Thoughts on the Trans-Pacific Partnership

(Original publish date: Oct 2015.)

Many people have asked for my opinions about the Trans-Pacific Partnership (TPP) since the last round of negotiation reached final agreements on Oct 5, 2015. To the extent that (1) the content of the negotiations is still kept secret, (2) the only content available for reading is the three chapters on environments, intellectual rights, and investment published by Wikileaks, and (3) I am not an expert on trade, I will not claim to have anything interesting or credible to say about TPP itself. Instead, in this post, I simply flash out thoughts about the potential impacts of TPP on the Vietnamese economy.

Why is Vietnam even in TPP?

Currently, TPP consists of 12 members: Japan, Vietnam, Brunei, Malaysia, Singapore, Australia, New Zealand, Canada, Mexico, Peru, Chile, and the US. This list clearly represents a wide range of economic development, from developed states such as the US, Japan, and Australia, to developing countries such as Vietnam, Mexico, and Peru. It is worth noting that Vietnam has the lowest GDP per capita among all members. With a huge population, a large market, and as a country whose economy emphasizes trade (trade of Vietnam in 2013 stands at 165% of GDP – data from World Bank, see graph), Vietnam is a good potential partner for many developed economies. A harder question to answer is the reverse question: “should Vietnam join TPP after all?”

Data from World Development Indicators (World Bank)

Gains from trade

Many people have a wrong perception that upon joining TPP, small countries like Vietnam only stand to lose, as we cannot compete against technological giants like US or Japan. First, economic theories have long pointed out that countries can all benefit from trade even if a country has worse technology in every sector compared to the other country. David Ricardo, a renown 18th century British economist, taught us that as long as a country produce the good in which it has comparative advantage in, everyone should expect to gain from trade. For example, Vietnam uses labor more productively in making rice than making electronics, while Japan is more efficient in making electronics than making rice. Then, according to Ricardo, opening up to free trade and removing of tariffs will allow Vietnam to specialize on making (and exporting) rice, while Japan specializes on electronics, and both countries earn higher welfare through free trade and specialization.

Another theory, Heckscher-Ohlin theory of trade, which focuses on differences in endowments of resources rather than differences in technology like Ricardian theory, explains that everyone can gain from trade by exporting the service of factor in which that country is relatively more well-endowed in. For example, Vietnam is more relatively well-endowed in labor compared to capital, and the textile industry uses labor intensively. Therefore, according to the Heckscher-Ohlin theory, opening up to (more) trade will increase the international price of textile products, inducing more textile outputs, and increase the wage of workers in the textile industry.

Though both theories are over-simplified, these International Trade 101 theories provide us with intuition of how a small country like Vietnam can gain from more and more free trade. Just imagine how farmers in Binh Thuan can now export dragon fruits (Thanh Long) to Australia and earn higher price for each fruit (since Australia previously has no dragon fruits and has very high valuation for it), while the same farmer can buy cheaper tablets made in Japan.

Important Questions

With this, having worse technologies in all sectors and being totally different in terms of socio-political economy should not be good reasons for Vietnam not to join TPP. We should think about other, more valid potential problems of joining TPP:
1) What is the implication of joining TPP on income inequality in Vietnam? Who gains, who loses?
2) Theories certainly do not hold perfectly in practice. However, it is important to know what the frictions that will make us deviate completely from the theories are.
3) What are our goals of economic growth in terms of industries composition? Will TPP be consistent with that goal?
4) What should be our strategies to make the best out of TPP?

These are the four things to keep in mind. I will present here my thoughts on each of the question, though please keep in mind that these thoughts are not based on careful analysis with real data (hence, it’s not what I believed to be good economics analysis), so please take the words “things to keep in mind” literally.

1. TPP and income (in)equality

This topic is very new, and still explored by many experts in the field of international trade. Intuitively, I would think that as a country well-endowed in labor, farmers, workers in textiles, or labors in any other labor-intensive industries would see a rise in income, at the expense of contraction, loss, and re-allocation of labor in other industries. Considering that these workers/farmers are at the lower end of the income distribution in Vietnam, this shift up in their relative income would mean more of closing the inequality gap rather than widening it. Newer research suggests that within these industries, there will be rising income differentials (i.e. high skill textile firms vs. low skill textile firms) – but I subjectively think that this is not at an order of magnitude that we should concern about, at least for now.

2. Frictions that prevent gains from trade

As TPP remains opaque, many are still unsure about what exactly is in it. However, with whatever publicly available, it’s becoming increasingly clear that TPP seems much more about setting out standards for production and trade, rather than lowering trade barriers (e.g. tariffs) like traditional trade agreements.

