11Age of Ferment:

Developments in Asian–European
Trade Relations

Age of Ferment:
Developments in Asian–European Trade Relations

Publisher Information
Age of Ferment: Developments in Asian–European Trade Relations is published by
the Konrad-Adenauer-Stiftung’s Regional Economic Programme Asia (SOPAS).
Editor: Sanjay Kathuria
Copy Editor: Floreza Alpuerto, Marina Dane
Publication Coordination: Cristita Marie Perez, Sakuya Iwakawa
Design, Layout, and Typeset Artist: Hayati DigiArts, Paula Duman© 2021, Konrad-Adenauer-Stiftung Japan
ISBN 978-4-9911837-7-5
Publisher:
Konrad-Adenauer-Stiftung Japan Office/Regional Economic Programme Asia
(SOPAS)
Officially registered as:
Konrad-Adenauer-Stiftung Association Japan
OAG-House #4F 7-5-56 Akasaka, Minato-ku, Tokyo, Japan+81-3-6426-5041
KAS-Tokyo@kas.dewww.kas.de/japan

All rights reserved. No part of this publication may be reprinted, reproduced, or
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are to be sent to the publisher. The responsibility for facts and opinions in thispublication rests exclusively with the authors, and their interpretations do notnecessarily reflect the views or the policy of the Konrad-Adenauer-Stiftung.

ii

Table of Contents

Table of Contents
About the Editor							viiForeword								viii
Rabea BRAUER, Cristita Marie PEREZ
Editor’s Introduction							ixSanjay KATHURIA
Section I.
Asia in Transition
1. COVID-19 and Resilient Supply Chains: A Regional 			Economic Perspective						3Amitendu PALIT
2. The Semiconductor Industry in the Age of Trade 			Wars, COVID-19, and Strategic Rivalries			21
Willem THORBECKE
3. Digital Investment and Post-Pandemic Recovery in 				ASEAN								35Sineenat SERMCHEEP
4. Rebooting South Asian Trade for the Post-COVID-19 				World								57Srinivasan THIRUMALAI
5. Sri Lanka’s Apparel Industry: COVID-19 Impacts, 			
Resilience, and Recovery					77Anushka WIJESINHA

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Age of Ferment:
Developments in Asian–European Trade Relations
Section II.
Asia–Europe Trade Connectivity
1. European Trade Relations with Asia				Axel BERGER

99

2. On the Relevance of Free Trade Agreements in 				the Asia-Pacific: A European Perspective			117
Jürgen MATTHES
3. Asian-European Supply Chain Risks				
Hubertus BARDT

135

4. The Future of Europe-Asia Trade Relations after RCEP		
Alessia AMIGHINI

149

5. A Marriage of Convenience: A Critique of the 				EU-China Comprehensive Agreement on Investment		
163
Chien-Huei WU
6. EU-Asia Relations Post-COVID-19: Green Recovery, 			
Value Chains, and Sustainable Trade				179
Gauri KHANDEKAR

iv

Abbreviations

Abbreviations
AEC

ASEAN Economic Community

AR, VR, MR

Augmented, virtual, or mixed reality

ASEAN

Association of Southeast Asian Nations

BRI

Belt and Road Initiative

CAI

Comprehensive Agreement on Investment

CBAM

Carbon Border Adjustment Mechanism

CBSL

Central Bank of Sri Lanka

CEPA

Comprehensive Economic Partnership Agreement

CMOS

Complementary metal oxide semiconductors

CPTPP

Comprehensive and Progressive Agreement for Trans-PacificPartnership

CUSMA

Canada-United States-Mexico Agreement

DRAM

Dynamic random access memory

e-CNY

Digital yuanEC

European Commission

ECH2A

European Clean Hydrogen Alliance

EDA

Emerging and developing Asia

EP

European Parliament

EPA

Economic Partnership Agreement

EU

European Union

EU ETS

European Emissions Trading Scheme

EUA

Emergency use authorisation

EUJEPAEU-Japan Economic Partnership Agreement

EUR

Euro

FDI

Foreign direct investment

FTAFree trade agreement

G7Group of Seven

GATS

General Agreement on Trade in Services

GATT

General Agreement on Tariffs and Trade

GDP

Gross domestic product

GHG

Greenhouse gases

GMV

Gross merchandise volumev

Age of Ferment:
Developments in Asian–European Trade Relations

vi

GSP+

Generalised Scheme of Preferences Plus

GVC

Global value chains

HR/VP

High Representative of the Union for Foreign Affairs andSecurity Policy

HS codesHarmonised Commodity Description and Coding System

ICT

Information and communications technology

IDI

ICT Development Indicator

ILO

International Labour Organization

IMF

International Monetary Fund

IPI

International procurement instrument

ISDS

Investor-state dispute settlement

ISPs

Internet service providers

IT

Information technology

ITA

Information Technology Agreement

ITRI

Industrial Technology Research Institute

IUCN

International Union for the Conservation of Nature

IXPs

Internet exchange points

JAAF

Joint Apparel Forum of Sri Lanka

JSI

Joint Statement Initiative

Lao PDR

Lao People's Democratic Republic

LCDs

Liquid crystal displays

LEED

Leadership in Energy and Environmental Design

LKR

Sri Lankan rupees

MFN

Most-favoured nation

MIMOS

Malaysian Institute of Microelectronics Systems

MITI

Ministry of International Trade and Industry

MNCs

Multinational corporations

MOQs

Minimum-order quantities

NAFTA

North American Free Trade Agreement

NPL

Nonperforming loans

OECD

Organisation for Economic Co-operation and Development

PLI

Production-linked incentive

PMOS and
NMOS

Positive and negative channel metal oxide semiconductor chips

PPE

Personal protective equipment

PPP

Public-private partnerships

Abbreviations

PTPL

Pluriregional Trade Partnership of Like-Minded Countries

R&D

Research and development

RCEP

Regional Comprehensive Economic Partnership

SARS

Severe acute respiratory syndrome

SCRI

Supply Chain Resilience Initiative

SKUs

Stock-keeping units

SMEs

Small and medium enterprises

SOEs

State-owned enterprises

TAC

Technical Advisory Committee

TRIPS

Agreement on Trade-Related Aspects of Intellectual Property
Rights

TSMC

Taiwan Semiconductor Manufacturing Company

UAE

United Arab Emirates

UK

United Kingdom

UMC

United Microelectronics Corporation

US

United States

USD

US dollar

WITSWorld Integrated Trade Solution

WTO

World Trade Organizationvii

Age of Ferment:
Developments in Asian–European Trade Relations

About the Editor
Dr. Sanjay KATHURIA
Dr. Sanjay Kathuria is a fellow at the Wilson Center in Washington, DC; senior
visiting fellow at the Centre for Policy Research, India; non-resident senior
fellow at the Institute of South Asian Studies, Singapore; adjunct professor at
Georgetown University; and visiting faculty at Ashoka University. Earlier, he
was a lead economist at the World Bank in Washington, DC. He is a pre-eminent
thinker and commentator on economic development and integration in South
Asia. He spent over 27 years at the World Bank, working on South Asia, Latin
America and the Caribbean, and Eastern Europe, including field assignments in
New Delhi and Dhaka. Before joining the World Bank, he was a fellow at the
Indian Council for Research on International Economic Relations in New Delhi.
His scholarly and popular writing has focused on South Asia, economic growthand development, trade and globalisation, regional integration, the economics
of small states, and gender issues, among others. He is on the editorial board of
the Rising Asia Journal. He holds a PhD in economics from Oxford University as an
Inlaks scholar. He graduated from St. Stephen’s College, Delhi, and pursued his
master’s at the Delhi School of Economics.

viii

Foreword

Foreword
The COVID-19 pandemic severely disrupted trade. Alongside this massive shock,nationalist and protectionist policies have been on the rise over the last few
years. Tariffs have increasingly been abused for negotiation and retaliation in
disputes between the world’s biggest economies. While it is uncertain how thesetrends will impact global recovery, they are likely to continue. Yet these trends
notwithstanding, international trade endures.
The manifold COVID-19 responses around the world have influenced the futureof global trade. Although uncertain and unpredictable in their eventuality andscope, the changes to global trade will likely be substantial and will create
significant opportunities as the world deals with, and eventually recovers from,the ravages of the pandemic. In this vein, the papers in this volume—Age of
Ferment: Developments in Asian–European Trade Relations, published by the
Konrad Adenauer Stiftung’s (KAS) Regional Economic Programme Asia (SOPAS)—examine the role of trade in facilitating recovery from the COVID-19 pandemic.
The publication contains two sections. The first section deals with transformationsin Asia’s global value chains in selected sectors and also provides a sketch of theregion’s economic trajectory following these systemic disruptions. The second
section analyses Europe’s evolving trade relations with Asia using the recent freetrade and investment agreements as lenses.
As trade relations become increasingly more complex, it is essential to findcommon ground to ensure an inclusive recovery from the ravages of the current
crisis. We hope that the perspectives that these papers offer will be able tocontribute to these efforts.

Rabea BRAUER
Director, Regional Economic Programme Asia (SOPAS)Country Representative, KAS Japan
Cristita Marie Perez
Senior Programme Manager, Regional Economic Programme Asia (SOPAS)KAS JapanixAge of Ferment:
Developments in Asian–European Trade Relations

Editor’s Introduction
Sanjay KATHURIA

Continued Ferment
The global economy is in ferment. Even before the COVID-19 pandemic, theworld was already struggling to cope with slowing growth across advanced andemerging market economies, escalated trade tensions—including the US-China
trade war and Brexit—and the growing urgency of dealing with climate change.
The World Bank’s January 2019 edition of its global economic prospects termed
this situation as ‘darkening skies’ (World Bank, 2019).
Then came COVID-19, which had a catastrophic impact on the global economy.
World economic growth dropped from 2.6% in 2019 to -3.4% in 2020. This was
accompanied by an unprecedented increase of 97 million in the ranks of the
global poor in 2020. Even though poverty declined in 2021, the number of people
living in poverty in 2021 is estimated to be much higher than in 2019, a reversalof the historical decline in global poverty (Mahler et al., 2021).
Recovery is now under way, with world economic output estimated to havegrown at 5.5% in 2021. But this growth is projected to slow down to 4.1% in 2022,
reflecting continued global uncertainty, continuation of COVID-19 outbreaks,
falling fiscal support, and persistent supply chain disruptions arising fromdemand and supply imbalances (World Bank, 2022).
Trade is an integral part of the world economy and, if anything, has been morevolatile than overall output. The volume of world trade declined by 8.2% in 2020,
rose by 9.5% in 2021, but is projected to slow to 5.8% growth in 2022.1
Indeed, after an initial collapse, especially in the first two quarters after the spreadof COVID-19 in 2020, trade has proved resilient and supportive of recovery.
Goods trade bounced back more sharply than GDP. Despite having been
under considerable strain, global supply chains have been quite resilient andhave allowed countries critical access to medical supplies, food, and consumer
goods, thereby supporting their economic recovery. GDP recovered more swiftlyin countries which had strong trade linkages with countries less affected by
COVID-19 (WTO, 2021).

1

x

Trade here includes both goods and non-factor services. Data from World Bank, 2022.

Introduction

However, while trade has picked up, a surge in global inflation has created new
problems for the poor across the globe, and much of this price increase can be
attributed to supply chain snags.

Emerging and Ongoing Cross-Border Issues
The pandemic has pushed cross-border issues to the forefront of political,
economic, and business discourse. These issues include, but are not limited to:the cross-border communicability of the virus; the global collaboration in thehunt for the COVID-19 vaccine; the debate on the waiver of intellectual property
for new vaccines; vaccine nationalism and unequal access to vaccines; the surge
in trade in medical goods, including the export of vaccines, once developed andapproved; the pressure on global supply chains in the face of the massive shift
in demand towards goods and away from services; and the renewed push todiversify supply sources for critical raw materials and products.
Even before COVID-19, trade issues had often occupied centre stage. This was thecase for many reasons, inter alia, the US-China trade war and its global impact;
Brexit and its aftermath; the backlash against globalisation; the decline in thecredibility of the World Trade Organization, including the paralysis of the disputesettlement mechanism; and the far-reaching implications of digital and digitallyenabled trade. There was also growing recognition that trade can play a very
important role in addressing climate change.
These issues will serve as a useful backdrop to the specific topics addressed inthis book, highlighted in the following sections. The book is primarily about tradeand deals with issues that are set to occupy or, in some cases, already occupy
centre stage in global economic relations. Part I of the book focuses on issues
within Asia, although many of those considered are also relevant to Part II, which
examines trade and connectivity between Asia and Europe.

Asia in Transition
East Asia and South Asia are always cited as foremost examples of regions thathave benefitted the most from international trade and the creation of jobs thathave lifted hundreds of millions of people out of poverty. For these regions, trade
will continue to play a big role in future growth and poverty reduction, including
for those countries that remain relatively poor, which means most countries inSouth Asia, as well as some in East Asia.
East Asia has developed a well-justified reputation as a dynamic trading region,
being at the centre of many global value chains, as well as a large and growingxiAge of Ferment:
Developments in Asian–European Trade Relations
market for consumer goods from all over the world. It also trades a lot within theregion, with well-developed regional value chains and trading relationships.
To further cement regional trade and value chains, and to reduce the noise froman increasingly protectionist world, fifteen countries of the Asia-Pacific region,
led by the ASEAN grouping, negotiated the world’s largest trade agreement,
the Regional Comprehensive Economic Partnership (RCEP). Apart from ASEAN
countries, the other signatories include China, Australia, Japan, South Korea, and
New Zealand. While the agreement may not appear to be ambitious, it will have asignificant impact on trade facilitation by harmonising the rules of origin within thefifteen countries, replacing the five different trade regimes that hitherto prevailed
among different sets of countries. Its framework also allows improvements overtime, in the manner that ASEAN-driven trade agreements tend to do. The RCEP
became effective on 1 January 2022, for the ten governments that had ratified
the pact till that point.
In the wake of COVID-19, there are renewed concerns in importing countries
about concentration of supply chains, both at a general level and also focusing
on products deemed to be critical. Not surprisingly, given their success, East
Asian countries, particularly China, are the focus of such concerns.
South Asia could not be more different from East Asia on the trading front. It is
often labelled as the least integrated region in the world, with significant barriers
against trade within the region, as well as with the rest of the world.2 Despite its
trading success in the last two decades, the region remains protectionist andhesitant to commit to open trade regimes. No country in the region has signed
on to any regional/major trade pacts in recent years: India, which was a party to
RCEP, dropped out of the negotiations in 2019.3 In this context, could COVID-19
and global trade realignments force South Asian countries to take a fresh look attheir approach to trade and integration?
Resilient supply chains
Despite popular perceptions, headlined by a four- to six-fold increase in shipping
costs in 2021, and the image of a giant container ship stranded in the Suez Canal,xii

2

See Kathuria (2018) for more details.

3

In February 2022, India signed a free trade agreement with the United Arab Emirates.
Under this, according to news reports, India would allow duty-free access to 90% of
goods from the UAE in 10 years. A large number of ‘sensitive’ products have been kept
outside the FTA.

Introduction

global supply chains have, for the most part, held up well during the pandemic.
They have been resilient and responsive to market signals. And they are not easy
to reverse, having been built up over decades.4
But there is no denying the strains supply chains have been subject to, owing to
the enormous shift in demand towards goods, combined with labour shortages.
These strains are reflected in inflation surges across the world: in the US, forexample, consumer prices rose by 7.5% in January, a 40-year high. Similar stories
are echoed in Europe and emerging markets.
Persistent concern has been expressed with regard to supplier concentration
and resultant vulnerabilities along the supply chain and are likely to lead tosome shifts. These concerns appear to exercise governments more than privatecompanies, especially since China has not hesitated to use coercive trade policy
to advance its geopolitical interests.
Indeed, the theatre of the Indo-Pacific has seen a flurry of activity since September
2020—at least in terms of discussion and planning—focusing, in one way or
another, on supply chain vulnerabilities and the production location of criticalproducts. Such issues are discussed by Amitendu Palit in the opening chapter ofthis book. Palit notes that many countries and businesses focused on reducing
economic dependence on China, for geopolitical reasons and also because, as
the first epicentre of the pandemic, supply disruptions began from China. One
such organised effort was the Supply Chain Resilience Initiative (SCRI), announced
by Japan, India, and Australia in September 2020 and formally launched in April
2021. These three countries, along with the United States, are also part of the
Quad initiative, which was conceived as an informal security dialogue. The Quadwas resurrected in 2017 and has taken on new momentum since 2020, with newemphasis on its economic dimensions. Most recently, in February 2022, the WhiteHouse released the Indo-Pacific Strategy for the US (White House, 2022), whichseeks, inter alia, to support a free and open Indo-Pacific, strengthen partnerships
with regional partners, and strengthen the Quad.
None of this has led to much by way of concrete investments yet. The intent todecouple from China is clearly strong, but how far these efforts go in practiceremains to be seen. On the one hand, there are a variety of initiatives, often
complementary to each other, to encourage and incentivise, for example,
investment in vaccines and alternative supply chains in critical technologies.
These might well lead to new rules and frameworks for important supply chains.

4

See, for example, The Economist (2021).

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Age of Ferment:
Developments in Asian–European Trade Relations
On the other hand, as Palit elucidates, China controls many resources and has avery competitive ecosystem for a wide range of industrial inputs; it is also seeking
to reduce its own dependence on external markets and localise supply chains
within China. It remains to be seen how these different forces will play out.
Semiconductors and strategic rivalries
Perhaps no industry has so focused the mind of policymakers in recent times
as semiconductors. Semiconductors are the brains of modern electronics andare critical for smartphones, computers, transportation, clean energy, militarysystems, and advances across all these and countless other products. Even before
the pandemic, the Trump administration had launched a trade war against the
Chinese semiconductor industry. Then came COVID-19.
COVID-19 generated a shortage of semiconductor chips, thanks to people being
forced to work from home, and the resultant unforeseen soaring demand for
consumer durables, among other things. The knock-on effect of this was also awidely felt shortage of semiconductors for automobiles.
In the wake of these shortages, it was perhaps inevitable that Westerngovernments would want to intervene in semiconductor production, given thatthe currently dominant producers are in ‘faraway’ locations such as South Korea,
Taiwan, and other East Asian countries. The potential threat of war between China
and Taiwan also makes the US nervous about semiconductor supplies. Apartfrom the US and Europe, India, too, is making a push for domestic manufacturingin this sector.
The second chapter in this volume, by Willem Thorbecke, considers these issues
and also provides a historical account of the semiconductor industry, starting with
their invention in the US, their subsequent development in Japan, followed bySouth Korea and Taiwan, and, more recently, China. This is useful background forthe policy lessons Thorbecke puts forward. Given how expensive semiconductor
fabrication is, policymakers could end up saving a lot of taxpayer money bypaying close attention to the kinds of issues raised in the paper.
Semiconductors will continue to occupy centre stage in global economics andgeopolitics for the foreseeable future. Whether East Asian countries continue todominate the sector or become more integrated into their regional market, andwhether or not other serious players will emerge, will be fascinating to observe.

xivIntroduction

The digital economy and recovery
All over the world, trends towards digitalisation were accelerated by the
pandemic, arising from the need for physical distancing. This led to work from
home, increased demand for goods instead of services, a boom in e-commerce,
and a surge in remote delivery of critical services like health and education,
among other things. None of this, however, could compensate for the lockdowns
and the resultant declines in output, which led to a decline in world GDP in 2020,
the first time since 2009, reflecting the global financial crisis.
Given these changes, it is logical for countries to ask whether the digital economy
can be a significant part of their recovery strategies in the short term andsustainable growth in the long term. This is what Sineenat Sermcheep sets out todo, in the third chapter in this volume, posing the questions for the ten economies
that constitute the Association of Southeast Asian Nations (ASEAN). Sermcheep
notes the strong fundamentals in ASEAN for riding the digital bandwagon,
including a young population, a large and growing economic base (including theregional market), and growing internet usage. The fact that many countries are
below the global average on digital development in fact provides an opportunity
for catch-up growth.
Sermcheep proposes a set of measures that ASEAN can consider to push digitaldevelopment in the region, with a strong focus on policies to attract foreign
investment in the digital economy. Many of these proposals would also be
applicable to other economies that share ASEAN-type features—such as manyof the economies in South Asia, with young populations, dynamic growth rates,
growing internet usage, and significant potential for catch-up growth.
While some of the lower-hanging fruit will be relatively easier to implement,
policymakers will need to pay close attention to issues that are important but
more intractable. One over-arching issue in a development sense is digital
inclusion—ensuring that digitalisation becomes a force for inclusion, minimising
the potential for the ‘digital divide’. Other issues include, but are not limited to:regional regulatory mechanisms, which are important if markets are to become
truly regional; data protection and data localisation; cybersecurity; and ensuringcontinued competition in digital provision.
South Asia reboot through trade
COVID-19 hit South Asia’s growth harder than it did most other regions in theworld, thanks to severe lockdowns, especially in India, the dominant economy in
the region. More than half of the pandemic-induced poverty originates in Southxv

Age of Ferment:
Developments in Asian–European Trade Relations
Asia, partly owing to the dominance of the informal sector in the region. A strong
recovery is now underway, with growth estimated at 7% in 2021 compared to-5.2% in 2020, and forecast at 7.6% for 2022 (World Bank, 2022). However, thepandemic has also led to higher public and private debt and exposed external
sector vulnerabilities in some countries that were highly dependent on tourism.
Also, formal sector employment has yet to recover to pre-COVID levels.
Even though South Asian countries have reaped significant benefits from trade,they have historically been protectionist and, at best, cautious, in their approach
to international trade. In fact, they have become even less open to trade overthe last decade, which represents a denial of their own experiences and success.
Could changing global trade alignments and the impact of COVID-19 change thisapproach? These are the questions tackled by Srinivasan Thirumalai in chapter 4of this volume.
In fact, as Srinivasan points out, South Asian exports have recovered faster thanreal GDP, and in most countries, this pattern is also true for labour-intensive
manufactured exports. Remittance inflows, which are critical for the balance of
payments of most countries, have proved resilient, despite fears to the contrary.
On the other hand, tourism in the region is yet to recover fully, and this is in linewith global trends—for example, international tourist arrivals are still 65% lower
in December 2021 than December 2019.5
As trade settles down to a more ‘normal’ pattern, what can South Asian countries
do to benefit from international opportunities on a more permanent footing?
Clearly, the region is missing a big opportunity by not creating a regional buffer
against world trade volatility, in the manner of East Asia. Srinivasan also suggeststhat COVID-era liberalisation measures, including those undertaken in the
medical goods sector, could be made more permanent.
The apparel sector after the pandemic: Sri Lanka
The textiles and apparel sector dominates goods exports in many South Asian
countries, especially for Bangladesh (apparel exports exceed 86% of total goods
exports), Pakistan (apparel and textiles account for over 40%), Sri Lanka (apparelover 46%), and Nepal (apparel and textiles exceed 34%). Such dominance makesthese economies vulnerable to export fluctuations in the sector, which may arise
from a downturn in demand, increased competition, or supply-side issues suchas raw material shortages. Given the informal nature of employment, especiallyin the apparel sector in the region, this vulnerability can quickly translate into
joblessness and poverty, as happened in the aftermath of COVID-19.

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Introduction

Sri Lanka is a distinct case. Its apparel industry has gained recognition as a
producer of ‘garments without guilt’, based on ethical practices, environmentallyconscious production, and high labour standards. It now produces high-quality
garments, and several firms do their own design and innovation, and haveestablished production bases in many different countries all over the world.
Anushka Wijesinha, in chapter 5 of this volume, explores how the industry reacted
to the shock of COVID-19 and how it is seeking to increase its resilience. The
latter is particularly relevant to other countries in South Asia and beyond.
One aspect of post-COVID resilience is companies’ clear desire to diversify their
supply chains and not rely only on China, a theme similar to that raised by Palitin chapter 1. This desire to diversify, Wijesinha notes, has positive implications
for sourcing from South Asia, where, for example, India and Pakistan have input
supply capabilities. Another upshot is consideration of ‘flexible redundancy’ acrossthe domestic supply chain and also building redundancy through establishing or
increasing overseas investment and production.

Asia-Europe Trade Relations
Europe-East Asia trade constitutes the largest inter-regional trading relationshipin the world. Goods trade between Europe-Central Asia and East Asia-Pacificamounted to almost 1.9 trillion USD in 2019 (WITS data). Compare this with the
1.46 trillion USD in trade between North America and Europe and Central Asia.6
Trade is a symbiotic exchange. Europe relies on East Asia for a wide range of
inputs; moreover, the region is a growing market for European goods. East Asia,
meanwhile, relies on Europe for technology and, in turn, as a vast market for its
own products.
But the strength of this relationship also raises questions, especially for Europe,and these questions are centred around China. Of European imports worth 1.12
trillion USD from East Asia, 57% originated from China. Against the backdrop of
the US-China trade war, and continued frictions thereafter, there is pressure on
Europe to reduce its trade and technology exchange with China. These pressures
have been exacerbated by the pandemic and its aftermath. Some also anticipate
that RCEP could lead to further consolidation of supply chains around China,
lending urgency to the China question.

6

The aggregate data presented in WITS groups Europe with Central Asia, and East Asiawith the Pacific, and this is the aggregation used in this section of the introduction.
Even though the discussion here pertains to the European Union and East Asia, all theinferences remain valid.

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Age of Ferment:
Developments in Asian–European Trade Relations
India and, more broadly, South Asia are sometimes discussed as a possible pathfor the diversification of supply chains away from China. However, given that
South Asia lacks a large-scale and competitive ecosystem in a wide range of
products and also has much higher tariffs than China, this could only be a longterm play. Compared to Europe’s imports of 638 billion USD from China in 2019,
imports from South Asia amounted to only 120 billion USD. And India chose not
to be part of the supply chain opportunities presented by RCEP.
Europe Asia trade relations
The question thus presents itself: how should Europe navigate its tradeand economic relations with Asia in an increasingly complex geo-economic
environment, defined by US-China antagonism, intensification of regional
integration in Asia, and the crisis in the rules-based international trade order?
The sixth chapter in this volume, by Axel Berger, considers these important issues,
both for the European Union and for the UK.
Berger notes that despite China’s primacy in EU and UK imports, both the EU andthe UK should pursue (and indeed are pursuing) FTAs with the many countries of
the Asia-Pacific region. This is a strategic move given the increasing integration
within this dynamic region, and the importance of not losing preference margins.
The EU, after failed negotiations with ASEAN, concluded bilateral negotiations
with Singapore and Vietnam; the EU is also pursuing bilateral negotiations with
Australia, New Zealand, and India. FTAs with South Korea and Japan are alreadyin place. The UK, on its part, launched a flurry of trade activities after Brexit,
including rolling over FTAs that were already in place while it was part of theEU; new agreements were signed with Japan and Australia, and negotiations
are underway with India and New Zealand. Additionally, the UK applied to join
the Comprehensive and Progressive Agreement for Trans-Pacific Partnership(CPTPP) that currently has eleven member states from the Asia-Pacific region.
Berger suggests that the latter development may also goad the EU into discussing
integration with the CPTPP, with the most important aspect of such a major interregional agreement being an affirmation of a rules-based liberal trading order tobalance China’s state-led system.
Given the growing economic clout of the Asia-Pacific, it is not surprising that the
EU and the UK are seeking deeper engagement with the region, all the while,
given geo-economic realities, keeping China at arm’s length. At the same time,the EU will need to continue engaging with China, not only because it is its mostimportant extra-EU trading partner, but also due to its critical quest for WTO
reform, for which China’s cooperation is required.

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Introduction

A different idea
Clearly, whether and how to decouple from China is a pressing issue for the EU, as it
is for many other economies. Bilateral trade agreements with different countries
in the Asia-Pacific are one option that is already being pursued, but, while more
tractable, this is less systemic in its impact. Moreover, as pointed out by Jürgen
Matthes in chapter 7 in this volume, the EU’s ambitious FTA standards have so far
not allowed the completion of FTAs with many dynamic ASEAN economies. Tying
up with RCEP does not seem realistic, given that the agreements in the pact do
not match up to the EU’s FTA standards, and given that China is an integral partof RCEP. Joining the CPTPP is certainly a possibility, but Matthes advances a more
‘far-reaching option’.
Matthes proposes a ‘Pluri-regional Trade Partnership of Like-Minded Countries’(PTPL) which would include all the important market economies, such as theEU, the US, Japan, Canada, the UK, Switzerland, and others in the Indo-Pacific.
Besides giving the EU a foothold in the Indo-Pacific, the main objective of the
PTPL would be to advance a set of modern trade rules that could form the basisof reform in the global trading system under the WTO.
The similarities and contrasts between the two approaches (EU-CPTPP and
PTPL) are instructive. Both would be so-called ‘mega-regional’ agreements, andreforming the world trading system would be a common objective. By joining
the CPTPP, the EU would avoid potential frictions with the US, with which it
differs in approach on several fronts. Presumably, it would also be quicker tojoin an existing framework than to create a new one. On the other hand, therallying point of a new PTPL would be to bring together a coalition of like-mindedcountries, united in their desire to reform global trade, an objective that could be
far more explicit than was the case in the CPTPP. And, of course, by bringing in
the EU and the US together, it would become the world’s biggest mega-regional,
with enough clout to influence global trading rules.

xix

Age of Ferment:
Developments in Asian–European Trade Relations
Supply chain risks
Globalisation has enabled a high degree of specialisation, division of labour, andthe formation of complex and interwoven supply chains. For Europe, the shareof Asian economies in total extra-EU imports has been growing, and Asia is now
the largest supplier of imports to the continent. Hubertus Bardt, in chapter 8 ofthis volume, discusses the increasing attention being paid to risks in the supply
chain arising from COVID-19. He notes that managing supply chain risks has
always been important for internationally active companies. That China is where
COVID-19 began has made this discourse highly politicised.
Bardt discusses many different kinds of supply chain risks, or the perceptions of
those risks, such as those relating to shipping, inadequate competition, natural
resource monopolies, trade distortions, politicisation, protectionism, health,climate change, and so forth. The biggest risk is China’s state capitalism, its
resulting distortions, and China’s enormous share of global exports. But despite
the stresses, globalisation has delivered very significant benefits, and even themaligned global supply chains weathered pandemic-induced shocks and strains
successfully. He notes that the supply chain risks need to be managed for thesake of preserving the gains of globalisation. The baby should not be thrown out
with the bathwater.
Asia Europe trade after RCEPAs the world’s biggest trade agreement, and with Asia being Europe’s largest
trading partner, it is not surprising that European scholars and policymakers havefocused their attention upon RCEP. In chapter 9 of this volume, Alessia Amighini
suggests that RCEP signals the need for a fresh look at EU-Asia trade relations,and points out that it may be more effective to have agreements around sectors(such as digital trade) rather than with different countries/regions.
Amighini notes that even without RCEP, trade among its member countries was
growing, with much higher intra-regional shares for imports than for exports,
reflecting the high degree of sourcing already taking place. With the harmonisationof rules of origin, ‘Factory RCEP’ is likely to become even more integrated, withfresh inducements for integration between Northeast Asia and Southeast Asia.
For Europe, the overall impact on trade volumes may not be very large, but in
individual sectors, e.g. automotive and industrial machinery, the impact can belarger because of inroads from Japan and South Korea.
Cross-border e-commerce is highly dynamic and of growing importance in world
trade, with the rules for digital trade still being formulated. Many Asian countriesxx

Introduction

are, or are likely to be, on the frontiers of e-commerce. Amighini proposes
deepening EU-Asia relations via collaboration on defining the new rules of digitaltrade, dealing with the major contentious issues, including personal data privacy
and protection, and data localisation.
EU-China investment agreement
As mentioned earlier, the EU has high standards when negotiating trade
agreements, which renders an EU-China FTA a complex proposition. An
investment agreement appears to have been the more feasible option. ChienHuei Wu, in chapter 10 of this volume, argues that the Trump administration’s
unilateral approach to trade and industrial policy pushed both sides to conclude
the EU-China Comprehensive Agreement on Investment (CAI). Not that the draft
agreement was soft: according to the EU, it ‘will be the most ambitious agreementthat China has ever concluded with a third country’ (European Commission,2020).
Of course, the CAI has been in the works for a while, at least since 2013, and bothsides have had substantive reasons to push forward. But incentives can swiftlychange. Wu writes that with the Biden administration reaching out to reconcile
with its allies, imposition of reciprocal sanctions against Chinese and EU officials,
an inward turn in Chinese economic policies, and rising nationalism in China,
the ratification of the CAI by the EU appears increasingly unlikely. In fact, Wu
cautions the EU against ratification, arguing that it is a choice between upholding
European values and succumbing to the lure of the Chinese market.
Trade and the European Green Deal
Europe’s Green Deal, announced towards the end of 2019, was a global
breakthrough for sustainable development, committing the EU to net zero
greenhouse gas emissions by 2050. It is also seen as an opportunity for the
EU’s industrial sector to transition to carbon neutrality while safeguarding its
competitiveness. Gauri Khandekar, in the last chapter of the volume, discusses
the differential impact of COVID-19 on value chains in the EU and Asia, and thelikely impact of the EU’s green commitments on EU-Asia trade.
To ensure that its climate goals do not hamstring its domestic firms, the EU has
proposed a ‘Carbon Border Adjustment Mechanism’ (CBAM) for some sectors.
The CBAM—set to become fully operational in 2026—will require importers ofcarbon-intensive production, such as cement, steel, aluminium, fertiliser, etc,
to buy carbon certificates corresponding to the EU’s own carbon pricing rules.
Khandekar argues that given the size of the European market, the climatexxi

Age of Ferment:
Developments in Asian–European Trade Relationstransition creates significant incentives for producing countries to green theirown production. It also creates opportunities for trade in hydrogen, that could
play an important role in decarbonisation. She also suggests that the EU could
lead a collaborative platform for low-carbon technologies in energy-intensive
sectors, with potentially far-reaching consequences.

The Age of Ferment
The book offers a rich and diverse menu of discussions, much more than canbe captured in an introduction. Nonetheless, the following final thoughts, posed
mainly as questions, draw attention to some of the most important trade-related
issues of the day, in an EU-Asia context, including one issue—the possible impactof the Russian invasion—which has only come to the fore after the chapters were
written.
Conflict and Response. Russia’s invasion of Ukraine on 24 February 2022 will
have a deep and lasting impact on the global economy. In the short term, it willlead to higher inflation and inhibit the post-COVID economic recovery. Whiledifficult to predict, the longer term could see a more pronounced reorientationof global supply chains than seemed likely in what was ‘merely’ a post-COVID
world.7 Moreover, Russia and the world now have knowledge of what severe andrelentless financial and economic sanctions can look like, and the learnings fromthe imposition and response to sanctions will become part of collective memory.
Diversification. The EU has sought autonomy in its economic relations withcountries like China, rather than be pushed by the US into taking uncomfortable
positions. The negotiation of the CAI was one such manifestation. Nonetheless, theEU, like other regions/countries, is actively seeking to diversify its supply chains,
including some amount of reshoring, despite the higher costs. Will the aftermathof the invasion energise the impetus to diversify supply chains away from China?
This could happen as a sanctioned Russia seeks even deeper economic ties with
China, and China accelerates its own push to inward economic orientation tocope with what may possibly become an increasingly antagonistic environment.
Future of RCEP. On Asian/Pacific integration, manifested for instance in RCEP,
could there be some fractures over Russia? Singapore, Japan, South Korea, andAustralia have announced or joined sanctions, but China, a strong partner ofRussia, has not condemned the invasion and, instead, called for dialogue. It is
hard to say whether these differences will reduce some members’ enthusiasm

7

xxii

See the Economist (2022)

Introduction

for RCEP, or whether the logic of trade and economics will prevail, and RCEP
value chains will continue to deepen.
The X Factor. India has been the big hope for countries seeking a huge, dynamic,
and democratic counterweight to China. This is manifested, for example, in the
renewed enthusiasm for the Quad, the formation of the SCRI, the start of FTA
discussions between India and the UK, and resumption of such talks between
India and the EU. But India, like its South Asian brethren, has been famously
hesitant on trade and has turned more protectionist over the last six years.
Could India provide the missing X factor in the global quest for supply chain
diversification? Could it become economically more ambitious and shed its
inward-oriented approach?
Climate Cooperation. Despite all the other centrifugal pressures, the world does
have common cause in reducing greenhouse gas emissions. Trade can play arole here. The EU is the largest economy in the world. If the economies of the
Asia-Pacific (including China, the world’s biggest emitter), which accounted formore than half of global carbon dioxide emissions in 2020, are incentivised by
the EU’s enormous volume of imports to comply with the CBAM, this can be asignificant contribution to the cause. Of course, this can only supplement—albeit
in important ways—global climate talks and national commitments (see Weyand,2021).
WTO Reform. Reform of the WTO is urgently needed to restore the credibility of
the rules-based trading system. The EU will need to play a leading role in thisprocess and should galvanise support from other major players, such as China
and members of the CPTPP—or even the CPTPP as a group (either as part of a
coalition or via an FTA with the CPTPP).
The age of ferment is truly upon us. One scenario is that despite all the current
provocations, the inherent logic of globalisation is not jettisoned, and thepowerful incentives for trade and international exchange prevail. If this scenario
plays out, it will likely entail more supply chain diversification, domestic reshoringand near-shoring, and perhaps conscious building of strategic reserves ofdifferent products. A more pessimistic scenario would see a more antagonistic
global environment, a sharper division of the world towards China-led and USled economic blocs, and, accompanying that, an accelerated diversification of
supply chains away from China. For the collective good, let us hope that theformer scenario prevails.

xxiiiAge of Ferment:
Developments in Asian–European Trade Relations

References
Daniel Gerszon Mahler, Nishant Yonzan, Christoph Lakner, R. Andres Castaneda
Aguilar, and Haoyu Wu (2021, June 24). Updated estimates of the impact of
COVID-19 on global poverty: Turning the corner on the pandemic in 2021? https://
blogs.worldbank.org/opendata/updated-estimates-impact-covid-19-globalpoverty-turning-corner-pandemic-2021
Economist, The (2022, February 26). The economic consequences of the war in
Ukraine. https://www.economist.com/finance-and-economics/2022/02/26/
the-economic-consequences-of-the-war-in-ukraine
Economist, The (2021, October 9). In search of resilience. Special report on world
trade. https://www.economist.com/special-report/2021/10/06/in-search-ofresilience
European Commission (2020, December 30). Key elements of the EU-China
Comprehensive Agreement on Investment. https://ec.europa.eu/commission/presscorner/detail/en/IP_20_2542
Kathuria, Sanjay (2018). A glass half full: The promise of regional trade in South
Asia. South Asia Development Forum, World Bank, Washington, DC. http://
hdl.handle.net/10986/30246
Weyand, Sabine (2021, October 16). Role of trade policy in fighting climate change.
The
Economist.
https://www.economist.com/by-invitation/2021/10/16/
sabine-weyand-on-role-of-trade-policy-in-fighting-climate-changeWhite House, The (2022, February). Indo-Pacific strategy of the United States.
https://www.whitehouse.gov/wp-content/uploads/2022/02/U.S.-IndoPacific-Strategy.pdf
World Bank (2019). Global economic prospects: Darkening skies. WorldBank,
Washington,
D.C.
https://openknowledge.worldbank.org/
handle/10986/31066World Bank (2022, January). Global economic prospects. World Bank,
Washington,DC.
https://openknowledge.worldbank.org/bitstream/
handle/10986/36519/9781464817601.pdf
World Trade Organization (WTO) (2021). World Trade Report 2021: Economic
resilience and trade. WTO, Geneva. https://www.wto.org/english/res_e/publications_e/wtr21_e.htm

xxiv

11

Asia in Transition

Section I.

RESILIENT SUPPLY CHAINSCOVID-19 and Resilient Supply
Chains: A Regional Economic
Perspective
Amitendu PALIT

Abstract
The outbreak of the COVID-19 pandemic has accelerated the reorganisationof supply chains with the goal of enhancing their resilience. The Supply Chain
Resilience Initiative (SCRI) proposed by Japan, Australia, and India is a major
effort in this regard. This paper examines the prospects of the initiative from theperspective of the Indo-Pacific.

The COVID-19 pandemic has drawn attention to the vulnerabilities of global
supply chains and to the importance of enhancing their resilience. The degree towhich supply chains are able to remain resilient in the face of multiple sourcing
disruptions has always been a matter of concern for businesses. Such concerns
on part of businesses are now frequently accompanied by sovereign concerns.
The latter generally focus on the risk of over-dependence, for instance on China,
which is then able to geopolitically exploit its controls over supply chains. The
gravity of these concerns has led to the growth of initiatives such as the Supply
Chain Resilience Initiative (SCRI), promoted by Japan, India, and Australia.
This chapter examines the differences in the nature of reorganisation of supply
chains before and after the COVID-19 pandemic in order to comprehend thecontext behind the SCRI. It studies the objectives of the SCRI and tries to identify
the industrial supply chains that might be impacted by the initiative. It attempts
to shed light upon the prospects of the SCRI, including the possibility of its
triggering a decoupling from China. The paper concludes by reflecting on thescope of the initiative contributing to economic rule-making in the Indo-Pacific.
Supply chain reorganisation: Before and after COVID-19
Global supply chains were shifting even before the outbreak of COVID-19
from January 2020. The pre-COVID-19 reorganisations in the last decade were
influenced by several factors. These include structural transformations ofindustries, notably automation and digitalisation of industrial functions, as
3Age of Ferment:
Developments in Asian–European Trade Relations
well as rising labour costs in major sourcing locations. The changes compelledlead firms in various manufacturing industries to contemplate supply chain
reorganisations.
One of the strongest exogenous motivations for repositioning supply chains in
the last decade arose from the United States (US)-China trade war. The conflictthat began in 2018 has led to sharp increases in tariffs on several imports byboth countries. This accelerated tendencies of global businesses to consider
producing in countries other than China. This was an inevitable outcome of higher
tariffs that made manufacturing in China and exporting to the US a much more
expensive proposition than before. Several businesses, particularly American
firms operating from China, were compelled to consider relocation elsewhere in
the Asia-Pacific, such as Southeast Asia (Wong, 2018).
The relocation engineered by the ‘price effect’ of higher tariffs was, however,mostly for industrial items that could be relatively easily produced from otherlocations without incurring significant capital costs (e.g. vehicle parts andcomponents). Locations already producing similar final products as mainland
China were obvious choices for lead firms when deciding relocation. The shiftingof smartphone parts and electronics supply chains out of China to elsewhere in
the Asia-Pacific followed the same logic of existing capacities.1
COVID-19 highlighted the vulnerabilities of supply chains and thus heightened
the imperative of undertaking a more exhaustive reorganisation. A critical point
relates to the risks arising from excessive dependence on specific locations forsourcing and production. The received wisdom was specifically with respect
to heavy dependence on China, which was also the earliest epicentre of thepandemic.
That excessive dependence on a single location caused risks for supply chain
security was already known and had been felt during natural disasters, such as the
Fukushima earthquake and tsunami in Japan in 2016, or the large-scale floodingin Thailand in 2011. On both occasions, heavy dependence of downstream finalproduct manufacturers and assemblers on parts and components sourced fromJapan and Thailand adversely impacted performances across the entire supply
chains, notably in automobiles and high-tech industries (WEF, 2013). However,the disruptions were temporary and confined to a few supply chains. The impact
of COVID-19 has not only been more widespread and severe, but also more
lasting.
1

4

Samsung moved part of its smartphone production to its facilities in India andVietnam, while LG shifted consumer electronics production to Korea (Aylor et al.,2020).

Section I.

