on the agreement and how SMEs can take advantage of its various provisions. In addition, the chapter provides for an SME Committee that will meet regularly to review how well TPP is serving SMEs and oversee activities to support them such as information sharing, export counselling, training programmes and trade financing. Proliferation of SMEs in the TPP markets will clearly mean an expansion of potential business partners for their counterparts in Hong Kong and mainland China.
TPP also includes a chapter on state-owned enterprises (SOEs) with provisions regarding activities that affect trade or investment. This chapter addresses potential commercial disadvantages to private sector firms from state-supported foreign competitors receiving preferential treatment. This could make it more challenging for China and various other Asian economies to accede to TPP at a later stage.
The chapter covers designated monopolies and SOEs mainly engaged in commercial activities where the government owns more than 50% of capital share, controls more than 50% of voting rights, or selects a majority of board members. As the focus is on commercial companies, the obligations do not apply to entities that primarily serve a public benefit such as health and education agencies, even if those entities have some commercial activities or charge for some of their services. It ensures that businesses, regardless of ownership, compete fairly through enforceable rules to ensure that foreign-owned SOEs compete on the basis of quality and price, not on the basis of discriminatory regulation, subsidies or favouritism.
On labour, TPP requires all member countries to meet core, enforceable labour standards stipulated by the International Labour Organisation (ILO). These include the freedom to form unions and bargain collectively, prohibitions against child labour and forced labour, requirements for acceptable pay and conditions including a minimum wage, regulation of working hours and workplace safety, as well as protections against job discrimination. Moreover, this chapter includes commitments to discourage the importation of goods that are produced by forced labour or child labour or that contain inputs produced by forced labour, regardless of whether the source country is a TPP party. In this context, TPP’s high standards for labour rights protection, not least the freedom to form unions, are another major obstacle for China to join at a later date, and would possibly restrict the importation of certain mainland products alleged to involve forced labour or child labour.
The environment chapter will create enforceable commitments across a range of environmental issues and transnational challenges such as wildlife trading, the implementation of national and multilateral environmental laws and agreements, eliminating environmentally destructive subsidies, and eliminating tariffs and other barriers to trade in environmentally-beneficial products and technologies. It will also foster closer co-operation among TPP governments to more effectively address transnational threats and police environmental crimes such as trading in endangered species and illegal fishing, and will help lower-income countries administer environmental laws and conservation programmes.
The agreement contains broad commitments to promote sustainable fisheries management. These can support measures being developed or implemented through relevant regional fisheries management organisations and other avenues in the Asia-Pacific region designed to address illegal fishing and offer species-specific protections for threatened marine species such as whales and sharks. The TPP parties have also agreed to safeguard the marine environment from ship pollution and to protect the ozone layer from ozone-depleting substances.
The TPP dispute settlement mechanism applies across the agreement, ranging from trade in goods and services to SOEs, labour and environmental issues. Submissions made in disputes, as well as final reports produced by the relevant panels, will be made available to the public, and hearings will be open to the public unless the disputing parties agree otherwise. Panels will be composed of three international trade and subject matter experts independent of the disputing parties. To maximise compliance, the agreement allows for trade retaliation (for example, the suspension of benefits) if a party found not to have complied with its obligations fails to bring itself into compliance. Before the use of trade retaliation, a party found in violation can plead for a reasonable period of time in which to remedy the breach.
It should be noted that this chapter only applies to signatories, and hence the TPP countries are not obliged to provide the same dispute settlement provisions across the board. Non-TPP parties will therefore be disadvantaged when disputes occur. For example, while a Hong Kong investor may benefit from the new laws when investing in a TPP country, if there is a dispute that investment is not protected under TPP.
The Way Forward
After formally signing the TPP deal on 4 February 2016 in New Zealand, the 12 signatories are required to ratify the agreement to make way for its implementation. There are basically two ways in which TPP can come into effect. The first option is that within two years of the date of signature (i.e., between now and 4 February 2018), TPP will enter into force 60 days after the date on which all 12 signatories ratify the agreement. If this does not occur, TPP will enter into force 60 days after the date on which at least six of the signatories with together accounted for at least 85% of the group’s total GDP in 2013 have ratified the agreement.
The US and Japan would therefore both have to ratify the agreement in order for any group of six signatories to achieve the required 85% threshold, and that group would probably also need to include Australia, Canada and/or Mexico. In the US, the chance of ratification in 2016 is slim given that this is a presidential and congressional election year. In Japan, the government will likely hold off debate on TPP until after its upper house elections in mid-2016. For their part, a number of smaller countries may face an even longer ratification process. For example, Vietnam initially indicated that its TPP ratification process could take up to a couple of years; however this has been further complicated by an impending change of prime minister and a cabinet reshuffle.
In all, while it is not expected that the ratification process will take more than two years in all 12 signatory countries, it would be highly unlikely that all will pass the deal by 4 February 2018. Nevertheless, provided that the US and Japan, in tandem with Australia, Canada and/or Mexico, complete the ratification process within that time, there is a reasonably good possibility that TPP could indeed enter into force on or around 4 April 2018, although further delays are very much possible.