First, let’s consider potential problems for policy-makers. Joseph Stiglitz and Paul Krugman, two Nobel prize winners in Economics, have expressed concerns over such nature of the TPP, arguing that these chapters on standards could leave room for foreign companies to sue governments on regulatory changes, henceforth reducing the governments’ flexibility for domestic policies. For example, from the leaked draft on investors protection, TPP bans any governments’ policies that relate a company’s volume of trade to the allowable amount of capital flows for that company. I’m still not sure how this can be used against the Vietnamese government; but, I think Vietnam has to be extra careful on any capital control measures that it takes in order to not be sued by TPP investors. (And, for a developing market, the ability to implement capital controls is an important tool for defense against excessive capital inflows and the ‘sudden stop’ problem, which may shock the economy).

The second, and somewhat more realistic, reason comes from the industries themselves. For an industry to benefit/be protected by TPP laws, the productive activity of such industries must meet TPP’s standard. I do not have hard number, but I’m thinking very hard about how small-sized businesses, retail farmers, and small factories who do not have the human capital and skills needed to ensure a TPP-high standard of production can survive in TPP. If the government is not careful in monitoring and providing help to sectors in need, this could be a serious problem when we are signing a rule that we cannot follow ourselves. It’s like competing in a soccer match with players who don’t know which goals they should score at.

3. TPP and Long-run economic goals

Let’s remind ourselves about the need for trade barriers. A country usually needs trade barriers to (1) generate government’s revenue (this was the case for the US immediately after the American Revolution, when the federal government wasn’t given the right to tax), (2) control consumption of certain goods (e.g. Vietnam wants to limit the number of cars in Ho Chi Minh City to avoid congestion), and (3) to protect the so-called “infant industries”, i.e. industries that are still in development, with hope that they will grow to be important for the economy.

Certainly, once joined TPP, we will be able to expand production in sectors that we are more efficient or have relative well-endowed factor, such as textile. (I’m using textile as an example very often because it is an important industry for Vietnam right now, and the Vietnamese officials who negotiated TPP keep bringing up this example). However, we should consider, what industries do we want to be strong at 10, 20 years from now? Do we want to be good at automobile? Computer chip production? Softwares?

Within these sectors, some are arguably not Vietnam’s comparative advantage, and may lose when Vietnam embraces TPP (except for the case of diversifying their products, see next part). Therefore, if Vietnam plans on continuing to have textile as an important industry in the future, then TPP will be perfect. However, if Vietnam plans on having more modernized, high-tech industries, I’m not sure TPP will be a good choice. That said, I don’t know if focusing on being strong at textile now and forever would be good or bad, so this remains a question.

4. Best strategies to approach TPP

What should firms do to make the most out of TPP? For industries such as textiles, it seems like a clear gain, so I will not discuss it further. Consider instead a more ambiguous case, say, the software industry. There are of course much stronger, more high-tech, more endowed in skilled workers software industries in US, Japan, and Australia. Does that mean Vietnamese software firms will stand to lose with a 100% certainty? No. It is a common understanding under the New Trade Theory developed by Helpman and Krugman in the 1980s that competing firms within the same sectors can enjoy benefits from trade and economies of scale if they focus on differentiation of products. That means, Vietnamese software firms should not try to produce a competitor to Microsoft Word, or a glass that can compete with Google Glass; but rather something else more unique, like a dating software for industrial workers, for example. (Sorry for the terrible example, but if I had a good idea about an app or software, I would be making a start up instead of being an economist…)

I think, to best embrace TPP, from the firms’ perspective, product differentiation is key.

Conclusion

To state my (conditional) opinion, I think that Vietnam will benefit from TPP. An authoritative study on the impact of TPP by the Peterson Institute for International Economics (which I just found out that it’s located on Mass Ave., only a few miles away from Harvard) estimated that Vietnam will gain 46.1 to 72.9 billion dollars by 2025 if TPP becomes reality. Of course, this estimate, together with my opinions, is conditional on the implicit understanding that Vietnam is rational, understands the game it is signing up to play, and the Vietnamese government has timely measures to ensure that industries and workers are embracing TPP in the best possible ways. (I have mentioned a few things the government should do in this post).

At a final thought, economic experts on Vietnamese newspapers often conclude about TPP: “We are at a crossroad that is full of opportunities, but it’s also full of challenges”. Though, I’m skeptical that people understand what exactly these opportunities and challenges are. I do not claim that I know them myself, but I hope that this post has listed out a few ideas to think about.

 Oct 11, 2015.
Vu.