A Chinese military exercise in the South China Sea. There are multiple flashpoints in the region, including China’s disputes with Japan and Taiwan
A Chinese military exercise in the South China Sea. There are multiple flashpoints in the region, including China’s disputes with Japan and Taiwan © Reuters

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Greetings from Tokyo. The big news in Asia is the long-awaited signing of the Regional Comprehensive Economic Partnership (RCEP), a sprawling free trade deal that takes in the 10 members of the Association of Southeast Asian Nations along with Australia, China, Japan, New Zealand and South Korea. The text is now available in all its glory (there are 1,338 pages for Japan’s tariff commitments alone) and there will no doubt be more to say once the trade community has had time to digest it.

Today’s main note looks at something slightly different: the potential economic costs if there were a disruption of trade in south-east Asia. One of the reasons why trade matters is its potential to build trust, understanding and mutual benefit between countries that may otherwise dislike each other. Some analysts deprecate the economic importance of RCEP, but it is a big step forward for governance in a region where such arrangements are scarce. Today’s Policy watch looks at how David Frost, the UK’s Brexit envoy, once felt far less bullish about the likely outcomes of trade talks with Brussels, while our chart of the day covers Beijing’s displeasure at how Big Tech is behaving.

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Taiwan, Vietnam, Saudi Arabia and Hong Kong could be among those hit, says report

Geopolitical risk is a spectre often raised but seldom quantified. Many a forecaster hedges against the unexpected with a quick mention of geopolitical peril, but when a shock does hit — such as the 2019 drone attacks on Saudi Arabian oil refineries — the impact often comes as a surprise. That is why a recent paper by Kerem Cosar and Benjamin Thomas, of the University of Virginia, makes interesting reading.

They set out to answer the question: what would happen if a geopolitical event halted east-west maritime trade through the South China Sea and the various straits of Indonesia, forcing vessels to reroute around the south of Australia? The answer is a large but differing shock, ranging from a 0.7 per cent reduction in gross domestic product for China up to 34 per cent of GDP for Taiwan in a baseline scenario. Those figures have both economic and geopolitical implications.

A crisis that closes the South China Sea is not a fanciful scenario. There are multiple flashpoints in the region, including the dispute between China and Japan over the Senkaku or Diaoyu islands, China’s increasingly tense relationship with Taiwan, and overlapping territorial claims in the South China Sea. Shipowners and insurers might reroute their vessels even if a crisis did not turn into actual conflict.

To capture what might happen, Mr Cosar and Mr Thomas use data on bilateral trade flows and the geographic location of ports, then feed it into a gravity model where the costs of trade rise with distance. Then they block the routes between east and west, forcing all ships to sail around the south of Australia, and calculate how much trade is lost to the increased shipping costs.

Vietnam’s PM Nguyen Xuan Phuc, left, and trade minister Tran Tuan Anh cheer during the RCEP virtual signing ceremony in Hanoi on Sunday
Vietnam’s PM Nguyen Xuan Phuc, left, and trade minister Tran Tuan Anh cheer during the RCEP virtual signing ceremony in Hanoi on Sunday © Luong Thai Linh/EPA-EFE/Shutterstock

Not surprisingly, those most affected are small, trade-dependent economies in and around the South China Sea. Using a baseline elasticity of trade volumes to trade costs, Taiwan would lose a third of its GDP, and the figures are 22 per cent for Singapore, 15 per cent for Hong Kong and 13 per cent for Vietnam. In a sense, this is mechanical, since the ports in these countries would be blocked, and the more interesting figures are 2.5 per cent for South Korea, 2 per cent for Australia, 5 per cent for the United Arab Emirates and 3 per cent for Saudi Arabia.

Perhaps most significant of all is the figure of just 0.7 per cent for China, which has its own huge internal market, and ports outside the exclusion zone in the East China Sea and Yellow Sea. China does incur a cost, note Mr Cosar and Mr Thomas, so it has no clear incentive to close the Malacca Straits. But they add: “More broadly, our results emphasise the possibility of a large country maintaining control over the region by imposing substantial costs on smaller countries.”

There are obvious limitations to this kind of analysis. Mr Cosar and Mr Thomas note that they ignore air freight and that some goods are easier to substitute than others, while a shock might not close all shipping routes. More generally, a crisis would have political effects they cannot cover: would the US still trade with China during a crisis over Taiwan, even if the ports were open?

The signing of RCEP is a hopeful sign that Asia can work together for mutual trading benefit. But much of that trade goes through a few narrow waterways and their security, for the past 75 years, has relied ultimately on the dominance of the US military. With that dominance increasingly in doubt, it is all the more important to see how incoming US president Joe Biden re-engages with the region.

Charted waters

The climate is cooling rapidly for China’s tech giants. After years of warily allowing companies such as Alibaba and Tencent the freedom to grow without significant interference, Beijing has signalled it does not like how Big Tech is behaving. Last week, Chinese tech stocks lost hundreds of billions of dollars in value, with Alibaba falling 12 per cent in Hong Kong, after the release of new antitrust guidelines for the sector. Analysts forecast that pain was on the way.

China's unique internet ecosystem (sharing)

Policy watch

UK Brexit negotiator David Frost, centre, warned in 2016 that Britain would be forced to make concessions in order to get a deal from the EU
UK Brexit negotiator David Frost, centre, warned in 2016 that Britain would be forced to make concessions in order to get a deal from the EU © Francisco Seco/AP

David Frost, UK prime minister Boris Johnson’s Brexit envoy, was hanging tough as trade talks entered the endgame in Brussels this week, but he once felt far less bullish about the likely outcomes of such negotiations. Writing in a largely forgotten pamphlet just before the 2016 Brexit referendum, Lord Frost warned that in trade talks with the EU “it will be Britain that has to make the concessions to get the deal”. Talks in Brussels are now in what Irish foreign minister Simon Coveney called “move week”, with both sides waiting for the other to blink. Officials in London and Brussels expect talks to succeed or break down next week.

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