RESILIENT SUPPLY CHAINSThe early supply-chain setbacks from COVID-19 primarily affected industries
and countries sourcing extensively from China. Economic shutdown in China
following the outbreak of COVID-19 impacted several supply chains, as the halt infactory output adversely impacted procurement of inputs. The supply-side effectcompounded over time as the pandemic spread to the rest of the Asia-Pacificregion, particularly to Southeast Asia, which houses several hubs for global
manufacturing.
Moreover, the supply-side bottlenecks in sourcing were soon further magnified
by demand-side impacts. Widespread shutdowns almost everywhere affected
livelihoods, wages, and incomes, leading to a marked reduction in consumer
demand. There were also significant shifts in demand for sourcing of inputs, suchas a surge in semiconductor chips, which arose from new customer preferencesinduced by COVID-19.2 With the pandemic persisting into 2021, and most of AsiaPacific slipping into periodic economic closures, industries continued to facepoor prospects due to diminished demand.
China recovered reasonably fast from the setback it suffered during the onset
of COVID-19. From the middle of 2020, economic activity on the mainland had
begun returning to full capacity. However, the supply disruptions that had alreadyoccurred were severe enough to draw the attention of several global businesses,
and their home countries, to the importance of reducing economic dependence
on China. This realisation was compounded by the geopolitical urge to reduce
economic dependence on China in greater national security interests. Several
countries (e.g. the US, Australia, India, and Japan) whose relations with China
worsened following the outbreak—contributed partly by concerns over China’srole in the origin and spread of COVID-19 and the resultant mistrust of it—haveincreasingly been joined by other major democracies and global middle powers
wary of China, including those from the G7, in working collectively to increase theresilience of global supply chains (White House, 2021b).
The noticeable efforts of several major global economies to reduce economic
dependence on China so as to increase the resilience of global supply chains isdifferent from supply-chain-reorganisation efforts witnessed before COVID-19.
The difference lies primarily in the geopolitical provocation behind reshuffling
supply chains in the current instance, namely, China’s proclivity to ‘weaponise’

2Lesser demand for automobiles led to lower demand for automotive chips as vehicle
suppliers cut back orders. However, the shift to digital modes of working and workfrom home practices led to a higher demand for electronic devices, and a concomitant
demand for consumer electronic chips (White House, 2021a, p. 25).

5Age of Ferment:
Developments in Asian–European Trade Relations
the economic dependence that various countries have on it (Braw, 2020). In
the aftermath of COVID-19, concerns over such weaponisation have increased,
given many countries’ realisation of their heavy sourcing dependencies on China,
particularly in strategic industries like pharmaceuticals and electronics. Anxieties
have focused upon how China might use its economic heft to restrict supplies
through coercive trade measures.3 Moreover, both COVID-19 and subsequent
supply-chain-resilience fears about China arose following the US’ weaponisationof its own economic heft in various trade actions of the Trump administration(Wilson, 2021), making such worries understandable.
These geopolitical apprehensions add a different impetus to the imperative of
making supply chains resilient. Achieving such resilience, as revealed by themulti-country strategies announced post-COVID-19, requires a variety of efforts.
These include national efforts to enlarge domestic capacities for augmenting
local production, particularly in industries where import dependence on China
is overwhelming. Some of these industries, as seen from initiatives announced
by the US and India, are sensitive from a national security perspective, suchas the production of semiconductors, electronics, telecommunications,
pharmaceuticals, and the mining of critical minerals.4 These domestic efforts toreorder supply chains are joined by larger initiatives involving groups of countries.

Understanding the Supply Chain Resilience Initiative (SCRI)The SCRI announced by Japan, India, and Australia is one of the leading postCOVID-19 multi-country initiatives for strengthening supply chains. The effort
may significantly influence the configuration of future supply chains in the IndoPacific, if it matures unhindered.
Statements and intentions
Economic ministers from Australia, India, and Japan announced the SCRI on 1
September 2020 (Birmingham et al., 2020). The key features of the initiative, as
reflected in the statement by the ministers, are as follows:6•

The proponent countries commit to delivering ‘a free, fair, inclusive, nondiscriminatory, transparent, predictable and stable trade and investment
environment’.

3

Wilson (2021) discusses trade coercive actions by China before and after COVID-19.

4

The Biden administration’s 100-Day Supply Chain Review and India’s Production
Linked Incentive (PLI) scheme both highlight these industries.

Section I.

RESILIENT SUPPLY CHAINS•The COVID-19 pandemic and the shifts in the global economic andtechnological landscapes highlight the ‘necessity and potential to enhance
the resilience of supply chains in the Indo-Pacifc region’.

•

The need for regional cooperation in enhancing resilience of supply chains in
the Indo-Pacific is ‘pressing’ and the three countries intend to work together,through the SCRI, so as to achieve this objective.

•

Other countries in the region subscribing to the broad goals of the initiative
are invited to join it.

Nearly eight months after the first pronouncement, the economic ministers
from the SCRI countries issued their next statement, on 27 April 2021 (Tehan etal., 2021). This statement marked the formal launching of the initiative. The key
points in the statement were as follows:•

The impact of the pandemic was far-reaching, including human lives,
livelihoods, and economies, but also supply chains and their vulnerabilities.

•

Avoiding supply chain disruptions required managing risks and ensuringcontinuity, which can be achieved through greater utilisation of digitaltechnology and diversification of trade and investment.

•

The initial projects under the initiative are to include ‘best practices on supply
chain resilience’, investment promotion, and buyer-seller events for exploring
diversification.

•

The ministers agreed to meet annually in order to review progress on theinitiative. They also agreed that consensus is required so as to expand thescope of the initiative.

Taken overall, the statements on the SCRI so far have emphasised the urgency
of increasing the resilience of supply chains in the Indo-Pacific region and havehighlighted the importance of countries working together for this purpose. The
initiative is clearly not intended to stay confined to Japan, Australia, and India
but is meant to expand to more countries. The geographical emphasis of theinitiative is clear—it aims to cover as much of the Indo-Pacific as possible. It isalso important to identify which industries the initiative is likely to focus upon.
Industries and resilience
Neither of the two ministerial statements mentioned above highlight specificindustries to be addressed by the initiative. Nevertheless, in the September
2020 statement, there is a rather general allusion to ‘regional supply chains’,
7Age of Ferment:
Developments in Asian–European Trade Relations
and in the April 2021 statement, these are further specified as ‘some supply
chains [which] have been left vulnerable due to a range of factors’ (Tehan etal., 2021). The efforts to increase resilience, ostensibly, would focus more uponthese ‘vulnerable’ industries. Yet which industries are in fact being referred to isleft unsaid. An examination of other initiatives evolving alongside the SCRI, andinvolving SCRI countries, may shed some light.
Significant announcements on supply chains in the Indo-Pacific have come fromthe quad partnership, involving the three SCRI countries and the US. The Quad,as the quadrilateral informal security dialogue between the US, Japan, India, andAustralia is popularly referred to, has enlarged its collaboration beyond security
issues. In a meeting of its foreign ministers on 6 October 2020, the group agreed
to work on improving supply chain resilience with the broader goal of ensuring a
free, open, and inclusive Indo-Pacific region (Chaudhury, 2020). In its subsequent
pronouncements, articulated during the summit of its heads of state on 12 March
2021, the Quad focused on three key areas in which greater engagement among
the four members was desired—namely, vaccines, climate change, and criticaltechnologies (White House, 2021c). These priorities may yield some insights
about the supply chains that the SCRI might be acting on.
The current global COVID-19 pandemic makes the emphasis on vaccines by the
Quad a natural priority. The experience has shown the importance of ensuring
the robustness and agility of pharmaceutical supply chains, so as to enable themto overcome unforeseen supply setbacks. Vaccines, or biologics, are importantend products of the pharmaceutical industry, along with finished dosage forms.
Supply chains for vaccines are complicated, involving extensive sourcing ofa wide range of pharmaceutical ingredients. Given the crucial need to ensure
uninterrupted access to vaccines in the fight against COVID-19, it is fairly evident
that the SCRI will work on ensuring smooth vaccine distribution as part of its key
priorities.
The manner in which vaccine supply chain resilience will be enhanced can begleaned from the strategies proposed by the Quad Vaccine Partnership (WhiteHouse, 2021c). The partnership outlines specific roles for each SCRI country.
India will be the core manufacturing hub for vaccines. Japan will work on
providing concessional loans to expand vaccine manufacturing, as well as theirsubsequent export across the Indo-Pacific. Australia will contribute financially tovaccine provision and ‘last mile’ delivery in the region. This arrangement is basedon what the partnership specifies as ‘multi-sectoral cooperation across many
stages of action . . . drawing on each of our strengths’ (White House, 2021c).

8

Section I.

RESILIENT SUPPLY CHAINS

Multi-country initiatives like the SCRI and the Quad partnership are also
complemented by national strategies focusing on supply chains. Notable
among these is India’s Production Linked Incentive (PLI) scheme, which provides
businesses with financial incentives to invest in local capacity development. The
pharmaceutical industry is an important focus of this scheme; the goal being toenhance indigenous outputs of pharmaceutical raw materials and intermediates,
like active pharmaceutical ingredients and bulk drugs (Dept. of Pharmaceuticals,2020). Australia is also providing financial assistance to businesses in the formof grants in order to encourage greater local production of biopharmaceuticals(Business.gov.au, 2021).5 A similar attempt to expand local capacities in thepharmaceutical industry can be seen in the Biden administration’s review ofbuilding resilience of critical supply chains (White House, 2021a).
While not being a part of the SCRI directly, the US’ efforts in enhancing resilienceof supply chains in the Indo-Pacific is expected to be in sync with those of the SCRI,
given the presence of SCRI members in the Quad, and their efforts to engage
actively in supply-chain reordering in the region. In addition to pharmaceuticals,
the US’ review of supply chains also highlights the significance of semiconductors,
large-capacity batteries, and critical minerals. The identification of theseindustries, again, is similar to those noted by the Quad, as mentioned earlier.
Securing the supply chains of products which use critical technologies is importantfor both SCRI and Quad. Critical technologies cover a large range of industrial
items. These have the common characteristic of using a great deal of dual-use
technologies. Such technologies are essential to industries like semiconductors,
telecommunications, large-capacity batteries, information technology (IT),electronics, solar panels, and many others that produce items for daily use.
Simultaneously, these industries produce items that advance technologicalcapacities and frontiers of countries, including in defence, thereby rendering
themselves significant from a national security perspective.
Similar significance is comprehensible for industrial activities like mining andextraction, particularly for critical minerals (e.g. cobalt, lithium, chromium, andrare-earth elements). As such, it would hardly be surprising if the SCRI invests
collective energy into safeguarding supply chains in priority strategic areas, suchas critical minerals that are vital for production of smartphones, automobiles,
and aircraft. There are already examples of bilateral cooperation within the SCRI
in this regard, such as between India and Australia (Bhaskar, 2021). There are5

Similar incentives are also being provided in order to augment capacities for domestic
manufacture of personal protective equipment (PPE) (Australian Govt., 2021).

9Age of Ferment:
Developments in Asian–European Trade Relations
also wider efforts visible between SCRI members in collaborations with otherprominent middle powers (e.g. with the United Kingdom, Korea, and Canada)
regarding the development of more alternatives in 5G technology (Sherman,2020). Over time, these cooperations are expected to widen by including morecountries.

Will the SCRI Take Off?
The SCRI is underpinned by a set of fundamental motivations. The first of theseis the imperative of making major supply chains, especially those discussed
in the earlier section, as resilient as possible by minimising the risks of, andassociated to, disruptions. One of the key issues in this regard is the vulnerability
which arises from excessive concentration in sourcing. The ostensible goal is todiversify sourcing to various locations, especially in the case of supply chains thatare currently sourcing predominantly from one or a few locations. The second
motivation behind the SCRI is to relocate production out of mainland China in thelonger term. Overseas businesses, such as Japanese manufacturers producing
in China, are sourcing heavily from within China as well. For India and Australia,
whose businesses are invested relatively less into manufacturing in China, thesupply chain worries are mainly over their excessive import dependencies—aworry which Japan shares.6
Securing the objectives of the SCRI implies working on significant decouplingof production from China. As mentioned earlier in the chapter, the decouplingis sought both in the light of the experience of the supply shocks inflicted by
the production lockdowns in China following COVID-19, and due to geopoliticalanxiety over China utilising its near monopoly as the key source for various raw
materials, inputs, and components to its strategic advantage.
The anxiety stems from various coercive trade measures taken by China during
the last decade to ‘punish’ countries for taking what it viewed as anti-China
postures on various regional and global issues (Wilson, 2021).
Decoupling from China
This desire to reduce dependence on China by diversifying procurement wasreflected as early as March 2020 in a statement by then Japanese Prime Minister
Shinzo Abe. Following the outbreak of the COVID-19 pandemic in China, and6

10

China is the largest source of imports for Australia (25.8%), India (14.3%), and Japan(23.4%) as reflected in the country trade profiles published by the WTO (2021).

Section I.

RESILIENT SUPPLY CHAINS

focusing on the issues pertaining to reforms of Japan’s supply chains, Prime
Minister Abe noted,
There are some concerns over the impacts of the decline in productsupply from China to Japan on our supply chains. In light of that, asfor those products with high added value and for which we are highly
dependent on a single country [emphasis added], we intend to relocate
the production bases to Japan. Regarding products that do not fall into
this category, we aim to avoid relying on a single country and diversify
production bases across a number of countries, including those of the
Association of Southeast Asian Nations (ASEAN). (Prime Minister of Japan,
2020)
Prime Minister Abe’s thoughts underscored Japan’s concern over its sourcing
dependence on China, particularly regarding certain high added-value products
and the necessity of relocating their production back in Japan. For relatively lower
value-added products, the route to higher resilience was envisaged as relocationfrom China to other countries in the Asia-Pacific region. Much of the subsequent
thinking around the narrative on resilience of supply chains in the Indo-Pacifichas grown out of these thoughts articulated by Prime Minister Abe.
As such, the SCRI aims to work closely with a group of countries to dilute China’s
power over certain supply chains and prioritise greater local production in SCRI
countries. Key industries are those that produce high value-added products andwhich are high in strategic importance, particularly from a national and regional
security perspective. Such priorities become more obvious in light of China’s
overwhelming presence in these supply chains.
In pharmaceuticals, for example, China is the largest producer of active
pharmaceutical ingredients in the world. This makes major global pharmaceuticalfirms heavily dependent on China for sourcing active pharmaceutical ingredientsfor the manufacture of finished dosage forms (MHRA, 2017). The vulnerabilitiesof pharmaceutical supply chains arising from such dependency on China areclear. Similarly, production of critical minerals, processing of rare earths, andelectric-vehicle manufacturing are some other strategic industries where China
enjoys overwhelming leads over the rest of the world (Kim & Karpinski, 2020).
China has similarly rapidly expanded its capacity for making a wide variety ofsemiconductor chips. In pharmaceuticals, India and Australia, as mentioned
before, are focusing on developing large-scale domestic capacities by financially
incentivising businesses. At the same time, democracies with strong technologicalcapacities, such as the Quad members, are looking to partner together in thedevelopment of critical and emerging technologies. Indeed, collaborations among11Age of Ferment:
Developments in Asian–European Trade Relations‘techno-democracies’ are extending beyond the Quad in strategic industries likesemiconductors, with the US working with Japan and Taiwan so as to reduce
future dependence on China (He, 2021).
Finding the economic rationale
Ultimately, supply chains will only move out of China—thereby ensuring their
purported resilience, from the perspective of SCRI countries and allies—if such
relocation is economically justified. In other words, the costs of relocating from
China will have to be compensated by higher benefits from elsewhere.
The cost-benefit calculations would have to be significant given that mainland
China continues to have a favourable business environment and remains the key
source for multiple parts and components for several industrial supply chains.
Sacrificing these advantages poses disincentives to relocating from China, as
has been noted by some Japanese businesses (Business Times, 2020). Moreover,
China’s emergence as a major global hub for high-end consumption, including
high-tech items, such as smartphones, consumer electronics, and electricvehicles, might in fact encourage some businesses to stay closer to the final
demand market, which would also help in avoiding supply-chain disruptions.
China’s recently adopted ‘dual circulation’ strategy aims to encourage theseperceptions by fostering domestic supply chains (Hofman, 2021).
The challenge is thus for countries to make relocating from China an attractive
proposition by providing businesses with favourable cost-benefit scenarios (Palit,2021). This realisation has encouraged Japan, India, and Australia to announce
large-scale financial incentives. Japan’s subsidies are aimed at motivating its
industries to relocate from China back to Japan, as well as to Southeast Asia
and South Asia (e.g. India and Bangladesh), consistent with the goals voiced byformer Prime Minister Abe (Sharma & Gakuto, 2020).
India’s and Australia’s incentives are more focused on expanding domestic
capacities.7 However, in view of the fact that SCRI countries are working together
towards the goal of supply chain resilience, the current incentives offered by India
and Australia are likely to be viewed by businesses from Japan and from other
SCRI-friendly countries as a broader Indo-Pacific compact. Apple has already7

12

India has announced production-linked incentives (PLIs) for a dozen major industries.
The schemes offer financial incentives for increasing manufacturing in India (Invest
India, 2020). Australia, too, has announced an economic package for enhancing
supply chain resilience and enlarging domestic manufacturing capacities (Australian
Govt., 2020).

Section I.

RESILIENT SUPPLY CHAINS

identified India as the future site of one of its major facilities in the Indo-Pacific,
reflecting the intention of large firms to reposition supply chains by shifting
production out of mainland China.8
Notwithstanding the financial packages, the eventual success of SCRI in drawing
supply chains out of China, and thereby making them less vulnerable to risks ofexcessive concentration in a single location, will depend on a variety of factors.
Research on prospects of industries actually migrating physically to otherlocations highlights that the challenges of relocation are largest for industries like
automotive components and consumer durables. This is essentially due to China’s
control over resources and supplies, as well as due to the wider ecosystem on
mainland China, which includes availability of capable skilled labour and businessfriendly conditions on several parameters (Aylor et al., 2020). These, however,might not be as strategically sensitive as industries like pharmaceuticals, medical
devices, telecommunications, semiconductors, and mining. For all these latterindustries, the impetus for enhancing resilience is particularly high among the
SCRI and Quad countries. The technologies embedded in several products ofthese industries are sources of national security concern given the information
they can capture and pass on to technology owners. For these, the focus is
expected to be on creating supply chains afresh by expanding local capacities,
rather than making production move physically. Financial incentives are a major
influencer in this regard and can hasten the process.

SCRI and Indo-Pacific: Concluding Thoughts
The impact of COVID-19 on supply chains in the Indo-Pacific will be significant. The
pandemic has released disruptive forces that are set to fundamentally reorder
supply chains. As opposed to pre-COVID-19 supply-chain shifts, which were
influenced by systemic industrial transformations, natural disasters, and the USChina trade war, COVID-19 has exacerbated the impetus for physical migrationof supply chains out of China. This has come about due to a combination of
economic motivation, precipitated by supply disruptions from China, and thegeopolitical spur of not allowing China the opportunity of exploiting the influence
it exerts on supply chains to its strategic advantage.
Apart from changing the geographical pattern of supply chains in some strategic
industries as discussed earlier, initiatives like the SCRI might also contribute

8Apple is looking at India as a major hub both on account of India’s large domestic
market, which presents significant prospects for local sales, and due to the fact thatthe location enables third-country exports (Lovejoy, 2020).

13

Age of Ferment:
Developments in Asian–European Trade Relations
to the growth of new economic rules in the region. The SCRI emphasises the
Indo-Pacific—a natural emphasis given that Japan, India, and Australia are all
key stakeholders of the region. The US’ interest in the Indo-Pacific is equallypronounced. The convergence of interests on the Indo-Pacific is clearly visible
through the economic agenda of the Quad. The stated intention to work together
in vaccines and critical technology industries by the Quad (Tehan et al., 2021)—
coupled with the focus of the SCRI on the use of digital technologies, investment
diversification, and investment promotion—may lead to agreements on industrial
processes, investment standards, and associated rules. These, over time, mightdevelop into broad benchmarks for the Indo-Pacific as a whole.
Neither the SCRI members nor the Quad group are part of any existing regional
trade or economic partnership agreements exclusively among themselves. They
are, of course, bilaterally connected through FTAs, such as between India andJapan, and Japan and Australia. Japan and Australia are also in the Comprehensive
and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and Regional
Comprehensive Economic Partnership (RCEP) agreements. Whether the common
rules surrounding the function and operation of the new and reorganised
supply chains would be drawn up based on the features of these existing
trade frameworks would be seen over time. Regardless of their founding basis,
however, that new rules within the spheres of supply chains of specific strategic
industries may emerge is a distinct possibility. This possibility is compounded by
the fact that the Quad is looking to acquire a strong and prominent economicrole, as was made evident in the declaration by Quad leaders in their latest inperson summit in Washington, in September 2021 (Quad, 2021).
Given the overlapping membership, there is also a distinct possibility that the
Quad and the SCRI may converge. However, the Quad has a wider agenda, as
articulated in its latest pronouncement, including vaccines, critical technologies,
clean energy and climate, connectivity, people-to-people movement, and supply
chains. Regarding the latter, this has mostly taken the shape of concerted efforts
to safeguard semiconductor supply chains. But if the Quad does go on to acquirea primarily economic character with an emphasis on supply chains, some ofthe emphasis of the SCRI might get pulled into it. The SCRI might then become
embedded within the Quad, with the latter acquiring ownership.
The challenge for regional supply chains to adapt to new rules might, however,
become more complex if the SCRI migrates to the Quad. The complexities
would increase further when taking into account China’s efforts to minimise
the economic damages it may suffer from the decoupling attempts of various
countries, as well as its attempts to reduce its own economic dependence on

14Section I.

RESILIENT SUPPLY CHAINS

external markets. Localising supply chains within China is an important objectiveof this effort, as outlined in the dual circulation policy (Lo, 2020), announced
soon after the outbreak of COVID-19 in May 2020. For a large number of regional
supply chains, the goal of increasing resilience might run into difficulties createdby the tension between reorganisation encouraged by the SCRI and Quad, on the
one hand, and by China, on the other.

Amitendu PALIT is an economist specialising in comparative economic studies,international trade and investment, political economy, and public policies.
He has been with ISAS at the National University of Singapore since 28 April
2008. Prior to joining ISAS, he was with the Indian Council for Research on
International Economic Relations (ICRIER), a leading economic policy research
institute and think tank in Delhi. He has authored several books, including The
Trans Pacific Partnership, China and India: Economic and Political Implications(2014), China India Economics: Challenges, Competition and Collaboration (2011),
and Special Economic Zones in India: Myths and Realities (2008, co-authored).
He is a columnist for India’s well-known financial daily Financial Express and acontributor for various newspapers and major online public policy platforms
such as the Asia Pacific Bulletin, China Daily, Business Times, East Asia Forum, andPacific Economic Cooperation Council (PECC). He is a visiting faculty for several
leading management and business schools and has been a consultant for the
Commonwealth Secretariat, International Labour Organization, United Nations
Development Programme, and the Indian Institute of Foreign Trade.

15

Age of Ferment:
Developments in Asian–European Trade Relations

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RESILIENT SUPPLY CHAINS

Department of Pharmaceuticals—Ministry of Chemicals and Fertilizers.
(2020). Guidelines for the Production Linked Incentive (PLI) Scheme forpromotion of domestic manufacturing of critical key starting materials (KSMs)/
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Hofman, B. (2021, June 8). China’s economic policy of dual circulation. Hinrich
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hsmi=132350000&_hsenc=p2ANqtz-8RtafkCQfskjeZ69WtBgkZfTEqhYwd
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Invest India. (2020). Production linked incentive (PLI) schemes in India. https://www.
investindia.gov.in/production-linked-incentives-schemes-india
Kim, T., & Karpinski, M. (2020, May 6). Clean energy progress after the COVID-19
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Lo, C. (2020). China’s new ‘dual circulation’ strategy: Two views. The International
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Asian regional growth. Georgetown Journal of International Affairs. https://gjia.georgetown.edu/2021/01/30/resilient-supply-chain-initiative-a-politicaldriver-to-revive-asian-regional-growth/17Age of Ferment:
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Prime Minister of Japan and His Cabinet. (2020, March 5). Council on investments
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Sharma, K., & Gakuto, T. (2020, September 4). Modi calls for ‘trustworthy’ supply
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Sherman, J. (2020, June 2). The UK is forging a 5G club of democracies to avoid
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Tehan, D., Goyal, P., & Hiroshi, K. (2021, April 27). Joint statement on the supply
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Wilson, J. (2021, July 13). ‘NATO for trade’: A bad answer to a good question? Hinrich
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18

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www3.weforum.org/docs/WEF_RRN_MO_BuildingResilienceSupplyChains_
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english/res_e/statis_e/daily_update_e/trade_profiles/IN_e.pdf
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english/res_e/statis_e/daily_update_e/trade_profiles/JP_e.pdf

19Age of Ferment:
Developments in Asian–European Trade Relations

20

Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIESThe Semiconductor Industry in
the Age of Trade Wars, COVID-19,
and Strategic Rivalries
Willem THORBECKE

Abstract
Semiconductors are vital for countless applications. The pandemic has generated
a surge in IT spending and has resulted in a shortage of semiconductor devices.
The semiconductor industry is also facing geopolitical challenges, as many
fear the concentration of production in East Asia. This chapter examines thechallenges the industry faces and suggests possible solutions.

Integrated circuits are vital not only for smartphones, computers, and otherelectronic goods, but also for countless other products. Microchips power
automobiles, toasters, robots, refrigerators, and airplanes. In addition, cuttingedge chips drive artificial intelligence and other applications that are crucial tonational defence. It is little wonder that policymakers focus on securing a stablesupply of semiconductor devices.
In 2017, the former president of the United States (US), Donald Trump,launched a trade war against the Chinese semiconductor industry. The Trumpadministration initiated an unfair trade investigation into opaque subsidies toChinese semiconductor firms. It then tightened the screws for national security
reasons, forbidding sales by US firms to Huawei, Semiconductor Manufacturing
International Corporation (SMIC), and other Chinese firms. It also restricted thesale of US technology to firms abroad that supplied semiconductors to these
entities.
As Trump’s actions were sowing uncertainty in the semiconductor industry,
the COVID-19 pandemic whipsawed the sector. When the coronavirus news hit
the world stage in February 2020, the bleak macroeconomic outlook caused
semiconductor stock prices to fall by 30% in Taiwan and by more in South Korea
and Japan. Automakers facing lockdowns cancelled orders for chips. As individuals
began working from home, spending on information and communication
technology (ICT) soared. This increased the demand for chips. When demand forautomobiles recovered later in 2020, semiconductor manufacturers lacked chips
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Age of Ferment:
Developments in Asian–European Trade Relations
to sell to automakers. The shortage of these semiconductor devices that might
cost only 2 USD forced car plants to shutter production (see, e.g. Song, 2021).
The next section recounts the history of the semiconductor industry from its
founding until the present. Section 3 presents evidence of how the COVID-19
crisis has impacted this sector. Section 4 draws policy lessons.

A Brief History of the Semiconductor Industry
The transistor was invented at Bell Labs in New Jersey in 1946. Tadashi Sasaki
was in New Jersey at the time. Sasaki had studied electrical engineering at
Kyoto University and Dresden University and worked with Karl Spangenberg
from Stanford University on minimising the space between a cathode-emitting
negatively charged electrons and the gate leading to the electrode (Sasaki,1994). Sasaki grasped the potential of the transistor and sought applications for
consumer goods. While US electronics firms serviced lucrative military contracts,
Japanese firms were not allowed to and focused instead on hyper-competitive
consumer markets.
Sasaki envisioned revolutionising consumer electronics by adding transistors to
an integrated circuit. This would enable goods to be miniaturised. He encouraged
his company, Hayakawa, to produce pocket calculators (Sasaki, 1994). His
engineers doubted his plan but studied the technology at Osaka University(Johnstone, 1999). Hayakawa decided they needed to use complementary metaloxide semiconductor (CMOS) chips to save power. Japanese companies were
unwilling to produce these, so Sasaki turned to the American company Autonetics,
a company providing inputs to missiles, fighter jets, and other weapons. These
applications were lucrative, and producing integrated circuits for calculators
offered low margins. Sasaki nevertheless convinced Autonetics by arguing thatthey would learn by doing, improving yields, and increasing profits.
In 1969, Hayakawa introduced the Sharp QT-8D calculator with four integrated
circuits produced by Autonetics that each contained 900 transistors. Hayakawa
then asked RCA, a major American electronics company, to produce liquid crystal
displays (LCDs) for Hayakawa’s calculators to save energy. RCA refused because
it considered consumer electronics to be unprofitable. Hayakawa thus had tomaster producing LCDs itself, and Sasaki stated that this was one reason why
Hayakawa succeeded (Sasaki, 1994). By 1975, Hayakawa (renamed Sharp) would
produce 10 million calculators.

22Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIESAs calculator production soared, Japanese semiconductor companies that
had previously refused to supply Hayakawa now complained to the Japanese
Ministry of International Trade and Industry (MITI) that Japanese producers
were purchasing integrated circuits from the US. MITI then prohibited Japanesecompanies from buying US microchips (Johnstone, 1999). Autonetics, which had
been promised the benefits of the learning curve, was thus no longer able toproduce for Sharp.
By then, Sharp and other Japanese companies had mastered CMOS technology,
while US companies now preferred PMOS and NMOS (positive and negative
channel metal oxide semiconductor) chips. CMOS was developed by the US
company Fairchild Semiconductor. Sasaki and other Japanese engineers saw thepotential of CMOS to reduce power requirements and facilitate miniaturisation.
US firms missed the potential that CMOS offered for the consumer market,
and focused instead on the more powerful PMOS and NMOS technologies andmilitary applications. As such, when the industry standard in the 1980s turned to
CMOS, Japanese firms were in the pole position.1 Bown (2020) reported that in1980, three of the four leading semiconductor firms by revenues were American,
while in 1990, three of the top four were Japanese. Bown also noted that Japanesefirms leapfrogged in the dynamic random access memory (DRAM) sector, with
their market share rising from less than 30% in 1978 to over 75% in 1986 (seealso Irwin, 1996).
As Bown (2020) noted, US manufacturers responded to the Japanese juggernaut
by lobbying for protectionism. They initiated a Section 301 case against Japan,
arguing that US firms lacked access to the Japanese market. One of theircomplaints was that the Japanese government had, in the past, overtly excluded
US semiconductor firms from the Japanese market. The case of Autonetics not
being allowed to supply Hayakawa was an example of this. The US government
also launched three antidumping cases, claiming that Japanese firms sold chips
in the US below their fair value. Bown reported that the US and Japan reached
an agreement in 1986, hinting that Japan would allocate 20% of the Japanese
semiconductor market to US firms and that Japanese firms would limit export
quantities and raise prices. Determining market shares by government decree
represented a sea change for US trade policy (Irwin, 1996).
The voluntary export restraint that Japan agreed to opened a door for South
Korean firms. South Korea faced the constant threat of invasion from North Korea.
South Korean President Chung-Hee Park prioritised economic development

1

Voinigescu (2013) noted that by 2011, 99% of chips are manufactured using CMOS.

23

Age of Ferment:
Developments in Asian–European Trade Relations
as a means of facing this threat. His government allocated bank loans to firms
in order to export and only continued directing loans to successful exporters.
Korean workers took the export imperative seriously and worked hard to maketheir companies successful (Pecht et al., 1997).
Samsung founder, Lee Byung-Chull, prioritised DRAM chips as an area where
Samsung could export and succeed. Investment requirements are heavy forsemiconductors, and Samsung was able to borrow because of the implicit
government guarantees. Samsung purchased DRAM technology in 1983 fromthe American company Micron. Korean engineers then studied semiconductor
technology day and night in the US. On their return to Korea, they attained
high yields. While Japanese firms were constrained to export at higher prices
and limited quantities to the US, Korean firms could sell at these higher prices
without any quantitative restrictions. Samsung channelled the revenues that
resulted into research and development (R&D) and capital formation. In the early
1990s, it became the leading producer of DRAMs, a distinction it retains in 2021.
The second leading producer in 2021, SK Hynix, is also Korean.
While Korea dominates in DRAM and other memory chips, Taiwan has focused on
logic chips. As South Korea faced the threat of invasion from North Korea when it
developed its semiconductor industry, Taiwan faced the threat of war with China.
In the 1970s, Taiwan was decimated by inflation, following the 1973 oil crisis, andhad lost access to Japanese capital goods in 1974. In this crisis environment, it
turned to economic development as a means of national survival. Many Chinese
researchers in the US sympathised with Taiwan and shared their expertise free ofcharge. Wen-yuan Pan, director at RCA’s David Sarnoff Laboratories, chaired thetechnical advisory committee (TAC) of researchers from leading US universities
and firms.
Pan recommended that Taiwan develop a semiconductor industry, and the TAC
advised that Taiwan begin with a mature technology. As Lin and Rasiah (2014)
noted, Pan recommended that Taiwan spend an enormous sum for its economy(10 million USD). Taiwan established the Industrial Technology Research Institute(ITRI) to oversee its technology development. Taiwan purchased semiconductor
technology from RCA, and ITRI recruited forty engineers. Some held PhDs fromUS universities. These engineers worked hard to master the technology, and ITRI
spun off the United Microelectronics Corporation (UMC) in 1979. ITRI continued
to nurture technological development and, in 1987, also created the Taiwan
Semiconductor Manufacturing Company (TSMC). As Lin and Rasiah discussed,
TSMC did not design integrated circuits itself but rather made these based on its
customers’ specifications. According to Bown (2020), in 2020, TSMC is the thirdlargest semiconductor firm by revenue in the world.
24Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIES

Malaysia sought to imitate Korea and Taiwan in using industrial policy to develop
a cutting-edge semiconductor industry. However, unlike Korea and Taiwan,
Malaysia faced no existential threats.2 Malaysia established the MalaysianInstitute of Microelectronics Systems (MIMOS) in 1985 to function as ITRI did in
Taiwan. MIMOS created the semiconductor firm Silterra in 2000. However, asRasiah (2017) documented, the Malaysian government did not choose the mostqualified candidates to lead Silterra and other institutions. Since the 1970s,
Malaysia sought to promote indigenous citizens (Bumiputera) over Malaysians
who are ethnically Indian or Chinese. For instance, Rasiah noted that Malaysia
did not choose Loh Kin Wah, an ethnic Chinese, the managing director of theGerman company Qimonda, and best placed candidate for the job, to head
Silterra. The government also withheld grants from the most dynamic electronic
firms if they were not led by a Bumiputera, and continued bestowing benefits
on indigenous firms even if their performance was poor. Malaysia’s emphasis
on redistribution generated rent-seeking activity, and its semiconductor industry
never progressed to higher value-added activities such as design, R&D, andmanufacturing.
China has become the world’s largest consumer of semiconductors and uses
these to produce final electronics goods. Bown (2020) noted that 90% of
smartphones, 67% of smart televisions, and 65% of personal computers are
made in China. Bown also reported that China’s exports of semiconductors now
comprise 20% of the world’s total. These exports, however, are lower-end chips,
while its imports are cutting-edge devices. The Chinese government is using
opaque subsidies to promote its domestic semiconductor industry and thereby
pursue self-sufficiency.
Bown (2020) recounted how these subsidies and national security concerns
caused the Trump administration to launch a trade war against the Chinese
semiconductor industry. In 2017, the US government initiated a Section 301
investigation into unfair trade practices. This resulted in 25% tariffs being imposed
upon Chinese chip imports. In 2019, the US targeted the Chinese company
Huawei. Huawei is a leading player in producing equipment for fifth-generation(5G) telecommunications networks. The US feared that Huawei might be required
to provide sensitive military and civilian data that it obtained to the Chinese
government. The Trump administration then restricted the sale of US chips to
Huawei. However, Huawei was able to obtain sufficient chips from Taiwan, South
Korea, and other sources. The US then said that any foreign semiconductor

2

Yoshitomi (2003) observed that Malaysia had overcome existential threats from ruralunrest.

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Age of Ferment:
Developments in Asian–European Trade Relations
manufacturer that supplied Huawei would no longer have access to US tools
and technology. In 2020, the US also prohibited domestic firms from selling to
SMIC without explicit government approval. In the midst of this dislocation, thecoronavirus crisis hit the semiconductor sector.

Investigating How the Coronavirus Shock Impacted the
Semiconductor Industry
To investigate how COVID-19 is affecting the semiconductor industry, this chapter
examines the fluctuations of stock returns. Finance theory teaches that stock
prices equal the expected present value of future cash flows. Black (1987, p. 113)
observed that
The sector-by-sector behavior of stocks is useful in predicting sector-bysector changes in output, profits, or investment. When stocks in a given
sector go up, more often than not that sector will show a rise in sales,earnings, and out-lays for plant and equipment.
The response of stock prices should thus provide information about how sectors
are being affected.3
The coronavirus shock began causing stock prices around the world to fall on 19
February 2020. An equation is thus estimated explaining stock returns until 18
February 2020, and then actual out-of-sample values of the explanatory variables
are used to predict stock prices during the crisis period. The difference between
actual stock prices and predicted stock prices may shed light on how the crisis isaffecting the sector.
The performance of the Taiwanese semiconductor sector is investigated since
Taiwan is the most technologically advanced producer of semiconductors.
The performance of two key downstream sectors, consumer electronics andautomobiles, is also examined. The data for Korea are also included, since it is amajor exporter of both consumer electronics and automobiles.
To explain sectoral stock returns, the returns on the countries’ aggregate stock
markets, the return on the world stock market, the price of oil, the nominal
exchange rate relative to the US dollar, and a measure of interest rates areincluded. There is a long tradition in finance of using the return on a country’s
aggregate stock market to capture the impact of economy-wide factors on

3

26

Stock prices can also overreact, so there is a need for caution when drawing inferencesfrom stock return data.

Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIES

individual firms or sectors (see, e.g. Brown and Warner, 1980, 1985). The returnon the world stock market then captures the impact of global factors on individual
entities. The price of oil has been found by many to be helpful in explaining Asianstock returns (see Thorbecke, 2019). The exchange rate is included to capture
the sectors’ exposure to exchange rate changes. The interest rate is included tocapture the influence of monetary policy on stock returns.
The following equation is estimated:∆Ri,t=α0 + α1∆Rm,t + α2 ∆Rm,World,t + α3∆Poil,t + α4∆ert + α5∆MPt,
where•∆Ri,t is the change in the log of the stock-price index for sector i,•∆Rm,t is the change in the log of the price index for either the Taiwanese or the
Korean aggregate stock market,•∆Rm,World,t is the change in the log of the price index for the world stock market,•∆Poil,t is the change in the log of the spot price for Dubai crude oil,•∆ert is the change in the New Taiwan dollar/US dollar exchange rate (forTaiwan) or the Korean won/US dollar exchange rate (for Korea), and•∆MPt represents the change in the Taiwan Central Bank discount rate (forTaiwan) or the Bank of Korea base rate (for Korea).

The data are obtained from the Datastream Database and from the websites of
the Central Bank of the Republic of China and the Bank of Korea.
The above equation is estimated using daily data over the 19 January 2001 to
18 February 2020 period. Actual values of the right-hand side variables overthe 19 February 2020 to 19 January 2021 period are then used to forecast stock
prices. Figure 1 presents results for the Korean consumer electronics sector.
Actual returns fell more than 50% beginning on 19 February 2020. Although
the forecasted values plummeted due to the deteriorating macroeconomic
environment with the advent of the crisis, actual stock prices fell more thanforecasted based on the macroeconomic variables and remained below
forecasted values until July 2020. Stock prices then soared, and by 19 January
2021, they were more than 70% above pre-crisis values and more than 40% above
forecasted values. As individuals were forced to work from home, their demandfor consumer electronics and other ICT goods soared. This, in turn, generated
the large stock-price gains.

27

Age of Ferment:
Developments in Asian–European Trade Relations
Figure 1. Actual and forecasted stock prices for the Korean consumer electronics
sector

Source: Datastream Database and calculations by the author.

Figure 2 presents results for the Korean automobile sector. Actual returns fellalmost 70%, beginning on 19 February 2020. The forecasted values, due to thedeteriorating macroeconomic environment, fell only half as much. Actual stock
prices remained below forecasted stock prices until August 2020. They thereafter
posted steady gains, and by 19 January 2021, they were almost 70% above precrisis values, and almost 40% above forecasted values. As many were shuttered athome, the outlook initially looked abysmal for the automobile industry. However,with the global recovery and peoples’ desire to avoid public transportation, theprospects for the auto industry brightened anew.

28Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIES

Figure 2. Actual and forecasted stock prices for the Korean automobile sector

Source: Datastream Database and calculations by the author.

Bown (2020) noted that 75% of semiconductor devices flow to electronics
products, and the other 25% go to automobiles and other applications. With
the outlook for electronics and automobiles improving, one would expect thesemiconductor industry to also benefit. Figure 3 confirms this. Actual returns on
the Taiwanese semiconductor sector fell about 30% with the advent of the crisis.
Actual returns remained close to predicted returns until the beginning of July
2020. Actual returns then far outpaced predicted returns, and by 19 January 2021,
they were almost 70% above pre-crisis values, and almost 30% above forecasted
values. The semiconductor industry is thus profiting during the pandemic.

29Age of Ferment:
Developments in Asian–European Trade Relations
Figure 3. Actual and forecasted stock prices for the Taiwanese semiconductor
sector

Source: Datastream Database and calculations by the author.

Policy Lessons
Semiconductors are vital for the world economy. Though they were invented
in the US, their manufacturing has migrated to South Korea, Taiwan, and other
Asian countries. The US and its Western allies now perceive the risks of having
the production of such crucial components based so far away. Earthquakes,
fires, or wars could cut off producers in the West from these vital inputs. The US
and the EU are thus seeking to nurture domestic semiconductor manufacturing(see, e.g. Fleming et al., 2021). As Eric Schmidt, who had served as CEO for Google
between 2001 and 2011, observed in an interview, they are unlikely to succeed
merely by throwing money at the problem (Tanaka, 2021).
The successes of Japanese, Korean, and Taiwanese firms offer some lessons.
First, lucrative government contracts are less likely to produce a strong industry
than competing in world markets. After World War II, US electronics firms
developed transistors, CMOS semiconductors, LCD displays, and countlessother technological breakthroughs. These firms were often coddled by defence
contracts and thus faced little pressure to convert these technologies into
marketable products. Asian firms, on the other hand, focused on exporting andcompeting in consumer-goods markets. This discipline forced them to choose
technologies carefully and adapt them to make profitable products.

30

Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIESA second lesson is that entrepreneurs are essential. Tadashi Sasaki had thevision to use integrated circuits to miniaturise calculators. This led to hundredsof millions of calculators being sold. Byung-Chull Lee took risks to produce DRAM
chips. His success in this area helped make Samsung a company that in 2021 hasa market capitalisation of 400 billion USD. Recounting the factors such as good
policies and educated workers that contributed to the East Asian miracle between
the 1960s and the 1990s, Yoshitomi (2003) concluded that entrepreneurs wereparamount. By taking risks and translating new ideas into productive activities,
they sustained technological progress and drove economic growth.
A third lesson is that industrial policy is more likely to succeed when citizens view
their national survival to be at risk and therefore unite for the national good. Thismay have been the case for South Korea and Taiwan facing the threat of invasion
from neighbours. Economic development was viewed as imperative; workers,
entrepreneurs, government officials, and outside advisors worked together toachieve it. When, as in the case of Malaysia, redistribution is a primary goal ofgovernment, industrial policy can lead to rent-seeking waste and not produce
a competitive industry. The implication is not that countries should create asituation where their survival is at stake, but that countries without existential
threats should be aware that industrial policy may generate rent-seeking losses.
A fourth lesson is the importance of education and technology transfer. Tadashi
Sasaki was well educated and quickly sensed the technologies that his firmshould invest in. Engineers in Korea and Taiwan were relatively well-educatedand absorbed know-how from their counterparts in America. This bridged theknowledge gap until they acquired the requisite manufacturing experience.
A fifth lesson is the necessity of providing firms with targeted and calibrated
incentives. Malaysia often did not let Bumiputera firms fail even when theirperformance was poor. On the other hand, Hausmann and Rodrik (2003) showedthat the Korean government stopped providing benefits to firms that did not
succeed at exporting. Proper incentives can help industrial policy to achieve its
target.
A sixth lesson is that protectionism can be counterproductive. Japan’s refusal tolet firms like Autonetics continue selling semiconductors to Japan and America’s
actions against chip firms in Japan ultimately weakened the semiconductor
industries in both countries.
A seventh lesson is that cooperation between academia, industry, and government
research institutes can be valuable. Not only did the TAC in Taiwan contain31Age of Ferment:
Developments in Asian–European Trade Relations
leading professors, but Taiwanese science parks enabled fertile interactions
between universities, businesses, and the government.
Many Western countries are desirous of building vibrant semiconductor
manufacturing sectors. They recognise that in the event of war or natural disaster,
they could be cut off from East Asia’s semiconductor supplies. Developing
semiconductor manufacturing capacity requires careful thought and planning.
Simply observing that the Korean and Taiwanese governments invested money
into semiconductors and declaring that Western governments should follow suit
will prove insufficient.
Another lesson from the COVID-19 experience is that firms which make use of
semiconductors should move beyond just-in-time inventory management. As
the pandemic emerged, demand for automobiles fell rapidly and recovered ata similar pace. It was hard for automakers to foresee how their semiconductor
needs would change. Keeping excess inventory for precautionary reasons would
be wise. Also, achieving a greater understanding of their own supply chains, andtheir inherent vulnerabilities, could save companies a lot of money. During the
pandemic, it became clear that a fourth-tier supplier could suffer difficulties, whichsometimes reverted through the entire supply chain, causing multiple delays. It
is therefore clear that firms need careful planning and adequate preparations tomaintain resilience in the face of wars, natural disasters, pandemics, and otherdisruptions.

Willem THORBECKE is a senior fellow at the Research Institute of Economy,
Trade, and Industry. Prior to this, he was a senior research fellow at the AsianDevelopment Bank Institute and a professor at George Mason University. He has
written many papers investigating the determinants of trade flows in Asia andthe rest of the world and the spillovers that result from trade.

32Section I.

SEMICONDUCTORS IN TRADE WARS, COVID-19, & RIVALRIES

References
Black, F. (1987). Business cycles and equilibrium. Basil Blackwell.
Brown, C. P. (2020, December). How the United States marched the semiconductor
industry into its trade war with China [Working paper 20-16]. Peterson Institutefor International Economics. https://www.piie.com/sites/default/files/
documents/wp20-16.pdf
Brown, S. J., & Warner, J. B. (1980). Measuring security price performance. Journalof Financial Economics, 8(3), 205-258. https://doi.org/10.1016/0304405X(80)90002-1
Brown, S. J., & Warner, J. B. (1985). Using daily stock returns: The case of
event studies. Journal of Financial Economics, 14(1), 3-31. https://doi.
org/10.1016/0304-405X(85)90042-X
Fleming, S., Hollinger, P., & Hall, B. (2021, July 21). Semiconductors: Europe’s
expensive plan to reach the top tier of chipmakers. Financial Times. Retrieved 21
July 2021, from https://www.ft.com/content/d365bfe0-98c4-49b5-8e82dc4386623ace
Hausmann, R., & Dani, R. (2003). Economic development as self-discovery. Journalof Development Economics, 72(2), 603-633. https://doi.org/10.1016/S03043878(03)00124-X
Irwin, D. A. (1996). The U.S.-Japan semiconductor trade conflict. In A. O.
Krueger (Ed.), The political economy of trade protection (pp. 5-14). Universityof Chicago Press.
Johnstone, B. (1999). We were burning: Japanese entrepreneurs and the forging of
the electronic age. Basic Books.
Lin, Y., & Rasiah, R. (2014). Human capital flows in Taiwan’s technological catchup in integrated circuit manufacturing. Journal of Contemporary Asia, 44(1),64-83. https://doi.org/10.1080/00472336.2013.801167
Pecht, M., Bernstein, J. B., Searls, D., Peckerar, M., & Karulkar, P. C. (1997). The
Korean electronics industry. Routledge.
Rasiah, R. (2017). The industrial policy experience of the electronics industry
in Malaysia. In J. Page & F. Tarp (Eds.), The practice of industrial policy:
Government—business coordination in Africa and East Asia. Oxford University
Press.
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Developments in Asian–European Trade Relations
Sasaki, T. (1994, May 25). Oral-History: Tadashi Sasaki. Interview by W. Aspray.
Engineering and Technology History Wiki. Retrieved 31 July 2021, from https://ethw.org/Oral-History:Tadashi_Sasaki
Song, J. (2021, March 24). Hyundai faces production hit from April as chip shortage
bites. Financial Times. https://www.ft.com/content/8f48ea84-ec31-479aa3c0-f4a231299ce2
Tanaka, A. (2021, July 9). US needs Japan and Korea to counter China tech: Ex-Google
CEO. Nikkei Asia. https://asia.nikkei.com/Editor-s-Picks/Interview/US-needsJapan-and-Korea-to-counter-China-tech-ex-Google-CEO
Thorbecke, W. (2019). How oil prices affect East and Southeast Asian economies:
Evidence from financial markets and implications for energy security. Energy
Policy, 128, 628-638. https://doi.org/10.1016/j.enpol.2019.01.044
Voinigescu, S. (2013). High-frequency integrated circuits. Cambridge University
Press.
Yoshitomi, M. (2003). Post-crisis development paradigms in Asia. Asian Development
Bank Institute. https://www.adb.org/sites/default/files/publication/159393/
adbi-post-crisis-development-paradigms.pdf

34Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

Digital Investment and PostPandemic Recovery in ASEAN
Sineenat SERMCHEEP

Abstract
Digital investment is a crucial factor for ASEAN’s post-pandemic recovery, as well
as long term growth and development in the digital era. It boosts ASEAN’s digitalcompetitiveness and assists the region in reaping the benefits of the digital
economy. To be successful in attracting digital investment, policies, regulations,and measures that influence the decisions of potential digital investors are
required.

Introduction
The COVID-19 pandemic has severely disrupted economic activities aroundthe world, and Southeast Asia is no exception. This unprecedented pandemic
has caused a devastating impact on the ASEAN economy. According to WorldBank data, the outbreak caused a 5.59% contraction of ASEAN GDP in 2020.
The pandemic also had a significant impact on trade and investment. In 2020,
the total trade of six ASEAN countries, namely, Cambodia, Indonesia, Malaysia,
the Philippines, Singapore, and Thailand, dropped by 13.68%. Foreign direct
investment (FDI) flows in the region also recorded a 25% contraction to 136
billion USD in 2020 (UNCTAD, 2021).
The restrictive measures imposed in response to COVID-19, such as lockdowns,
stay-at-home orders, temporary business closures, and travel restrictions or
prohibitions, have impacted both ASEAN consumers and businesses. ASEAN has
seen a decline in tourism flows, air travel disruption, and a reduction in consumer
and business confidence (ASEAN Secretariat, 2020a).
The pandemic has also accelerated an existing trend of digital transformation in
the region. The government measures to contain COVID-19 have pushed firms
towards digitalisation, and increased online operation, so as to meet the increasein demand. Digitalisation has also enabled businesses to enter new markets
via online platforms, as well as to integrate logistics services, and to automate
production facilities. The outbreak of the pandemic made the adoption of digital
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Age of Ferment:
Developments in Asian–European Trade Relations
technology particularly essential as a means of mitigating the negative effect oflockdown policies and adapting to the new environment for future growth. The
pandemic has also accelerated consumer use of digital technologies. In one year,
internet usage in Southeast Asia increased by 40 million new users, reaching 400
million users in 2020, equivalent to just under two thirds of the total population(Google et al., 2020).
The promotion of the digital economy is a critical driver of ASEAN’s economic
recovery, with digital development viewed as essential for the region. Digitaltechnology has caused significant change all over the world. Countries such as
China and the United States (US) have reaped the benefits of the digital revolution
and emerged as winners in the digital world. ASEAN is still in the early stagesof digital development, but it has an enormous potential to become one of theworld’s leading digital economies (A. T. Kearney, 2015; Bain & Company, 2018).
ASEAN is one of the world’s key economies, ranking third in terms of population,
after China and India, and ranking fifth in terms of GDP after the US, China, Japan,
and Germany, in 2019 (ASEAN Secretariat, 2020b). However, the region is not a
key digital economy yet. ASEAN’s digital economy lags behind its global peers,
accounting for only 7% of GDP, in comparison to 16% in China, 27% in Europe,and 35% in the US (Bain & Company, 2018).
ASEAN has the potential to leap to the forefront of the fast-moving global digital
economy because many of the fundamentals of digital development are alreadyin place. First, ASEAN has a strong and vibrant economy, with a GDP of 3.2 trillion
USD in 2019 and an annual average real GDP growth rate of 5.7% from 2000
to 2019 (ASEAN Secretariat, 2020b). Second, ASEAN has a sizeable and growinginternet user base. This is due to the fact that the majority of ASEAN countries
had an adult literacy rate of more than 94% in 2018 (ASEAN Secretariat, 2020b).
Furthermore, the youth population accounts for 34% of ASEAN’s total populationof 654 million (ASEAN Secretariat, 2021c), and these digital natives are critical todriving innovation and facilitating ASEAN’s digital transformation. Third, ASEAN’s
investment into digital infrastructure, which is critical for digital development,
has made significant progress, with over 100 billion USD invested in 2014, anda 15% increase in 2015 (A.T. Kearney, 2015). According to World Bank data,
Indonesia’s investments into information and communications technology (ICT),
including private participation, reached 204 million USD in 2016 and 385.29
million USD in 2017. Myanmar has also seen significant investment into digital
infrastructure, with an all-time high of 1.618 billion USD in 2017 and a new low of
119 million USD invested in 2018. Fourth, the region’s growing integration underthe ASEAN Economic Community (AEC) and the implementation of the Regional

36

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DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

Comprehensive Economic Partnership (RCEP) benefit ASEAN’s digital economy
through greater economies of scale.
Although ASEAN governments have made significant investments into digital
infrastructure, there is still much room for improvement in order to keep up withnew technologies, serve the increasing regional demand for internet usage, andbridge the digital divide within ASEAN. One of the primary reasons for insufficientdevelopment of telecommunication networks, which is required for ASEAN to
become a leading digital community and economic bloc, is a lack of infrastructure
investment (ASEAN Secretariat, 2021a). According to the ASEAN Secretariat(2021b), the region requires approximately 14 billion USD per year in 5G
infrastructure investment. Thus, attracting more digital foreign direct investment(FDI) is one way for ASEAN to reap the benefits of digital development, recoverfrom the COVID-19 pandemic, and maintain itself as the leading digital economy
for future growth. According to Bain & Company (2018), the radical developmentof a digital economy has the potential to power and accelerate intra-regional
trade and growth and could add up to 1 trillion USD to ASEAN’s GDP by 2025.
Attracting digital FDI requires different policies, regulations, and measures.
Digital firms’ business models differ from those of traditional businesses, andtheir decision to invest relies heavily on data and technology (Stephenson,
2020; Stephenson & Sen, 2020). Thus, it is important to fully analyse what thepotential policies for attracting digital investment in ASEAN are. This paper aims
to consider the economic effects of the pandemic on ASEAN (Section 2), examine
the role of digital investment in addressing the recovery of the ASEAN economy(Section 3), discuss the potential policies on digital investment promotion toensure said recovery is sustainable (Section 4), and draw some conclusions for
digital investment in the region (Section 5).

Impacts of COVID-19 on the ASEAN Economy
The COVID-19 outbreak has impacted the ASEAN economy on multiple fronts,
including supply chains, the service sector, foreign direct investment, and digitaltechnology adoption. This section investigates the pandemic’s effects and how
digital technology can help to mitigate them.
ASEAN has played an important role in global supply chains in recent decades,with Vietnam, Thailand, and Malaysia serving as large-scale manufacturing hubs.
Currently, the region serves as a major manufacturing base for the automotive,
computers, electronics, and clothing industries (Mazumdaru, 2021). As such,when lockdown measures and strict restrictions were imposed to control the
spread of the virus, the reduced business activity and operations had wide37

Age of Ferment:
Developments in Asian–European Trade Relations
ranging effects. The resulting factory closures in many ASEAN countries—and ensuing manufacturing capacity reductions, particularly in Thailand andVietnam—disrupted global supply chains.
Manufacturing companies are adopting digital technology, such as cloud, mobile
platforms, Internet of Things (IoT), and data analytics, to help automate manual
processes and create new ways to move products (Goel, 2021). Multinational
corporations (MNCs) may reshape their global supply chains in ASEAN to be more
resilient by reshoring or nearshoring to reduce complexity and interdependence
in the global supply chain networks and by diversifying supply, operations, anddistribution channels to avoid concentration (UNCTAD, 2021). ASEAN will be
impacted in both instances—negatively, by outward FDI due to reshoring to basecountries, and positively, by inward FDI due to investment diversification fromother locations.
COVID-19 control measures, such as restrictions on people’s movement andsocial distancing, have directly disrupted traditional services, such as travel
and tourism, hotels and restaurants, business, and aviation (ASEAN Secretariat,
2020a; Kimura et al., 2020). ASEAN is heavily reliant on the tourism industry,
which the World Travel and Tourism Council estimates accounted for 12% of
total ASEAN GDP (380 million USD) in 2019. ASEAN is one of the regions mostaffected by the global tourism slump. By utilising digital technologies such as IoT
and robots, hotels can improve the safety and security of their services. During
the pandemic, augmented, virtual, or mixed reality (AR, VR, and MR) could help
in the provision of alternative tourism experiences known as virtual tourism.
These digital technologies can provide viewers with a seamless, uninterrupted
interactive experience from their own locations (Pillai, 2021).
The COVID-19 pandemic has accelerated the growth of many modern services,
including digital financial and insurance services, telecommunications, computers,
and information services, all of which are new potential engines of ASEAN growth(Sermcheep, 2019). ASEAN consumers and small and medium enterprises (SMEs)
have embraced digital financial services like never before, resulting in increases
in remittance flows (43%), digital payments (3%), insurance (30%), and investment(116%) (Google et al., 2020).
The COVID-19 pandemic disrupted FDI flows into ASEAN, resulting in a 25%
decrease to 137 billion USD in 2020. Lockdown measures, supply chain disruptions,falling corporate earnings, recurring waves of COVID-19, economic uncertainty,
and the postponement of investment plans have all contributed to this sharp
drop. Despite the decline, ASEAN remained an attractive investment destination,
and although the actual amount of investment decreased over this period, the38Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

region’s share of global FDI increased from 11.9% in 2019 to 13.7% in 2020. FDIin the manufacturing sector fell by 55% and also lowered in service industries,
such as finance, hospitality, tourism, real estate, and construction. The overall
decline in regional FDI is offset partially by a resilient FDI in infrastructure-relatedindustries, such as electricity, information, and transportation and storage, as
well as digital economy industries, such as digital technologies, e-commerce, andonline activities (UNCTAD, 2021).
For decades, FDI has been a key driver of ASEAN’s growth. This growth channel
was disrupted during the COVID-19 outbreak; however, ASEAN countries are still
attempting to attract FDI and maintain the momentum of FDI-led growth for theircountries. Falling company performance and the phenomenon of reshoring will
result in lower FDI in the post-pandemic period, leading to increased competition
for FDI attraction. For countries to be attractive for FDI in the digital economy,
they must have a good infrastructure and network.
The pandemic has accelerated the adoption and growth of digital technology
in most of related sectors. According to Google et al. (2020), six from seven
leading digital economy sectors in ASEAN—namely, e-commerce, food delivery,
online media, digital financial services (insurance, investment, payment, andremittance), HealthTech, and EdTech—have experienced continued growth or
rapid expansion due to the COVID-19 pandemic. The seventh sector, which the
pandemic temporarily set back is, unsurprisingly, online travel (Google et al.,2020).
The digital economy remains resilient in six ASEAN countries—namely, Indonesia,
Malaysia, the Philippines, Singapore, Thailand, and Vietnam. This includes thesectors of e-commerce, transport and food delivery, online travel, and online
media. They reached a gross merchandise volume (GMV) of 100 billion USD in
2020. The value of this digital economy is expected to reach 300 billion USD in
GMV by 2025, despite a challenged environment (Google et al., 2020).
HealthTech and EdTech have emerged as new frontiers in ASEAN’s digital
economy. The use of telemedicine platforms increased fourfold, and they wereable to retain their users in the post-lockdown period, with investment into suchplatforms more than doubling during the pandemic. Widespread collaboration
between existing providers and telemedicine start-ups, as well as continued
interest from investors, and stronger regulatory and policy support from
regulators have all contributed to the future commercialisation of HealthTech
in ASEAN. Meanwhile, EdTech funding tripled in 2019, with the majority of funds
going to online learning platforms and student adoption of EdTech increasing
more than threefold. EdTech has the potential to expand further in the post39

Age of Ferment:
Developments in Asian–European Trade Relations
pandemic period, with potential barriers being connectivity and affordability.
Many people, particularly those living in rural areas in the region, continue toface difficulties with regard to universal access to, and affordability of, digital
devices and networks (Google et al., 2020).
Because of their resilience to the economic slowdown caused by the COVID-19
pandemic, these digital-related sectors have the potential to become key driversof ASEAN’s economic recovery. However, ASEAN is still in the early stages of digitaldevelopment, with much room for improvement. In order to boost further digital
investment and innovation in ASEAN, the region must develop a digital-friendly
ecosystem. Promoting ASEAN digital start-ups could be a successful strategy forstimulating innovation and creating new users and service providers.
In sum, the spread of COVID-19 has severely impacted the region, resulting in asignificant economic slowdown. However, some sectors of the digital economy
are resilient to this shock and may become the growth engine in the postpandemic period. ASEAN’s continued digital technology development contributes
to making digital tools more accessible for businesses to adopt. The more they
do so, the more they are able to survive such shocks and compete in the postpandemic economy. This development process requires digital investment.

Role of Digital Investment in Facilitating ASEAN Recovery
Role of digital investment on digital development
Digital investment has played an important role in the development of the digital
economy. According to UNCTAD’s (2017) digital development strategy, global
digital firms’ investment can contribute to host countries’ digital development
through two channels: investment in digital infrastructure and investment indigital firms (Table 1).
Developing digital infrastructure is the first step in digital development because
it leads to improved digital connectivity, which is the foundation of the digital
economy. Digital FDI is an important source of capital and technology for
infrastructure development and network deployment. This is particularly true fordeveloping countries looking to fill infrastructure gaps and improve their digitalconnectivity. As countries expand their digital coverage, they need investment indigital infrastructure to keep up with evolving technology and so as to expand
capacity in order to meet rising demand (UNCTAD, 2017).
A lack of investment in digital infrastructure is a major challenge for ASEAN,
particularly for Cambodia, Lao People’s Democratic Republic (PDR), and Myanmar,
40Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

which have significantly lower levels of digital development than the rest of ASEAN(ASEAN Secretariat, 2021a). Increased investment into digital infrastructure
can help to close the digital divide by improving network access and making
connectivity more affordable across ASEAN. This also helps in the achievementof the United Nations’ Sustainable Development Goals (SDGs), namely, Goal 9
on building resilient infrastructure, promoting sustainable industrialisation, andfostering innovation, and specifically Target 9.c, which aims to increase accessto information and communications technology and to provide universal andaffordable access to the internet (United Nations, 2015).
Second, digital firms’ investments in businesses such as local platforms, data
centres, and in training and capacity-building helps to stimulate demand for
digital services, while also increasing the availability of digital services in the local
ecosystem. In comparison to digital infrastructure investment, the digital content
and services industry requires less capital for its development. However, criticalinvestment components are required to support content creation, store anddeliver content locally, and build or improve related services, such as financial
and postal services (UNCTAD, 2017).
Table 1. Digital development and investment• Typical investment needs

Digitalinfrastructure

Digital firms• International,
national,
last-mileconnectivity• Local platforms(e.g. social
networks,
e-commerce)• Internet
exchange
points (IXPs)• Local enterprisedevelopment

Wider digital
adoption• ICT adoption/
devices• Training• Data centres• Training andcapacitybuilding

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Age of Ferment:
Developments in Asian–European Trade Relations• Typical
investors• (Mobile)
network
operators andinternet service
providers (ISPs)• Global digitalfirms• Governments• Relevance ofinvestment
policies andinvestment
supportmeasures• Sector-specificforeigninvestment
rules• Privatisations• Public-private
partnerships• Investmentrelated
policies (e.g.
competition)• Global digital
firms• Localbusinesses• Data centre
providers• Public
institutions andgovernments• Venture capital,
private equity,
other funds• Local firms (e.g.
media firms)• Innovation
hubs,
incubators• E-government
investment
facilitation• Enabling
environment
for innovative
forms offinancing• Businesslinkages
programmes
supporting
participationin global value
chains (GVCs)

Source: UNCTAD (2017)

Foreign firms have played an important role in accelerating ASEAN’s digitaltransformation process by serving as investors, technology users or providers,and manufacturers. They also contribute by training the local workers, being
influencers of digital adoption in SMEs, and becoming digital ecosystem enhancers(ASEAN Secretariat, 2021b). On the supply side, MNCs play a role by building
digital infrastructure and investing in digital firms in their host countries. They
also manufacture industrial hardware and provide technology to clients in local
markets, while some also provide digital content and services to local customers.
On the demand side, some digital firms require the use of local digital services tosupport their operations, which generates demand in the host countries. Some
MNCs also set up research and development (R&D) facilities, technology hubs,
and centres of excellence in the region, which helps with training and capacitybuilding.

42

MNCs are always equipped with capital and technological capacity, and they canadopt advanced digital technology far more swiftly than local companies. Their
adoption of a given advanced technology has the potential to influence local andother foreign firms in local markets to adopt this same technology, particularlyin the case of SMEs with vendor relationships with MNCs. MNCs also contributeto the improvement of ASEAN’s digital ecosystem. With a more developed digitalSection I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

ecosystem, local start-ups, which are a key driver of innovation in the digital
economy, can expand more rapidly (ASEAN Secretariat, 2021b).
Current state of digital development and investment in ASEAN
1. Digital development in ASEAN
The overall level of digital development of ASEAN countries, and that of theirmajor economic partners, is measured by the ICT Development Indicator (IDI),
here presented in Table 2. Singapore is the only ASEAN country on the 2017global list of the Top 20 countries for ICT development. Six ASEAN countries,
meanwhile, have digital development levels that are lower than the global
average. The large disparity in ICT development levels within the ASEAN
region, as well as the region’s relatively low level of digital development whencompared to the region’s economic partners, such as Korea, Japan, the US,
and China, has prompted ASEAN to invest heavily into this field, with the goalof becoming one of the world’s leading digital economies.
Table 2. ICT Development Index (IDI) in 2017

ASEAN
Countries

EconomicPartners

Country

IDI Rank

IDI Value

Singapore

18

8.05

Brunei53

6.75

Malaysia63

6.38

Thailand78

5.67

Philippines

101

4.67

Vietnam108

4.43

Indonesia

111

4.33

Cambodia

128

3.28

Myanmar135

3.00

Lao PDR

139

2.91

Korea

2

8.85

Japan

10

8.43

United States

16

8.18

China

80

5.60

India

134

3.03

Note: The latest published IDI is for 2017. The average global IDI value is 5.11.
The ICT Development Index (IDI) comprises three dimensions: ICT access, ICT use, andICT skills.
Source: International Telecommunication Union (ITU)

43

Age of Ferment:
Developments in Asian–European Trade Relations
Table 3 contains recent data on ASEAN digital development in terms ofinfrastructure and access, internet usage, and enablers and barriers. ASEAN
countries are at various stages of digital development, with Singapore,
Brunei, and Malaysia leading the way; Thailand, Vietnam, Indonesia, and thePhilippines in the middle; and the rest lagging behind.
In recent years, ASEAN’s governments have made significant investments
into digital infrastructure. Myanmar and Vietnam, for instance, have madesignificant advancements in 4G coverage. The government of Myanmar
ended the state operator’s monopoly in 2013 by granting MNC’s Telenor andOoredoo long licence tenures with low upfront costs, allowing consumers in
Myanmar to benefit from expanded 4G coverage and lower SIM card costs. In
recent decades, the Vietnamese government has taken the lead in expanding
digital connectivity by investing in the national backbone network (the NorthSouth optical fibre cable system), and in international infrastructure throughthe state-owned operator (VNPT) and public-private partnerships. As a result,
Vietnam’s 4G coverage increased to 95% in 2018 (Bain & Company, 2018).
Overall, network coverage in ASEAN appears satisfactory, with eight countries
having at least 80% of their population covered by a 4G mobile network.
However, taking the region as a whole, there are still large discrepancies
between countries. In Lao PDR, only 43% of the population is covered by the
network, whereas Singapore has full coverage. As such, the development of
4G networks in Lao PDR, Myanmar, Cambodia, and the Philippines remains
a critical issue.
Investment in infrastructure alone is insufficient to stimulate adoption. The
affordability of devices and broadband subscriptions are the key barriers. The
share of individual ownership of mobile phones and active mobile broadband
subscriptions varies across ASEAN countries, with Singapore, Malaysia, andBrunei having higher shares of both. Internet penetration in ASEAN varies
greatly, ranging from 95% in Brunei to 24% in Myanmar. The price of ICT, as
measured by the proportion of mobile broadband to income, is a significant
determinant of internet usage. Countries with higher subscription prices
have a lower share of internet penetration. The lack of digital literacy andskills is a major impediment to ASEAN’s digital development.

44Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

Table 3: State of digital development in ASEAN countries
Internet
usage

Infrastructure & access

Country

Network
coverage:percentage of
population
coveredby at least
4G mobile
network(2019)aMobilephone
ownership:
individual
owninga mobilephone(percentage of population)(2019)

Mobileand fixed
broadband
subscriptions:active mobile-broadband subscriptions
per 100
inhabitants

Enablers & barriers

Percentageofpopulation
using theinternet
(2019)ICT prices:mobilebroadbandbasket as apercentage
of GNI per
capita(2020)(2019)ICT skills(basicskills, standard skills,
advancedskills)(percentage of
population
with a skill
level)(2019)

Brunei

95

94

148

95

0.3

60, 36, 28

Cambodia

80

33a

96

41

1.6

29, 3, 1

Indonesia

98

64

81

48

1.3

60, 20, 4b

Lao PDR

43

n.a.

49

b

26

2.4

n.a.

a

Malaysia

87

96

127

84

0.9

59, 51, 8

Myanmar

75a

62b

93a

24b

1.0

n.a.

Philippines

b

80

79

b

68

43

1.4

6, n.a., 1

Singapore

100

88

156

89

0.4

54, 36, 7

Thailand

98

88b

87

67

1.2

21, 9, 1

Vietnam

97

n.a.

72

69

1.0

n.a.

and b represent data from 2018 and 2017, respectively, as 2019 data were unavailable.

Source: International Telecommunication Union (ITU)

2. Digital FDI into ASEAN
ASEAN’s governments have recognised the importance of the digital economy
as a driver of future growth. ASEAN countries have recently begun to build
more efficient communication networks, as well as digital infrastructure toserve as the backbone for the region’s transition to a digital economy. The
majority of ASEAN countries have signed contracts to develop their networks
or are already conducting network trials.
Many global telecommunications companies are involved in the ASEAN
5G roll-out by collaborating with local telecommunication companies in
the network’s construction. MNCs from Europe, ASEAN, and China are
actively involved in the development of ASEAN’s 5G infrastructure. Table 4
contains a list of MNCs investing in ASEAN countries’ 5G networks. Ericsson
45

Age of Ferment:
Developments in Asian–European Trade Relations(Sweden), Nokia (Finland), and Telenor (Norway) are major European
telecommunications MNCs involved in ASEAN’s 5G market; Huawei (China),
ZTE (China), and Samsung (Korea) are major players from Asia. Companies
involved in ASEAN’s 5G network are divided into four categories: equipment
and component suppliers, mobile phone companies, technology solutions
providers, and telecommunication infrastructure providers (Table 5).
Table 4: MNCs involved in ASEAN 5G roll-out
Local telecommunication
providers
Brunei
Cambodia

Huawei (China)
Viettel (Vietnam)

Huawei (China)

XL Axiata

Huawei (China) and Ericsson(Sweden)SmartfrenIndonesia

TelkomIndosat Ooredoo (Qatar)

Lao PDR

MyanmarPhilippines

Singapore46

ZTE (China)
ZTE (China)
Nokia (Finland)

Lao Telecom and Unitel(Vietnam)Axiata Group

Malaysia

Telecommunication MNCs

Maxis

Huawei (China) and Ericsson(Sweden)U Mobile

Huawei (China)

Ooredoo (Qatar)

ZTE (China)

Nokia (Finland)

Viettel (Vietnam)
Telenor (Norway) andEricsson (Sweden)
Globe Telecom

Huawei (China), Ericsson(Sweden), and Nokia (Finland)

Smart Communications

Huawei (China) and Ericsson(Sweden)SingtelEricsson (Sweden)

M1

Nokia (Finland)

Starhub

Nokia (Finland)

Section I.

Thailand

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEANAIS

Huawei (China), Ericsson(Sweden), Nokia (Finland),Samsung (Korea), and ZTE(China)True Corporation

Ericsson (Sweden), Nokia(Finland), and ZTE (China)

Total Access Communication Ericsson (Sweden) and Nokia(Finland)(DTAC)
VietnamViettelEricsson (Sweden) and Nokia(Sweden)Source: Adapted from ASEAN Secretariat (2021b)

Table 5: Types of 5G players in ASEAN
Type

Activity

ExamplesEquipment
andcomponent
suppliers

Production of 5G network
equipment, 5G chips for5G handsets and related
equipment

Huawei (China)
Mediate I (Taiwan)
Qualcomm (United States)
Samsung (Korea)

Mobilephone
companies

Involved with 5G
infrastructure, and provide
handsets that are 5G ready,with built-in 5G receptors
and transmitters

Apple (United States)
Ericsson (Sweden)
Samsung (Korea)
Nokia (Finland)
ZTE (China)

Technology
solutionsproviders

Involved with 5G
technology solutions andcommunication software

AT&T (United States)
Deutsche Telekom(Germany)
Ericsson (Sweden)
Huawei (China)
Nokia (Finland)

Telecommunication
infrastructure companies

Traditional
telecommunicationcompanies that provide
fixed and mobile
infrastructure, includinginternet connection

Axiata (Malaysia)
Ericsson (Sweden)
Huawei (China)
Nokia (Finland)
NTT (Japan)
Singtel (Singapore)47

Age of Ferment:
Developments in Asian–European Trade Relations
Source: ASEAN Secretariat (2021b)

ASEAN must continue to invest in 5G infrastructure, as the adoption of
the technology is expected to reach more than 225 million subscribers by
2025. ASEAN is expected to invest approximately 14 billion USD per year in
5G infrastructure between 2020 and 2025 to upgrade telecommunication
facilities, networks, and equipment to meet 5G requirements (A.T. Kearney,2019).

Digital Investment Promotion Policy for ASEAN’s Recovery
Given the importance of digital FDI in developing the digital economy and in
driving ASEAN’s growth in the post-pandemic period, the next step is to examine
which policies best encourage digital investment in the region.
Investment in digital infrastructure is mainly driven by demand-side factors.
Income levels, population size, economic growth, and educational levels are
all elements which make up demand and thus act as determinants of digital
infrastructure FDI. Governments can use policies to signal that their countries
are potential markets for the expansion of digital infrastructure. Privatisation,liberalisation, and FDI openness are examples of such policies (Table 6). Other
sector regulations, such as licencing requirements, spectrum rules, and publicprivate partnerships (PPP), also have an impact on investor decisions.
Furthermore, regulators can encourage investment in unprofitable areas bylowering deployment costs and making investment more appealing. In doingso, governments must balance between the public concerns raised by digitaltransformation, the interests of private investors, and the benefit for the country
at large. Licencing, for example, is required to promote competition and ensure
operating standards in order to protect broader digital business and consumer
interests (Table 7). This is due to the government’s important public service
responsibility of providing affordable internet access to all citizens (UNCTAD,
2017).

48

Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

Table 6: Policy determinants for investment in digital infrastructure and digital
firms
Digital infrastructure

Digital firms

Basic sector reforms and openness

Content rules and regulations• Privatisation• Privacy and data protection• Liberalisation• E-transactions and consumer
protection laws

• Independent regulator• FDI openness• Content restrictions• Copyright laws
• Intermediary liability rules• Applying traditional
telecommunication or media
regulators to online services• Data localisation laws

Sector regulations

Other regulatory areas• Licencing conditions• Mandatory source code disclosure• Spectrum rules• Regulations• Sector-specific taxes• Public-private partnerships (PPP)• Access to right of way• Local standards for equipment
Other support policies

Support policies• Streamlining import procedures
and rules for employing foreign
personnel• Innovation hubs

• Support for skills training• Regional coordination• E-government services• Crowdfunding• Venture capital

Source: UNCTAD (2017)49

Age of Ferment:
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Table 7: Development of digital infrastructure: balancing public policy andinvestor concerns
Selected
determinants

Public policy concerns

Basic sector reforms • State-owned incumbents
and openness• Public service responsibilities• National security

Licencing conditions • Competition• Operating standards (public
service responsibilities)• Public revenue

Investor concerns• Market access• Level playing
field• Regulatory
certainty• Investment costs• Flexibility
for businessdevelopment

Sector-specific taxes • Public revenue• Total cost to
customer• Return on (public) infrastructure
investment• Demandmaximisation

Local standards• Industrial development• Investment costs• Interoperability

Source: UNCTAD (2017)

Governments can attract foreign investors to set up local content and service
businesses by establishing innovation hubs, creating e-government services tosupport local developers and local data centres, and supporting venture capitalfunding. Regulations governing privacy and data protection, e-transactions andconsumer protection laws, as well as copyright laws all have an indirect impact
on online service investment (UNCTAD, 2017).
Policies aimed at attracting digital FDI into ASEAN can be grouped into three
categories: contextual policy, strategic investment policy, and policy tools to
remove bottlenecks (ASEAN Secretariat, 2021b). Policies at the contextual level
include cyberlaws, cybersecurity, data protection and privacy, and data residency,
all of which are important factors with an influence over investor decisions.
ASEAN is still in the early stages of developing privacy and cybersecurity laws, aswell as data governance, and progress is uneven across the region’s countries.
50Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

ASEAN has established some regional guidelines for developing such data privacy
laws—the ASEAN Framework on Personal Data Protection (2016) and the ASEAN
Framework on Digital Data Governance (2018). However, regional coherence isrequired to make the region attractive to investors, and this will only happen
if ASEAN’s countries are able to collaborate in the adoption of comparable
regulations, as well as in their implementation.
The second category is the strategic investment policy to attract FDI, which assistsin the development of enablers, and the enhancement of productive capacity.
ASEAN countries need to determine what kind of FDI to attract in order to build
digital infrastructure enablers. They must also consider which sectors of digitalequipment and solutions manufacturing offer them a competitive advantage inorder to become leaders in this field.
The third category includes policy tools for removing the region’s bottlenecks.
These specific policy measures address ASEAN’s bottlenecks that impede
the region’s digital transition, assist member countries in strengthening theircapacity, and make them more attractive to FDI (ASEAN Secretariat, 2021b). The
following are ten policy options for eliminating bottlenecks, as summarised by
the ASEAN Secretariat (2021b).
First, ASEAN should strengthen the regional digital ecosystem by attracting FDI.
This should be focused at improving digital infrastructure, manufacturing ofdigital equipment and technology solutions, as well as towards knowledge andtechnology-oriented R&D hubs and centres of excellence. Promoting PPPs is also
beneficial to digital infrastructure development.
Second, in order to prepare for inward FDI, governments should upgrade selectedindustrial parks or digitalise industrial parks to make them ready to attract digital
FDI.
Third, the important roles played by SMEs in the digital ecosystem should beconsidered. As SMEs expand their use of digital technology, the demand forsolutions and hardware will rise. This increased demand will attract foreign
investors seeking for a market to invest in ASEAN. They also serve as a support
industry for MNCs investing in ASEAN. As such, SME-friendly policies should be
implemented.
Fourth, because governments have public service responsibilities, they must
balance necessary regulation with innovation promotion. Policymakers should
develop regulations including cybersecurity and data protection to ensure
integrity of the digital system and to prevent cybercrime.

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Age of Ferment:
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Fifth, a significant challenge across the ASEAN region is a lack of digitally skilledhuman resources. The governments of ASEAN can remove this bottleneck by
attracting FDI in skills development centres and universities for Industry 4.0. Thismeans, for instance, incorporating digital technology into manufacturing andrelated industries, or into teaching; it can also involve MNC training and capacitybuilding.
At the regional level, there are five policy measures which ASEAN can implement tostrengthen the region’s digital development. ASEAN should consider establishinga regional skills development and resource centre, as well as supporting regional
cooperation in measuring Industry 4.0 progress, i.e. assessing firms’ digital
adoption rate and readiness to use digital technology in their production. ASEAN
can play a role in consolidating regulation and promotion measures for digital
investment, as well as compiling a list of related regional and national institutions
for members to use. Finally, regional institutions should be further strengthenedby broadening their role to include identifying and discussing investment policy
issues in order to attract digital FDI.

Conclusion
The COVID-19 pandemic has severely disrupted ASEAN’s economic activities.
The region has seen an economic slowdown, supply chain disruptions, and adecrease in FDI. However, digital economic activity has grown. When ASEAN
policymakers seek a post-pandemic recovery engine, digital investment could bea viable option.
ASEAN is one of the world’s major economies; however, it lags behind its peersin terms of reaping the benefits of digital advancement and becoming a fastgrowing digital economy. Thus, digital development is a must-have for ASEAN.
The regional digital economy has potential to grow due to a set of strong
fundamentals: a robust economy, a large and growing internet user base, ayoung population, increased ICT investment, and progress in regional economic
integration under the ASEAN Economic Community (AEC). However, there arebottlenecks that ASEAN has to overcome.
Digital FDI, which includes investment in digital infrastructure and digital firms,
has the potential to play a significant role in driving ASEAN’s economic growth in
the post-pandemic period. FDI inflows into the digital economy help to improve
digital competitiveness by developing digital infrastructure and stimulating
local content and service businesses. Governments must consider how to
encourage FDI, while also providing public services. As such, they must keep a52Section I.

DIGITAL INVESTMENT AND POST-PANDEMIC RECOVERY IN ASEAN

balance between investor benefits and digital inclusion by providing universal
and affordable access to all citizens. Digital technologies help in increasing
productivity, making supply chains more resilient, and providing alternativetrade channels.
Three groups of policy measures are proposed to ASEAN governments andpolicymakers in order to attract digital-focused FDI. The first group consists ofpolicies regarding regulations on privacy, cybersecurity, and data protection at
the national and regional levels. The second group of policies aims at attracting
FDI in sectors such as digital infrastructure enablers, equipment, and solutions
for the manufacturing sector, as well as improving regional productive capacity.
The final group consists of policies implemented at both the national andregional levels to address ASEAN’s bottlenecks in the digital ecosystem, digital
human resources and skills, progress measurement of digital development, anddigital promotion.

Sineenat SERMCHEEP is an Assistant Professor at the Faculty of Economics,
Chulalongkorn University, Thailand. She received her Ph.D. in Economics fromthe University of Utah. She was Associate Dean of the Faculty of Economics
at Chulalongkorn University and Director of Research Affairs, ASEAN Studies
Center, Chulalongkorn University. Her research interests include foreign direct
investment, digital economy, trade in services, economic integration, and ASEAN.

53

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56Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Rebooting South Asian Trade for
the Post-COVID-19 World
Srinivasan THIRUMALAI

Abstract
The COVID-19 outbreak dealt a severe blow to South Asian economies in 2020,
and the recovery is not yet complete. International trade can help expedite
recovery in South Asia if governments can step up to the challenge and reboot
their trade policies. The export of goods has experienced a swift recovery, evensurpassing pre-pandemic levels. This was helped largely by the pent-up demand
and restructuring of demand from services to goods. Once the pandemic ends,
the boost to demand may prove transient. International travel and tourism,
however, is continuing to languish below pre-pandemic levels. South Asian
countries should be pro-active, seizing new opportunities, including in the
trade of medical goods. First, COVID-19 era liberalisation measures should bemade permanent, and new barriers erected must be dismantled. Second, intraregional trade in South Asia must be fully tapped. Here, potential bilateral free
trade discussions could be hastened along between several partner country
pairs, including Bangladesh, India, Sri Lanka, and Nepal. Third, conclusions ofprotracted trade integration negotiations with dynamic trade areas, such as
between India and EU/UK, must be accelerated.

Rebooting South Asian Trade for the Post-COVID-19 WorldSouth Asian economies shrank in the wake of the global COVID-19 crisis of 2020,
although they got away lightly in terms of fatalities. Exports slumped initially,
as demand plunged and lockdowns choked production. The hope of a strong
rebound in 2021, predicted as late as March 2021, for South Asia has dimmed as
the more virulent second wave swept through the region, straining an alreadyweak health infrastructure and infecting people on a scale larger than the first. Sri
Lanka and Nepal have already experienced a third wave, with every subsequent
wave reaching higher peaks. In the first ten months of 2021, good progress wasmade with vaccination. Nearly 44% of the adult population in South Asia has
been fully vaccinated. With the difficulties of ramping up vaccine production
rapidly, unequal international access, limitations of the health infrastructure, and57

Age of Ferment:
Developments in Asian–European Trade Relations
vaccine hesitancy of the public rooted in illiteracy and culture, vaccinating thenearly two billion people of South Asia is going to be a big challenge that will test
governments.
However, the brightening prospects of global recovery—led by accommodative
monetary policies, fiscal support to firms and households, and rapid vaccination
rollouts in the advanced economies—provides an opportunity for South Asia
to increase exports of goods and commercial services. The spread of the deltavariant, followed by the very transmissible omicron variant has dampened
earlier hopes of speedy recovery. The International Monetary Fund (IMF) notesthat global recovery will continue into 2022 (IMF, 2021). During this time, South
Asian governments have stimulated their economies to the extent they thought
prudent. Sri Lanka and Bangladesh became net exporters of COVID-19-related
medical goods for 2020. Overall exports returned to pre-pandemic levels by thelast quarter of 2020, and a further significant rise was seen in India and Bangladesh
in 2021. Worker remittance inflows, which are critical for Nepal, Pakistan, andSri Lanka, also proved to be resilient, disproving dire predictions at the onsetof the crisis. However, international tourism revenues dried up, stressing the
economies of Nepal, Pakistan, and Sri Lanka. Sri Lanka was pushed into an
economic emergency at the end of August 2021 as its foreign reserves dwindled
rapidly. In the near-term post-COVID-19 world, the travel and tourism sector
will continue to languish for the second successive year as international tourists
keep away because of government-imposed travel, testing, and quarantine
restrictions. New migrant job opportunities will also be slow in returning to prepandemic levels, severely impacting countries like Nepal.
The bar of international competition has risen. Even in the pre-pandemic
world, strong performers in South Asia, such as India and Bangladesh, werefaltering relative to Vietnam. In India, although the foreign investment regime
is improving, reversals in tariff reforms and their slogan of self-reliance aresending mixed policy signals. Post-COVID-19 world trade is taking a different
shape, already jolted by the US-China trade war in 2019. The structure of world
trade, be it regarding products, services, or partners, is undergoing a numberof shifts, namely, the acceleration in digitalisation of commerce and services;the diversification of sourcing countries for critical products, such as semiconductors and life-saving pharmaceuticals; a United States (US) preference fordomestic products in government procurement; the reshaping of regional trade
agreements; and the adoption of net-zero carbon commitment goals by several
companies and countries.

58Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

The pandemic waves and vaccination progress in South Asia
The once-in-a-century pandemic started in the sub-continent in April 2020 andcontinues in waves with ever-higher peaks. With few options available, India
quickly imposed severe lockdown restrictions in April 2020. Nevertheless,
infection spread to a peak in September 2020 (Figure 1). With long and open
borders with India, infection in Nepal started to climb with a lag and surpassed
India’s by the time of traditional festivities in October 2020. The second Indian
wave in May 2021 with the more transmissible delta variant set a worrisome
new peak in India, again shortly followed by Nepal. In June 2021, Sri Lanka also
witnessed a surge in infections, followed by an even higher third peak in lateAugust 2021. In comparison, other countries in South Asia had smaller waves.
Figure 1. New confirmed cases of COVID-19 in South Asia

Source: Financial Times COVID-19 tracker charting tool: https://ig.ft.com/coronavirus-chart/?areas=eur&areas=usa&areas=bra&areas=gbr&areas=mys&areas=lka&areasRegion
al=usny&areasRegional=usla&areasRegional=usnd&areasRegional=usms&areasRegiona
l=usfl&areasRegional=ustn&cumulative=0&logScale=0&per100K=1&startDate=2020-0901&values=cases, accessed on 25 January 2022.

Mortality from COVID-19 has remained low in South Asia. Compared to the US,
with a mortality of 201 per 100,000 population, South Asian countries consideredhere ranged from 12.2 in Pakistan to 48 in Sri Lanka. Bhutan, meanwhile, does
not form a focus country in the analysis but had very low mortality rates, ata mere 0.4. The low mortality in South Asia is attributed by some to younger
59Age of Ferment:
Developments in Asian–European Trade Relations
populations and previous incidence of coronaviruses, such as severe acuterespiratory syndrome (SARS).
An inevitable result of lockdown policies is the inability, for those fortunate
enough to be employed, to get to work. This is a good measure of economic
activity, which generally requires people to move about. Google’s community
mobility for workplaces measures the frequency of visits and time spent at work
locations (Figure 2). Data for Bhutan and Sri Lanka were not available. Two clear
troughs of mobility are noted in April 2020 and May-June 2021. Again India and
Nepal, with their close links across a land border with free movement of peoples
stand out. Bangladesh work mobility is the least affected among the countries
compared, and as we shall see later, its GDP growth reflected this. Pakistan’s
workplace mobility also recovered gradually with no sharp second dip.
Figure 2. Work mobility percentage shifts compared to the pre-pandemic
baseline (30-day moving averages)

Source: Google LLC ‘Google COVID-19 Community Mobility Reports’: https://www.google.
com/covid19/mobility, accessed on 7 September 2021.
Notes: Mobility is measured by number of visitors and time spent at work locations; Sri
Lanka data are not available.

60Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Lasting recovery from the pandemic depends upon the progress of vaccination.
Luckily, India is the vaccine capital of the world, with private firm contract
manufacturing for the world’s big pharmaceutical companies. Vaccines for the
new virus were engineered in the US, United Kingdom (UK), and European Union(EU) and approved for emergency use in record time. India, China, and Russia
have also independently formulated vaccines. But production bottlenecks andvaccine nationalism have resulted in unequal access to vaccines, with nonproducing poor countries in South Asia having to wait their turn to buy doses, or
depending upon vaccine donations.
The first vaccine administered in India was on 16 January 2021; in the eightmonths that followed, good progress has been achieved in full vaccination (twodoses, where appropriate), as shown in Table 1. Bhutan and Sri Lanka are ahead,with Bangladesh trailing behind (Table 1). With vaccine production ramping
up world over, and with more manufacturers available, prospects for 2022
look better for poorer countries. India resumed its vaccine exports in October
2021, having achieved the milestone of administering one billion doses to its
population. However, several delays may occur, such as the emergence of newvariants of the virus or the preemptive allocation of vaccines to deliver booster
doses to those already vaccinated in the West.
Table 1. Percentage of population fully vaccinated in South Asia as ofNovember 2021
Country

Total percentage

Total percentage of 18+

Bhutan

73.4

100.0

Sri Lanka

62.9

91.8

Nepal

26.6

44.2

India

29.4

45.4

Pakistan

22.6

40.9

Bangladesh

20.9

32.8

Source: For vaccination https://coronavirus.jhu.edu/vaccines/international, accessed on
19 November 2021.
Source: For population structure https://population.un.org/wpp/Download/Standard/
Population/

61

Age of Ferment:
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South Asian GDP growth collapses in 2020 and recovery is slow anduncertain
The lockdowns necessitated by the rapid spread of the pandemic during thesecond quarter of 2020 shrank most South Asian economies. Back then, there
was extreme fear and uncertainty and neither vaccine nor cure. The quarterly
GDP series available from India and Sri Lanka shows the dramatic fall in overall
GDP growth during that quarter—a 22.4% drop in India and a 15.3% drop in
Sri Lanka. The ‘K-shape’ of the fall and recovery took root in that quarter. The
trade, transport, and hospitality sectors, in which many workers are informal
and transactions involve person-to-person contact, have suffered even greater
losses, and their recovery has been slower. India’s GDP in these highly vulnerable
sectors fell by 48% and has yet to recover to pre-pandemic levels. GDP in AprilJune 2021 was still 8% below its level two years before (National Statistical Office,2021). Fiscal and monetary policy accommodations by all governments helped
mitigate the misery, but there is limited capacity to do this. All the South Asian
economies recorded negative growth rates in the pandemic year, except for
Bangladesh where though growth rates halved, they remained positive at 3.9%.
India—the vaccine capital of the world—started its vaccination drive from January
2021. But the delta variant of the virus ravaged through South Asia in April-June,
dashing hopes of a rapid return to normality. Fortunately, although the deltamutant was more transmissible, it proved less deadly. Sri Lanka experienced athird wave of infections in late August 2021. Rapidly dwindling foreign exchange
reserves with no tourists and declining remittances forced Sri Lanka to declare an
economic emergency on 31 August 2021. The effect of the new omicron variant,and any further waves of infection this may bring to South Asian countries, isunpredictable, particularly until vaccinations reach a critical mass. The adverse
effects of the second and third waves manifested through 2021. GDP growth
slowly recovered in the period leading up to the onset of the second wave in all
the economies, but the vulnerable in-person service sectors are still trailing.

62Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Figure 3. GDP growth collapsed in 2020 and recovery is slow and uncertain

Percent, year
over year

INDIA
12.5
0
-12.5
-25
-37.5
-50

2019Q2 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1
GDP

Trade, Transport, Hotels, etc.

Source: Quick estimates released by Central Statistical Organisation, India, 31 May 2021.

RealAnnualgrowth,percent

PAKISTAN
5.0
2.5‘‘(2.5)‘(5.0)

2018-19F
GDP

2019-20R

2020-21P

Trade, Transport, Communication

Source: State Bank of Pakistan, accessed on 12 September 2021.
Notes: For Pakistan year suffixes F, R, and P refer to the Final, Revised, and Provisional
estimates.

BANGLADESH

GDP-All

GDP-Trade, Hotels, and Transport

Source: Central Bank of Bangladesh: https://www.bb.org.bd/econdata/nsdp/nsdp_
bb.php, accessed on 12 September 2021.

63Age of Ferment:
Developments in Asian–European Trade Relations

Percent per
year

NEPAL
5.3
1.8
-1.8
-5.3
GDP

GDP-Non Ag.

Note: Base year 2010-11
Source: Central Bureau of Statistics, March 2021

SRI LANKA
Percent, year
over year

5.0
0.0
-5.0
-10.0
-15.0
-20.0

GDP

GDP-Trade, Transport, Hotels

Source: Central Bank of Sri Lanka, https://www.cbsl.gov.lk/en/statistics/statistical-tables/,accessed on 12 September 2021.

Can international trade speed up South Asian recovery?
Pre-pandemic South Asia has been slow to reap the benefits of trade globalisation.
Countries in the region have been hesitant and slow to bring down trade barriers(Table 2). They lagged behind China and Vietnam in lowering barriers to tradein manufactured goods. Of the eight countries considered below (six fromSouth Asia, plus China, and Vietnam), the number of HS codes with the least
MFN tariffs, i.e. the number of commodities with the least tariffs, was highest in
Sri Lanka, China, and Vietnam. However, tariff rates are incomplete and can bemisleading indicators of trade barriers in the presence of paratariffs. Paratariffs
are duties that are levied on imports but not on domestic production. In SouthAsia, paratariffs (border charges and fees other than tariffs) present a significantly
higher barrier for trade (Kathuria, 2018). This is particularly true in Bangladesh,Pakistan, and Sri Lanka.
64Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Table 2. Import tariff barriers for manufactured goods in 2019
Country

Tariff rate

Count of Min

Sri Lanka

8.7

31

India

11.6

3

Pakistan

12.8

1

Nepal

13.2

1

Bangladesh

14.9

2

Bhutan22.1

1Comparators
China

6.9

24

Vietnam

9.9

13Notes:
1.

Tariff rate is the simple average of ‘MFN’ rates for 68 HS 2-digit sectors.

2.

Count of minimum is the number of HS 2-digit sectors where the country had
minimum tariff rates among the 8 countries listed.

3.

HS codes refer to the Harmonised Commodity Description and Coding System
which is an international standardised system for the classification of commodities
developed by the World Customs Organization.
MFN refers to the most-favoured nation tariffs, which are tariff rates a country applies
to imports from all WTO trading partners.

Source: TRAINS database hosted by the World Bank, accessed on 8 September 2021.

Over the last decade, South Asia has become less open to international trade.
The trade liberalisation reforms initiated in the 1990s opened the region tointernational trade. However, since 2011, trade barriers have risen, and as aconsequence, the trade-to-GDP ratio has been on a declining trend (Figure 3).
Moreover, only a third of the potential goods trade within South Asia has beentapped (Kathuria, 2018).
Figure 4. The declining merchandise trade-to-GDP ratio in South Asia

Source: https://data.worldbank.org/indicator/TG.VAL.TOTL.GD.ZS?contextual=default&
end=2020&locations=8S&start=1991&view=chart

65Age of Ferment:
Developments in Asian–European Trade Relations
Protectionism has also been rising in the US (the world’s largest importer)
because of the actual and perceived inequalities created by globalisation andthe inadequate remedies implemented to help affected workers. A peak within
this trend was the Trump trade war era, which mainly targeted China but spared
none. Bangladesh, meanwhile, lost its preferential tariff Generalised System ofPreferences (GSP) status regarding access to the US market1 in 2013 and India
in 2019. Under the US GSP, a selected list of products entered the US dutyfree. These trends were further exacerbated by the pandemic, which stoked
nationalistic responses in all countries with a view to protect their citizens. All
South Asian countries placed curbs on exports of COVID-19 medical goods
they produced and liberalised imports of COVID-19 medical goods that were in
short supply in their economies. Trade actions by South Asian countries spikedin 2020 and continued up until September 2021. From the point of view of therest of the world, actions by individual countries can be viewed as liberalising or
harmful.2 Though ensuring enough supply of COVID-19 medical goods motivatedmost of the trade actions, other products were also affected. During 2020, trade
restrictions increased to 200, more than doubling from pre-pandemic levels in
2019. India, Pakistan, and Sri Lanka took most of the adverse trade actions within
South Asia. Liberalising trade actions, undertaken by all countries in the region,
almost tripled to 117.
Figure 4. Number of trade actions by South Asian countries, March 2019 to
September 2021.

LiberalisingHarmful

Source: https://www.globaltradealert.org/, accessed on 12 September 2021

66

1

For more information on GSP, visit the website of the Office of the United States
Trade Representative: https://ustr.gov/issue-areas/trade-development/preferenceprograms/generalized-system-preference-gsp.

2

Subsequent trend is showing a decline in both liberalising and harmful interventions.

Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

The direct and critical contribution of trade to recovery from COVID-19
Despite the surge in trade restrictions in the wake of COVID-19, South Asian
exports contributed to global recovery. Comparing medical goods export levelsof South Asian countries’, looking at pre-pandemic 2019 levels and those of 2020,
Sri Lanka exported the most COVID-19-related medical goods to the world after
the outbreak of the pandemic (Table 3). Most of Sri Lanka’s exports were medical
supplies and personal protection equipment (PPE). Bangladesh and Pakistan
also exported more PPE. India exported medications related to COVID-19.
Table 3. Change in COVID-19-related medical goods exports to world, 2020
compared with 2019
BanglaBhutan
desh

India

Nepal

Pakistan

Sri
Lanka

South
Asian
Region(SAR)

Medicines

-6.6

.0

99.1

2.8

-8.8

.3

86.8

MedicalSupplies

-6.8

-.1

-58.3

.1

-98.8

105.6

-58.2

MedicalEquipment

.5

.1

-10.0

-.1

-44.4

8.6

-45.3

PPE

89.3

.1

-45.8

-5.0

78.3

141.6

258.6

All
COVID-19
Supplies

76.4

.1

-14.9

-2.1

-73.6

256.1

241.9

(USD million)
Notes: Identification of COVID-19-related medical goods is done at HS 6-digit
using WTO reports.
Source: UN COMTRADE database through World Bank’s WITS interface, accessedon 8 September 2021.
Just as exports of some of these goods helped the region’s economies, importsof other COVID-19-related medical goods helped people in South Asia to recover.
The medical goods sector saw a rapid flurry of liberalising interventions to ease
the import of critical supplies in order to save lives.3 An additional 500 million USD
worth of critical supplies were imported into South Asia (Table 4). India’s imports

3

A total of 36 liberalising interventions targeted the medical goods sector in 2020:
India 26, Pakistan 7, Nepal 2, and Bangladesh (Globaltradealert, 2020).

67Age of Ferment:
Developments in Asian–European Trade Relationsof medicines and medical supplies soared by 470 million USD. Considering thatthe spread of the pandemic in the region was first spotted in India and thenspread to others, the countries imported medical goods at different times of theyear.
Overall, trade played a pivotal role in coping with the COVID-19 outbreak. India isa known vaccine manufacturing leader, yet its ability to supply to the world waslimited by the urgency to protect its population first. Sri Lanka and Bangladesh,with their comparative advantage in textile manufacturing, were able to export
some related medical supplies and PPE. Employment in these sectors was
sustained by the demand for PPE even as the demand for apparels slowed. India
was a net exporter of medicines, and Sri Lanka was a net exporter of medical
supplies before and after COVID-19. Sri Lanka increased its net exports of medical
supplies between 2019 and 2020.
Table 4. Change in COVID-19-related medical goods imports from world, 2020
compared with 2019
Bangla- Bhutan
desh

India

Nepal

Pakistan

Sri
Lanka

SAR

Medicines

-11.0

4.0

234.7

-22.9

-16.9

28.0

215.9

MedicalSupplies

45.8

4.2

245.6

18.5

59.2

20.4

393.6

MedicalEquipment

-42.2

-6.8

-207.0

9.1

14.6

-36.6

-269.0

PPE

38.0

1.8

15.2

26.2

55.9

23.0

160.0

All
COVID-19
Supplies

30.6

3.2

288.4

30.9

112.7

34.8

500.5

(USD million)
Notes: Identification of COVID-19-related medical goods is done at HS 6-digit using WTO
reports.
Source: UN COMTRADE database through World Bank’s WITS interface, accessed on 8
September 2021.

68Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Exports have recovered to pre-pandemic levels
Overall exports recovered to pre-pandemic levels by the third quarter of 2020
everywhere in South Asia. In the first half of 2021, exports surpassed their prepandemic levels. This post-pandemic recovery is faster in exports than in realGDP, which shows the importance of export-oriented sectors (both formal andinformal) in aiding recovery.4 This pattern of recovery is also seen for labourintensive manufactures, where work is often informal. However, India’s appareland footwear exports (which may be taken as a proxy for labour-intensive
manufactures in general), appear to be on a down-trend, to below pre-pandemic
levels. This pattern of recovery in overall South Asian exports echoes the strengthof recovery of world trade as a whole (WTO, 2021). Accommodative fiscal andmonetary policies in several countries, the fast vaccination of adults in theWestern world, and the rebound in China have all helped world trade to recover.
Figure 5. Exports have recovered to pre-pandemic levels
All Exports

Labour-intensive

USD billion

USD billion

India

USD million

USD million

Pakistan4

For instance, India’s nominal GDP in 2021Q2 was only 1% higher than in 2019Q2. But
India’s exports in the same quarter was up 18%.

69

Age of Ferment:
Developments in Asian–European Trade Relations

USD billion

Bangladesh5

USD million

USD million

Nepal

USD million

USD million

Sri Lanka

Source: Central Bank statistical bulletins, accessed on 12 September 2021.

Resilient remittance inflows
Worker remittance inflows are very important for several South Asian countries.
For half a century since the oil crisis of the early 1970s, both skilled and unskilledworkers from South Asia have migrated abroad to work. Remittance inflows haveexceeded the sum of official aid, of net financial flows, as well as of net FDI—and
have proved much less fickle. Nepal has the highest inflows—at 25% of GDP.
Pakistan and Sri Lanka follow, at close to 10% of GDP. Bangladesh and India haveproportionately lower sums, at 6 and 3%, respectively (WTO, 2020).

570

For Bangladesh, since most of its exports are labour-intensive apparels, no separate
chart is shown.

Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Belying forecast decline at the onset of the COVID-19 crisis, remittance inflows
have proved to be resilient. In all South Asian countries considered, excepting
India, inflows during the first quarter of 2021 exceeded those of 2019 and 2020.
There could be several motivations for migrants to continue sending money
home. One possibility is the desire to support family members going through a
job and financial crisis at home, while they themselves were left stranded at work
locations because of the sudden cessation of air travel. It is also worth notingthat several host governments, such as the United Arab Emirates (UAE) and
Qatar, were benevolent towards migrant workers, while still fiscally stimulating
their own economies.
Figure 6. Worker remittance inflows

USD million

INDIA

USD million

PAKISTAN

71

Age of Ferment:
Developments in Asian–European Trade Relations

USD billion

BANGLADESH

USD million

NEPAL

USD million

SRI LANKA

Source: Central Bank statistical bulletins, accessed on 12 September 2021.

International tourism has stalled in South Asia
Since the outbreak of the virus, international travel has been severely restricted.
The World Tourism Organization notes that there was a decline of 74% in inbound tourism worldwide, in 2020. For 2021, the period from January to May also
showed a decline of 65%, compared to the same period over the previous year.
The decline in travel to developing country destinations is even stronger due
to lagging vaccination and fewer available flights. In South Asia, dependence on
tourism is higher in Maldives and the mountainous Bhutan and Nepal.
72Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Figure 7. Share of international tourism to exports, 2019

Source: World Tourism Barometer, May 2021, World Tourism Organization.

Focusing on Nepal and Sri Lanka, tourism revenues have pretty much dried up
since the COVID-19 outbreak, causing the collapse of dependent industries oftravel, hotels, restaurants, shops, and entertainment. The revival of international
travel for tourism is now deferred for the second successive year, and it is notclear when it will resume.
Figure 8. International tourism revenues dry up

USD million

NEPAL

73

Age of Ferment:
Developments in Asian–European Trade Relations

USD million

SRI LANKA

Source: Nepal Rashtra Bank, https://www.nrb.org.np/category/economicbulletin/?department=red, accessed on 13 September 2021; Central Bank of Sri Lanka, https://www.cbsl.gov.lk/en/statistics/statistical-tables/, accessed on 12 September 2021.

Conclusion
In conclusion, international trade can help in post-pandemic recovery in South
Asia if governments are able to step up to the challenge and reboot trade
policies. Exports have staged a faster recovery and surpassed pre-pandemic
levels, helped largely by world trade momentum feeding pent-up demand.
There has been a restructuring of demand from services to goods, as in-person
contact services have suffered. However, once the pandemic ends, the boost
to demand may prove transient. South Asian countries should be pro-active,
seizing new opportunities, and taking measures to ensure their permanence,
instead of reacting hesitantly. First, COVID-19 era liberalisation measures should
be made permanent, and new barriers erected must be dismantled. Second,
intra-regional trade in South Asia must be tapped fully—here, potential bilateralfree trade discussions could be hastened between a number of partner country
pairs, including Bangladesh, India, Sri Lanka, and Nepal. Third, conclusions ofprotracted free trade agreement negotiations with dynamic trade areas, such as
between India and the EU/UK, must be accelerated.

74Section I.

REBOOTING SOUTH ASIAN TRADE FOR THE POST-COVID-19 WORLD

Srinivasan G. THIRUMALAI is an economist specialising in trade, poverty,
and macroeconomics. He is currently a senior visiting fellow at the Centre for
Policy Research, New Delhi, India. Prior to this, he worked at the World Bank inWashington, DC, as a senior economist, as well as in the role of country economist
for Jordan, Yemen, Afghanistan, and Bhutan. He has also been a consultant
economist for Oman’s Ministry of Finance. Thirumalai’s most recent trade work
has focused on the poverty impacts of cross-border trade and the strengths ofcross-border manufacturing supply chains in South Asia. He has worked on anumber of trade and investment policy issues affecting East Asia, the Middle East,and North Africa, including China’s accession to the WTO and the MFA abolition.
In poverty analysis, he has led poverty assessments for Jordan, Yemen, Bhutan,
and Nepal. Additionally, he has worked on a number of development issues fora great variety of countries in the Middle East and North Africa such as Jordan,
Yemen, Oman, Lebanon, Egypt, and Libya. In South Asia, his contributions havefocused on India, Pakistan, Afghanistan, Sri Lanka, Nepal, and Bhutan.

75

Age of Ferment:
Developments in Asian–European Trade Relations

References
Global Trade Alert. (2021). Retrieved from https://www.globaltradealert.org/
International Monetary Fund. (2021). World Economic Outlook.
Kathuria, Sanjay. (2018). A glass half full: The promise of regional trade in South
Asia. South Asia Development Forum Washington, DC, World Bank.
National Statistical Office. (2021). Press note on estimates of GDP for Q1 20212022. Ministry of Statistics and Programme Implementation: Government ofIndia. Retrieved from https://static.pib.gov.in/WriteReadData/specificdocs/
documents/2021/aug/doc202183111.pdf
World Bank. (2020). Migration and remittances data. Retrieved from https://www.worldbank.org/en/topic/migrationremittancesdiasporaissues/brief/migration-remittancesdata
World Trade Organization. (2021). Goods trade barometer. World Trade Barometer.
Retrieved from https://www.wto.org/english/news_e/news21_e/wtoi_18au
g21_e.pdf

76Section I.

SRI LANKA’S APPAREL INDUSTRY

Sri Lanka’s Apparel Industry:
COVID-19 Impacts, Resilience, andRecoveryAnushka WIJESINHA

Abstract
The article discusses the ‘triple shock’ impact of COVID-19 on Sri Lanka’s apparelsector, as well as the industry’s efforts towards achieving resilience, including
pivoting manufacturing to personal protective equipment (PPE) and partneringwith government authorities to ease supply constraints. Further explored are
the emerging trends and implications for the sector’s resilience and growth,anchored on supply-chain restructuring, agile production, sustainability, andinnovation.

The onset of the coronavirus pandemic around the world in late 2019 and early2020 impacted the production, distribution, and consumption of many products,
including manufactured products like apparel. As the International Labour
Organization (ILO) noted, unlike earlier crises, the current one has been wideranging: all kinds of activities across the value chain have collapsed; up- anddown-streams have been damaged; apparel and raw materials suppliers havesuffered; and naturally this has also adversely affected brands, retailers, buyers,
employees, workers, and consumers (ILO, 2020).
In Sri Lanka, exports were particularly impacted with the onset of the pandemic
and the local lockdowns resulting from it in February and March 2020. According
to a survey on trade and labour market impacts of COVID-19 on the exportindustry by the Ceylon Chamber of Commerce (2020), three key challenges thatexport firms faced at the height of the crisis were (1) difficulties in the continuationof overall business operations, (2) lack of operational cash flow, and (3) decline inproduction or productivity due to working from home or termination of workers(CCC, 2020).
The fallout of the pandemic in major markets like the US, EU, and UK spilled overto Sri Lanka, weakening consumption demand, especially for textile and wearing
apparel-related manufacturing activities. The disruptions in global supply
chains, and the shortages of raw materials (along with poor local availability of77

Age of Ferment:
Developments in Asian–European Trade Relations
substitutes), coupled with labour shortages due to lockdowns and quarantine
regulations, adversely affected export manufacturing in 2020.
Among export sectors in the country, apparel exports is one of the most significant
contributors to the economy. The industry has recorded substantial growth levels
over the past four decades and is currently the country’s leading export sector,
accounting for 40 to 45% on average of total exports each year. Additionally, thesector employs over 300,000 people, accounting for approximately one-third of
the manufacturing jobs in the country. The industry is entirely privately owned
and has been successful in capturing a substantial share of the international
market.
According to the Central Bank Annual Report 2020, the manufacture of wearing
apparel recorded a contraction of 30.8% in 2020, compared to a growth of 1.9%
recorded in 2019 (CBSL, 2020). There has been a recovery in demand since thendue to a rise in orders for personal protective equipment (PPE) and also dueto the recovery of consumption in key markets further to the steady rollout ofvaccines.
This paper will first review the background and evolution of the apparel industry
in Sri Lanka, highlighting recent trade performance, and will thereafter discuss
the COVID-19 impacts on the sector. Various measures adopted to help boost thesector’s resilience and recovery will be considered, as will key emerging trends
shaping the sector’s future.

Sri Lanka’s Apparel Industry: Background and Evolution
The apparel industry is, today, Sri Lanka’s leading manufacturing export sector. It
was one of the first sectors to benefit from the economic liberalisation of 1977.
Following the trade opening and the first wave of reforms that year, Sri Lanka
attracted many East Asian garment exporters; encouraged by the country’s
liberal-trade regime, they relocated their already well-established garment
businesses to Sri Lanka. Initially, the investors were quota-hopping firms locatingin the country so as to take advantage of the Multifibre Agreement that offeredpreferential access to key markets in the West. Subsequently, local entrepreneurs
partnered with these firms and also set up their own enterprises to exploit
markets guaranteed by quotas, spurred on by incentives granted by the Sri
Lankan government. The 200-garment factory programme of the government at
the time encouraged the establishment of factories in many parts of the country,
providing jobs to over 300,000 workers directly and to many more indirectly. In
this way, for over three decades now, Sri Lankan apparel manufacturers havebecome world class, supplying global brands such as Nike, M&S, Hugo Boss, GAP,
78

Section I.

SRI LANKA’S APPAREL INDUSTRY

Next, Abercrombie & Fitch, L brands, PVH, Intimissimi, Decathlon, Uniqlo, George,
Lidl, and so forth. The industry is known for upholding high ethical practices,eschewing child and forced labour, implementing environmental sustainability
initiatives, and thus being known to the world as a producer of ‘garments without
guilt’ (EDB, 2015).
There are now over 300 manufacturers in the industry, with varying sizes andlevels of sophistication. Several have moved significantly up the value chain
and now engage in research and development (R&D), design, and innovation incollaboration with leading brands. In 2009, Nike partnered with Sri Lanka’s MAS
Active, the sports and active-wear division of industry leader MAS Holdings, toset up its global Apparel Innovation and Training Centre in Thulhiriya, Sri Lanka,
and went on to develop the flyknit technology for their sports shoes. Leading Sri
Lankan firms like Brandix, MAS, Hirdaramani, and Hela have invested in dozens ofplants overseas as well. Some have engaged in forward integration by launchingretail brands in large consumer markets, like India. Firms also now engage inhigh-tech clothing innovation—in the wearable-technology space, for instance—
establishing outfits in global hubs like San Francisco. For example, Flex, a large
electronics manufacturer for global brands across industries from health care toautomotive, partnered with MAS to develop new technologies and products inthe nexus between wearable technology and apparel (Flex, 2016).

Apparel Sector’s Recent Trade Performance
Table 1. Industry data on exports of apparel 2018–2021 (first quarter)
Year

2018

2019

2020

2021(f)

2021—Q1

Value (inBillion USD)

5.0

5.3

4.1

5.1*

1.2

Note: f = forecast* Forecast before the onset of the third wave of COVID-19 and associated lockdowns since
May 2021
Source: Joint Apparel Association Forum Sri Lanka

Over the last decade, Sri Lanka’s apparel exports had been steadily rising, from3,985 million USD in 2011 to a peak of 5,206 million USD in 2019. As noted earlier,apparel exporters are the standout contributor to the country’s merchandise
exports, accounting for a share of around 45% on average over the past decade.
The key markets for Sri Lankan apparels are the United States (US), the United
Kingdom (UK), and the European Union (EU), amounting to close to 60% of all79

Age of Ferment:
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apparel exports (with the US as by far the largest, followed by the UK). Exports tothe EU had been on a steady upswing, following the regaining of the preferential
tariff system known as Generalised Scheme of Preferences Plus (GSP+) in mid2017. Commodities under HS Chapter 61 and 62, in particular, saw strong growthover the years.1 The GSP+ concession resulted in significant tariff reductions forapparel export products to the EU, with the rate coming down from a range of
5.2%, to 9.6%, to zero. This growth continued robustly until COVID-19 causeddemand to collapse in 2020.

COVID-19 Impacts
Following the onset of the pandemic in the latter part of 2020’s first quarter,
exports during the year reached 1,150 million USD between March and December
2020, a 26% drop compared to the same period in 2019. This was somewhat
less adverse than early estimates of the drop in orders, and was attributed to
the recovery in the second half of 2020 due to increasing orders for PPE. For
the full year, apparel export earnings declined by 23% in 2020, as compared to
2019. According to the Central Bank of Sri Lanka (CBSL), the wearing-apparel
manufacturing sub-sector (within the industry sector) contracted by 30.8% in
2020, compared to a growth of 1.9% in 2019. More recent data show that export
earnings from January to April 2021 had recovered to 1,598 million USD, nearlymatching 2018 levels, albeit still below those of 2019.
The COVID-19 pandemic hit the industry in a number of ways over the courseof 2020. The sector experienced a triple shock. First, a supply shock due to therapid spread of the coronavirus in China, and the ensuing shutdown of their
manufacturing and logistics facilities, which affected Sri Lanka’s supply of raw
materials like fabrics, trimmings, and accessories. This was significant, as Sri
Lanka’s apparel industry imports over 30% of its fabric from China, and by
February, local apparel manufacturers feared going out of work temporarily andlosing orders due to supply-chain disruptions.
The second shock was the domestic-production shock, due to the countrywide
curfew that was imposed from mid-March. Factories were closed, transport
was restricted, and workers were not permitted to get to work. Subsequently,
in the latter part of the curfew period, some relaxation of restrictions for export

180

HS 61 and HS 62 refer to the chapters relating to apparels under the global Harmonised
System (HS) of commodity classification. HS 61 is for ‘articles of apparel and clothing
accessories in knitted or crocheted’ and HS 62 is for ‘articles of apparel and clothing
accessories not knitted or crocheted’.

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industries like apparel occurred; this was due to the recognition of the impact
on export orders and foreign earnings. Nonetheless, the industry still operated
below capacity due to government-imposed health restrictions.
Third, was the external demand shock due to the rapid spread of the virus, highdeath rate, and lockdowns across the US, UK, and EU—Sri Lanka’s primarymarkets. In the US alone (Sri Lanka’s single largest export market), the sales inclothing stores declined by 79% in April 2020, compared to March 2020. Due toexcess inventory at the retailers’ end, both buyers and brands had to cancel their
ongoing and future orders while applying the contract clause of force majeure.
The export results of March, April, and May 2020 demonstrate that the impactsof this triple shock were felt almost immediately. Total apparel exports in thosemonths collapsed year-over-year by 41, 82, and 49%, respectively, to 299 million
USD, 60 million USD, and 205 million USD. In April 2020, exports to both the EU
and US collapsed to 26 million USD, each, equivalent to approximately 18.5% of
the usual figure for the month for the EU, and 17% for the US.
With lower consumer spending in the affected markets, buyers were cancellingorders, refusing to accept shipments, and unilaterally extending the payment
terms. This naturally affected the cash flow of firms (Just Style, 2020), as wellas their ability to pay suppliers and wages, especially in the case of small andmedium enterprises (SMEs). Local manufacturers supplying buyers faced severe
delays in receiving payments. A recent report (Moazzem et al., 2021) noted thatpayment terms, which were usually extended from 30 to 45 days pre-pandemic,
had to be stretched to around 150 days, severely affecting liquidity across theapparel value chain, especially that of small- and medium-sized manufacturers,
which typically have thin cash reserves.
Industry interviews suggest that in that early period of curfew in 2020, Sri Lanka
lost new orders to competitor countries like Vietnam and Cambodia, which
continued to operate. However, Sri Lanka also won other orders that were being
diverted from countries like Bangladesh, where the health situation at the time
was even more severe.
During the latter half of 2020, there were some signs of a recovery; during JulySeptember, the monthly gap between the profits of 2020, as compared to thoseof 2019, was narrowing to between 2-12%. However, with the outbreak of a sharp
second wave in October, which hit apparel factories and workers particularly
hard, exports once again saw year-over-year declines of 20 and 35%, in Octoberand November, respectively.
By early 2021, the sector saw stronger recovery and rebound. For data available
up to April 2021 from the Apparel Exporters Association, exports to the EU under81Age of Ferment:
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HS Chapter 61 had exceeded that of all previous similar periods. HS Chapter 62
recovered only modestly during January to April compared to the same period
in 2020 and was still around 30% below the average in pre-COVID years. Exports
to the US, on the other hand, did not show a similar recovery trajectory. By April
2021, exports of HS Chapter 61 had recovered to around similar levels as thesame period in 2017, of 373.25 million USD, while HS Chapter 62 showed little
recovery compared to the same period in 2020.
According to the director of a leading manufacturer,
Although we envisage a reduction in the existing order pattern with end
market store closures in the US and EU during the next six months to ayear where most of our strategic customers are based, it is a possibility
that there will be potential from the PPE wear and new customers basedon the existing capabilities of the company. (Teejay Lanka PLC, 2020)
An industry stakeholder noted that demand from existing strategic customers—
via supermarket chains and online outlets—have seen significant growth in sales
even in a COVID-19 environment in both the US and EU. They acknowledge,
however, that margins will remain significantly challenged. Indeed, industry
interviews conducted between May to June 2021 suggest that Sri Lankan
manufacturers are facing tight margins amidst intense price competition frommanufacturers in other countries, which are now fighting to regain the market
share they lost during much of 2020 and early 2021 when the pandemic wasravaging their economies.
Impacts on livelihoods and employment
When considering the impacts of COVID-19 on the apparel sector, one cannot
ignore those felt by the workers. Moazzem et al. (2021) drew from a survey of
40 workers to show that among the 70% of whom were machine operators,
disruptive shocks to the supply chain had substantially impacted their incomes.
During the first lockdown in Sri Lanka (March to June 2020), 67% of the workers
surveyed said they had been temporarily retrenched, leading to severe income
impacts. Among the interviewed workers, 64% reported an increase in their debt
obligations in September 2020, compared to December 2019. There were 79% offemale workers and 66% of male workers who had been forced to sell their assets
or spend their savings to survive during this period. Among the measures they
took was pawning jewellery. This was considered especially troubling because
only 15% of those surveyed belonged to a social-protection programme. Most of
the workers had no effective safety net. It was revealed that some preliminary
discussions had taken place between the Ministry of Skills Development,
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Employment, and Labour Relations and the ILO aimed at establishing a socialand employment protection programme. However, this policy had not been
implemented.

Support for the Sector’s Resilience and Recovery: Fiscal andMonetary
Unlike in many other countries in the Asian region, Sri Lankan authorities did notprovide any specific fiscal stimulus to manage the economic fallout of COVID-19,
either at a macroeconomic level, or specifically targeted to the apparel sector.
The limited revenues (due to sweeping tax cuts introduced in December 2019
following the election of a new President), and an already ballooned budget
deficit, meant that the government did not have the fiscal space to provide any
firm- or worker-oriented relief.
However, there was a concerted effort to provide financial relief and support toenable the sector’s resilience and recovery by way of banking sector policies. The
Treasury and Central Bank introduced reduced-interest loan schemes, special
refinancing windows for working capital, and debt moratoria to help industries
tide over the COVID-19 impacts, and apparel firms also benefited from theseconcessions. According to internal reports from selected commercial banks, thenonperforming loans (NPL) ratio in the sector amounted to around 8% of total
sector exposure, which was only slightly above the NPL average across their
entire portfolios.
Of course, an important caveat to note here is that the financial-assistanceprogrammes extended by the government, the Central Bank, and the commercial
banks were directed at firms in general, and not to the apparel sector in particular.
Although there were some instances of specific lines of credit being made available
by banks to help apparel firms meet urgent production needs, specifically for
PPE manufacture. For example, the Sri Lankan unit of the global bank Standard
Chartered extended a 12 million USD credit line to apparel exporter Brandix (forPPE manufacturers at their Sri Lankan and Indian plants) under the bank’s global
1 billion USD COVID-19 financing facility (Standard Chartered, 2020).
The apparel sector’s prospects are also worth considering from the risk
perspective of banks. Slow growth is forecasted, but with a ‘positive outlook’,
judging from an interview with a major commercial bank to assess the forwardlooking risk appetite for lending to this sector. The chief risk officer of the bankfurther observed that,83Age of Ferment:
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The current demand for apparel exports is driven quite a bit by PPE
and the demand for PPE may see a reduction in line with the global
vaccination process. Considering the current market/demand dynamics,
it would be prudent for banks to closely monitor the order books of
the respective customers and to analyse the composition to ascertain
whether their regular orders (from the regular buyers) are re-instated.
(Personal communication, 2 June 2021)

Support for the Sector’s Resilience and Recovery: Strategic andOperational
There was a strong private-public partnership effort to help the sector weather
the impacts of each of the shocks. Regarding the supply shock, a joint effort
was launched between the Sri Lanka Export Development Board, the Ministryof Foreign Affairs (commercial attachés in overseas missions), and the apex
industry association, Joint Apparel Associations Forum (JAAF), to address sourcing
constraints. The head of the foreign ministry’s Economic Diplomacy Programme
noted that,At the request of the Joint Apparel Forum of Sri Lanka (JAAF), the Ministry
together with the Sri Lankan Missions have successfully coordinatedsourcing raw materials for the production of PPE, thus catering to therising demand from many countries. 53 potential suppliers for specificraw materials were identified (Economynext, 11 June 2020).
Meanwhile, to counter the domestic-production shock, the Board of Investment(which manages the export-processing zones, where most apparel industries arelocated), together with the Export Development Board and the Presidential Task
Force on COVID-19, worked on easing the curfew conditions for the industry.
As such, apparel-sector workers were permitted to return to work despite thecurfew, factories were permitted to operate at reduced capacity, and publichealth inspectors advised establishments on how to adjust work layouts inorder to meet physical-distancing guidelines. Even during the second and third
lockdowns (October to November 2020, and April to May 2021), the authorities
facilitated the operations of export industries in general and of the apparelindustry in particular. However, there was criticism that this came at the expenseof worker welfare. Large numbers of COVID-19 patients were observed among
apparel-sector workers (including a prominent apparel factory being the starting
point of a massive new cluster in October 2020), and there were substantial
delays in rolling out the vaccines to these workers, despite the expectation thatthey return to work.
84Section I.

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Finally, as relates to the external-demand shock, the short term focus was topivot to the manufacturing of PPE, as part of a larger programme initiated by
the government to respond to the collapse in demand for exports (Ministry ofForeign Relations, 2020). Since the COVID-19 outbreak, the global supply chain for
PPE has not been able to adequately cope with the surge in worldwide demand.
Constraints in supply and logistics, including export bans on PPE and materials,
have contributed to a global shortage of PPE. This was exacerbated by abrupt
supply disruptions in China, a major producer of PPE.
As early as May 2020, Brandix, one of the country largest apparel exporters, had
pivoted around 9,000 of its 30,000 workers in Sri Lanka to the manufacture ofPPE (and was due to increase this share to 50% of its workforce). It was one of thefirst to ship 200 million face masks to the US, and ramp up factory production for
PPE manufacture (Economynext, 2020b). Brandix took a factory that made fabricfor lingerie and other apparel, and reoriented it to mask production.
According to a survey done by the author in May 2020, other manufacturers had
also begun pivoting their manufacturing to PPE so as to sustain their operations,or were planning to produce PPE in the near future. The orders for PPE were also
being subcontracted to smaller-scale producers.
However, while Sri Lanka has emerged over the years as a leading supplier of
ethically manufactured high-quality apparel for global fashion brands, successfully
exporting to the US and EU, the industry had no prior experience in producing
and exporting PPE in compliance with stringent regulations governing medical
devices in the US market. As such, a number of exporters belonging to the JAAF
were interested in exploring export opportunities of PPE to the US market (thelargest market for PPE at the time) but were finding it difficult to understand andnavigate US Food and Drug Administration (FDA) regulations governing PPE. This
includes, for instance, the emergency use authorization (EUA) and how to obtain
FDA approval for medical devices. Similarly, the industry is neither well-versedwith US federal and state government procurement processes, nor with US
distribution channels of PPE.
The industry began sharing available best practices for the manufacture of PPE(obtained from online sources) through JAAF and other informal channels, butmore reliable and detailed information was still required, especially with regard
to medical devices. A donor-supported project at the time invited commercial
experts from the US to provide detailed guidance to the industry—throughonline consultations and guidebooks—both on how to obtain FDA approval andon how to navigate federal and state procurement processes (USAID, 2020). Postprogramme feedback showed that while a majority of participants who joined85

Age of Ferment:
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the programme had some prior awareness of the regulatory landscape, theirknowledge substantially improved afterwards, and a high number reported being‘more confident about exporting PPE to the United States’ after the programme.
The survey also showed that the majority were focusing on production and exportof so-called class 1 products, as these do not require FDA premarket review andcompliance registration is quicker and easier.
The latest data suggests that the surge in demand for PPE has now passed, thatexport restrictions imposed by the US, the UK, the EU, and China have been
lifted, and that market conditions are normalising. Although the demand for PPE
will not entirely abate and annual demand growth from 2022 to 2025 is forecast
at 6 to 9% (IFC, 2021). To be sure, Sri Lankan apparel exporters had not seen PPE
manufacturing as a longer-term focus. By mid-2021, most Sri Lankan apparel
manufacturers had moved away from the earlier pivot and reverted to their usual
product segments. Although some smaller manufacturers continue to produce
PPE for the domestic market.

Emerging Trends and Implications for Sri Lanka
The pandemic accelerated trends that were in motion prior to the crisis, andthese point to the direction in which the Sri Lankan apparel industry ought tohead. As acknowledged by the Organisation for Economic Co-operation andDevelopment (OECD), successful risk-management strategies at the firm level
include an ‘emphasis on risk awareness, greater transparency in the value
chain, and promoting agility’ (OECD, 2020, p. 2). Meanwhile, as noted by a Sri
Lankan stock exchange–listed fabric maker, ‘the primary driver of retail growth
remains digital channels, while heightened focus on environmental sustainability
and social justice has led to increased demand for greater accountability andtransparency’ (Hayleys Fabric PLC, 2021). These comments highlight some ofthese trends, which the following sub-sections will explore, along with theirimplications for Sri Lanka.
Supply chain shifts and opportunities for Foreign Direct Investment (FDI)
At the supply-chain level, resilience can be achieved by reshoring, diversification,
regionalisation, and replication. The global apparel value chain is likely toexperience many of these at different levels in both crisis and post-crisis
periods (Moazzem et al., 2021). Zhan et al. (2020) notes that diversification ofsources is expected to be the most widely used in actual practice, followed byreshoring, regionalisation, and replication (Zhan et al., 2020). A similar conclusion
was reached as regards implications of global supply chain shifts for Sri Lanka(Deloitte, 2020).
86Section I.

SRI LANKA’S APPAREL INDUSTRYThe COVID-19 induced global shutdown, and ensuing supply disruptions, haveled many companies to recognise their over-reliance on supplies from China(Bell, 2020). These companies are now actively seeking new suppliers andmanufacturing locations outside China. This is not only to diversify their supply
chains, and mitigate their risks, but also in view of rising production costs in
China. As noted by an industry leader in a message to shareholders,
Because of COVID-19, companies are apprehensive about relying on asingle destination for its supply chain and are moving away from China
and looking at the South Asian region… Supply chain strategising tomaintain the total supply chain within a country and mitigating its relianceon a single destination may become a reality in the future. (Teejay Lanka
PLC, 2020, 7)
Industry officials also believe that the trade tensions between the US and China
could have positive ramifications for countries such as Sri Lanka and others in
the South Asian region.
Clearly, there is a window of opportunity for countries like Sri Lanka to benefit
from the supply chain shifts that are currently underway. Sri Lanka’s focus should
be on proactively promoting FDI to attract investors looking for new locations
and to support existing firms to find joint venture partners. Promotional efforts
should focus on the country’s geographic location, the competitive and efficient
port, preferential market access to the EU and US, and bilateral FTAs with several
South Asian countries, as well as ethical and sustainable business practices.
The industry expects that a key focus in investment attraction is backward
integration, that is, securing input supplies domestically. The government andindustry have embarked on a joint effort to establish a fabric processing plant withforeign investment, and built on strong green credentials in the eastern town of
Eravur. It is aimed at helping to secure more of the supply chain domestically,
thereby raising domestic value addition from 52% to 65%, according to industry
estimates (Just Style, 2021), as well as acting as a vital sourcing-risk mitigator.
Meanwhile, retaining existing, as well as enhancing, preferential market access(EU GSP+, US GSP, etc.) will be essential to making the country an attractive
FDI location. On retaining current advantages, recent developments with the
EU GSP+ have cast worries. In June 2021, the European Parliament passed a
resolution that, among other things, called on the EU Commission to investigate
and subsequently consider temporary withdrawal of GSP+ concessions granted
to Sri Lanka. It cited deteriorating human rights conditions, and the government’s
non-adherence to certain legal reforms that the country had committed to, which87Age of Ferment:
Developments in Asian–European Trade Relations
are conditionalities under the GSP+ scheme (European Parliament, 2021). The
apex industry body JAAF has urged the government to ensure the continuationof GSP+ as it is ‘necessary when the industry faces significant challenges in the
post-pandemic world’ (Daily Mirror, 2021).
Greater agility, redundancy redefined, and digitalisation
With the uncertainties surrounding the pandemic, new variants continuing toemerge, sudden lockdowns and travel restrictions, and the long-tail effects of
COVID-19, economic and otherwise, the changes seen in retailers’ and consumers’purchasing behaviour may well be permanent. Given the costs associated withholding stocks, brands and stores (whether physical or online) generally preferto maintain smaller inventories. As such, they prefer to work with manufacturersthat can be agile and nimble in adjusting to market demands. A survey by theBusiness of Fashion and McKinsey (2021) revealed that a vast majority of fashionindustry executives are deploying several strategies to avoid overstock—61%
plan on reducing the number of stock-keeping units (SKUs), 60% reported theywould improve analytics for consumer insights, 55% said they plan to implementa more agile supply chain, and 43% intend to reduce product development leadtimes.
Some larger Sri Lankan manufacturers are well positioned for this, given theirfocus on innovation, logistics, and design in recent years, while some others(more traditional players and SMEs that rely on the more traditional seasonality
and orderbook model) may find it difficult to adjust. Leading apparel exporter
MAS Holdings has two unique initiatives to latch on to this trend and ensure
resilience in the face of fashion industry pressures. The first is the Runway Kit,
the digital arm of MAS manufacturing, set up to support small- and mediumscale apparel brands in sample-making and in manufacturing swimwear andactivewear under low minimum-order quantities (MOQs) (‘Runway Kit’, n.d.).
The second is MAS Click, a concept-to-delivery business model that helps brands
rapidly adapt to evolving consumer demand by testing consumer preferenceswith low MOQs, and replenish bestsellers multiple times in season (‘MAS Click’,n.d.). The company uses advanced analytics across sales data and consumer
sentiment to gain insight on style performance, and helps the brands derive
greater profitability by minimising the risk of markdowns, slow-moving stock,
and returns.
While firms focus on enhancing their internal capabilities in design, digital, andprocess efficiency to capitalise on these trends, as an economy, Sri Lanka should
focus on accelerating reforms for better trade facilitation, i.e. border efficiency
and the removal of trade-related obstacles.
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Many of Sri Lanka’s larger firms had invested in the digitalisation of systems
and processes prior to the pandemic, which helped them remain resilient. This
helped them, for instance, when work-from-home rules applied following the first
lockdown, or when implementing contact-tracing and risk management in plants,
or when delivering better customer solutions. Industry players have also usedtechnology to help product-creation teams to anticipate sales trends, validate
customer preferences, and research pricing options, all of which were upended
by the pandemic. Digitalisation had helped incorporate a feedback loop into
product design, and to reduce lead times, as well as speed to market. Technology
had also played a role in virtual prototyping for firms like MAS Holdings, which
had previous relied exclusively on in-person visits. As noted by their chief digital
officer, ‘We would usually pack our bags and visit our customers and present it
on a catwalk. Now product presentations are done digitally’.
Evidently, however, there is some ongoing discussion in the apparel industry
about finding the right balance between striving for agility and building inredundancy. The latter comes from the disruptions to the supply chain observed
during the pandemic and from input sourcing difficulties (the first of the threeshocks outlined earlier). At the time of writing, the industry is faced with a further
challenge—the severe shortage of shipping capacity and associated delays,
along with heightened freight costs. Apparel-industry leaders interviewed notedthat traditional ways of building redundancy are no longer feasible, and that
redundancy is being redefined. Redundancy is changing in type, as well as in
the manner in which it is achieved; a form of flexible redundancy appears to be
emerging. Redundancy, by way of holding inventory purely in a manufacturer’s
own location in-house, is being pursued much less than redundancy acrossthe supply chain. Manufacturers are entering risk-sharing arrangements withcustomers so as to secure inventory buffers. Moreover, redundancy by way ofholding inventory is being focused not on the finished product, which was the
traditional approach, but more at the raw material stage.
Manufacturers are, thus, enabling flexible redundancy with the goal of achieving
supply chain resilience. They do this through at least three different approaches:(1) outright owning more of the raw-material supply chain (upstream investments
in fabric mills, for instance), (2) deep, strategic relationships with suppliers withwhom dynamic adjustments to inventory can be made at little cost and timecommitment, and (3), even if it is not the first or second approach, at least having
the suppliers onshore rather than offshore (example is the proposed Eravur
Fabric Park discussed in the previous section).

89Age of Ferment:
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One industry leader outlined that a key focus for enabling flexible redundancy
across the supply chain—in a bid to build resilience—is for Sri Lankan apparelfirms to maintain a presence in countries outside Sri Lanka. Top customers in
the US, UK, and EU have increasingly prevailed on their Sri Lankan partners to
distribute manufacturing (i.e. location diversification) and to build redundancy
through production facilities in other countries. This has added a new dimension
to Sri Lankan apparel firms’ strategy of investing overseas, which was hitherto
largely driven by considerations of cost efficiency (cheaper labour costs orpreferential tariff advantages) and logistics proximity. Already, Sri Lankan
manufacturers like MAS, Brandix, Hirdaramani, and Hela have establishedproduction facilities in Bangladesh, Indonesia, Honduras, Jordan, Vietnam, Haiti,
Ethiopia, Kenya, and the US.2 This has helped keep these players competitive
amidst rising manufacturing costs, a tightening labour market at home, and Sri
Lanka’s stalled trade integration (set to afford preferential market access for its
exporters).
Focus on sustainability and innovation
A looming twin challenge facing the industry is that of escalating labour costs, andthe dependence on EU GSP+ concessions, which some consider to have reduced
the competitiveness of the industry, and increased the vulnerability of the sector
to global market shocks. To counter this, the apparel industry has begun to climb
the value chain by investing in innovation and environmental sustainability. As
noted by a sector leader in a message to shareholders, ‘A key future strategy
is innovation and development of sustainable products such as biodegradable
products, bio-based materials and chemical-free performance products’ (Teejay
Lanka PLC, p. 7). In a recent poll with fashion-industry executives, around halfindicated that sustainability has moved up their list of priorities in the postCOVID environment.3
As such, Sri Lankan apparel manufacturers are now focusing on sustainability
principles with regard to product innovation—and doing so in a more strategic
and formalised in-house manner. In 2019, leading exporter Hirdaramani Grouplaunched the Hirdaramani Discovery Lab as a product innovation and technology

902

The size of these overseas investments are not publicly known as the firms are allprivately held.

3

Participant poll (n >300) conducted during the ‘McKinsey Sustainability in Fashion:
Apparel, Fashion & Luxury’ executive webinar hosted by the Global Fashion Agenda(2020).

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centre to develop and implement products, processes, and technical innovations
with the goal of improving sustainability and productivity (HSBC & IUCN, 2021).
Another leading manufacturer, Brandix, has had a long-standing focus onsustainable manufacturing, having opened their first green-apparel factory in
2008, which was the first manufacturing facility in the world to be rated platinum
under the Leadership in Energy and Environmental Design (LEED) Green Building
rating system. More recently, their plant in Batticaloa was also recognised as theworld’s first net-zero-carbon–certified manufacturing facility.
The sector will also benefit from having access to innovative fabrics that are
particularly relevant in a post-COVID era. A leading Sri Lankan welt-knit producer,
who supplies many of the apparel firms in the country, has developed a collectionthat focuses on so-called defensive fabrics, such as antiviral/antimicrobial
defences, as well as textiles with carbon compounds, and sustainable fabrics(Teejay Lanka PLC, 2020). Also, as noted earlier, Sri Lanka intends to establish agreen industrial park for fabric production with state-of-the-art facilities for water
treatment and effluent management. This is an important step, considering that
textile wet processing is the most resource intense step in the entire apparel
manufacturing lifecycle, using over 80% of water, over 75% of energy, and nearly
60% of chemicals (HSBC & IUCN, 2021).
Recently, the Sri Lankan office of the International Union for the Conservation of
Nature, (IUCN) in partnership HSBC Sri Lanka, launched a ‘Road Map to a Greener
Apparel Sector in Sri Lanka: A Sustainable Financing Strategy for Sri Lanka’, which
recommends 12 areas for the apparel sector to focus on, including renewableenergy, zero discharges, science-based targets, circularity, and sustainablefinancing (HSBC & IUCN, 2021).

Concluding Remarks and Outlook
Sri Lanka’s apparel industry—a significant export revenue earner and employer—
has been substantially hit by the pandemic. Yet certain characteristics of thesector, as well as some public-private collaborative efforts, have helped thesector weather the crisis and pick up business once more. In terms of the sector’s
overall resilience through the crisis thus far, Moazzem et al. (2021) have notedthat,
Better inventory management, flexibility in the sourcing of raw material
supplies, flexible supply chain management, innovative approaches, andbetter use of digital infrastructure, helped Sri Lankan suppliers manage
the crisis better. This was partly due to the medium- and high-end product91Age of Ferment:
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market segment of the apparel value chain where Sri Lanka primarily
resides, and the smaller scale of supply orders. (p. 24)
At the time of writing, Sri Lanka had just gone into a fourth lockdown (the secondin two months) following a sharp spike in infections and deaths, attributed tothe spread of the delta variant. An industry leader noted that the estimate for
Sri Lanka’s 2021 exports was 5.1 billion USD, but reaching that was unlikely due
to lockdowns and associated production disruptions during the third and fourth
quarters of 2021. The 2021 export data are yet to be released, at the time ofwriting. By the start of 2022, Sri Lanka’s infection rates recorded low levels, andmore than 80% of the population had been fully vaccinated. The likelihood ofmajor disruptions to production during 2022 is low, even as new variants emerge.
Yet, other factors will put pressure on the sector.
Government restrictions on imports continue, and restrictions on exports havealso begun to bite. Regarding the latter, monetary authorities have stipulated
that exporters must compulsorily convert all their export proceeds from foreign
currencies to the domestic currency, and banks receiving the remittances must
send 10% to the Central Bank right away. This is quite challenging, given thatapparel exporters need to retain foreign currency to pay for inputs bought
overseas, and coercing conversion into the domestic currency unnecessarily
adds to their transaction costs. More recently, the tightening of foreign-exchange
markets have meant that there is a severe shortage of dollar liquidity, as banks
are compelled by the regulator to quote exchange rates at artificially held prices(between 198-202 Sri Lankan rupees (LKR) to 1 USD, when market rates werecloser to 230-240 LKR by end 2021). Successive sovereign ratings downgrades
over the past 6 to 12 months and forex-reserve concerns have led the overseas
counterparts of Sri Lankan banks to cap or cut dollar credit lines, which, in turn,impacts banks’ ability to finance exports and imports. All these macroeconomic
conditions, coupled with the ongoing COVID conditions, will no doubt affect theapparel industry’s near-term resilience and profitability.
Yet on a positive note, the rapid vaccine rollout in Sri Lanka’s key markets—the
US, UK, and EU—and the concomitant decline in the spread of COVID will help
the industry turn a corner. Winter-season orders are reportedly at strong levels.
Already various data in these markets relating to economic activity, purchasing
inventory, retail sales, and household spending point to an overall recovery inconsumer sentiment and, consequently, to a boost in demand for Sri Lankan
apparel exports. Risks of new virus variants notwithstanding, the short term
future of the industry looks promising, provided domestic health conditions
remain under control. Whether the medium-term goal of moving from recovery

92Section I.

SRI LANKA’S APPAREL INDUSTRY

to resilience, and thereafter a new wave of growth, will indeed occur will depend
on in-sector upgrades and innovation. This includes attracting new investmentthat drives innovation (in business models and products), establishing new supply
chains, meeting sustainability targets, complying with buyer requirements, andcatering to consumer preferences.

Anushka WIJESINHA is an economist focusing on trade, competitiveness, andinnovation based in Colombo; he recently co-founded the Centre for a Smart
Future, a new interdisciplinary think tank. He consults independently forinternational organisations like the United Nations Conference on Trade andDevelopment (UNCTAD), International Trade Centre (ITC), and the United States
Agency for International Development (USAID). His recent work has been in
Pakistan, Myanmar, Maldives, and Sri Lanka. He was formerly an advisor to the
Ministry of Development Strategies and International Trade of Sri Lanka. He wasa member of the World Economic Forum’s Global Future Council on Innovation
Ecosystems.

93Age of Ferment:
Developments in Asian–European Trade Relations

References
Bell, S. (2020, April 23). Thoughts on business opportunities for Sri Lanka postCOVID-19. LKI’s Blog on International Relations. https://lki.lk/blog/thoughtson-business-opportunities-for-sri-lanka-post-covid-19/
The Business of Fashion (BOF), & McKinsey & Company. (2021). The state of
fashion 2021. https://www.mckinsey.com/~/media/McKinsey/Industries/
Retail/Our%20Insights/State%20of%20fashion/2021/The-State-of-Fashion2021-vF.pdf
Central Bank of Sri Lanka (CBSL). (2020). Annual report 2020. https://www.cbsl.
gov.lk/en/publications/economic-and-financial-reports/annual-reports/
annual-report-2020
Ceylon Chamber of Commerce (CCC). (2020). Findings report: Business survey on
trade and labour market impacts of COVID–19 on exporters in Sri Lanka.
Daily Mirror Online. (2021, August 26). JAFF formulates 5-point plan to sustain
long term industry growth amid Covid challenges. https://www.dailymirror.lk/
business-news/JAFF-formulates-5-point-plan-to-sustain-long term-industrygrowth-amid-Covid-challenges/273-219014
Deloitte. (2020). Global supply chain strategies: Current trends and future shifts.
USAID - Partnership for Accelerating Results in Trade, National Expenditure,
and Revenue (PARTNER).
Economynext. (2020, May 4). Brandix apparel plants in Sri Lanka, India making PPE
in Covid-19 battle. https://economynext.com/brandix-apparel-plants-in-srilanka-india-making-ppe-in-covid-19-battle-69553/
Economynext. (2020, May 14). Sri Lanka starts shipping 200mn face mask madeby Brandix to the United States. https://economynext.com/sri-lanka-startsshipping-200mn-face-mask-made-by-brandix-to-the-united-states-69968/
Economynext. (2020, June 11). Sri Lanka diplomats claim their efforts helping
country regain lost export markets and win new buyers. https://economynext.
com/sri-lanka-diplomats-claim-their-efforts-helping-country-regain-lostexport-markets-and-win-new-buyers-70998/
European Parliament. (2021, June 10). European Parliament resolution of 10 June
2021 on the situation in Sri Lanka, in particular the arrests under the Preventionof Terrorism Act. https://www.europarl.europa.eu/doceo/document/TA-92021-0290_EN.html
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SRI LANKA’S APPAREL INDUSTRY

Flex. (2016, July 12). Flex and MAS Holdings partner to drive innovation in wearable
technology for clothing. https://flex.com/newsroom/press-releases/flex-andmas-holdings-partner-drive-innovation-wearable-technology-clothing
Hayleys Fabric PLC. (2021). Rooted in trust [Annual report 2020/21]. https://cdn.
cse.lk/cmt/upload_report_file/403_1622543611245.pdf
HSBC Sri Lanka, & International Union for Conservation of Nature and Natural
Resources (IUCN). (2021). A roadmap towards a greener apparel sector: A
sustainable financing strategy for Sri Lanka. https://www.hsbc.lk/content/dam/
hsbc/lk/documents/financial/roadmap-towards-a-greener-apparel-sectorbrochure.pdf
International Finance Corporation (IFC). (2020). Covid-19—PPE demand & supply
perspectives [Final report - December 2020]. https://www.ifc.org/wps/
wcm/connect/1d32e536-76cc-4023-9430-1333d6b92cc6/210402_FCDO_
GlobalPPE_Final+report_v14updated_gja.pdf?MOD=AJPERES&CVID=nyiUnTU
International Labour Organization. (2020). COVID-19 and the textiles, clothing,leather and footwear industries [ILO sectoral brief]. https://www.ilo.org/
wcmsp5/groups/public/---ed_dialogue/---sector/documents/briefingnote/
wcms_741344.pdf
Just Style. (2020, June 18). Covid-19 has taken its toll on Sri Lanka clothing
sector. https://www.just-style.com/analysis/covid-19-has-taken-its-toll-on-srilanka-clothing-sector
Just Style. (2021, August 25). Sri Lanka’s JAAF outlines plan to address Covid
challenges. https://www.just-style.com/news/sri-lankas-jaaf-outlines-plan-toaddress-covid-challenges/
MAS Click. (n.d.). MAS Holdings. https://www.masholdings.com/mas-click.html
Ministry of Foreign Relations. (2020, April 24). Sri Lanka missions abroad seek
to re-position Sri Lanka’s exports to meet market conditions resulting from the
COVID-19 crisis. Permanent Mission of Sri Lanka to the United Nations. https://www.un.int/srilanka/news/sri-lanka-missions-abroad-seek-re-position-srilanka%E2%80%99s-exports-meet-market-conditions-resulting
Moazzem, K. G., Ahmed, T., Khatun, F., Pathirana, A., & Hewage, K. (2021). Recoveryof the apparels sectors of Bangladesh and Sri Lanka from the COVID-19 crisis: Is avalue chain based solution possible? [Occasional Paper Series No. 70]. Southern
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Developments in Asian–European Trade Relations
OECD. (2020). COVID-19 and global value chains: Policy options to build more resilient
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covid-19-and-global-value-chains-policy-options-to-build-more-resilientproduction-networks-04934ef4/
Runway Kit. (n.d.). MAS Holdings. https://www.masholdings.com/low-moqmanufacturing.html
Sri Lanka Export Development Board (EDB). (2015, June 8). ‘Garments without
guilt’ from Sri Lankan apparel manufacturers & suppliers. https://www.
srilankabusiness.com/blog/garments-without-guilt.html
Standard Chartered. (2020, July 15). We’ve financed apparel manufacturer Brandix
for personal protective equipment production. https://www.sc.com/en/
media/press-release/weve-financed-an-apparel-manufacturer-brandix-forpersonal-protective-equipment-production/
Teejay Lanka PLC. (2020). Standing the test of time [Annual report 2019/20]. http://
www.teejay.com/imgup/pdf/annual-report-2019-20.pdf
USAID. (2020, July 27). United States works with Sri Lankan apparel industry toincrease PPE exports. https://www.usaid.gov/sri-lanka/press-releases/jul-272020-united-states-works-sri-lankan-apparel-industry-increase
Zhan, J., Bolwijn, R., Casella, B., & Santos-Paulino, A. (2020, August 13). Global
value chain transformation to 2030: Overall direction and policy implications.
VoxEu. https://voxeu.org/article/global-value-chain-transformation-decadeahead

96

12
1

Asia–Europe Trade
Connectivity

Section II.

EUROPEAN TRADE RELATIONS WITH ASIA

European Trade Relations
with Asia
Axel BERGER

Abstract
Asian countries are actively participating in a new wave of trade and investment
agreements. While recent focus has been on the Regional Comprehensive
Economic Partnership (RCEP), this chapter analyses the Comprehensive
Agreement on Investment (CAI) and the possible expansion of the Comprehensive
and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and theircontribution to accelerating trade and investment, as well as to achieving
sustainable development.

Free trade agreements (FTA) have come a long way. Once designed asagreements between two or a small number of countries to eliminate tariffs
and quotas on trade in goods, they have become broader economic treatiesthat also liberalise trade in services and foreign investment regulations, while
also protecting intellectual property rights, defining competition policy regimes,
and establishing environmental and labour protection rules (Dür & Elsig, 2015).
These modern trade agreements can be described as ‘deep FTAs’ regulating
trade-related issues ‘behind the border’.1 While the number of newly signed
FTAs has been declining since the heydays of the 1990s, their size—in terms oftrade covered, or gross domestic product (GDP)—has been increasing, which
justifies referring to them as ‘megaregionals.’ These agreements have become
geoeconomic instruments via which rules and standards are set, internationally;
similarly, they allow economic powers not only to facilitate the cross-borderactivities of their domestic companies, but also to export a certain concept of
economic governance. European countries are at the forefront of this trend; theynegotiate deep FTAs with other economies so as to ensure a level playing field forEuropean companies abroad and to maintain a rules-based international trading
system. While European countries have signed FTAs with partners from all world1

Behind-the-border barriers refer to a variety of non-tariff barriers that operate inside
countries rather than at the border but that nonetheless can restrict or discriminate
trade.

99

Age of Ferment:
Developments in Asian–European Trade Relations
regions, Asia has received special attention given its centrality for global value
chains (GVCs) and economic dynamism.2
The purpose of this chapter is to provide an overview of current trade relations
between European and Asian countries and to review Europe’s Asia trade policies
and the challenges they face. These challenges are due to developments in thearea of trade and the broadening geoeconomic environment. At least three key
challenges need to be mentioned.
First of all, Asian economies have intensified intraregional integration inrecent years. The Comprehensive and Progressive Agreement for Trans-PacificPartnership (CPTPP) was signed in 2016 among 12 economies from Asia andNorth and Latin America and entered into force—despite the withdrawal of theUnited States (US)—in 2018. The second major trade agreement in Asia is theRegional Comprehensive Economic Partnership (RCEP), which was signed in 2020
between the ten countries of the Association of Southeast Asian Nations (ASEAN)
and Australia, China, Japan, Korea, and New Zealand. These two megaregional
trade agreements will accelerate the trend of intraregional integration in Asiaand necessitate a policy response from European countries to offset any negative
effects.3
Second, the US-China conflict will be a defining factor for European trade
policymaking in the years to come, in particular, with regard to European traderelations towards Asia. The attempt of the US to decouple its economy from
China poses the question of how Europe should position itself towards China,
as well as towards the rest of the Asian countries, which are accelerating theirtrade integration with China despite difficult diplomatic and security relations
with Beijing.
Third, Europe and Asia need to find an answer to the crisis of the rules-based
international order and associated trends towards de-globalisation. Theinternational trade system, with the World Trade Organization (WTO) as its
multilateral core, has been in crisis for a long time and came under severe
attacks during the Trump presidency, in the years 2016-2020. However, it isfar from certain that the Biden administration, despite its initial multilateralrhetoric, will resist the impulse of inward-looking and protectionist trade policies.
Furthermore, the multiple protectionist trade policies seen around the world
during the COVID-19 pandemic have shown that these impulses are not limited
to the US.

100

2

See the contribution of Hubertus Bardt.

3

See the contribution of Jürgen Matthes.

Section II.

EUROPEAN TRADE RELATIONS WITH ASIA

How should European actors define their trade policy towards Asia in thisincreasingly complex geoeconomic environment? This chapter takes the recent
disintegration within Europe into account and will not only focus on the European
Union (EU) as the main European trading power, but will also analyse the United
Kingdom’s (UK) emerging trade policy towards Asia.
The chapter is structured as follows. Section 2 will briefly consider Europe-Asia
trade policy, putting it into perspective by means of a general analysis of current
trade flows between the two regions. Sections 3 and 4 will dive into the trade
policies of the EU and UK with Asia. After providing a general overview of thevarious trade agreements, the focus will be on the EU’s most recent trade andinvestment agreements with Japan and China, as well as on the UK’s bid to join
the CPTPP. Section 4 concludes with a review of the policy choices of European
trade policymaking towards Asia.

Current Trade Relations
The centre of gravity of the global economy is shifting eastwards, and the AsiaPacific region is becoming the main area of economic activity. Against thisbackdrop, it is necessary to briefly review Europe’s trade relations with Asian
countries—notably those with which the EU and UK have (or are in the processof negotiating) trade agreements. On a general level, it is clear that Asia has
become the number one source of imports to Europe, and many supply chainsof European companies depend on inputs from Asia. The share of imports from
Asia to the EU increased from 39% in 2002 to 45% in 2019.4
A closer look shows that most of this growth is driven by one country, China.
For both the EU and the UK, China is the main export destination and importsource among Asian countries (see Tables 1 and 2). On the export side, Chinais the fifth and seventh most important export destination for the UK and EU,
respectively. Furthermore, regarding imports, China’s weight is even greater. For
the EU, China is the second largest importer, as well as the number one exporter,
if one only looks at extra-EU exports. In the case of the UK, China ranks as thirdlargest importer. As will be discussed in the remainder of this paper, neither the
EU nor the UK have a trade agreement with China in place, and given the strained
geoeconomic relations, such an agreement is not in sight for the foreseeable
future.

4

See the contribution of Hubertus Bardt. The share of imports does not include imports
from within the EU.

101

Age of Ferment:
Developments in Asian–European Trade Relations
Table 1. EU exports and imports in 2019, in billion USD
Rank

Trading
Partner

Exports

in %

Rank

Trading
Partner

Importsin %1

Germany

746.8

12.6

1

Germany

769.1

13.0

2

United States

481.2

8.1

2

China

506.2

8.6

3

France

425.6

7.2

3

Netherlands

358.8

6.1

4

UnitedKingdom

324.7

5.5

4

United States

345.9

5.8

5

Italy

272.6

4.6

5

France

319.7

5.4

6

Netherlands

268.8

4.5

6

Italy

271.9

4.6

7

China

246.2

4.2

7

Belgium

245.1

4.1

8

Belgium

240.9

4.1

8

Spain

201.2

3.4

9

Spain

211.0

3.6

9

UnitedKingdom

193.7

3.3

10

Poland

187.5

3.2

10

Poland

187.5

3.2

18

Japan

74.3

1.3

16

Japan

97.9

1.7

26

Korea Rep.

51.2

0.9

23

Korea Rep.

61.2

1.0

29

India

46.9

0.8

25

India

56.4

1.0

33

Australia

38.0

0.6

27

Vietnam

51.3

0.9

34

Singapore

37.5

0.6

33

Malaysia

33.3

0.6

53

Thailand

16.1

0.3

37

Thailand

28.7

0.5

54

Malaysia

15.6

0.3

39

Singapore

24.4

0.4

58

Vietnam

12.9

0.2

45

Australia

20.3

0.3

62

Indonesia

10.9

0.2

48

Indonesia

19.4

0.3

63

Philippines

8.8

0.1

59

Philippines

10.8

0.2

72

New Zealand

6.6

0.1

78

New Zealand

4.0

0.1

148

Pacific EPA

0.5

0.0

160

Pacific EPA

1.1

0.0

Source: Based on data from World Integrated Trade Solution (WITS), https://wits.
worldbank.org/
The inspection of current import and export patterns reveals two additional
insights.
First, both the EU and the UK trade mainly with economies from their own(European) region. Given this strong intraregional trade pattern, trade with
Asian economies is of relatively lesser importance (with the exception of China).
Furthermore, both in the case of the EU and UK, the US is a key trading partner
and transatlantic trade relations are still important despite recent trade policy
frictions.
102Section II.

EUROPEAN TRADE RELATIONS WITH ASIA

Table 2. UK exports and imports in 2019, in billion USD
Rank

Trading
Partner1

United States

72.1

15.5

1

2

Germany

46.4

10.0

3

France31.4

4Netherlands

5

China

6

Exports

in %

Rank

Trading
Partner

Importsin %Germany

85.7

12.5

2

United States

67.1

9.8

6.8

3

China

65.5

9.5

30.4

6.5

4

Netherlands

53.9

7.9

30.0

6.5

5

France38.9

5.7

Ireland

27.8

6.0

6

Belgium

32.2

4.7

7

Belgium

16.5

3.6

7

Italy

26.2

3.8

8

Switzerland

15.1

3.3

8

Switzerland

23.7

3.4

9

Spain

13.7

2.9

9

Spain

21.2

3.1

10

Italy

12.7

2.7

10

Norway

19.8

2.9

11

Hong Kong,
PRC

10.8

2.3

15

Japan

13.0

1.9

14

Japan

8.3

1.8

17

Australia

10.8

1.6

15

Singapore

6.8

1.5

18

India

9.8

1.4

20

India

5.8

1.3

24

Vietnam

6.0

0.9

21

Australia

5.5

1.2

25

Korea Rep.

5.0

0.7

22

Korea Rep.

4.8

1.0

28

Hong Kong, PRC

4.4

0.6

38

Malaysia

1.7

0.4

31

Thailand

3.8

0.6

45

Thailand

1.5

0.3

40

Malaysia

2.4

0.3

48

New Zealand

1.1

0.2

42

Singapore

2.2

0.3

50

Philippines

0.9

0.2

44

Indonesia

2.0

0.3

52

Indonesia

0.9

0.2

52

New Zealand

1.1

0.2

137

Pacific EPA

0.03 0.0071282

49

Pacific EPA

0.1

0.0

Source: Based on data from WITS, https://wits.worldbank.org/
Second, the countries that the EU and UK sees as trade-policy partners, withwhich they have agreements in place, or with which they are in the processof negotiations, are of comparatively minor economic importance. The mostimportant Asian country next to China is Japan, and it is the EU’s 18th mostimportant export destination, and in the case of imports, it ranks 16th. The picture
is similar for the UK. With the exception of China, the (potential) FTA partners of
the EU and UK have a limited importance in terms of exports and imports. Other
European economies and the US are the main trading partners of the EU and the
UK.

103

Age of Ferment:
Developments in Asian–European Trade Relations
Closer trading ties with Asia are nevertheless desirable in light of the increasing
integration within Asia and of the region’s economic dynamic. Asian countries
have engaged in two significant trading initiatives, the RCEP and the CPTPP.5
These important intra-Asian integration projects risk negatively affecting
European countries. In order to counter this, European trade policymaking needs
to engage Asian countries.

The EU’s Trade Policy towards Asia-Pacific
The EU has the world’s largest network of bilateral and regional trade agreements.
At the end of 2020, the EU had 44 signed and applied FTAs with 76 countries(European Commission, 2020). With the exception of the Economic Partnership
Agreement (EPA) with the Pacific countries,6 all of the EU’s agreements with Asian
countries are bilateral FTAs. The FTA with Korea, signed in 2010, and applied
since 2011, was the first of the EU’s so-called ‘new generation’ FTAs. These wereenvisaged in the EU’s 2006 trade strategy, Global Europe, and the 2009 Lisbon
Treaty provided a reformed legal basis of the EU’s trade policymaking. The EUKorea FTA covers many trade and non-trade issues, such as tariff liberalisation,
services, investment, competition, intellectual property, and sustainable
development. As such, it has come to represent an important reference point for
subsequent FTAs negotiated by the EU (Horng, 2012).
At the centre of the EU’s initial strategy towards Asia was a region-to-region FTA
with ASEAN. The EU and ASEAN started negotiations in 2007. However, only two
years after the launch, the two regional blocs discontinued the negotiationsin 2009. The failure of interregionalism may be explained by the EU’s desire
to negotiate a comprehensive FTA. That desire proved incompatible with theeconomic and political heterogeneity of ASEAN members, which affected their(un)willingness to sign a high-standard FTA with the EU (Meissner, 2016). The EU
fell back to the bilateral approach and initiated negotiations with Singapore (startof negotiations in 2010), Malaysia (2010), Vietnam (2012), Thailand (2013), thePhilippines (2015), and Indonesia (2016). The EU views the successful negotiationof these bilateral agreements as building blocks towards a future EU-ASEAN
agreement (European Commission, 2021a). However, as yet, it is only the FTAs

104

5

The CPTPP includes not only important Asian economies but also countries from
North and South America.

6

The EU-Pacific EPA was signed in 2009. The EU and Papua New Guinea ratified theagreement in 2011. The agreement is provisionally applied by Fiji (since 2014), Samoa(since 2018), and the Solomon Islands since 2020 (European Commission, n.d.)Section II.

EUROPEAN TRADE RELATIONS WITH ASIA

with Singapore and Vietnam which have entered into force—in November 2019and August 2020, respectively. The negotiations with Malaysia, Thailand, and
the Philippines are on hold, while the negotiations with Indonesia are ongoing.
The EU has also been negotiating an investment-protection agreement with
Myanmar since 2013, which has not led to a successful outcome thus far. In sum,
the strategic engagement of ASEAN member states as FTA partner countries has
met with only mixed success. Only in the case of Singapore and Vietnam—twoexport-oriented economies with large networks of trade agreements—did theEU succeed to conclude comprehensive FTAs. All other negotiation processes areeither discontinued or still ongoing.7
A key milestone of the EU’s trade relations with Asia was the conclusion andentry into force (effective 1 February 2019) of a comprehensive FTA with Japan,
Asia’s second largest economy. The (geo)economic significance of the agreement
should not be underestimated, as it is the largest FTA the EU has ever signedwith another economy, covering close to 30% of global GDP (Chowdhry et al.,2018). The EU-Japan Economic Partnership Agreement (EUJEPA) has been
described as a highly comprehensive FTA (Chowdhry et al., 2018). It will lead toa substantial liberalisation of tariffs, including of the EU’s agricultural exports,
and Japan’s exports of automobiles. The agreement will reduce a number ofnontariff barriers, in particular, on the side of Japan. The EUJEPA will also leadto a liberalisation of services trade, however, without requiring governments toderegulate public services. The investment chapter provides rules on investment
protection, liberalisation, and the prohibition of performance requirements,
but does not include an investor-state dispute settlement (ISDS) provision.
The agreement, furthermore, contains far-reaching chapters on government
procurement, intellectual property rights, competition, regulatory cooperation,and sustainable development. In terms of coverage and depth of commitments,
the EUJEPA is similar to other new generation FTAs, such as those between the EU
and Korea, Singapore, or Canada. But it also includes some novel features, suchas a commitment by the parties to implement the Paris Agreement on climatechange or a chapter on corporate-governance standards (Chowdhry et al., 2018).
Negotiations between the EU and Japan started in 2013. It took 18 rounds ofnegotiations to reach an agreement in principle in July 2017, ahead of the G20
Summit in Hamburg. This was one of the first major global summits attended
by former US President Donald Trump, who made no secret of his disdain ofrules-based, liberal trading systems. The significance of the EUJEPA therefore

7

The EU has no specific trade policy towards Brunei. Cambodia and Laos are part of
the EU’s ‘Everything but Arms’ trade preferences scheme.

105Age of Ferment:
Developments in Asian–European Trade Relations
goes beyond narrowly defined trading relations, and has a strong geoeconomic
dimension too. It has been described as a commitment of the EU and Japan
towards a rules-based international trading order (Harding, 2017). As exportoriented economies, the EU and Japan have a joint interest in upholding thisorder. This is particularly true in view of an increasingly inward-looking andprotectionist trade-policy stance by Washington. This began under the Trump
Administration—with a withdrawal from the Trans-Pacific Partnership on
Trump’s first day in office in January 2017—however US trade policy making has
not shifted as much as pundits had predicted under current President Biden.
In 2018, the EU launched trade negotiations with two like-minded countries,
namely, Australia and New Zealand. The parties aim to conclude ambitious
and comprehensive FTAs that should not only facilitate trade, services, andinvestment flows, but also promote a rules-based international order. Assuming
the negotiations with Australia and New Zealand are concluded successfully, theEU would have bilateral FTAs in force with all but two of the 11 members of
the CPTPP.8 Against this backdrop, a region-to-region FTA between the EU andthe CPTPP countries might be more conceivable than the initial attempt to form
an interregional agreement with ASEAN (Draper & McDonagh, 2021; Hilpert,2021). The UK’s possible accession to the CPTPP may force trade policymakers
in Brussels, and EU member states, to consider closer integration with CPTPP.
However, while the two blocs have a preference for high-standard trade
agreements and converge on a number of issues, important differences remain,such as on ISDS or data protection.
Furthermore, the additional economic effects of closer EU-CPTPP trade relations
should not be overstated, as trade and nontrade barriers are already lowered dueto the various bilateral FTAs in place or under negotiation. The key significanceof such an interregional agreement would be the upholding of a rules-based,
liberal trading order in the Asia-Pacific as a counterweight against China’s stateled economic system (Draper & McDonagh, 2021).
The EU’s trade relations with India are more complicated. On the one hand, India
is one of the key economic powers in Asia, and is often viewed as a potential
counterweight to China. India therefore plays a key role in the EU’s externalrelations outlook towards Asia-Pacific. On the other hand, India’s economic
policymaking has become increasingly inward-looking and protectionist. This
trend has become evident through India’s withdrawal from the RCEP negotiations,

8106

The EU hast not launched FTA negotiations with Brunei and has discontinued
negotiations with Malaysia.

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in 2019. Despite these challenges, the potential of an FTA between the EU and
India is significant due to the size and complementarity of the two economies.
Furthermore, current trade barriers are high, which may lead to significant tradeflow increases. Trade negotiations between the EU and India were initiated in
2007, but were abandoned in 2013. The main sticking points that troubled EUIndia trade negotiations relate to agriculture, services (including the movementof people), digital trade, patent protection for pharmaceutical goods, as wellas environmental and labour rights (Poitiers et al., 2021). Most of these issues
remain contentious to this day, and will also be key challenges in reviving tradenegotiations.
Against this backdrop, it is a noteworthy development that the EU and India
agreed to reopen trade negotiations at their summit in May 2021. The reasonsthat led to this significant change of course are diverse. On the side of India, its
dissatisfaction with existing trade relations with Asian partners, and its rivalry
with China, may be part of the explanation. Furthermore, the economic crisis in
India, aggravated by the COVID-19 pandemic, may also play a role in forcing theModi government to seek closer trade relations with the EU. On the side of theEU, India could become an increasingly important trading partner in a region
that is integrating further via both RCEP and CPTPP. Finally, the competition
with the UK, which has also entered into trade negotiations with India, may
be another motive for EU trade policymakers to approach India (Poitiers et al.,2021). Despite these changes, which are often driven by geoeconomic rationales,
the fundamental challenges to a comprehensive EU-India FTA remain, and theoutcome of this negotiation process is open.
A stronger economic impact could be expected from an FTA between the EU
and China—a possibility that has, paradoxically, become less likely due to theconclusion of the Comprehensive Agreement on Investment (CAI) between the
EU and China. Negotiations on the CAI between the EU and China were underway
since 2014, but it took the two economic heavyweights 35 rounds of negotiations
to reach an agreement in principle, in December 2020. Despite these efforts, theCAI does not address all the initial negotiation objectives of the EU. The EU wanted
to negotiate an agreement that would cover both investment protection andmarket access. As such, it was hoped that the conclusion of the CAI would replacethe 25 bilateral investment treaties signed by EU member states individually with
China. These bilateral treaties were negotiated during the 1980s, 1990s, andearly 2000s and included outdated yet overly investor-friendly rules backed upby ISDS provisions (Berger, 2019).

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The CAI focuses on market access, technology transfer, regulatory cooperation,and sustainable development (European Commission, 2021b). The additional
market access granted by China is limited to some sectors, such as electricvehicles or financial and air-transport services. Perhaps the key outcome of the
CAI is the preservation of existing market access both in China and the EU. The
CAI includes rules that prohibit forced technology transfer and joint-venture
requirements; so-called ‘level playing field’ provisions with regard to subsidies;rules to ensure procedural transparency, as well as predictability and fairnessof regulatory and administrative procedures; and regulations for state-owned
enterprises (Bickenbach & Liu, 2021). Last but not least, the CAI includes asustainable-development chapter, with many standard provisions from EU
FTAs—these are, however, to be considered best-effort clauses (Berger, & Chi,
2021). It therefore remains to be seen whether China is willing to follow up on its
non-binding commitments, in particular, in the area of labour rights.
Importantly, the CAI does not include provisions on investment protection or
ISDS. The EU’s insistence on replacing the traditional ISDS clauses with its newinvestor court system may explain this omission (Berger, & Chi, 2021). Bothparties agreed to continue negotiations on investment protection and disputesettlement to replace the existing 25 bilateral investment treaties. The fate ofthese negotiations—and, more importantly, of the CAI as such—is uncertain inlight of the recent worsening of diplomatic relations between China and the EU.
As a result of the EU’s decision to impose sanctions on four Chinese officials overhuman rights abuses against the Muslim Uyghur minority in the Xinjiang region,
China imposed sanctions on several European politicians and individuals. As aresult, the European Parliament decided to freeze the ratification process of the
CAI (European Parliament, 2021). Achieving the successful conclusion of the CAI
was considered by the EU as an important precondition to starting negotiationsof a full-blown FTA with China. Recent developments make it unlikely that an
investment agreement, let alone a trade agreement, between the EU and China
can enter into force in the near future.
The uncertain future of the EU’s trade relations with China will also haverepercussions for its relations with ASEAN. A region-to-region agreement
between the EU and ASEAN has become more unlikely, as ASEAN has intensified
its integration efforts with its ASEAN+1 dialogue partners within the RCEP
framework. Closer integration with the ASEAN-led RCEP, as discussed by some,9would also imply a bilateral EU-China trade agreement, which is, at present,
inconceivable. Closer cooperation with like-minded countries from the Asia9108

See the contribution of Jürgen Matthes.

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Pacific, building on existing bilateral trade agreements and negotiations, should
therefore be the preferred option for EU trade policymaking—and the CPTPP
may be the right platform for this.

The UK’s Post-Brexit Trade Policy towards Asia-PacificAfter Brexit, which is quintessentially the UK’s decision to move away from the
EU as its main trading partner, one of the key strategic decisions of the British
government was to reorient its foreign and trade policy towards the Asia-Pacificregion. The ‘Integrated Review,’ a strategy paper that describes the UK’s new
external relations after Brexit, explicitly mentions ASEAN and the CPTPP as
key collective actors, with which the UK desires to engage more closely (United
Kingdom, 2021). It is therefore wholly unsurprising that the UK was active inrolling over some agreements it had signed with this region while still being
part of the EU. The so-called ‘trade continuity agreements’ entered into force, orwere provisionally applied, with South Korea, Singapore, Vietnam, and the Pacificstates (Dept. for Intl. Trade, 2020).
Additionally, the UK government managed to sign two new agreements withJapan and Australia in an exceptionally short period. A new Comprehensive
Economic Partnership Agreement (CEPA) was negotiated within less than halfa year with Japan and entered into force in December 2020. The UK-Japan CEPA
largely replicates the EUJEPA but diverges from the EU’s agreement with Japanin a few important areas, such as e-commerce (Morita-Jaeger & Ayele, 2020).
Similarly, the UK reached an agreement in principle with Australia in June 2021
(Dept. of Foreign Affairs and Trade, 2021). This agreement will comprehensively,
and more or less immediately, eliminate tariffs and quotas on bilateral trade
between the two economies. This ‘unprecedented’ level of trade liberalisation isespecially welcomed from the perspective of Australia, as ex ante trade barriers
were higher in the UK than in Australia. It may, however, be less welcomed bycertain groups in the UK, such as farmers, who will face increased competition
from Australian imports (Grozoubinski, 2021). Nevertheless, the overall
economic impact of the FTA with Australia will be limited. The UK’s exports toAustralia may increase by 0.35%, and Australia’s exports may grow more strongly
by 2.2% (Gasiorek & Larbalestier, 2021). The rush to sign the agreement with
Australia without entering into the typical substantive and often time-consuming
negotiations of detailed provisions may be a result of the British government’s
interest in signing the agreement, at least in principle, on the sideline of the G7
Summit in Cornwall, which took place in June 2021 (Payne & Romei, 2021).

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The UK is in the process of negotiating FTAs with other Asia-Pacific countries. It
is negotiating FTAs with New Zealand and India. However, the most high-profile
negotiation process currently underway is the one with the members of the
CPTPP. In February 2021, the UK applied for membership to the CPTPP (Dept.
for Intl. Trade & Truss, 2021).10 Notwithstanding the US’ decision to withdraw
from the agreement it helped build, the CPTPP remains one of the largest andmost-advanced trade agreements currently in force. It accounts for almost 15%
of world trade and includes a number of far-reaching rules, for instance, on
e-commerce, investment, and the environment.
Accession to the CPTPP offers the United Kingdom, having only recently regained
the competency to negotiate its own trade agreements, the chance to sign asingle trade agreement with 11 economies of the dynamic Asia-Pacific region.
However, the UK already has trade agreements in place with seven of the 11
CPTPP members, including with the Asian economies, Japan, Singapore andVietnam (Matsuura, 2021). The additional market access for the UK as a memberof the CPTPP will therefore be limited (Gasiorek et al., 2021). The UK may benefit
from more flexible use of rules of origin within a regional grouping comparedto the ‘spaghetti bowl’ of bilateral treaties. However, the geographic distancemakes it difficult to use this advantage to import tariff-free intermediates fromthe CPTPP countries for use in products that are then exported back to the
CPTPP region (Gasiorek et al., 2021). These relatively modest gains from CPTPP
accession have, thus, to be weighed against the potential risks of, for example,
regulatory divergence with the UK’s main trading partners, such as the EU. The
CPTPP is ultimately a US-style FTA that includes a number of provisions—for
example, on e-commerce, ISDS, or regulatory coherence—that are different toEU-style FTAs. Joining the CPTPP may therefore increase the transactional costsof trading with the EU, or with countries that adopt the EU’s standards, due todivergent regulatory regimes (Morita-Jaeger, 2021).
What is clear is the high importance the UK places on the Asia-Pacific region inits new post-Brexit trade policy. Under the headline ‘Global Britain’, it is engaged
with a host of Asia-Pacific countries to pursue existing, or negotiate new, trade
agreements. The rolling over of trade agreements that Britain had signed whilestill being a member of the EU is important to stabilise trade relations, but they
will not yield substantial additional economic benefits. As previously mentioned,
the UK rushed into trade negotiations with Japan and Australia, and has applied
for membership of the CPTPP. In these negotiations, it appears to be a rule-taker,

10 The CPTPP includes Japan, Australia, Canada, New Zealand, Vietnam, Singapore,
Malaysia, Brunei, Mexico, Chile, and Peru.

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willing to accept the terms proffered by its counterparts. The benefits of its trade
agreements with Asia-Pacific countries are, therefore, more likely to be of the
diplomatic, rather than economic, kind.
A different (economic) matter would be if the UK were to negotiate and sign a
trade agreement with a larger trading power, such as the EU, the US, or China.
The UK has signed a Trade and Cooperation Agreement with the EU, which has
been provisionally applied since January 1, 2021, and entered into force on
May 1, 2021. The agreement, however, is far less advantageous than the UK’s
previous EU membership, including regarding its access to the internal market.
Trade negotiations between the UK and the US were formally launched in
May 2020. While four rounds of negotiations took place until September 2020
under the Trump administration, it remains to be seen if and when the Biden
administration continues them. A trade agreement with China is not in sight, andthe recent worsening of diplomatic relations between London and Beijing makecloser UK-China trade relations unlikely in the near future.

Conclusion
Asian economies are key partners of European trade policymaking. The EU and
UK have launched a number of trade policy negotiations with Asian economies.
Trade integration in Asia is increasingly conducted in the context of megaregional
trade agreements, such as the CPTPP and the RCEP, with 11 and 15 members,
respectively. In contrast, European countries have had to resort to bilateralnegotiations, in particular, after the EU’s initial plan to negotiate a region-toregion agreement with ASEAN failed.
The UK’s decision to apply for membership of the CPTPP may be a first step
towards a more comprehensive approach. Whether Brussels follows London’slead and tries to negotiate an interregional agreement with the CPTPP remains
to be seen. Independent of this strategic decision, the EU should advanceand conclude the ongoing negotiations with countries such as Australia, New
Zealand, and Indonesia. Furthermore, it should try to reengage countries such
as Malaysia, Thailand, the Philippines, and India. Closer cooperation with Asian
economies is important not only to secure access to the growing Asian market,
but also to counter China’s attempts to export its state-led economic system.
The crucial challenge for European trade policymaking is to establish theirposition within the wider context of worsening geopolitical rivalry between the
US and China. While a strong transatlantic relation is of key importance for boththe EU and UK, and stronger ties with China are more controversial, the Asian
region remains of importance as a whole. While the UK is not attempting to enter
111Age of Ferment:
Developments in Asian–European Trade Relations
into trade negotiations with China, the EU has learnt a hard lesson in view of theincreasing resistance within Europe against the CAI, which makes the vision tostart negotiations towards an EU-China FTA highly unlikely in the short to medium
term. China, nevertheless, remains an important actor the EU needs to engage
in order to reform the WTO, which forms the main set of rules underpinning thetrade relations between Europe and China.

Axel BERGER is a senior researcher at the German Development Institute/
Deutsches Institut für Entwicklungspolitik (DIE), Programme Transformation of
Economic and Social Systems. He heads the G20 Policy Research Group at DIE
and led the T20 Task Force on Trade, Investment, and Tax in 2017, 2018, and2019. Axel holds a doctorate in political science from the University of DuisburgEssen and a master’s degree from the Munich Ludwig-Maximilians-University inpolitical science, economics, and modern history. He works on the design, effects,
and diffusion patterns of international trade and investment agreements, with afocus on emerging markets and developing countries. Other areas of current
research include the effects of an international investment-facilitation framework,
the impact of free trade agreements on upgrading within global value chains,
and the role of the G20 in global governance. He teaches international political
economy at the University of Bonn and regularly advises developing countries,
development agencies, and international organisations on trade and investment
matters.

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On the Relevance of Free Trade
Agreements in the Asia-Pacific:
A European Perspective
Jürgen MATTHES

Abstract
The Asia-Pacific has gained more attention in Europe recently, mainly due toits economic and geopolitical relevance, as compared to other world regions.
Moreover, the European Union (EU) increasingly sees the need to diversify
economic ties away from China, due to their increasingly strained relations. This
article suggests new ways to achieve this aim.

The Asia-Pacific Region from an EU Perspective
The economic and political role of the Asia-Pacific
From the perspective of the EU, the Asia-Pacific is an important economic andpolitical partner. In economic terms, the region consists of countries with verylarge populations (and thus large markets)—the largest being China, India, andIndonesia. Moreover, even when one excludes advanced nations like Japan,
South Korea, and Singapore, the region is still thriving economically, as comparedto other developing and emerging regions of the world.
Based on the International Monetary Fund (IMF) country groupings, Figure
1 illustrates below that economic growth rates in emerging and developing
Asia (EDA) are high compared to all other country groupings—be it the EU,
the entire world, the average of all emerging and developing economies,
Latin America, or Sub-Saharan Africa. On closer inspection, a differentiation is
warranted within the EDA group between very fast-growing China and the rest.
A subgroup of the Association of Southeast Asian Nation (ASEAN) bloc, theASEAN-5 countries—Indonesia, Malaysia, the Philippines, Thailand, Vietnam—
illustrate this rapid growth rate. While these economies have grown less rapidly
than China, they accomplished, impressively, an average growth rate of morethan 5% per year since 2000. As a result, their economic growth has been much117

Age of Ferment:
Developments in Asian–European Trade Relations
more dynamic than that of Latin America and, in recent years, also of SubSaharan Africa.
Figure 1. Economic growth in comparison: Change of real GDP (year on year),annual averages (%)

Sources: IMF; German Economic Institute
Figure 2 underlines the essence of this comparison. It shows that the economic
relevance (measured as the share of global GDP in current US dollars) of theASEAN-5 (3.1% in 2020) is already larger than all of Sub-Saharan Africa (1.9%). Thisdata also allows for the calculation of the total share of the EDA group, excluding
China, which amounts to 7.0% in 2020. This share is significantly higher than theshare of Latin America (5.1%), which has declined nearly continuously since 2011.
However, Figure 2 also illustrates the large economic weight of China, which has
contributed not only to the impressively rising share of the whole Asian group,
but also to that of the EDA economies.

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Figure 2. Global economic relevance: Share in global GDP in current USD (%)

Sources: IMF; German Economic InstituteThis large economic weight is also reflected in the high relevance of China as a
trading partner for the EU, with a share of 16% in terms of merchandise trading
volume. By comparison, other Asian countries, including advanced economies,
are much less important on an individual basis, be it Japan (3%), South Korea(2.5%), India (1.8%), or countries such as Vietnam, Singapore, and Malaysia with
about 1% each. However, as relations with China have become more challenging
in recent years, there is a tendency in the EU to increasingly diversify economic
relations so as to reduce reliance on China and focus more on the Asia-Pacificregion as a whole (for options regarding how to achieve this, see Section 3).
With the goal of diversification in mind, the EU and several of its member states(for instance, France and Germany) have recently published strategy papers on
broadening not only the economic but also the political ties in the Asia-Pacific,
designated as the Indo-Pacific for this purpose (Auswärtiges Amt, 2020; EEAS,2021). In addition to the economic importance of the region, the EU recognises
the relevance of the Asia-Pacific when it comes to upholding an open and rulesbased global trading system in view of rising geopolitical tensions. Moreover,issues like security of sensitive supply chains and of maritime trading routes comeinto play. In fact, according to the EU strategy, about 60% of global maritime tradepasses through the oceans of the Asia-Pacific, including the South China Sea,
where geographical tensions have risen recently. The EU considers that its offer
of cooperation could be of considerable interest to such Asia-Pacific nations, as
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Developments in Asian–European Trade Relations
they—akin to the EU themselves—often toe a delicate line so as not to choosesides between the United States and China.
The current EU approach to deeper economic integration with the AsiaPacific
The EU and several countries of the Asia-Pacific have already signed a number ofimportant trade agreements. As such, there is a basis to build upon for further
cooperation. However, the key drawback is that the current approach does notappear particularly effective in terms of reaching all the new partners.
Important and successful bilateral free trade agreements (FTAs) exist between
the EU and Japan, South Korea, Singapore, and Vietnam; additionally, FTA
negotiations are or were underway with other countries in the region. Relatively
good prospects are seen for deeper trade cooperation with Australia and New
Zealand. However, negotiations with the important and fast-growing countriesof the ASEAN-5 (excluding Vietnam) have proved to be very difficult. This
pertains to Indonesia, Malaysia, the Philippines, and Thailand. The EU insists on
implementing its ambitious standard approach in this respect, as such, conflicts
over human rights or sustainability (mainly social and environmental standards)
are key impediments. This pertains, for example, to the lack of a democratic
government in Thailand and to the environmentally challenging production ofpalm oil in Malaysia and Indonesia. As a result, FTA negotiations with Indonesia
have proved to be very difficult, while those with Thailand, Malaysia, and thePhilippines have been put on hold.
The same is true for FTA negotiations with India, mainly because ambitions forliberalisation on both sides proved incompatible. However, there have been
recent high-level political statements on both sides in favour of restarting FTA
negotiations. From the EU’s perspective, this step has to be seen in the context
of the above-mentioned Indo-Pacific strategies. In economic terms, India, with
its very large population, is an important economic player in the region, andthus also an important partner for the EU, especially if the dependency on China
is to be reduced. In geopolitical terms, the recent political and military tension
with China render India a key ally to counter China’s territorial ambitions in
the region. The United States has also recently intensified its relations to India
mainly for this reason. However, the prospects of an EU-India FTA might stillencounter difficulties due to India’s protectionist stance. Whether geopoliticalconsiderations will be a sufficient counterweight remains an open question.

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In late December 2020, the European Commission (EC), concluded negotiations
with China on a bilateral Comprehensive Agreement on Investment (CAI).
However, the likelihood of ratification is not high. The CAI would not liberalise
tariffs on both sides, as it is not a trade agreement. However, the EU has advocatedfor greater reciprocity in bilateral investment relations. The EU is, in principle,
completely open to foreign direct investment (FDI) and corporate takeovers from
non-European countries. In contrast, China has traditionally implemented ahighly restrictive approach to FDI, and remains far more restrictive than advanced
European economies, as data from the Organisation for Economic Co-operation
and Development (OECD, 2021) suggests.
China used to demand that foreign companies enter into joint ventures with
Chinese firms (as majority owners) in many sectors, thereby gaining access tomodern technologies. However, the EU (and the United States) grew increasingly
critical of this form of indirectly forced technology transfer (Matthes, 2020a). In
recent years, China has loosened some of the former constraints, albeit mostly insectors where the Chinese government considers the technological developmentof domestic firms to be sufficiently advanced. The CAI would mostly be a tool
to lock in these reforms (i.e. to prevent China from withdrawing the recent
concessions).
The conclusion of the CAI negotiations under the German EU presidency has
attracted criticism for several reasons:•

As indicated above, the ambition and scope of the CAI are relatively limited.

•

The timing was heavily criticised to offend the Biden administration, which
was not yet in office in December 2020. China clearly intended to sideline
the United States and, to this aim, appeared to have put some additional
concessions on the table in order to create the (teasing) impression that
the EU would not get any further concessions on top of this, even in case of
longer negotiations. Moreover, Brussels obviously wanted to demonstrate
strategic autonomy vis-à-vis the United States—bearing in mind that the
Trump administration had concluded a limited bilateral (Phase One) trade
agreement with China in January 2020.

•

Even though China may have put some additional concessions on the tablein December, there is a lack of additional investment market access, so thateven with the CAI, there would still be a severe lack of reciprocity. Had the EU
waited for closer alignment with the Biden administration over the courseof 2021, Brussels might have been able to extract more concessions from
China.
121

Age of Ferment:
Developments in Asian–European Trade Relations•

Beijing used the CAI to present itself as a state that favours liberalisation overprotectionism—again offending the US and its approach under the Trumpadministration.

•

China got away with relatively vague concessions on labour standards, theenforcement of which was also unclear.

•

The EU attempted to separate economics from values. Despite multiple
human rights abuses by the Chinese government, the EU offered China aplatform to present itself as a normal negotiating partner. What is more,
after the CAI, China continued to clamp down, particularly on Hong Kong.

Due to these drawbacks and developments, the pressure on the EU to face thechallenges vis-à-vis China increased.
•

Concerning the human rights abuses in Xinjiang, the EU issued (very limited)sanctions on certain Chinese individuals in March 202—in conjunction with
the US and several other democratic countries. As China retaliated furiously,
also targeting members of the European Parliament and several European
institutions critical of China, the current prospects for ratification of the CAI
remain dim as long as these sanctions remain effective.

•

The EU continued to develop additional economic instruments to level
the playing field in view of distorted competition from China. Immediately
after the conclusion of the CAI, the fear arose that this process of levellingout might be stopped for diplomatic reasons during the course of bothsides’ ratification. This would have been a serious mistake, as competitive
distortions due to China’s state capitalism (i.e. subsidies and state-owned
enterprises) are increasingly felt by European and also German companies(Matthes, 2020b; 2021).

The EU is therefore rightly developing new instruments to expand its toolbox so
as to better counter these unfair distortions of competition. This pertains, forexample, to an EC proposal to target foreign subsidies in the single market. The
proposed regulation would close a regulatory gap by introducing the possibilityof targeting foreign firms which are active in the EU market, and which benefit
from subsidies granted to them by their home governments. After several years
without progress, the Council agreed to introduce a so-called international
procurement instrument (IPI) as a tool to achieve better balance in bilateral
reciprocity. The IPI would allow the EU to limit or prohibit access of foreign firms
to its public procurement market if the firm’s home country does not sufficiently
open the domestic procurement market for EU firms. These instruments are notspecifically targeted at China, but apply to all third countries.
122Section II.

RELEVANCE OF FREE TRADE AGREEMENTS

The Relevance of RCEPIn November 2020, the Regional Comprehensive Economic Partnership (RCEP)
was signed; it includes the ASEAN countries, plus China, Japan, South Korea,
Australia and New Zealand. RCEP has entered into force in January 2022 among
the countries that concluded the national ratification processes in 2021 andleads to a free trade zone larger than that of the EU. From an EU perspective,
RCEP must be considered with the above-mentioned facts and developments inmind. While it has been hailed in the media as a major breakthrough for regional
economic integration, favouring particularly China’s role in the Asia-Pacific, on
closer inspection, RCEP loses some of its gloss. This regards both the extent oftrade liberalisation, and China’ role in RCEP.
Key features of RCEPIn terms of quality and depth, RCEP is not comparable to the EU’s modern
FTAs, which involve much more trade liberalisation, and establish many more
new standards for trading partners. In many respects, RCEP has had to limit
itself to a lowest common denominator approach, partly because its members’
development levels are so heterogeneous.
Already prior to RCEP, the Asia-Pacific had achieved intensive economic integrationin terms of cross-border value chains in important manufacturing sectors,
particularly in the electronics industry. This development had been fosteredby many (albeit fairly shallow) bilateral FTAs among many countries. However,this approach had led to a complex web of overlapping FTAs—the spaghetti bowl
effect, a term coined by the renowned economist Jagdish Bhagwati many years
ago. This burdens businesses, particularly SMEs, with high administrative trading
costs due to different regulations in the various bilateral FTAs (see below).
1. Limitations
RCEP is not very ambitious when it comes to tariff dismantling.
•

Unlike in many EU FTAs, where nearly all tariff lines are reduced to zero on
average, in RCEP only around 90% are; in some bilateral trade relations
among RCEP members, the share is even smaller.

•

Many tariffs are only reduced over a very long period of up to about 20
years, and the tariff reduction of sensitive goods tends to be backloaded
for political-economy reasons.

123Age of Ferment:
Developments in Asian–European Trade Relations•

Tariff reductions are established in complicated ways. Each RCEP partner
has its own very extensive tariff-reduction list, which details exact
schedules of tariff reductions over time for thousands of product groups.

•

The ten-country ASEAN alliance were already signatories to a regional
trade agreement, as well as to numerous bilateral FTAs between ASEAN
and the other RCEP partners. Thus, tariffs had already been reducedin these FTAs in the past. Therefore, the added value of RCEP is small.
According to a calculation by the Economist (2020), around 83% of the
trade flows of around 2,300 billion USD are already accounted for byexisting agreements within RCEP.

•

Unlike EU FTAs, liberalisation is also limited in relation to trade in services(DFAT, 2020; Pelkmans, 2020). The main aspect RCEP partners agree tois that the existing extent of liberalisation will be maintained and cannot
be restricted again (lock-in). While this does not create new openings,
it does create more legal certainty and transparency. In addition, somecountries have made certain new concessions in individual services
sectors (Matthes & Kolev, 2020).

•

Moreover, the agreement contains hardly any new standards. In the caseof product standards, it refers only to World Trade Organization (WTO)
rules. Environmental and social standards are not included. And there
are no new regulations against distortions of competition by state-owned
enterprises (DFAT, 2015).

2. Progress
However, there are also areas where RCEP leads to relevant progress in tradeliberalisation or facilitation.

124•

Significant additional liberalisation is envisaged between Japan, South
Korea, and China. While these countries had been negotiating a trilateral
trade agreement for some time already, they had not reached anagreement before RCEP. Within RCEP, they are by far the three mostimportant countries in economic terms. However, the extent of reciprocal
tariff reductions appears to be somewhat more limited than the RCEP
average in terms of coverage and transition periods (Matthes & Kolev,2020).

•RCEP reduces the administrative trading costs of the spaghetti bowl effectof FTAs to a significant degree by consolidating the multiple bilateral FTAs
which already exist between RCEP members. Unifying rules of origin isSection II.

RELEVANCE OF FREE TRADE AGREEMENTS

particularly important in this respect (PIIE, 2020). Rules of origin in a trade
agreement specify which extent of the value of a given exported productmust be produced within the territory of a signatory country, rather
than in a third country, in order to benefit from the tariff preferencesof the agreement when the good is exported to the partner signatory
country. The existing FTAs also contain such rules of origin. However,
the rules differ depending on the specific bilateral trade agreement.
Given the many overlapping bilateral agreements, businesses facedhigh administrative trading costs, and thus a reduced incentive to takeadvantage of agreements’ benefits in terms of tariff preferences. By
unifying the rules of origin, RCEP greatly reduces these administrative
trading costs. It is also important that a given RCEP country is able toinclude the value-added produced by other third RCEP countries in the
future when calculating whether the requirements for tariff preferences
are met. This will further increase the exchange of intermediate inputs in
the region.
While RCEP does not remove many trade barriers, it builds on the principle
of progressive liberalisation that ASEAN has already employed before.
The agreement provides various mechanisms to potentially expand tradeliberalisation in the future. In the case of services, for example, a forwardlooking, most-favoured-nation clause applies. Accordingly, if an RCEP member
offers better service-market access to a third country in a future FTA, the same
concession will automatically apply to all other RCEP countries. In addition, if
an RCEP member liberalises unilaterally in the future, this progress is madepermanent by means of a so-called ratchet clause. Furthermore, a separate
secretariat for RCEP is to be established, which can coordinate negotiations
on further liberalisations or on the creation of new standards.
3. Overrated role of China in RCEPIn the reception of RCEP in Europe, the agreement was portrayed as a successfor China, enabling Beijing to impose its mark and standards on the region.
In some cases, it was also said that RCEP had come about under China’s
leadership (Spohr & Reinartz, 2020). However, China’s role and relevancewithin RCEP ought to be viewed in a differentiated manner. Contrary to theabove claims, RCEP was initiated and driven by the ASEAN countries andnot under China’s leadership (Matthes & Kolev, 2020). Along with Japan,
South Korea, Australia, and New Zealand, China is one of five countries withwhich ASEAN already had a bilateral FTA. The goal for the ASEAN states wasprimarily to consolidate the aforementioned complex thicket of bilateral
FTAs in the region.
125

Age of Ferment:
Developments in Asian–European Trade Relations
For China, participation nevertheless means a political success—in several
respects that are also relevant for Europe. First, China was allowed toparticipate—presumably because of its outstanding economic importance—even though there are considerable political and economic conflicts in theregion, and even though Japan, South Korea, Australia, and New Zealandare political allies of the United States. Second, China participates, while
its geopolitical rivals such as India and the United States do not. Third, thecommunist leadership in Beijing can use RCEP to portray itself as an advocate
for liberalisation, sending a signal against US protectionism, as it did with the
CAI. These advantages of RCEP have apparently prompted the communist
leadership to agree to the planned tariff reduction vis-à-vis Japan and South
Korea, as well as to further trade liberalisation in services.
In the EU, there is a concern that China will use RCEP to further expand its
influence in the region in the medium term by using RCEP’s progressive
liberalisation opportunities (Drysdale & Armstrong, 2021). For example,
China could increasingly spread its domestic product standards under RCEP,
which would be in line with its goals under the China Standards 2035 strategy.
However, Japan and South Korea are likely to use their influence in RCEP to
oppose unwelcome Chinese standards. In addition, China is expected to takeadvantage of easier market access to invest (even) more in the RCEP region,
including in the context of the Belt and Road Initiative, which will naturally
further strengthen China’s role in Asian value chains.
Relevance for the EU
RCEP is directly relevant for the EU in economic and political terms. On theeconomic side, outsiders to FTAs are generally affected mainly by two contrasting
effects (Glania & Matthes, 2005). Firstly, a positive effect for outsiders, is thatthey too will benefit from the stronger growth in FTA members’ markets, which is
generally triggered by the increased trade liberalisation. The second main effectfor outsiders is, however, negative. When FTA partners grant each other mutual
benefits in the form of tariff preferences, they automatically discriminate against
third countries, with the latter’s products losing relative competitiveness. These
negative effects are greater, if the external tariffs for third countries are high,if trade liberalisation among FTA members is large, and the transition period isshorter. These trade-distorting effects can be further exacerbated by restrictive
rules of origin, which disfavour value-added from third countries.
In the case of RCEP, the extent of liberalisation is moderate in the aggregate.
Before its conclusion, it was estimated that RCEP would raise global GDP by 186
billion USD (0.1%) in 2030, compared to a baseline scenario before the trade war
126

Section II.

RELEVANCE OF FREE TRADE AGREEMENTS

between the US and China (Petri & Plummer, 2020). For Europe, an income gainof 13 billion USD (0.1% of GDP) was calculated, alongside small export losses of 4
billion USD, both in 2030 compared to the baseline. Thus, positive and negative
effects appear to broadly outweigh each other.
On the positive side for the EU, there are some expansionary market effects.
RCEP’s rules of origin are relatively generous with regard to value-added fromthird countries. This improves the possibility for European firms to participate
in the additional growth in the region. On the other hand, there are also trade
diversion effects. Here, a distinction is required. In cases where RCEP limits itself
to consolidating existing FTAs without significant additional tariff decreases,
negative effects on third countries are likely to remain small. The situation isdifferent in the trilateral relationship between Japan, South Korea, and China,
where tariffs are being significantly dismantled, albeit with considerable
exceptions and, in some cases, long transition periods. This could, potentially,
result in disadvantages for the EU relative to the current situation. A moredetailed look at the tariff dismantling lists of the three countries is necessary fora more precise assessment of the trade diversion effects.
RCEP may also increase incentives to relocate production from Europe to Asia.
This is more likely (1) the larger the diversion effects are, and (2) the more
attractive the market growth in the region proves to be. These effects apply
more to Japan, South Korea, and China, and less so to remaining RCEP countries.
Moreover, RCEP will lead to an expansion of intraregional value chains, in which
European firms will likely wish to participate. As such, European companies withan existing presence in the region will benefit from facilitated intraregional trade,
thereby increasing the offshoring incentive.
In political terms, RCEP has been a wake-up call for the EU. RCEP has signalledthat Asian countries will not wait for the EU to get on board. Instead, regional
integration is moving forward—with the participation of China, and without thatof the EU (or, indeed, of the US). Thus, the EU should reconsider its approachto the Asia-Pacific. Strategic considerations should become more important.
In particular, the EU should be prepared to make compromises in the abovementioned conflicts with the larger ASEAN countries in order to move forwardwith FTA negotiations. However, an even more far-reaching strategic analysis
appears necessary.

127Age of Ferment:
Developments in Asian–European Trade Relations
Options for a more ambitious EU approach to economic integration with
the Asia-Pacific
The EU should consider broader forms of economic integration. Efficiency
considerations regarding speed and negotiating capabilities would suggest
seeking trade agreements with larger groups of countries. Such interregional
negotiations allow efforts to be pooled. While the different interests of individual
participants in interregional approaches certainly make negotiations more
complex and intensive, such an approach should significantly reduce humanresources required compared to many individual bilateral negotiations.
Applying for accession to RCEP?
The EU had originally planned to walk down this avenue and negotiate aninterregional FTA with the ASEAN as a whole. However, among other issues, theabove-mentioned obstacles with the individual ASEAN members stood in theway. In consequence, the EU chose the bilateral path—with the limited results
pointed out above. If the EU reconsidered its strategic approach, an agreementwith ASEAN might become possible again. Moreover, were the EU to focus on abroad-based trade approach, and therefore to apply to join RCEP, it would offer
an even larger interregional partnership than ASEAN. Thus, RCEP could potentiallybe a suitable platform from which to foster the EU’s economic relationship with
the Asia-Pacific.
This initiative towards interregional negotiations is considered in the next section.
Even though this might not be taken as a panacea, it is assumed, for the purposeof the following consideration, that RCEP members could favourably consider anaccession by the EU under suitable circumstances. From the perspective of theEU, several criteria need to be taken into consideration when contemplating aninterregional agreement, such as:128•

the extent of additional market access that might be achieved (in this case, in
the Asia-Pacific),•

the relevance of own market access concession the EU would have to provide,•the extent of administrative trading costs involved,•

the existence of rules for fair competition, and against market distortions
induced especially by industrial subsidies,•

the existence of standards on sustainability and human rights in the relevant
trade agreement, and•the role of China.

Section II.

RELEVANCE OF FREE TRADE AGREEMENTS

As already mentioned, an accession to RCEP would considerably reduce
administrative trading costs compared to those incurred through bilateral FTAs
between the EU and RCEP countries on an individual basis. The additional criteria
can be analysed with particular reference to China, which plays a relevant rolein this respect. Regarding market access, participating in RCEP would avoid theabove-mentioned trade diversions at the expense of European firms that arelikely to occur in China (as well as in Japan and South Korea). But participatingin RCEP would very likely also mean a significant reduction of EU trade barriers
with regard to China. While this step would be advisable in principle, the tradedistortions of China’s state capitalism prohibit such a step because it would leadto a further increase in unfair competition by China within relevant EU industries.
In addition, joining RCEP could also limit the EU’s scope to use trade-defence
instruments vis-à-vis China’s dumping or subsidisation strategies. Moreover,
the additional aim of the EU of being part of a trade agreement with sufficiently
ambitious rules on fair competition, as well as on sustainability and human rights
standards, would also very likely not be viable in the case of China’s participationin such a group. These considerations clearly speak against joining RCEP and infavour of choosing an interregional FTA without China’s participation.
To this aim, joining the Comprehensive and Progressive Agreement for TransPacific Partnership (CPTPP) could be an option (Matthes & Kolev, 2020). However,in the following section, an even more far-reaching option is considered.
Proposal for a multi-regional trade partnership of like-minded countries
In a context of enlarging contacts to the Asia-Pacific, and also in relation to
the strategic geoeconomic systemic rivalry between market and non-market
economies, Matthes and Kolev (2020) propose a plurilateral interregional FTA
of market-oriented, like-minded countries with global reach, aiming at several
objectives simultaneously.
This mega FTA could be named the Pluri-regional Trade Partnership of LikeMinded Countries (PTPL). It would include, inter alia, the EU, the US, Japan,
Canada, the United Kingdom, Switzerland, and potentially many market-oriented
emerging economies in the Indo-Pacific region and beyond. Besides tradeliberalisation, the main objective of this FTA would be to create modern trade
rules that could form a blueprint for reformed WTO rules. This is particularly
needed in view of the global distortions of competition emanating particularly
from China’s state capitalism, as these distortions increasingly endanger welfare
and jobs in the EU and in other market-oriented countries. Reformed global
competition rules would allow small amounts of industrial subsidies, and the129Age of Ferment:
Developments in Asian–European Trade Relations
use of market-oriented state-owned enterprises (SOEs), but prohibit outsizedsubsidies and SOEs that do not act in a competitively neutral manner.
PTPL would aim at several objectives simultaneously:•

establishing a more prominent role for the EU in the Indo-Pacific,•

avoiding the transaction costs of the ‘spaghetti bowl effect’,•creating modern trade rules for a prosperous future in a liberal global tradeorder,•

incentivising cooperation of nonmarket economies on creating fair global
competition rules by offering a blueprint for reforming WTO rules on
industrial subsidies, SOEs, and countervailing measures•offering cooperation to the US on the issue of competitive distortions by nonmarket economies.

On the latter two objectives, further elaboration is needed. A reform of WTO
rules—potentially in a plurilateral WTO agreement—would require China’s
consent. However, Beijing’s cooperation appears highly unlikely under current
circumstances. If this continues to be the case and presuming a scenario in which
the negative spillovers from China’ state capitalism on the world market continue
to increase PTPL could be developed into an alternative to the WTO. This ultimaratio backdoor of PTPL would thus serve as an incentive for China to cooperate
on reforming WTO rules. Otherwise, without such a mechanism and in such a
scenario, the WTO crisis would be likely to deepen even further, as more andmore countries would tend to use trade-defence measures that go beyond WTO
rules, like the United States (probably) did under Donald Trump. Thus, it might benecessary to put the WTO at stake in order to save it.
Creating PTPL would by no means be a panacea. One issue would be the different
trade-policy approaches of the EU and the US in their FTAs (for instance, in termsof sustainability standards). However, the EU and the US clearly have common
strategic interests in reforming the WTO, reining in the global spillovers from
China’s state capitalism, and, more generally, in building a broad coalition of likeminded countries. In view of the geopolitical tensions between China and the US,
the strategic value of PTPL could make it worthwhile for the EU and US to joinhands in this respect and to strive for compromises.
For the EU, Brussels would have to allow certain changes in its trade-policy
approach. However, the EU could pay tribute to its objective of strategic autonomy
because it would be one of the drivers of a coalition of like-minded market
economies alongside the US. Moreover, it could position itself as a trade-policy
130Section II.

RELEVANCE OF FREE TRADE AGREEMENTS

actor that provides an answer to one of the most burning issues of the global
trade order—the distortions of competition by large non-market economies thatjeopardise the WTO.

Jürgen MATTHES heads the research unit for international economics andeconomic outlook at the German Economic Institute (Institut der deutschen
Wirtschaft [IW]), the largest privately financed economic think tank in Germany.
Before taking this position in 2015, he held several positions in the IW, which hejoined in 1995. His economic studies were undertaken in Dortmund and Dublin(1988–1995). Matthes has published on a wide range of topics covering trade
policy, globalisation, China, global value chains, EU and Economic and Monetary
Union (EMU), structural economic change, and the competitiveness of nations.

131

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References
Auswärtiges Amt. (2020). Leitlinien zum Indo-Pazifik: Deutschland—Europa—Asien:
Das 21. Jahrhundert Gemeinsam Gestalten. [Guidelines for the Indo-Pacific—
Germany—Europe—Asia: Shaping the 21st century together] https://www.
auswaertiges-amt.de/blob/2380500/33f978a9d4f511942c241eb460208
6c1/200901-indo-pazifik-leitlinien--1--data.pdf
Department of Foreign Affairs and Trade. (2015). Trans-Pacific Agreement [Fact
Sheet]. Australian Government. https://www.dfat.gov.au/sites/default/files/
state-owned-enterprises-and-designated-monopolies.PDF
Department of Foreign Affairs and Trade. (2020). Regional Comprehensive
Economic Partnership [Fact Sheet]. Australian Government. https://www.dfat.
gov.au/sites/default/files/rcep-outcomes-services-and-investment.pdf
Drysdale, P., & Armstrong, S. (2021). RCEP: A strategic opportunity for
multilateralism. China Economic Journal, 14(2), 128-143. https://doi.org/10.10
80/17538963.2021.1937092
Economist, The. (2020, November 21). Who gains from RCEP, Asia’s new trade
pact? Retrieved June 18, 2021, from https://www.economist.com/financeand-economics/2020/11/19/who-gains-from-rcep-asias-new-trade-pact
European External Action Service. (2021, April 19). EU Strategy for Cooperationin the Indo-Pacific. Retrieved June 13, 2021, from https://eeas.europa.eu/
headquarters/headquarters-homepage/96741/eu-strategy-cooperationindo-pacific_en
Glania, G., & Matthes, J. (2005). Multilateralismus oder Regionalismus? Optionen fürdie Handelspolitik der Europäischen Union [Multilateralism or Regionalism?—
Options for EU trade policy] [IW-Analysen 11]. Institut der deutschen
Wirtschaft. https://www.iwkoeln.de/fileadmin/user_upload/Studien/IW-Ana
lysen/PDF/Bd._11_Multilateralismus_oder_Regionalismus.pdf
Matthes, J. (2020a). Technologietransfer durch unternehmensübernahmen
Chinesischer investoren [Technology transfer through company takeovers by
Chinese investors]. Wirtschaftsdienst, 100(8), 633-639. https://doi.org/10.1007/
s10273-020-2723-2

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RELEVANCE OF FREE TRADE AGREEMENTS

Matthes, J. (2020b). China’s market distortions and the impact of theCovid-19 crisis. CESifo Forum, 21(3), 42-48. https://www.cesifo.org/en/
publikationen/2020/article-journal/chinas-market-distortions-and-impactcovid-19-crisis
Matthes, J. (2021). Wettbewerbsverzerrungen durch China: Akademische Evidenz
und Ergebnisse einer Befragung Deutscher Unternehmen [Competitive
distortions by China: Academic evidence and results from a survey ofGerman firms] [IW Report 10]. Institut der deutschen Wirtschaft. https://www.iwkoeln.de/fileadmin/user_upload/Studien/Report/PDF/2021/IWReport-2021_Wettbewerbsverzerrungen-China.pdf
Matthes, J., & Kolev, G. (2020). Eine Einordnung von RCEP. Was das regionale
Handelsabkommen für die EU und die deutsche Wirtschaft bedeutet—und wasnicht [RCEP: What the FTA implies for the EU and the German economy] [IWPolicy Paper 28]. Institut der deutschen Wirtschaft. https://www.iwkoeln.de/fileadmin/user_upload/Studien/policy_papers/PDF/2020/IW-Policy-Paper2020-RCEP.pdf
Pelkmans, J. (2020, November 23). New Asia-Pacific trade deal: Implications for East
Asia and the EU. CEPS. Retrieved June 15, 2021, from https://www.ceps.eu/
ceps-publications/new-asia-pacific-trade-deal/Peterson Institute for International Economics. (2020, November 18). 143.
RCEP—Separating fact from friction. Trade Talks with Soumaya Keynes & Chad
P. Brown [Audio podcast episode]. https://www.tradetalkspodcast.com/
podcast/143-rcep-separating-fact-from-friction/
Petri, P. A., & Plummer, M. G. (2020). East Asia decouples from the United States:
Trade war, COVID-19, and East Asia’s new trade blocs [Working Paper 20-9].
Peterson Institute for International Economics. https://www.piie.com/
system/files/documents/wp20-9.pdf
Spohr, F., & Reinartz, A. (2020, April 27). Die Globalisierung geht weiter - unter
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133Age of Ferment:
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134Section II.

ASIAN-EUROPEAN SUPPLY CHAIN RISKS

Asian-European
Supply Chain Risks
Hubertus BARDTAbstract
Asia is the most important source of imports for Europe. Therefore, the presenceof stable and sustainable supply chains are of particular relevance to theEuropean economies. There are, however, currently certain risks to the securityof this supply chain. Some must be mitigated at the company level; others canonly be addressed by governments in bilateral or multilateral approaches tostrengthen global economic exchange and ensure the security of supply. One
way to reduce vulnerability would be simply to do away with the dependency
by reshoring supply chains. However, such an approach would risk the level ofprosperity created by globalisation.

Asian-European Value Chains
Asia’s large population, coupled with its industrialisation processes, has made theregion into the workshop of the world. Its economic development has been much
more dynamic than that of other developing regions, and its growing wealth hasthen naturally led to additional export opportunities. It has become an incredibly
important partner for European economies. Foreign direct investment (FDI)
and trade relations form the fundamentals of economic cooperation between
both continents. Asia has become the most important source of imports for
Europe. Many European industrial value chains are based on the division oflabour with Asian companies. Natural resources are mined and processed in
Asia; basic materials are produced and consumed in Asia; while labour-intensive
and high-technology products are exported to Europe. According to Eurostat,in 2019, 45% of all extra-EU imports to the European Union came from Asia,
having grown from 38.7% in 2002. As globalisation progresses, the economies ofboth continents are becoming increasingly intertwined. Value chains have been
integrated, with Asian companies exporting both final and intermediate products,
as well as natural resources, to Europe. Ensuring reliability of supply is crucial forthe stability and economic success of these international value chains. This has
been seen particularly clearly during the COVID crisis—the ensuing disruption of135

Age of Ferment:
Developments in Asian–European Trade Relations
global supply chains has demonstrated how vulnerable industries can be once
their supply of components is compromised. More critically, the public healthof societies was challenged when health goods could not be delivered after
the outbreak of the pandemic. As a consequence, the stability and resilience of
supply chains is being widely discussed, to the point of some even questioning
the benefits of economic globalisation and free trade. Others point out that the
pandemic only highlighted the importance of secure global sourcing, as this was
how many necessary supplies were procured during the COVID crisis (Kober etal., 2020).
It is important to note that the relative increase in Asia’s share of imports wascaused by the economic growth of one country that has changed the global
economy—China. China was responsible for just shy of 10% of extra-EU imports
in 2002, a share which has risen to 20% in 2015, and almost 21% in 2019.
Combined, the countries from South Asia, Southeast Asia, China, and the East
Asian industrialised economies of Japan, South Korea, and Taiwan are responsiblefor 32% of extra-EU imports, rising from 25% in 2002.
The economies of the selected regions and countries have very different
characteristics. Japan, South Korea, and Taiwan are innovative, industrialised
countries that resemble European economic standards. Trade between Europe
and these East Asian countries is well-established, and counts as trade between
industries at the same level of development. Meanwhile, Southeast Asia isincreasing its trading share, and becoming a growing supplier of intermediate
and consumer goods. South Asia, although it contains two of the largest
countries in the world, India and Bangladesh, is still lagging behind. China—with
its exceptional development, impressive growth rates and integration into global
value chains—is a category of its own. Although its exports to the EU were aquarter smaller than those of the three East Asian industrialised economies in
2002, they are now twice as high as the exports of all other countries of theselected group. China has increased its share of imports from Asia (including
Turkey and the Middle East) to the EU from 25 to 45% and is thus the dominant
player in Asian-European value chains.
Comparing the absolute values of extra-EU imports from Asia, significant
differences can be seen (Figure 1). While the trade value of imports from theindustrialised countries of East Asia to the EU has remained fairly stable since
2002 (only +26% by 2019), there has been constant growth in the imports fromSoutheast Asia (+111%), and an even higher increase in those from South Asia at
a much smaller absolute level (+261%). China, meanwhile, increased its importtrade flows to the EU from 90 to 420 billion euros (+366%) and, in 2005, overtook136

Section II.

ASIAN-EUROPEAN SUPPLY CHAIN RISKS

the three industrialised East Asian countries—Japan, South Korea, and Taiwan.
EU member states now import more products from China than from all the othercountries in the selected group.
Figure 1. European imports from Asia—Extra EU imports to the EU-28 (in million
euro)Southeast Asia: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines,
Singapore, Thailand, Timor-Leste, Vietnam
South Asia: Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka
Source: Eurostat, IW

China is not only the most important supplier from Asia, but it also has a highshare of total extra-EU imports to Europe (Figure 2). The incredible growth of thiseconomy, after its reintegration into the world market and into global supply
chains, is also reflected in international trade flows. China has doubled its shareof EU imports from less than 10%, to more than 20% between 2002 and 2015, andhas remained stable since then. In the same time period, the share of the three
East Asian industrialised countries shrank from 13 to 8%. South Asia maintained
a steady increase from 2 to 4%, while the Southeast Asian countries lost market
share from 7 to 5% between 2002 and 2008, but returned to their previous levelin 2016. The last years have proven remarkably stable; the selected countries’
137Age of Ferment:
Developments in Asian–European Trade Relations
and regions’ share of the European market only changed marginally prior to the
COVID crisis.
Figure 2. Shares of imports to Europe (as a percentage of total extra-EU imports
to EU-28)

Southeast Asia: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines,
Singapore, Thailand, Timor-Leste, Vietnam
South Asia: Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka
Source: Eurostat, IW

Multiple Supply Chain Risks
The COVID crisis has stressed international value chains. In early 2020, many
companies feared that supply chains from China would break down and,
therefore, that necessary goods would not be available on short notice. This was a
critical threat when it came to securing the supply of medical products to protect
against infection. However, it naturally also affected the supply of consumer
goods and intermediate products. Nonetheless, after the initial supply-side shock,global value chains have proven to be remarkably stable. While deliveries within
Europe from its own neighbours became increasingly problematic as borders
closed across the continent, and the pandemic forced European societies and138

Section II.

ASIAN-EUROPEAN SUPPLY CHAIN RISKS

economies into strict lockdowns, the situation in China and other Asian countries
was already improving.
A year after the initial COVID shock, multiple new supply-chain problems
emerged—steel was partially unavailable, semiconductors became a majorbottleneck for the automotive industry, and shipping capacities were challenged
by scarcity and high prices. However, all these phenomena are not caused byadditional negative-shock events but reflect the developments from the beginningof 2020. The expectations of a long-lasting economic crisis had led steelmakers to
reduce their capacities. As restarting production for the many different productson the market takes months, it was not surprising that production levels would
struggle to meet the high demand in the face of strong economic recovery.
The situation was similar for manufacturers of semiconductors, as automotive
customers cancelled orders and production capacities were shifted to otherconsumers. Shipping logistics faced a sharp decline in the spring of 2020, but ahuge additional demand to replace the cancelled deliveries subsequently led tounusual peaks in shipping demand. In other words, the prolonged stress withininternational value chains is a dual result of the COVID shock, and the surprisingly
quick recovery.
The COVID crisis has drawn new attention to supply risks within global value
chains. However, managing supply risks has always been an important task forthe procurement of internationally active companies (vbw, 2021). International
supply chains are associated not only with wealth-creating effects due todivision of labour, but also with additional risks, as compared to fully integrated
production. COVID has increased the perception of risks and put the debate on
the stabilisation of international supply chains on the political agenda.
Supply-chain risks faced by companies can be economic, technical, or legal
in nature. They include, inter alia, price fluctuations, financial-market shifts,
macroeconomic events, increased competition, lack of solvency, or disputes
between trading partners. Some risks are more difficult for companies tocomprehend and manage. For instance, external shocks, lack of competition, andpolicy-related risks are challenges that may require more political attention. Somerisks can have consequences for entire economies or societies and therefore
need to be assessed politically, not only by the companies directly involved inorganising the value chains. The risks outlined below are not specific to trade andcooperation between Asia and Europe but form universal risk categories which
also apply to these value chains.

139Age of Ferment:
Developments in Asian–European Trade Relations

140•

International shipping risks. Most of the trade between Asia and Europe isshipped by large cargo vessels. Some shipping routes are threatened bymilitary conflicts or piracy. In other cases, lacking infrastructure, closed ports,
or missing capacities can harm supply chains, as important raw materials orintermediate product deliveries can be postponed or cancelled. Free-traderoutes are an important precondition for international economic cooperation,
which can only be guaranteed by governments. While a lack of capacity or
price fluctuations are typical entrepreneurial risks, the current situation withmissing shipping capacities after the COVID shock is a rebalancing process
after an unexpected global economic shock.

•

Lack of competition. Market economies are based on competition between
companies on markets. Lack of competition is a major reason for inefficiencies,
and for lack of innovation. In cases where there is a monopoly, high prices(monopoly rents) can be charged, as consumers have no freedom to choose
from other suppliers. Moreover, dependence on a single supplier increases
the risks in the value chain, as the reliance on the monopolistic supplier canbe abused. Additionally, should the sole company be unable to produce anddeliver its products for any reason, there are no short term replacements, ascompletely new supply structures would have to be established.

•

Natural resource monopolies. A monopolistic position in natural-resource
markets poses additional risks. Unlike a monopoly of industrial goods,
natural-resource deposits cannot be duplicated. The main country thiscurrently relates to is China. While most virtual monopolistic positions heldby China could be contested, this would be extremely expensive. Mining
and processing of rare earths or other high-tech minerals is not geologicallylimited to China, but the investments and operating costs that would beneeded to reduce dependency are high, and the process would take years
to establish. Hence, there are no alternatives even in the medium term.
Additional extraction and production capacities can be developed in Africa,
although China has already established a strong position in these countries
as well.

•

Short term inflexibility. Another potential risk is when supply chains need toshift on short notice and there are no available options allowing for that
adaptability. In such situations, any disruption, regardless of size, cannot
be adequately compensated for. Instances where short term reactions ona large scale were necessary include the post-tsunami situation in Japan in
2011, or during the COVID crisis in 2020. Inflexibilities create dependencies,
which can prove to be an expensive risk in case of disruptions to existing
supply chains.

Section II.

ASIAN-EUROPEAN SUPPLY CHAIN RISKS•

Trade distortions. Subsidies, protected over-capacities, or state-owned
enterprises have the potential to distort competition in markets, and thus
also affect trade. Competing against companies that enjoy such privileges isa politically generated market risk. As privileges can increase in magnitude
or relevance in unexpected situations, they constitute not only a systematic
disadvantage, but also a constant risk in supply chains.

•

Political interference. Government interference in market processes forpolitical reasons adds further risks to markets, and reduces the efficiencyof market-price-based coordination. Countries with a high tendency to exert
political influence on markets create risks for the supply chain, as interference
can disrupt existing cooperation.

•

Politicisation. An extreme form of interference is the use or abuse of market
position for political reasons. This is the case if monopolies take given actions
with political, rather than business, intent. It is also the case if countries use
state dependencies, or trade relations as political instruments. This can takethe form of sanctions, or boycotts of certain countries to increase pressure,
such as China stopping exports of rare earths to Japan to increase pressure
in a geopolitical conflict.

•

Protectionism. The increase of tariffs and non-tariff trade barriers, especiallyin the case of escalating trade conflicts, poses a severe threat to global trade,and therefore to the stability of international supply chains. Increased prices,or other import restrictions, lead directly or indirectly, to shifts in trading
patterns, which in turn, may cause supply risks. One widely discussed sourceof protectionism was the previous US administration, but the tendency ofgrowing trade restrictions and barriers is a global problem involving many
players.

•

Military conflicts. Military conflicts can cause a hard cut in existing supply
chains. Although these are not common in many parts of Asia, there are
territorial conflicts, especially between China and its neighbours. Taiwan, inparticular, is threatened by China’s rejection of Taiwanese independence.
An escalating conflict could immediately stop European trade with bothcountries, and thereby destroy much of the supply chains between Asia andEurope.

•Climate risks. Climate change is probably the most discussed long term global
development that affects all kinds of economic activities, and therefore
carries substantial economic risks. These risks can materialise directly, in the
shape of threats from changing climate conditions themselves. Events like141

Age of Ferment:
Developments in Asian–European Trade Relations
droughts, flooding, storms, or heatwaves can limit production and disrupt
transport lines, and therefore threaten established supply chains. Theserisks can also materialise indirectly, through climate protection policies, suchas emissions-reduction measures, or reduction of domestic carbon-intensive
production. For instance, European measures to restrict imports of carbonintensive products, or to increase their prices, may pose a threat for existing
supply structures. Additional costs may be imposed, which can reduce
competitiveness and lead to a shift in supply chains from Asian partners toother countries (for instance, on the African continent).
•

Health risks. The COVID pandemic has reminded us of a risk that had been
almost neglected until now. Health problems become economic risks when
production must be reduced, transport becomes more difficult, travel isrestricted, and borders are closed. In a pandemic situation, alternative
sourcing options are not a solution if all sources are similarly affected. Insuch a case, even regional production may not be helpful. Indeed, in the firstwave of the COVID crisis in Europe, closed borders obstructed European
supply chains more severely than their flow of imports from Asia.

•

Sustainability risks. Western societies are increasingly concerned about thesocial and environmental impacts of their consumption and production.
Therefore, sustainability within supply chains has become a political issue,
and many companies feel under pressure to act accordingly. A lack ofcompliance with social or environmental standards could jeopardise existing
supply structures in the short term, as consumers or public opinion could
force companies to immediately reorganise their supply.

The last years have been characterised by growing political conflicts, which have
led to increased uncertainty about political developments. Events such as theBrexit decision or the election of Donald Trump as president of the United States
have resulted in new highs of uncertainty for the future of globalised supply
chains. Political decisions and their consequences for economic development,
and for the stability of supply chains, have become even more difficult forcompanies to calculate. However, these risks seem, currently, to affect the EU
more than other players. For instance, both the EU and Japan experienced peaksof uncertainty following specific political events, such as Brexit, and the electionof ex-president Trump, or following disasters, such as the fully developed
global outbreak of the COVID pandemic. However, in the medium term, Europe
developed a trend of growing policy uncertainty, while the general level in Japan
has remained relatively stable (Figure 3). Although the international comparisonof these indicators is limited, politically generated risks may be more problematicin the EU than in Japan.
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Section II.

ASIAN-EUROPEAN SUPPLY CHAIN RISKS

Figure 3. High level of political uncertainty in Japan and Europe—Policy
Uncertainty Index 2006–2021

Source: ‘Policy Uncertainty in Japan’ by Elif C. Arbatli, Steven J. Davis, Arata Ito, Naoko
Miake, and Ikuo Saito and ‘Measuring Economic Policy Uncertainty’ by Scott R. Baker,
Nicholas Bloom, and Steven J. Davis at www.PolicyUncertainty.com

Risk Mitigation in a Globalised Economy
One political reaction to growing risks in supply chains is to question theinternational division of labour that has developed over the last decades. Complex
value chains that include companies with different competencies from various
countries have led to additional wealth being created in many countries aroundthe world. Although large, wealthy, and industrialised countries, such as Japan,
the US, and Germany are among the greatest beneficiaries of globalisation, thestrongest growth effect has been observed in emerging markets, such as China,
Poland, and Hungary (Figure 4).

143Age of Ferment:
Developments in Asian–European Trade Relations
Figure 4. Globalisation has led to prosperity—Cumulative income gains per
capita in relation to GDP per capita in 1990
China
Korea
PolandHungary
Chile
Slovenia
Romania
Ireland
Bulgaria
Indonesia
Estonia
Portugal
GreeceSlovak Republic
LatviaTurkeyIsraelLithuania
India
Finland
South Africa
Netherlands
GermanyJapan
Czech Republic
Nigeria
New ZealandAustralia
Switzerland
RussiaAustria
Italy
Denmark
BrazilBelgium
Spain
CanadaFranceMexicoSwedenUK
Luxembourg
Argentina
USA
Norway
0%

100%

200%

300%

400%

500%

600%

Source: Bertelsmann-StiftungIn these countries, the cumulative gross domestic product (GDP) per capita
enabled by globalisation is more than six times higher than the GDP per capita in
1990. In other words, China has seen a sixfold increase and Poland and Hungary
a three- to fourfold increase compared to 1990, while Germany has grown about

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1.5 times and the US by 40% (Petersen et al., 2020). The global convergenceeffect, wherein poorer countries grow faster than richer ones, also explains thelower relative impact of globalisation on the most advanced countries. They
have already been integrated into global value chains, while the developing andemerging countries still needed to catch up.
Globalisation has recently been greatly questioned. Negotiations about
multinational trade agreements on the World Trade Organization (WTO) level
have not been successful; bilateral agreements have been the only way forward.
The dispute-settlement mechanism of the WTO has been weakened, and tradedistortions have been growing. Trade conflicts and growing tensions between
the US and China have been an additional threat to free trade. The setback ofglobalisation is also demonstrated by the fact that international trade is growing
more slowly than global GDP.
In addition to these trends, the benefits of globalisation are at least partly atstake if growing international supply risks (or the perception of such risks)lead to massive reshoring of production. The aim must therefore be to ensure
supply chain security without significantly reducing the benefits of international
division of labour and global competition. This is a crucial precondition for future
prosperity. For example, many German companies have successfully specialised
in a small niche, but their business model depends on access to this niche on a
global scale. Otherwise, the market potential would be too small to enable thisspecialisation and technological progress. Restricting access to global markets
would therefore limit opportunities to develop specialised competencies andreduce the innovation potential of the global economy. Furthermore, additional
obstacles to global economic integration would reduce competition and therefore
constitute an additional threat to future global prosperity.
However, additional supply-chain security will not come without cost. For instance,
it can be expensive to integrate additional suppliers into a given supply chain, as
additional coordination efforts and reduced economies of scale have to be taken
into account. It is, naturally, the businesses that are part of the affected value
chains which must balance adaptation costs against supply chain risks. Supplier
diversification, long term contracts, equity investments, stockpiling, or other
instruments can be used at the company level to balance potential damages andcosts of risk reduction. Businesses are, of course, most effective in taking up theirprimary role in this matter when market-economy rules apply, and in countries
with similar standards. In this manner, risks in supply chains between developed,
industrialised countries in Asia, such as Japan, South Korea, and Taiwan, can be
managed by the companies involved.

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In low- and middle-income emerging economies, different standards regarding
social and environmental impacts of production create growing supply-chain
risks, as European companies must pay increasing attention to the sustainabilityof their value chains (Kolev & Neligan, 2021). This will lead to additional pressure
not only on suppliers, but also on governments, both to monitor and increase
existing standards. However, these economies need to preserve their competitive
advantages, which typically consist of low production costs based mostly in
low labour costs. Economic growth lifts people out of poverty and—over theyears—increases wage levels as soon as other competitive advantages can be
developed. The other important challenge for emerging countries in Asia is thatdiversification of value chains can result in some Asian suppliers being replacedby new suppliers from other regions, such as Eastern Europe or Africa.
Although pressure is high—and some companies will decide to invest in local
sourcing, diversification of suppliers, or more stockpiling—a fundamental
restructuring of global supply chains does not seem to be very probable.
Companies rely on qualified suppliers that cannot be replaced easily. Furthermore,
the experience of bottlenecks related to the COVID crisis does not axiomaticallypoint to the necessity of reshoring production. Value chains have proven to beremarkably stable even during the months when the whole industrialised world
was under some form of lockdown. It is unlikely that having had more regional
suppliers would have significantly reduced the existing problems. In Europe, forexample, European supply chains have been more vulnerable than global ones.

Summary
From the European perspective, Asia is the most important continent regarding
manufacturing sector supply chains. Asia and Europe benefited from globalisation,
but these gains are at risk as international trade has lost some of its dynamism—
mainly for political reasons. The COVID crisis has increased pressure to reorganise
supply chains. However, some of the most challenging structural supply risks are
the result of market politicisation. Non-market behaviour, unpredictable politicaldecisions within supply chains, and the threat of political intervention can lead toshort term disruption of value chains. Distortions of trade and competition put
risks on the stability and efficiency of value chains. The main source of these risks
is the state capitalism of China, with its massive interventions and resulting tradedistortions, combined with its high share in the global economy.
In the short term, the COVID pandemic was a shock to global value chains(Bardt et al., 2021). According to empirical studies, disruptions of international
supply chains may have been responsible for one-quarter of GDP losses during
146Section II.

ASIAN-EUROPEAN SUPPLY CHAIN RISKS

the COVID crisis (Bonadio et al., 2020). Compared to the possible damage,
however, global supply chains withstood the strains successfully. The worldwide
restrictions could, in fact, have had far more severe consequences. Furthermore,a global shock leaves few options: diversification does not help if all countries
and suppliers are affected. Even regional sourcing does not necessarily increase
security of supply in times of crisis, as it reduces sourcing options. If different
regions of the world are affected differently, supply from distant regions may bepossible, even if production in closer countries is restricted. During the first waveof COVID in spring 2020, regional supply chains in Europe were more problematicthan deliveries from Asia (Bardt & Grömling, 2020). Globalisation has increased
security of supply, and has stabilised value chains and, therefore, production in
European countries. Supply chain risks will always exist. However, they can andshould be managed for the sake of preserving globalisation gains.

Prof. Dr. rer. pol. Hubertus BARDT is managing director and head of researchat the Institut der deutschen Wirtschaft Köln (German Economic Institute) anda visiting lecturer at RFH University of Applied Sciences Cologne and Heinrich
Heine University Düsseldorf. He studied economics and business administrationin Marburg and Hagen and received his doctorate in economics from the Philipps
University Marburg. He joined the German Economic Institute in 2000 and headed
the research unit for environment, energy, and resources from 2005 to 2014.

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References
Bardt, H., Ezell, S., Flores, T., González, N., Hattingh, C., Randolph, S., & Bandini, G.
(2021). Global value chains after the COVID-19 crisis. Global Trade andInnovation Policy Alliance (GTIPA).
Bardt, H., & Grömling, M. (2020). Kein schnelles Ende des Corona-Schocks:Ökonomische Einschätzungen deutscher Unternehmen [No abrupt end to thecorona shock: How German companies assess the future of the economy]. IWTrends - Vierteljahresschrift zur empirischen Wirtschaftsforschung, 47(2), 2141. http://hdl.handle.net/10419/219325
Bonadio, B., Zhen, H., Levchenko, A. A., & Pandalai-Nayar, N. (2020). Global supply
chains in the pandemic [NBER Working Papers 27224]. National Bureau of
Economic Research. https://www.nber.org/system/files/working_papers/
w27224/w27224.pdf
Kober, K., Kirchhoff, J., & Matthes, J. (2020). Corona-Krise macht Liberalisierung desHandels mit Gesundheitsgütern noch dringlicher [IW-Kurzbericht No. 69/2020].
Institut der deutschen Wirtschaft. http://hdl.handle.net/10419/221776
Kolev, G., & Neligan, A. (2021). Nachhaltigkeit in Lieferketten: Eine ökonomische
Bewertung von Gesetzesvorschlägen [IW-Policy Paper No. 5/2021]. Institut derdeutschen Wirtschaft. http://hdl.handle.net/10419/232540
Kolev, G., & Obst, T. (2020). Die Abhängigkeit der deutschen Wirtschaft voninternationalen Lieferketten [IW-Report No. 16/2020]. Institut der deutschen
Wirtschaft. http://hdl.handle.net/10419/216214
Petersen, T., Rausch, T., Sachs, A., & Weiß, J. (2020). Globalisierungsreport 2020:
Wer profitiert am stärksten von der Globalisierung? [Policy Brief #2020/05].
Bertelsmann-Stiftung. https://www.bertelsmann-stiftung.de/fileadmin/files/
user_upload/Globalisierungsreport2020_PolicyBrief__2020_DE_final.pdf
vbw (2021). Internationale Risiken für bayerische Unternehmen. https://www.
vbw-bayern.de/Redaktion/Frei-zugaengliche-Medien/Abteilungen-GS/
Wirtschaftspolitik/2021/Downloads/vbw-Studie-Internationale-RisikenUpdate-2021-final.pdf

148Section II.

FUTURE OF EU-ASIA TRADE AFTER RCEPThe Future of Europe-Asia Trade
Relations after RCEP
Alessia AMIGHINI

Abstract
The European Union (EU) has growing trade relations with many Regional
Comprehensive Economic Partnership (RCEP) signatories. European companies
have well-established intra-Asian supply chains and can thus benefit fromthe harmonised rules of origin and reduced tariffs among RCEP countries. To
maintain good trade relations, the EU and Asia should cooperate to define the
new rules of digital trade.

After eight years of inconclusive negotiations, the Regional Comprehensive
Economic Partnership (RCEP) was eventually signed among 15 countries1 inNovember 2020. As global trade continued facing waves of uncertainty causedby the COVID-19 pandemic, along with continuing geopolitical tensions—not
least the unresolved trade war between the United States (US) and China—theachievement of such an agreement comes as something of a surprise. IntraAsian trade is already larger than Asia’s trade with North America and the EU
combined. The extended bottlenecks that troubled long-distance trade during2020 created a big incentive for Asian countries to deepen the already existing
pan-Asian trade network. The foundational belief behind such a push for greater
market regional integration is that it will lead to greater economic prosperity—
indeed, as the EU has shown since its inception.
RCEP creates the world’s largest free-trade zone among countries, accountingfor 28% of global GDP, 28% of global trade, and 29% of global population. RCEP
is set to increase trade relations among its members and further promote thedevelopment of regional value chains in ‘Factory Asia’. It can thus be surmisedthat intra-Asian trade will continue to be a growth engine for the global economy
and may accelerate the eastward shift in the centre of gravity of world growth.
This will likely exert a significant impact on Asian relations with the EU as well,as the two are now linked with each other by the most intense trade relations in
the world.

1

The 10 members of ASEAN and Australia, China, Japan, South Korea, and New Zealand.

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Age of Ferment:
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This chapter will first summarise and review the results of the few studies thathave ventured into estimations of the results of RCEP on global trade relations,and in particular those with the EU. It will describe recent trade and investment
developments involving RCEP members, with a view to estimating the likely
impact of RCEP on overall trade relations with the EU. Finally, the chapter will
discuss the urgent need to regulate digital trade so that it does not become a
trade-diverting factor in EU-Asia trade.

RCEP Expected Impact on Trade: A Short Review
According to the results of the most comprehensive empirical study on theaggregate impact of RCEP on world trade (Petri & Plummer, 2020), RCEP
strengthens East Asian interdependence, raising trade among members by 428
billion USD, and reducing trade among non-members by 48 billion USD. Using acomputable general-equilibrium model, the authors show that the agreements
will raise global national incomes in 2030 by an annual 186 billion USD. They will
yield especially large benefits for China, Japan, and South Korea (being the only
countries among RCEP members that are not yet linked by any trade agreementwith one another, and therefore can reap larger benefits from the new free-tradearea), with losses expected for the US and India.
As most RCEP members are already deeply connected through trade andinvestment, room for further regional integration may be limited. So far, theregion has already become a major source market for member countries—theshare of intra-regional imports (i.e. among countries within RCEP) has increasedby 10 percentage points since 1990, and already accounted for 50% of total
imports in 2018. Except for the country pairs Japan-China and Japan-South Korea,
trade agreements for all bilateral links between RCEP countries already exist. As
such, only a few additional tariff cuts are expected with the inception of RCEP.
In contrast, the role of RCEP as a sales market is more limited, as intraregional
exports only accounted for 39% of total exports in 2018. RCEP is still far awayfrom being an integrated market, equivalent to the EU, for instance, whereintraregional trade is dominant compared to extra-EU trade. In 2020, according
to Eurostat, most member states had a share of intra-EU exports between
50 and 75%. It was above 75% in Hungary (78%), Slovakia (79%), Czechia, andLuxembourg (both 80%).
What RCEP can change significantly is trade with and among the three largest
Asian economies involved (China, Japan, and South Korea). Estimates by Petri and
Plummer (2020) suggest that, by 2030, total exports to the world by China, Japan,
and South Korea will be up to 248 billion USD, 128 billion USD, and 63 billion USD,
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FUTURE OF EU-ASIA TRADE AFTER RCEP

respectively. Exports by each of the three countries to the other two will increaseby 96 billion USD, 193 billion USD, and 36 billion USD for China, Japan, and South
Korea, respectively. Moreover, the largest reduction of trade barriers will be dueto the harmonisation of the rules of origin. Given the deep production linkages
within the region, the current network of bilateral treaties, each with different
provisions for rules of origin, constitutes a high bureaucratic burden for firms
operating in the region. Common and simplified rules of origin are designed
to facilitate the integration of regional value chains, so harmonisation will be amajor source of trade creation in the area.
The EU has a growing trade connection with RCEP signatories. China, Japan, andSouth Korea are not the only ones among the EU’s top ten trading partners.
In addition, the EU has signed free trade agreements (FTAs) with four RCEP
signatories and is negotiating with five others. According to Eurostat 2019 tradedata, in value (euro) terms, RCEP signatories globally account for one-fifth of
the EU’s total extra-EU exports, and 31% of the EU’s total extra-EU imports. In
volume terms, RCEP member states account for 12% of total extra-EU export
volume (in kilograms) and 7% of total extra-EU import volume. In both imports
and exports, machinery products and automotive goods are among the top fivecommodity categories. In 2019, these two categories accounted for 44% of thetotal value and 7% of the total volumes of EU exports to RCEP countries, withequivalent import figures at 53 and 18%, respectively.
It is worth remembering that while intraregional trade has been growing in RCEP
countries since 1990, the relative importance of the EU-28 and North American
Free Trade Agreement (NAFTA) countries as trading partners for RCEP members
has sharply declined (Flach et al., 2021). Between 1990 and 2018, imports from
NAFTA and the EU-28 together decreased by 17 percentage points to 22%, andexports to NAFTA and the EU-28 together decreased by 14 percentage points to
33%. The fact that much of this development took place before China’s accession
to the World Trade Organization (WTO) in 2001 (Flach et al., 2021) suggeststhat regional production networks were already growing between Northeast
Asian advanced economies and Southeast Asian developing economies, partly
independent from China. Now RCEP will complement this with further integration
among the three manufacturing powerhouses—China, Japan, and the Republicof Korea. For example, under RCEP, China commits to eliminate tariffs on 86% ofJapan’s exports, including auto parts (Dadush, 2020). Together, the three nations
generated 5.3 trillion USD of value-added in manufacturing in 2019, which is over1 trillion USD more than the US and EU combined.

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Besides the aggregate effects on trade flows, an interesting question is, to what
extent and in which manner will RCEP impact EU-Asia trade? Although scenarios
are difficult to estimate, many elements have been offered in a number of
extant studies that, taken together, allow for an understanding of the most likely
implications of RCEP on trade relations between the EU and Asia. As a significant
share of trade is embedded in global value chains (GVCs), the latter offer a useful
criterion for the assessment of the type of trade interdependencies at work
between the EU and Asia, and how they could be affected by RCEP. A handy
starting point is the analysis of backward and forward linkages among the threemajor world trading regions or blocs: Asia, Europe (taken here as predominantly
the EU), and North America. These trading blocs are centred around therespective leading manufacturing powers (China, Germany, and the US), each, inturn, embedded in regional production networks with supplying countries. These
blocs have also been called factories, namely, ‘Factory Asia’, ‘Factory Europe’, and‘Factory North America’. The latter two world factories both used to be deeply
integrated through regional production networks or value chains back in the
1990s. Factory Asia, on the other hand, taken as a whole to include both Eastand South Asia, has been much less of a unanimous bloc. This can be seen fromthe fact that the share of value-added produced within Asia was, at the time,
lower than in Europe and North America in many high-tech sectors. This has
progressively changed, as a larger share of value-added production started tocome from within the Asian region. Today, Asia is a highly integrated region
through regional production networks. As mentioned in the World Bank’s 2020
World Development Report,
In an average European country, 65% of the imported intermediates
embodied in its exports in 2018 originated from other European
countries. This share is about 55% for an average East Asian economy,
and almost 40% for a member country of NAFTA. The other regions are
all more integrated globally than regionally. (WDR 2020, p. 25)
With further trade liberalisation and harmonisation of rules of origin within RCEP,
Asia has the potential to become an even more integrated ‘Factory RCEP’. This
raises concerns among EU-based firms that reduced tariffs and common rules oforigin in the RCEP group will lead to deeper production and trade linkages within
the region—to the detriment of trade with the EU.
However, there are important differences among the three world factories.
Akin to Europe and North America, RCEP is centred around China as the largest
manufacturer. However, unlike Germany’s and the US’ share within Factory
Europe and Factory North America, respectively, the share of China’s value-added152

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FUTURE OF EU-ASIA TRADE AFTER RCEP

traded with RCEP has decreased over time, both for backward and forward
linkages (Flach et al., 2021). This means that China has decreased the valueadded it imports from RCEP countries, and has increased the domestic valueadded content of production and exports. Consistent with China’s industrial
development goals aimed at building indigenous productive capacities, thecountry has reduced its participation in GVCs, including within Factory RCEP. As
a consequence, the latter has grown less centred on China. As such, in termsof value-added trade, RCEP is now more dependent on the other two worldfactories, and on Germany and the US, in particular.
These developments are consistent with the evolution of foreign direct
investment (FDI) within RCEP. According to Garcia-Herrero (2021), ASEAN
countries have been receiving an increasing amount of manufacturing FDI fromJapan, South Korea, and Taiwan—a share which is already larger than the FDI
they send to China. Such a sharp increase in investment into ASEAN is not only
a response to higher labour costs in China, but is also a means of diversifying
from excessively China-centric value chains. When RCEP negotiations started in2012, it was largely to try to disentangle the ‘spaghetti bowl’ of complicated rules,
particularly for trade in goods, across Asia. The largely export-oriented countries
in Northeast Asia wanted to create a new agreement to make it easier for supply
chains to operate with ASEAN (Elms, 2021).
The signing of RCEP is very significant for ASEAN because it will secure thegroup’s centrality in East Asian economic integration. Indeed, RCEP is a megaFTA proposed and promoted by ASEAN, not by Japan or China (Shimizu, 2021).
RCEP will make it easier for Northeast Asian investments to build value chainsin Southeast Asia. When considering China’s ambition to increase its domesticinput content of production, this is likely to detach China from regional value
chains within RCEP.
China will nonetheless remain a major sales market in Asia, and tariff reduction
will boost trade, especially imports from Japan and South Korea. This is a major
reason for concern in the EU, as there may be a detrimental impact on EU exports
to RCEP signatory countries with which the EU has no trade agreement. The EU
has important trade agreements in force with Japan, South Korea, and Vietnam;
therefore, exports to these countries are unlikely to be displaced. However, mostof the EU’s total exports to RCEP in 2019 are not covered by trade agreements,
including those to China, the EU’s second largest export destination, where theapplied trade-weighted tariff was 9.15% in 2017 (since reduced by about 2%).
Other significant markets include Indonesia, Malaysia, and Thailand, where the
EU faces high tariffs, and Australia, where the EU faces lower tariffs. Considering

153Age of Ferment:
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that the EU’s exports to China are composed mainly of machinery and othermanufactures, some displacement of these on the Chinese market in favour of
those from Japan and South Korea may be expected (Dadush, 2021).
Overall, it is still unclear how large the direct economic impact of RCEP on the EU
will be. On the one hand, lower import prices on intermediate inputs from RCEP
will benefit European consumers and firms, with some significant margins still
to be gained. Moreover, increased economic activity and income within RCEP
will boost demand and imports—to the benefit of partner countries, including
the EU. On the other hand, the trade displacement or diversion effect will more
likely act in favour of the most technologically advanced countries in RCEP—Japan and South Korea—which will gain a larger share of the Chinese market.
These elements complement the conclusion of the most widely cited study on
the impact of RCEP (Petri & Plummer, 2020), which indicates that the EU could
be a small net gainer from RCEP, at about 0.1% of GDP by 2030. Nevertheless,whatever the net effect will be, trade relations will be significantly impacted.
This is particularly true for individual sectors where Japanese and South Korean
suppliers can effectively replace European suppliers, most likely in industrial
machinery and automotive sectors.
Consequently, future EU trade strategy towards Asia should carefully consider
the specificities of production networks in Factory RCEP. RCEP value chainsare likely to increasingly withdraw from their prior China-centrism. As such, astrategic approach for the EU might be to conclude that closer ties with Chinamight be the most beneficial option. The EU and China are both each other’s
largest trading partner, albeit with very different trade flows on the export andimport sides. EU exports to China largely consist of intermediate high-tech
inputs, whereas EU imports from China are dominated by manufactures. As theambitious Made in China 2025 plan suggests, national industrial policies are likely
to challenge EU exports to China. The expected reduction in exports to China was
hoped to be compensated by improving EU-based firms’ production activities
in the country through FDI, but this has not proved easy. Negotiations on theComprehensive Agreement on Investments (CAI) with China—eventually leading
to an agreement signed in December 2020—have shown that the average EU
stance in such deals is much more ambitious than China can accommodate.
Additionally, China has confirmed that it is not willing to fully discuss marketaccess issues. Achieving a comprehensive FTA beyond the rather more limited
sphere of investments is very unlikely, yet the alternative of limited free-tradedeals is likely to face political resistance within the EU. This is because, although
they would be technically feasible, such an approach would go against theambitious spirit of the EU approach towards more comprehensive agreements.
154Section II.

FUTURE OF EU-ASIA TRADE AFTER RCEP

Moreover, given China’s attitude on non-trade issues, which the EU always
includes in its comprehensive agreements, there is not much sense in thinking
that partial progress in negotiations—be it on trade or investment—will increase
the likelihood of such a deal being signed.
An effective policy option for the EU today would be to accelerate comprehensive
bilateral agreements with other countries in Asia, such as Indonesia, Malaysia,
the Philippines, and Thailand, with whom negotiations have already started in the
recent past. This would increase the likelihood of benefitting from the efficiency
gains that RCEP will bring to member countries in terms of common rules andharmonisation. However, for developing Asian countries now signatories of RCEP,
non-trade issues are also likely to be a stumbling block, given the environmental
and labour standards always included in negotiations involving the EU and otheradvanced countries.
Joining the Comprehensive and Progressive Agreement for Trans-PacificPartnership (CPTPP), regarding which the United Kingdom (UK) has also alreadyexpressed interest, might be a worthwhile option for the EU, maybe more so on
a geopolitical level than on an economic one. CPTPP already includes countries inNorth America and Asia, with which the EU already has trade agreements, so thebenefit from further trade liberalisation might be limited. However, the sheer sizeof what would become a monster partnership—spanning from America to Asia
to Europe—might push the US to reconsider its withdrawal from the agreement,
and therefore turn CPTPP into a challenging competitor to RCEP.
Whatever the future course of US trade policies towards Asia may be, thesigning of the RCEP mega-regional agreement requires a comprehensive rethinkof overall EU-Asian trade strategy. This will be closely related to the EU-China
strategy, which has not been reconsidered so far, despite some anticipation madeby EU’s foreign policy chief, Josep Borrell, back in 2021. Forging a China strategy
has proved to be a difficult exercise for the EU Commission, squeezed between
the pressure from Washington not to enter into any agreement whatsoever, andthe more realistic and forward-looking need to remain engaged with China. This
being said, the systemic rivalry between China and Western democracies is not
simply an accusation from Washington, but a condition that is more and moredifficult to deny, given the ambitious Chinese aim of technological independence.
In view of this, before engaging in yet another summit with Beijing, the EU needs
to have an internal dialogue, so as to build an independent and unified position
regarding China.
When reasoning on the most effective avenues to promote EU-Asia traderelations, a few elements are worth remembering.
155

Age of Ferment:
Developments in Asian–European Trade RelationsFirst, the legacy of the Trump administration in the US has shown that a
confrontational approach is more likely to push other important trade partners
to secure the future of their trade relations by entering into other deals, as
happened with RCEP.
Second, ignoring the systemic importance of mega-regionals may be unwise, as
they are the second best form of multilateral deals left in the doldrums of WTO
reform. However inefficient they may be, they keep dialogue going, albeit withinclubs, and create incentives for third countries to join. The concern of an evenmore complex ‘spaghetti bowl’ of agreements should not stall progress on megaregionals, as the series of bilateral FTAs the EU has signed with a number ofcountries in Asia is already creating potential inconsistencies.
Third, instead of aiming to work on broad agreements with selected geographies,
it may be more effective to build coalitions of countries that are willing to agree
on individual sectors. One such sector is that of digital trade—indeed, the futureof global trade—which, thus far, remains unregulated.

RCEP and the Future of Digital Trade
RCEP is set to be a major catalyst for post-pandemic recovery across Asia. In
fact, for Asia-Pacific businesses, RCEP effectively creates an unprecedented
framework for pan-Asian trade, as it covers large and growing segments of the
global population, involving both emerging markets and developed economies,
while also setting trade standards across the region in areas such as intellectual
property and labour rights.
One of the areas where the agreement will have the most effect is likely tobe e-commerce. Indeed, many of the world’s largest super apps—online ormobile platforms that combine multiple services into a single app—are based in
RCEP countries. Examples include Chinese platforms WeChat and Alipay, Japan’sLine, South Korea’s Kakao Talk, Indonesia’s Gojek, and Singapore-based Grab.
Spurred by the pandemic, many digital providers are looking to expand theirfootprint in the region by moving into new markets—a process that should befacilitated by RCEP. As a matter of fact, RCEP countries (with the exception of
Cambodia, Indonesia, the Philippines, and Vietnam) are also part of the WTO’s
joint statement initiative (JSI) on e-commerce, which aims to negotiate aplurilateral agreement on the ‘commercial aspects of e-commerce’, as economictransactions increasingly take place in digital form. Leblond (2020) suggests that
RCEP’s Chapter 12 on e-commerce is a potential illustration of what we may
expect from the JSI, because it shows what China, RCEP’s dominant member state,is willing to accept in terms of e-commerce/digital trade provisions. Meanwhile,156

Section II.

FUTURE OF EU-ASIA TRADE AFTER RCEPJapan, RCEP’s other key player, agreed to the digital trade provisions in the CPTPP.
The CPTPP’s Chapter 14 on e-commerce was driven by the US, which then used
it as the template for Chapter 19 on digital trade in the Canada-United StatesMexico Agreement (CUSMA). In principle, both chapters constrain their member
states’ ability to restrict cross-border data flows.
However, the language of the RCEP is such that it allows member states to impose
whatever domestic regulatory restrictions they wish, as long as they are appliedin a nondiscriminatory manner (i.e. applied equally to domestic and foreigncompanies). But even with regard to no-discrimination provisions, a member
state could get away with discriminating against specific foreign companies
since RCEP’s dispute-resolution mechanism does not apply to Chapter 12. The
e-commerce issue had been regulated very differently in the TPP, and now in the
new CPTPP, where instead e-commerce is also covered by a dispute-resolution
mechanism.
The recent application in February 2021 by the UK to be the first new country to
the join the CPTPP will expand the geographic scope of the agreement’s digitaltrade rules, and therefore the coalition of countries interested in being involvedin the related regulatory efforts. China followed suit, with an application in
September 2021. As China is by far the largest market for e-commerce, and has
the largest Asian companies in the digital sector, one should expect that China
will aim to exert a dominant role in the regulation of cross-border e-commercein the Asia-Pacific. Moreover, the scope for the international use of the renminbi,
in particular the new digital currency e-CNY, in cross-border trade, will largely
increase, especially within ASEAN. Japan, the first country to insist, some years
ago, that global rules for e-commerce should be adopted, will likely resist thepossibility of this ambition being lowered to the regional level, especially if China’srole in their development is too great.
Meanwhile, as previously noted, EU companies with well-established intra-Asian
supply chains or Asian subsidiaries can benefit from reduced costs under the
harmonised rules of origin and reduced tariffs between RCEP countries. This isparticularly the case for EU industries with well-established supply chains in Asia,
such as the automotive, electronic machinery, and textile sectors. For example, in
2019, 69% of Adidas’ suppliers were located in the Asia-Pacific region. Naturally,
EU manufacturers have a higher risk of losing competitiveness in sectors withwell-established intra-Asian supply chains in the RCEP market. This will most likely
be the case—e-commerce will expand within RCEP countries but not between
RCEP and third countries due to segmented regulatory frameworks. Therefore,
in order to build strong and sound EU-Asia relations, there is an urgent need to157

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define the new rules of digital trade, which will become the largest segment ofworld trade very soon.
In spite of the interesting opportunities offered by digital trade, there are a numberof unresolved issues with regard to cross-border e-commerce (i.e. electronictransactions that take place internationally) involving two or more countries.
The development of the international e-commerce market has been too swift toallow for the adequate development of rules on its functioning, with countries
acting in an uncoordinated manner. This situation has led to high uncertainty on
how to access many important markets, and resulted in a fragmentation of tradein what is potentially one of the most global contexts.
Three major issues should be adequately addressed at the international level toavoid diplomatic frictions and to ensure fair market access conditions.
Handling of personal data
Every online transaction also involves the transfer of data that must be handled
carefully, and which constitute a key asset for the companies participating in
the exchange. However, there aren’t clear international standards on how thisdata should be handled, and the sensitivities of the world’s major economic
powers are divergent in this regard. The EU is currently the most advanced area
when it comes to personal-data protection, having launched the General Data
Protection Regulation (GDPR) in 2018. The US has lower standards in a bid toprioritise the commercial interests of companies over the individual rights ofusers and customers. Regulation in China (which is currently the target market
for e-commerce expansion) is even less transparent. However, it is important toinclude rules regulating data processing in the new generation of commercial
agreements; otherwise, the online sale of goods and related services could
be compromised. The experience of Brexit provides us with another concrete
example in this regard; pending an ‘adequacy’ decision by Brussels, a temporary
mutual recognition regime was granted by the EU to the UK (which is continuing
to apply GDPR for now), thus avoiding further uncertainties and ‘bottlenecks’.
Multilateral governance still ineffective
Through the agreements underpinning the WTO, which govern trade ingoods (GATT), services (GATS), information technology (ITA), and intellectual
property (TRIPS), it is possible to identify some shared principles underpinning
e-commerce. However, issues such as the differentiation between digital goods
and services, and the definition of the crossing of ‘physical’ borders in the caseof online transactions still need to be specified. To this end, WTO negotiations
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FUTURE OF EU-ASIA TRADE AFTER RCEP

on e-commerce are underway, although it has not yet been possible to reach an
agreed text.
Data localisation issue
As previously noted, RCEP’s language is such that it allows member states toimpose whatever national regulatory restrictions they wish, as long as these areapplied in a nondiscriminatory way. Indeed, the legitimacy of any public policythat could require a firm to locate computing facilities in a member state is selfjudging—i.e. anything can be deemed legitimate if a party says so. If RCEP’s
member states cannot resolve a dispute on their own through consultation, thenit moves to the RCEP Joint Committee (ministerial level) for further discussion.
However, they do not have the power to impose any decision. Moreover, unlike
CPTPP, RCEP does not contain any provision regarding source code. Thus, RCEP
member states are free to require such transfer or access as a condition formarket access. This means RCEP members will be allowed to make market accessconditional upon data transfer.
Current efforts by the international community beyond RCEP to reach a draft
agreement on digital trade are more ambitious in this area and lean towards
forbidding countries from linking market access to data transfer. The supposed‘willingness shared by the international community to move forward and actively
engage in such a treaty’, as recently suggested by Murri (2021), will be tested,
however, if China declares the looser RCEP provisions as standard conditions or
requirements for them to agree to any future treaty on digital trade.

Alessia AMIGHINI is the co-head of the Asia Centre and a senior associateresearch fellow at the Italian Institute for International Political Studies (ISPI).
She is an associate professor of economics at the Department of Economic andBusiness Studies at the University of Piemonte Orientale in Novara, Italy. Amighini
previously worked as an associate economist at the United Nations Conference
on Trade and Development (UNCTAD) in Geneva, Switzerland. Alessia holds a
doctor of philosophy in development economics from the University of Florence
and a master’s degree in economics as well as a bachelor of arts in economics
from Bocconi University in Milan.
She has published in many international peer-reviewed journals such as China
Economic Review, World Development, World Economy, International Economics,
and China & World Economy. Alessia also published chapters in several books
for Edward Elgar, Harvard University Press, Oxford University Press, Palgrave,
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Age of Ferment:
Developments in Asian–European Trade Relations
and Routledge. She has contributed to several international research projects
sponsored by Central Bank of Sweden, Inter-American Development Bank, and
UNU-WIDER. She edited Xi’s Policy Gambles: The Bumpy Road Ahead (2015, with A.
Berkofsky), China Dream: Still Coming True? (2016), China’s Belt and Road: A Game
Changer? (2017), China: Champion of (Which) Globalisation? (2018), and China’s
Race to Global Technology Leadership (2019), all published by ISPI.

160

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References
Burri, M. (2021). Towards a new treaty on digital trade. Journal of World
Trade,
55(1),
77–100.
https://kluwerlawonline.com/journalarticle/
Journal+of+World+Trade/55.1/TRAD2021003
Dadush, U. (2020, November 19). The impact of the new Asian trade mega-deal on
the European Union. Bruegel. https://www.bruegel.org/2020/11/the-impactof-the-new-asian-trade-mega-deal-on-the-european-union/
Elms, D. K. (2021). Getting RCEP across the line. World Trade Review, 20(3), 373–
380. https://doi.org/10.1017/S1474745620000592
Flach, L., Hildenbrand, H., & Teti, F. (2021). The Regional Comprehensive
Economic Partnership Agreement and its expected effects on world
trade. Intereconomics, 56(2), 92–98. https://doi.org/10.1007/s10272-0210960-2
Pelkmans, J. (2020, November). New Asia-Pacific Trade deal: Implications for East
Asia and globalisation [CEPS policy insight no. PI2020-30]. Centre for European
Policy Studies. https://www.ceps.eu/wp-content/uploads/2020/11/PI202030_New-Asia-Pacific-trade-deal.pdf
Petri, P. A., & Plummer, M. G. (2020, June). East Asia decouples from the UnitedStates: Trade war, COVID-19, and East Asia’s new trade blocs [Working paper].
Peterson Institute for International Economics. https://www.piie.com/
system/files/documents/wp20-9.pdf
Shimizu, K. (2021). The ASEAN Economic Community and the RCEP in the world
economy. Journal of Contemporary East Asia Studies, 10(1), 1–23. https://doi.or
g/10.1080/24761028.2021.1907881

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162

Section III.

CRITIQUE ON THE EU-CHINA CAIA Marriage of Convenience:
A Critique of the EU-China
Comprehensive Agreement on
Investment
Chien-Huei WU

Abstract
This chapter examines the dramatic developments of the EU-China
Comprehensive Agreement on Investment (CAI) and explores what brought the
EU and China together, as well as what drove them apart. This essay argues thatthe unilateralism under the former Trump administration compelled the twosides to cooperate, but the new Biden administration has reduced the incentive
for them to move forward. Domestic politics within the EU and China also playa role. The turn of Chinese economic policies from liberal to inward-looking
forms the backdrop for the EU-China stalemate. Equally important is that some
EU member states have expressed their discontent with the Franco-German
dominance of the EU’s China policy and have called for an EU summit on China
policy. The suspension of the ratification process offers an opportunity for the
EU to rethink its China policy, in general, and the destiny of EU-China CAI, in
particular. European values or the Chinese market—the EU has to make a choice.

On 30 December 2020, the president of the European Council, Charles Michel;the president of the European Commission (the Commission), Ursula von derLeyen; the former chancellor of Germany, Angela Merkel; the president of France,
Emmanuel Macron; and Chinese counterpart, President Xi Jinping, announced
the conclusion of the EU-China Comprehensive Agreement on Investment (CAI)
through videoconference (European Commission, 2020). The long road towards
an investment agreement between the two trade powers seemed to come to anend, but this high hope was soon dampened by political incongruence between
the two sides. On 22 March 2021, the vice president of the Commission and thehigh representative of the Union for Foreign Affairs and Security Policy (HR/VP),
Josep Borrell, announced the decision of the European Union (EU) to impose
sanctions against Chinese officials in Xinjiang—for the first time in thirty years

163Age of Ferment:
Developments in Asian–European Trade Relations
since the Tiananmen Square Massacre (EEAS, 2021).1 This decision immediately
angered China, which retaliated with sanctions against, inter alia, some membersof the European Parliament (EP), the human rights subcommittee of the EP, and
the Political and Security Committee of the Council of the EU (Ministry of Foreign
Affairs of the PRC, 2021a). The EP then suspended its debates on the CAI, in
March, and adopted a decision on 20 May 2021 to freeze the ratification processunless Chinese sanctions against the EU are lifted (European Parliament, 2021).
This dramatic turn in events over the past five months illustrates a great deal
and is worth some exploration. This essay aims to examine what brought the
EU and China together and what drove them apart. The basic argument is thatthe unilateralism under the former Trump administration compelled the twosides to cooperate, but the new Biden administration reduced the incentive forthem to move forward. Domestic politics within the EU and China’s changing
attitude towards foreign relations also play a role. This essay begins with a brief
introduction of the negotiation process of the CAI and identifies the key actors
and factors that made the breakthrough possible. It then explains why the
relations between the EU and China deteriorated sharply within three months
and probes the future of EU-China relations, in general, and the destiny of the
CAI, in particular.

What Brought the EU and China Together
An EU-China CAI is economically attractive to both parties. The EU wishes tobenefit from earlier access to the Chinese investment market, preempting
US enterprises. China wishes to leverage its counterparts through parallel
negotiations with the EU and the US. Nonetheless, the earlier rounds of the CAI
saw limited progress. Momentum was only gained with the victory of Donald
Trump in the 2016 US presidential elections, with a breakthrough only recently
occurring, on 30 December 2020.
In view of the trade and technological war launched by the former Trumpadministration, China had to diversify its market and secure critical technologies
and components from other partners, including the EU. Simultaneously, Donald
Trump also showed little sympathy for the EU. He praised Brexit as a smart
decision (Stewart et al., 2017), demanded European allies to share the military
expenses under NATO (Wadhams & Jacobs, 2019), and most recently withdrew

1164This decision was implemented by Council Decision (CFSP) 2021/481 of 22 March
2021, amending Decision (CFSP) 2020/1999 concerning restrictive measures against
serious human rights violations and abuses.

Section III.

CRITIQUE ON THE EU-CHINA CAI

around one-third of the US military force from Germany (BBC News, 2020). Thus,
the Trump administration provided an impetus for the EU and China to seek
closer partnership and alliance.
The EU-China CAI can be viewed as a legacy of the German presidency of theCouncil of the EU under the final year of Merkel’s chancellorship. It can also be seenas the EU’s struggle between its conventional transatlantic partnership with the
US and its ambiguous new partnership with an emergent nondemocratic power,
China. For China, the CAI meant it could diversify its economic engagements andmarkets to European countries, the importance of which was amplified by the
US-China trade war (see Aaken et al., 2019). The conclusion of the CAI reflects
China’s anxiety in the midst of the US’ economic containment. The conclusion of
the Regional Comprehensive Economic Partnership (RCEP) is one illustration ofthis, and the EU-China CAI, another (ASEAN, 2020).
For China, the CAI is an economic instrument of the Belt element of its Belt andRoad initiative (BRI) launched in 2013 (Huang, 2016). The Belt, short for ‘Silk
Road Economic Belt’, connects China and Europe via Central Asia. This economic
instrument supplements and complements the political instrument of the 16+1
format launched in 2012, where China regularly meets with Central and Eastern
European countries. The 16+1 format was transformed into 17+1 when Greecejoined in 2019 (Kowalski, 2017). This format is widely perceived as China’s ‘divideand conquer’ strategy, and risks undermining the unity of the EU.
For the EU, the goals of signing an investment pact with China are twofold.
From an economic perspective, while the trade relationship between the EU
and China has been booming, particularly since China’s accession to the World
Trade Organization (WTO), the foreign direct investment (FDI) flows between the
EU and China have been relatively low. In view of this, the EU hoped that theconclusion of an investment agreement with China would encourage increased
bilateral FDI flows, and provide a more predictable and transparent environment
for investment, both from the EU and China.
As revealed by the impact assessment conducted by the Commission regarding
the conclusion of the CAI, four main objectives were pursued by the EU in its
negotiations with China: (1) improving legal certainty regarding the treatment of
EU investors in China; (2) improving the protection of EU investments in China;(3) reducing barriers to investing in China; and (4) increasing bilateral FDI flows(European Commission, 2013). Specifically, the EU hoped to facilitate better
market access and expand the scope of the application of nondiscriminatory
treatments (especially national treatment) to both pre- and post-establishment
stages, in order to improve the competitiveness of European investors (e.g.
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automobile, pharmaceutical, and high-tech industries). Additionally, the EU also
aimed to eliminate or reduce the adverse impacts of Chinese subsidies, or similar
discriminatory advantages, offered to Chinese enterprises. Providing stronger
protection of intellectual property rights and prohibiting forced technology
transfer were also points on the EU’s negotiation agenda (European Commission,2013). Overall, the EU’s primary objective with the CAI was to maximise European
enterprises’ economic benefits in their dealings with China.
From a political perspective, the conclusion of the CAI demonstrates the EU’s
ambition to be a global economic actor. Stretching beyond the European continentand near neighbourhood to dynamic Asia has been a priority of EU external trade
policies—and China undoubtedly stands out on the Asian map. Already in 2003,
the EU and China established a ‘comprehensive strategic partnership’, and bothsides held Leaders’ Summits annually thereafter (Council, 2003; Mission of the
PRC to the EU, 2014). Three years on from that, and the possibility of creating
an EU-China bilateral investment agreement was floated in the Global Europe
Strategy (Commission of the European Communities, 2006).
When the Trump administration displayed its preference for unilateralism, andits focus on fair as opposed to free trade, China seemed to be one of the few
partners that the EU could cooperate with to safeguard the multilateral, freetrade order.2 Moreover, although the EU and the US share similar values—suchas democracy, the rule of law, and economic liberalisation—and are traditional
allies, the EU is nonetheless an independent actor. In this capacity, it has a strong
ambition to demonstrate its geopolitical and economic power in the international
community, and maintain an independent foreign policy, especially as regards
relations with China. Viewed through this prism, the significance of the CAI is firstand foremost geopolitical (Meunier & Nicolaidis, 2019). The conclusion of the
CAI can, thus, be considered as the EU’s attempt to pursue a middle-of-the-road
strategy between US-China rivalry (Liu, 2021).
Finally, a desire to coordinate the common foreign-investment policy of its member
states is another critical factor in the EU’s decision to initiate negotiations on the
CAI. Since the Going Abroad Policy was adopted in 1982, China has been eager toattract more FDI flows to stimulate its domestic economic developments. In view

2

166

The EU’s high hopes reached their peak when President Xi made a speech in Davos in2017 calling to safeguard the system of multilateral trade. This hope was nonethelessdampened by China’s constitutional amendment eliminating the term limit andthereby enabling President Xi to be reelected after 2023. Such an illiberal andauthoritarian move darkened the potential political liberalisation that was thought, in
the West, would naturally follow from economic integration.

Section III.

CRITIQUE ON THE EU-CHINA CAIof this, China signed investment agreements with several European countries,
which were primarily the capital exporting countries at that time. Since then,China has concluded 28 investment pacts with almost all EU member states.
However, the level of protection granted to foreign investors and theeffectiveness of the dispute-settlement mechanism differ significantly from eachother, depending on the pact. The discrepancies in investment treaties between
EU member states and China pose a risk to the EU’s efforts to achieve further
integration among its member states in the field of external economic relations.
The strong investment climate between both sides, and the deficiencies of
the current legal framework, impelled the EU to coordinate its member states’
investment policy towards China so as to ‘create a coherent legal framework formutual investment flows’ (Berger, 2014). Plus, after the Lisbon Treaty enteredinto force in 2009, the competence to regulate FDI and conclude investment
agreements with other countries was exclusively shifted to the EU-level bymember states, with a view to progressively removing restrictions on foreign
investments (Woolcock, 2010).
In view of this legal competence, the Commission adopted a communication
titled ‘Towards a Comprehensive European International Investment Policy’ in
2010. In this communication, China was identified as a potential partner withwhich to initiate an investment agreement negotiation (European Commission,2010). Two years later, at the 14th EU-China Summit, China State Council Premier
Wen Jiabao and president of the Commission José Manuel Barroso, reached apolitical agreement to express their joint desire to launch a bilateral investment
agreement (Council, 2012). Consequently, Karel De Gucht, then European
commissioner for trade, and Chen Deming, then China’s Minister of Commerce,agreed to launch a Joint EU-China Investment Task Force to scope out the options
for an EU-China investment agreement. The negotiating mandate of the EU-China
investment agreement was approved by the Council of the European Union in2013 (Council, 2013), and the first round of negotiations was initiated a year later,
in Beijing (European Commission, 2016).
The first major step in the tough negotiation process, which had already goneon for two years, was achieved in 2016. The two parties agreed the scope ofthe future EU-China investment deal, including issues of market access,nondiscriminatory treatments, and environmental and labour-related matters(European Commission, 2021). Then, in 2018, they exchanged their first marketaccess offers; Premier Li Keqiang, then European Council president Donald Tusk,
and then Commission president Jean-Claude Juncker agreed to accelerate thenegotiation during the 20th EU-China Summit (Delegation of the EU to China,

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2018). The two sides further exchanged revised market-access offers, andcommitted to complete the negotiation, and conclude the EU-China CAI no later
than at the end of 2020, and ideally during the 21st EU-China Summit to be heldin 2019 (Delegation of the EU to China, 2019). Despite the outbreak of COVID-19,
the EU and China eventually concluded the negotiations for the CAI almost on
the last day of 2020 (European Commission, 2020).

What Drove the EU and China Apart?
Paradoxically, the Trump administration that brought the EU and China together
also drove them apart. As Donald Trump failed to secure a second term in office,the shift of US foreign policy inevitably changed the expectations and responsesof third countries. The Biden administration is believed to place greater value ontransatlantic partnerships and to show more sympathy for multilateralism. The
Biden administration’s aim to reassure its alliance, and rebuild the transatlantic
partnership, is evidenced by its choice for Europe as the destination for the
first overseas trip of President Biden. Before his departure, in an op-ed to the
Washington Post, President Biden wrote,
In this moment of global uncertainty, as the world still grapples with aonce-in-a-century pandemic, this trip is about realizing America’s renewed
commitment to our allies and partners, and demonstrating the capacityof democracies to both meet the challenges and deter the threats of thisnew age. (Biden, 2021)
In addition to greater transatlanticism, the Biden administration, was also, atleast initially, expected to be less hawkish on China.
During the campaign trail, Biden emphasised the importance of counteracting
China’s unfair trade practices by focusing on the Western alliance in multilateralfora. The EU’s conclusion of the CAI with China thus clearly runs counter toBiden’s foreign policy objectives. Whether the EU will be able to smoothly ratify
the CAI will, therefore, largely depend on the Biden administration’s China
policy. Importantly, the EU chose to reach an agreement with China during thetransition period of the US. Such a move may be seen as unexpectedly unfriendly
to the US. In fact, Jake Sullivan, National Security Council advisor to the Biden
administration tweeted that the EU should consult with its alliance before
concluding the CAI (Sevastopulo et al., 2020). Clearly, the Biden administration
sent a strong message to Brussels about its disappointment regarding the EU’s
move on the CAI, noting that this would split the alliance and undermine theeffectiveness of countering China’s unfair trade practices.

168

Section III.

CRITIQUE ON THE EU-CHINA CAIFor China, the EU is a refuge for Chinese enterprises and exporters endangeredby the US-China trade war, and an alternative when access to the US market
is difficult. The victory of Joe Biden in the presidential election brought China
some hope that the US-China trade war might come to an end and that US-China
engagement might regain some momentum. If China believes in such trend,
then the need for courting the EU is much lessened. It would spare them theunwelcome need to listen to European values, in particular, on human rights anddemocracy.
Further context for the EU-China stalemate is the surge in Chinese nationalism
and the turn of Chinese economic policies from liberal to inward-looking. In theXi era, Chinese economic policies have been more and more state-centred, anda large proportion of previous reform efforts has been cancelled out.3 Moreover,the surge in Chinese nationalism has made it difficult for China to find a common
ground between itself and Western countries. Notably, on 6 March 2021, in his
address to the annual session of the National People’s Congress and Chinese
People’s Political Consultative Conference National Committee, President Xi
proclaimed that China can head up to the world with confidence and pride (XiJinping, 2021). Such tone is in sharp contrast to his predecessors and reflects aclear deviation from the longstanding Chinese foreign policy Tao guang yang hui(韬光养晦)—roughly translated as ‘hide your strength, bide your time’—famously
laid down by Deng Xiaoping. A more confident China does not necessarily leadto incongruence between the EU and China. However, the tendency to refer toChinese characteristics and development needs—sometimes under the cover of
Asian values—as a justification for China’s deviation from international norms
or universal values may introduce obstacles for the EU in its cooperation with
China, in particular, in view of the EU’s esteemed self-image of normative power(Manners, 2002).

The Future of EU-China Relations and the Destiny of the CAI
The destiny of the CAI pends on the broad context of EU-China relations, which,at this vantage point, appear challenging. Both the EU and China have imposed
sanctions against each other; whether or not they will deescalate the tension
will be pivotal for the ratification of the CAI. The leaders of Germany and France
held a virtual summit with President Xi on July 5, 2021, and exchanged views

3

The prime examples of this trend are the guiding policies of ‘common prosperity’and renationalisation. The strengthening of the supervision regulations governing
the implementation of these policies can be found in recent regulatory measures on
e-commerce and platform economies, such as Alibaba and Ant Group.

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on a number of issues, in particular, on climate change; however, no official
statement was made. It is, therefore, doubtful whether they reached any concreteconsensus. Indeed, judging from the different sources reporting the summit, little
progress seems to have been made. According to the Chinese Ministry of Foreign
Affairs, ‘France is committed to promoting cooperation with China in a practicalmanner, supports the conclusion of the EU-China investment agreement and thestrengthening of cultural exchanges, and welcomes Chinese companies to invest
in France’. (Ministry of Foreign Affairs of the PRC, 2021b) and ‘Germany supports
the convening of the 23rd EU-China leaders’ meeting at an early date, and hopesthat the EU-China investment agreement will be approved as soon as possible’(Ministry of Foreign Affairs of the PRC, 2021b).
In contrast, the French Ministry of Foreign Affairs did not mention the CAI, but
focused mainly on the IUCN World Conservation Congress, COP15 in Kunming,
COP26 in Glasgow, and the G20 Summit in Rome. On China, ‘President Macron
and Chancellor Merkel reaffirmed European expectations as regards access to
the Chinese market and conditions of fair competition’ (Ministry of European andForeign Affairs, 2021). The German chancellor released a brief statement notingthat Chancellor Merkel, President Macron, and President Xi exchanged views inparticular on the status of relations between the EU and China. They also talked
about international trade, climate protection, and biodiversity (Bundeskanzlerin,2021). It is also reported that Macron and Merkel made ‘demands concerning
the fight against forced labour’ and raised the thorny issue of China’s Uyghur
minority with President Xi (Deutsche Welle, 2021). As such, it is clear that eachparty had different interpretations on what the summit was about, and it is thus
hard to say if they are on the same page. Additioanl evidence of this incongruenceis that the annual EU-China Summit scheduled to be held in the end of 2021
was cannecled; repportedly, tit-for-tat sanctions over Xinjiang and ‘dealth’ of CAI
rendered this Summit meanless (Lo et al., 2021).
Importantly, some EU member states have expressed their discontent about theFranco-German dominance of the EU’s China policy and have called for an EU
summit on China policy. The goal is to reach a common position, as opposed
to having powerful countries decide for the whole bloc (Lau, 2021a). Suchdiscontent surfaced when the EU leaders and Chinese President Xi announced
the conclusion of the CAI, and has only intensified since. In view of the current
atmosphere, the ratification of the CAI may meet challenges both in the EP andin the Council of the EU.
For the EU, the political wisdom of concluding and ratifying an investment
agreement with China at this moment is doubtful. The EU has long conceived and170Section III.

CRITIQUE ON THE EU-CHINA CAI

portrayed itself as a normative power, upholding democracy, human rights, andrule of law in its external relations. Meanwhile, during the past years, China has
persistently violated human rights and undermined the rule of law. To reference
but a few such actions, this includes ‘reeducation’ camps in Xinjiang, excessive
violence in anti-extradition-ordinance movements in Hong Kong, the Hong Kong
National Security Law, and various intimidating actions based on its wolf warrior
diplomacy. Such measures and actions are incompatible with ‘the principles whichhave inspired [the EU’s] creation, development and enlargement, and which it
seeks to advance in the wider world’.4 In a broader context, some of the EU’s allies,
for example, Australia, are suffering from China’s wolf warrior diplomacy, so it isquestionable how the EU can defend itself against the accusation of betraying its
alliance if it concludes an investment agreement with China. To conclude suchan agreement at this moment solidifies the accusations of hypocrisy which arelevelled against the EU (Lavenex, 2018; Hansen & Marsh, 2015). In other words,
were the CAI to come into force, one might justifiably consider that human rights
and the rule of law are only there for cosmetic purposes and that economic
interests trump European values.
If we shift the focus from the geopolitical EU-China relationship to the pure
plain of investments, there are still some outstanding issues, notably the threat
Chinese capital presents to the national security of the Union. The flood ofChinese capital has put European policy circles on alert, and some investments
have been blocked due to national security concerns;5 the story of Huawei is wellknown. When the current president of the Commission, Ursula von der Leyen,
took office in December 2019, she placed great weight on technology sovereignty,
proclaiming, ‘We must have mastery and ownership of key technologies in
Europe’ (Leyen, 2020; see also Barker, 2020).
Indeed, even before the von der Leyen commission, export-control regimes
were already being strengthened,6 and a new investment-screening mechanism,

4

Treaty on European Union (TEU), Article 21(1).

5Some examples include IMST, a satellite and radar technology firm (2020); 50Hertz, aBerlin-based company running a high-voltage transmission grid in Germany (2018);
and Leifeld Metal Spinning, a German mittelstand company with approximately 200
employees (2018).

6

Council Regulation (EC) No. 428/2009 of 5 May 2009, setting up a community regime
for the control of exports, transfer, brokering, and transit of dual-use items, OJ L
134/1, 29 May 2009, last amended by Regulation (EU) No. 599/2014.

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Developments in Asian–European Trade Relations
established.7 In view of these regulations, with or without the conclusion of the
CAI, the export of military or sensitive items is subject to stringent export control,and Chinese investments in European critical technologies or infrastructure aresubject to investment review with national security considerations taken into
account. That said, given that the investment-screening mechanism in the EU is at
its infant stage, it may turn out to be a regulatory loophole that China can exploit
and benefit from.8 Seen in this light, it is not difficult to understand why China is
willing to exchange access to its own investment market for critical technologies
or components in the EU.
Nevertheless, it still remains to be seen whether the US will rely on theextraterritorial application of its domestic export-control laws or exercise
diplomatic pressure to its alliances to block this loophole. A test case to watch isthat of Dutch company, ASML. US diplomatic pressure is being exerted to prevent
them from exporting to the Chinese; this is one of the key tensions in current USEU trade relations.9

Concluding Remarks
The dramatic developments in the CAI negotiations in the past few months—
from sudden conclusion to unexpected suspension—are reflective of the swiftchanging international climate. A key role was played by the former Trumpadministration that brought the EU and China together for the conclusion of
the CAI and then drove them apart. Another two factors, which explain the
sharp turn in EU-China relations post-conclusion of the CAI, are the increasingly
inward-looking character of China’s economic policies and the surge in Chinese
nationalism. For China, territorial integrity and, by extension, Xinjiang is a coreinterest and taboo for foreign countries. When the EU touches on the Xinjiang
issue, it inevitably angers China and invites retaliation. Moreover, European
sanctions against Chinese officials due to human rights violations in Xinjiang
recall the ghost of imperialism and trigger Chinese nationalism.

172

7

Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March
2019, establishing a framework for the screening of FDI into the Union, L 79 I/1, 21
March 2019.

8

The Chinese acquisition of the German robot maker Kuka is one of the many casesthat prompted the EU and Germany to realise the need for an investment-screening
mechanism.

9

ASML is the dominant supplier of extreme ultraviolet lithography machines. These
are critical equipment for foundry and chip-making. ASML wishes to supply Chinese
semiconductor manufacturers.

Section III.

CRITIQUE ON THE EU-CHINA CAIThe EU, meanwhile, has to defend itself against the accusation of double standards
when it sanctions weak states but turns a blind eye to China. In fact, it has taken
the EU three years to stand up to China. For the moment, the suspension of theratification process offers an opportunity for the EU to rethink its China policy, in
general, and the destiny of the CAI, in particular. European values or the Chinese
market—the EU has to make a choice.

Chien-Huei WU is currently an associate research professor at the Institute ofEuropean and American Studies, Academia Sinica, in Taipei, Taiwan. He worked
for the Ministry of Justice in Taiwan as a district attorney from 2001 to 2005, after
which he undertook his PhD at the European University Institute in Florence in2009. He published a book in the Nijhoff International Trade Law Series, entitled
WTO and the Greater China: Economic Integration and Dispute Resolution in 2012,and his new monograph Law and Politics on Export Restrictions: WTO and Beyond
was published by Cambridge University Press in September 2021. He is a visiting
fellow/professor and lecturer at various academic institutions, such as the Max
Planck Institute for Comparative Public Law and International Law, the World
Trade Institute, the University of Bern, the University of Cologne, the Universityof Passau, and Georgetown University, among others. In 2014, he was awarded
the Ta-You Wu Memorial Award, an award set up by the Taiwanese Ministry of
Science and Technology. His research interests cover EU external relations law
and international economic law.

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EU-ASIA RELATIONS POST-COVID-19

EU-Asia Relations Post-COVID-19:
Green Recovery, Value Chains, andSustainable Trade
Gauri KHANDEKAR
Abstract
The COVID-19 global pandemic has not only substantially transformed global
value chains in a very short time, albeit temporarily, but also led to a serious
rethink of domestic industrial structures, international trade, and value chains.
In the European Union (EU), there is recognition of the rigidity of the region’s
industry and the large dependence on international value chains, which left it
vulnerable to shortages of basic materials. Asia, on the other hand, has beenquick to capitalise on existing flexible value chains and reorganise in response to
growing demand. These changes are likely to become more permanent as nations
seek to restructure their most sensitive sectors, which have been brought under
the spotlight, such as health, and the basic materials industry, among others.
Both continents have also been differently impacted by the economic slowdown
and have set up diverse approaches to recovery. The EU, for instance, has sought
to pursue a recovery which underpins its goal of economy-wide decarbonisation
by 2050 through its ‘Green Deal’. This chapter explores the impact of COVID-19
on Asia-EU relations and assesses expected transformations in global value
chains (GVCs), industrial transition, and recent EU initiatives, such as the EU
Carbon Border Adjustment Mechanism.

Introduction
The COVID-19 crisis, which began in 2020, brought social and economic life toa standstill across the globe. The pandemic not only substantially transformed
global value chains in a very short time, but also led to a serious rethink of
domestic industrial structures, and international trade and value chains. In
Europe, it put up a fresh challenge to the general relevance of the European
Union (EU) with regard to its capacity to deal with such a crisis. EU member states
initially grappled with individual coping measures and containment strategies,
including bolting national borders within an area of free movement (Schengen).
At the start of the crisis, the coordinated EU response was weak, if not missing
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Developments in Asian–European Trade Relations
entirely. Asia, on the other hand, was quick to capitalise on existing flexible value
chains and to reorganise in response to growing demand in 2020. However, thedelta variant of the virus brought fresh challenges in 2021, stalling recovery.
These two continents have been differently impacted by the economic slowdown,
and have set up diverse approaches to recovery. In the EU, the biggest challenge
was how to swiftly revive its manufacturing and industrial sector. This wasnecessary given the heavy reliance on Asian, and in particular, Chinese imports,
which could no longer be delivered. The EU subsequently sought to pursue a longterm recovery and strategic autonomy, which underpins its goal of economy-wide
decarbonisation by 2050 through its ‘Green Deal’—an estimated multi-trillion
euro initiative set up to ensure a sustainable transition to carbon neutrality
by 2050. The Green Deal can also be a channel to revitalise the EU’s dwindling
manufacturing sector, which as the crisis has revealed, is highly strategic toEuropean interests. In addition, the EU also created a EUR 750 billion COVID-19
long term recovery fund: coupled with EU’s long term budget, this will total EUR
2.018 trillion and is the largest EU stimulus package ever financed (European
Commission, n.d.-a).
The Asia Pacific struggled hard with the delta variant resulting in a stalled
economic recovery following its initial early rebound (Leussink & Dogra, 2021).
By mid-2021, the region lagged behind an otherwise strong but fragile global
recovery. This is mainly due to a slower rate of vaccination than the West, which
in turn led to new pandemic restrictions. Some Asian countries thus had tofurther restrain manufacturing, while the exports that powered the recovery in
China seem to be slowing. Official Chinese manufacturing purchasing-managers’
indexes fell to their lowest levels in over a year in July (Yifan Xie & Emont, 2021).
Manufacturing powerhouses India, Indonesia and Malaysia, have been among
the worst affected. The region is nonetheless still expected to make a strong
recovery in the longer term according to the Manilla-based Asian Development
Bank, which forecasts developing Asia (consisting of 45 countries in the Asia
Pacific) to grow 7.3% in 2021 (5.3% in 2022), and China and India to grow 8.1%
and 11% in 2021, respectively (Lema, 2021).
In the immediate term, the region is likely to focus on the following key areas:
vaccine deployment; reviving certain sectors of the regional economy, suchas better coordination of fiscal and monetary policies, and expanding green
infrastructure; and building on their close integration into global value chains(Kwakwa, 2021). Some countries in the Asia Pacific have committed to stronger
climate action (notably China, South Korea and Japan, which have pledged to be
climate neutral by 2060, 2050 and 2050, respectively). Although this will have an180Section III.

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impact on growth and economy, it has not been prioritised to the same extent as
in the EU’s approach to recovery.
The impact on global value chains since the outbreak of the COVID-19 crisis has
led to changes that are likely to become longer-lasting, or indeed permanent,
as nations seek to restructure their most sensitive sectors, which have beenbrought under the spotlight. These include health, and the basic materials
industry, among others. The pandemic has thrown the north-south divide
into relief—notably in terms of vaccine access. This will have an effect on the
pandemic’s progression, but also on foreign policy. This chapter will focus on theimpact of COVID-19 on Asia-EU relations and assess expected transformations in
global value chains (GVCs). In this context, recent EU initiatives such as the EU
Green Deal (including possible Carbon Border Adjustment mechanisms) will be
explored.
Transformations in Global Value Chains (GVCs)
The COVID-19 crisis brought industries, indeed entire economies, to a halt.
International trade routes were disrupted, GVCs were obstructed, markets
contracted, and delays and costs increased. This section will seek to assess thetransformations in complex GVCs with a focus on the EU’s industry set in theframework of the transition to net-zero greenhouse gas (GHG) emissions by
2050.
The pandemic highlighted the interconnectedness of countries via GVCs.
Acute shortages of medical and other essential goods raised questions about
globalisation, and its associated risks and instability. The very first lockdown in
China created severe trade disruptions around the world, given the importanceof China as a hub in GVCs. While the shortages were as much a supply side
problem as an unprecedented demand side shock, the high centrality of China in
GVC networks, due to comparative advantages and specialisation, exponentiallymagnified the issue (OECD, 2021). GVCs are highly entrenched, and it is difficult
to swiftly reorganise industries. For instance, even amidst shortages, in 2020,
Chinese exports of COVID-19 critical medical supplies tripled from USD 38 billion
in 2019 to USD 105 billion, according to the World Trade Organization (WTO)(WTO, 2020). This issue has led many policymakers and analysts to favour areorganisation of value chains that limits import dependence, especially of
essential goods. The idea being to shorten value chains and thereby increase
resilience. Many in the West are thus implicitly, and at times explicitly, calling
for re-shoring—namely, a return to industrialised countries of manufacturing
activity and jobs which were previously offshored to the developing world.
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At the start of the COVID-19 crisis in Europe, essential supplies in particular ran
low, exacerbated by the shift of manufacturing to China over decades. This madeit starkly clear how important basic materials industries are to national andindeed EU interests. This relates to industries such as steel, cement, chemicals,
glass and non-ferrous production, which link to every possible economic sector,
including to each other, and form an intricate system of value chains. In theface of shortages, a number of European industrial sectors have had to modify
or change production lines to supply critical equipment (e.g. diagnostic tests,
ventilators, protective masks, gloves and gowns, Intensive Care Unit medicinesand equipment, and protective clothing) to patients and healthcare workers
across Europe. For instance, British chemical company INEOS, drew up plans to
produce 1 million bottles of hand sanitising gel per month to cover the European
shortage (Express and Star, 2020). INEOS was not alone. There have been
numerous other such examples.
The impact of COVID-19 on European industrial value chains must be understoodwithin the context of the climate transition in the EU, which had commenced
long before the global pandemic. Shortly prior to the outset of COVID-19, andsubsequent lockdown measures in EU member states, the European Commission(EC) had released along with its signature initiative, the European Green Deal, a
new industrial strategy for basic materials industries. The goal of this industrial
strategy was to help shepherd the basic materials industry—long seen as hard
to abate—towards the achievement of the target of carbon neutrality set by
the Green Deal. Although there have been many industrial strategies releasedin the past, this one for the first time aimed at carbon neutrality by 2050. The
strategy has been widely supported by the basic materials industry sectors—some of which have already published their own mid-century climate neutrality
roadmaps. However, it has failed to challenge classic industrial value chains,which, as seen during the COVID-19 crisis, have proved highly strategic to EU
interests.
Industrial transition to net-zero is not an easy task. European industry, moreover,is rather old and set in its ways as compared to those in emerging economies.
For the industrial sector to transition to net-zero, it needs a significant numberof things, inter alia, finance; infrastructure; brownfield conversion; electrificationof industrial processes; additional renewable energy in the energy mix; adequate
supply of hydrogen; CO2 capture and storage; circular economy promotion tostrengthen local value chains; the creation of robust new value chains; andregulations and standards to create new markets for low-CO2 products (Wyns,
Khandekar, & Robson, 2018). Over the course of the last three decades, EU-basedindustry has largely focused upon the low-hanging fruits of energy efficiency,
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with a number of production plants close to the thermodynamic limits of current
processes. New, innovative low-carbon technologies will be required for industry
to achieve carbon neutrality. In this regard, it is crucial to help secure the necessaryfinance for breakthrough low-carbon technologies to overcome innovation‘valleys of death’, and thus reach demonstration and commercialisation.
It is widely accepted in the EU that recovery from the COVID-19 pandemic cancome about from a renewed commitment to carbon neutrality by 2050 and that
the EU’s Green Deal is a unique opportunity for industry to transition to a carbonneutral EU while safeguarding competitiveness. However, the EU’s industry has
long lamented the possibility of ‘carbon leakage’, or the shift of manufacturingfrom the EU to countries with less stringent climate regulations. The EU’s industry,
with the exception of the chemicals sector, has still not recovered from the 2008
crisis (Wyns et al., 2018). Climate regulations have made EU industrial production
more expensive than elsewhere. In addition, the mass export—or dumping—of cheaper third country products, such as Chinese steel, in the EU has further
reduced competitiveness. Climate transition in the EU will not happen without
significant protection for the EU economy, be it through international climate
diplomacy, or certain trade protections. For industry, this will mean a significant
impact on value chains—and will imply a shift towards shorter, more regional
value chains. The EU has expressed an interest in exploring carbon borderadjustment taxes (which will be further discussed later in this chapter). However,these are difficult to set up swiftly and may trigger international dispute orretaliatory measures. In the meantime, standards can also be used: EU standards
often reverberate outside of EU borders given that non-EU producers are also
bound to apply these so as to maintain their access to the EU internal market.
With or without border carbon adjustment taxes, it is certain that the EU will not
import carbon-intensive products while producing low-carbon itself. Measures
are also being put in place to stimulate and protect domestic, climate-friendly
production, such as the greening of the EU internal market via low-CO2 standards
on final products and green public procurement.
In the short and long term, the goal of a carbon-neutral EU by 2050 is clear. To
achieve this target, the cooperation of industry will be vital. Every conceivable lowcarbon technology—ranging from energy-efficient buildings, to decarbonised
transport (hybrid, electric and fuel-cell vehicles); from renewable energy (solar
PVs, wind turbines, thermal systems, etc.), to battery storage—relies on materials
from energy-intensive industries. The EU’s Green Deal provides the most clearcut pathway to ensure industry remains in Europe while achieving carbon-neutral
growth. The EU will need to maintain open and efficient trade supply chains, bothwithin the EU and with the EU’s trading partners. Nevertheless, going forward,
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the bloc will likely prioritise shorter, stronger European value and supply chains,
especially given the uncertainty over how long the current crisis will last, and thepossibility of further disruption.
Overall, the impact of COVID-19 on GVCs will mainly be one of diversificationof supply chains, depending on the sector and on the costs of value chain
reorganisation. This, however, will not cause massive re-shoring for four
reasons: comparative advantage and specialisation, scale economies, innovation
spillovers, and a global division of labour (Bacchetta et al., 2021). The climatetransition, on the other hand, is likely to play a larger role in how industries in the
EU and Asia (especially those in countries that have pledged to achieve net-zeroby mid-century) will be shaped.
Sustainable Trade and Carbon Border Adjustment Taxes
The EU has not only pledged to achieve carbon neutrality by 2050, but has also
enshrined it in law. The EU adopted ‘Regulation (EU) 2021/1119’ of the European
Parliament and of the Council on 30 June 2021 (EUR-LEX, 2021). This regulation,
known as ‘European Climate Law’, establishes the framework for achieving
climate neutrality by 2050, along with an intermediary target of net GHG
emissions reductions of 55% by 2030, compared to 1990 levels. On 14 July 2021,
the EC adopted a series of legislative proposals called ‘the Fit for 55’ in order toachieve the 2030 target (European Commission, n.d.-b). Within this context andthe framework of the European Green Deal, the EC will propose a Carbon Border
Adjustment Mechanism (CBAM) for selected sectors. The goal of this mechanism,
which will become fully operational in 2026, is to reduce carbon leakage risks in amanner compatible with WTO rules. So far, the sectors covered pertain mainly tobasic materials (cement, iron and steel, aluminium, and fertilisers) and electricity,
both of which have high carbon emissions. The production of basic materials,
such as steel, cement clinker, plastic (HVC), fertiliser (ammonia), and aluminium,
contributes to 25% of global and 16% of EU emissions (Neuhoff et al., 2021). As
mentioned earlier, these are also the sectors most at risk of carbon leakage andloss of competitiveness.
In the EU, basic materials are subjected to the European Emissions Trading
Scheme (EU ETS), a cap-and-trade system in which a cap is set on the total
amount of certain GHGs that can be emitted by the installations (reduced overtime so that total emissions fall) and the trade of emissions allowances (tonnesof CO2 emitted) as needed, albeit curbed to a limit of allowances. As explainedin the section above, the basic materials sector is already subjected to climate
regulations in the EU, which add to production costs, while cheaper and more
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carbon-intensive imports (and at times dumping) of the same materials fromthird countries are not. CBAM seeks to create a level playing field.
Under CBAM, EU importers will be required to buy carbon certificatescorresponding to the carbon price that would have been paid had the goods
been produced under the EU’s carbon pricing rules. In other words, the direct
carbon emissions embedded in certain carbon-intensive products will now haveto be paid for, thereby reducing the likelihood of carbon leakage and encouraging
producers in non-EU countries to green their production processes. The cost of
the certificates will be linked to carbon prices under the EU ETS system. Revenues
collected from CBAM will then contribute to the EU’s budget.
Third countries have challenged the EU’s proposed CBAM as a protectionist
measure. However, the CBAM should generally be WTO compliant. WTO rules
allow for the inclusion of environmental exemption provisions under Article 20of the General Agreement on Tariffs and Trade (GATT) agreement (Whitmore,2019). CBAM also respects the basic WTO principle of not favouring domestically
produced goods over imports and is only applicable to those products that havenot been subjected to carbon pricing regulations in the country where the goods
were manufactured. Carbon pricing is not an aleatory tax—the purpose of thismeasure is to reduce carbon emissions and negative externalities.
The next steps will be the adoption of an intermediate target for 2040, as wellas implementation measures, both by EU institutions and member states. The
adoption of such new regulations in the next months and years will create
additional constraints and opportunities, both on companies located in the EU,
and on non-EU suppliers of goods and services intended for the EU market.
The European Single Market, the largest in the world, is well on its way to becoming
a green marketplace. Sustained access to it is crucial for Asian economies.
Annual EU-Asia trade, using 2018 figures, stands at EUR 1.5 trillion euros, while
two way foreign direct investment (FDI) reaches EUR 90 billion (Neves, Becker &Dominguez-Torreiro, 2019). In 2020, about 44% of EU imports came from Asian
countries, while 30% of EU exports went to Asia. The EU had a considerable trade
deficit with Asian countries (- EUR 188 billion).

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Figure 1. EU trade by geographical zone, 2010 and 2020
(EUR billion)

Going forward, the climate transition can also provide significant opportunities
for enhancing trade. Already, China and India, the world’s top two steel producers
are exploring low-carbon steel production, which would facilitate compliance with
the EU’s CBAM (‘China: Low-carbon steel’, 2021; Daksesh, 2020). So far, there area few such plants planned in China and India but in the near term, i.e. by 2025,
only Sweden is set to produce a limited quantity of net-zero steel. Meanwhile,
Indian cement production, the world’s second largest after China, is alreadyamong the greenest (We Mean Business Coalition, 2020). European and Asian
economies need to exploit the opportunities the low-carbon transition affords,
and help each other to adapt and build greener. However, trade in low-carbon
technologies, such as solar panels, batteries, windmills, and so forth, needs tobe encouraged. Environmental standards must be met, as must criteria related
to efficient and circular use of materials, i.e. ensuring they are created with highenvironmental standards in mind and can be recycled or reused. Doing so willallow for the achievement of economies of scale and further reduce the pricesof such technologies globally. Between 2008 and 2012, solar panel prices havefallen by as much as 80% due to improving technology and relocating production
to countries with lower labour costs (Shiphub, n.d.). Currently, the EU maintains
anti-subsidy and anti-dumping duties on solar glass from China ranging from 3.2
to 17.1%, and 17.5 to 75.4%, respectively (Bellini, 2020).
Trade in hydrogen will also become important given its increasing role indecarbonisation. Currently, the lack of infrastructure means that hydrogen is nottraded across borders significantly. This is an opportunity for the EU and Asia.

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The EC has decided to adopt a new dedicated strategy on hydrogen, so as tocreate an enabling environment to scale up clean hydrogen for a climate-neutral
economy; boost investments into the supply, storage, and transport of cleanhydrogen; as well as support the leadership of EU industry in this field (European
Commission, 2020).
A comprehensive EU approach will enable clean hydrogen to contribute toincreased GHG emission savings by 2030, with a view to larger-scale deployment
by 2050. Specifically, the strategy is expected to highlight the role that cleanhydrogen can play in the context of the green recovery and the growth strategy
that is the Green Deal, with the ambition of a climate-neutral EU by 2050. Morespecifically, it will identify the main barriers that currently prevent scaling up the
production and use of clean hydrogen; determine a set of actions to address
those barriers; foster a competitive European value chain; upscale production
and use of clean hydrogen in a cost-effective way, taking into account thesubsidiarity principle; and address the challenge of concomitant development ofa well-functioning hydrogen market alongside a corresponding cost-efficient EU
infrastructure.
Energy-intensive industries are expected to play a key role here. Unveiled as partof the EU’s new industrial strategy, the EC launched, in mid-2020, an EU-wide‘hydrogen alliance’ known as the European Clean Hydrogen Alliance (ECH2A).
The goal of ECH2A is to promote the production of clean hydrogen in an effort
to speed up the decarbonisation of industry. In addition to the EU, France, theUK, the Netherlands, and Germany also have national hydrogen strategies. The
latter two in particular aim to become key import ports for hydrogen. In Asia,
a number of countries (China, Japan, Australia, South Korea, India) have theirown hydrogen strategies/roadmaps and have increased investments in cleanhydrogen development. India launched a National Hydrogen Mission in August
2021, to turn the country into a global hub for green hydrogen production andexport. To a lesser extent, South East Asian countries have also taken some initialsteps to promote the development of the hydrogen industry. The EU and Asia
should rapidly assess the potential and logistics for hydrogen trade, which would
not only be profitable for both sides, but also, importantly, facilitate the green
transition.
Finally, technology transfer is imperative in meeting the goals of the Paris
Agreement. The EU and Asia could launch a platform for energy-intensive sector
breakthrough low-carbon technologies (Khandekar, 2020). Such a platform
could firstly help draw in finance for the sector’s considerable R&D needs while
opening up a vast global market for breakthrough technologies. This would, in

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turn, significantly bring down technology costs. It could eventually also create
large markets for low-carbon products, which would then be able to competewith incumbent products. Inter-regional promulgation of such technologies
could arguably be the fastest way to create a level playing field—a major concernof European energy-intensive industries. The platform could also enable greater
knowledge transfer and sharing of best practices in circularity and materials
efficiency, leading to shorter GVCs. Given that most of the breakthrough lowcarbon technologies in the energy-intensive sector are currently being developedin Europe, the EU could take the lead at facilitating the platform. This would
accelerate the development and deployment of low-carbon technologies; create
larger markets for low-carbon energy-intensive products; facilitate the creationof a global level playing; and hasten the decarbonisation of a growing sector,
which would otherwise continue to account for a fifth of global emissions.
Conclusion—Key Policy Recommendations
The COVID-19 crisis will undoubtedly leave an important mark on EU-Asia
relations. The climate transition will be the single largest policy priority for theEU, and CBAM can provide significant opportunities for enhancing trade andgreening adaption and recovery. Meanwhile, the impetus to shorten GVCs isbeing felt worldwide. In view of these considerations, and drawing upon thethoughts in this chapter, the following three policy recommendations are set out
with the aim of further enhancing inter-regional ties:

188•

Both sides must endeavour to maintain open, efficient, and shock-resilient
value and supply chains. A strategy must be designed to keep trade routes
open in extraordinary circumstances.

•

More needs to be done to facilitate the trade of low-carbon technologies andhydrogen in particular. An inter-regional hydrogen trade strategy would be
an excellent beginning.

•

The EU and Asia could launch a platform for energy-intensive sector
breakthrough low-carbon technologies, which would also help the EU win
allies for its CBAM rollout.

Section III.

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Gauri KHANDEKAR is a Project Researcher in the Environment and Sustainability
Cluster at the Institute for European Studies (IES). Prior to joining IES, Gauri was
Deputy Director and Director Europe at the think tank Global Relations Forumin Belgium, Coordinator for the Friedrich Ebert Stiftung’s Energy and Urban
Transformation Projects, and Project Leader for the EU delegation to India’s
Think Tanks Twinning Project. Between 2010 and 2015, Gauri was Head of Asia
Programme at the think tank FRIDE. In 2012, Gauri was Resident Handa Research
Fellow at the Centre for Strategic and International Studies (CSIS) Pacific Forumin Honolulu, US, where she conducted research on the US’ Asia rebalance policy
and its implications for the EU.
Gauri has a wide range of professional experience in European and international
affairs, having worked at the European Commission’s DG External Relations, theEuropean Parliament, the G20, the United Nations Headquarters in New York, aBrussels-based American consultancy (Burson Marsteller), and a Brussels-based
communications enterprise (Tipik S.A.). She has also worked for three years ina development and social welfare NGO in India. In 2013, Gauri initiated a largescale development programme in the South of Uganda.
Gauri holds two master’s degrees in European studies with distinction from theInstitute of Political Sciences in Lille (France) and the College of Europe in Bruges(Belgium).

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