Perspectives from Around the World 074

The Trans-Pacific Partnership and Global Value Chains

Samuel W. Morris University Professor, Harvard University

The Trans-Pacific Partnership (TPP) is an international trade agreement that would substantially reduce trade barriers among the 12 participating countries bordering the Pacific. The participants, including the United States and Japan, but not China, signed the TPP on February 4, 2016. The TPP is sometimes described as the largest free trade agreement in history. The participating countries generate more than 40% of world gross domestic product (GDP) and originate more than a third of world trade.

The TPP would have to be ratified by the participating countries to take effect. In the United States this would require legislation by the U.S. Congress. President Barack Obama has expressed strong support for the TPP, for example, at the Hangzhou Summit Meeting of the Group of Twenty (G20) leading nations on September 4 and 5, 2016. President Obama has called on Congressional leaders to ratify the agreement during his remaining term of office, ending on January 20 of next year. However, his support for the TPP has been called into question by both leading candidates for the U.S. presidency—Hillary Clinton and Donald Trump.

Ratification of the TPP by the United States during President Obama's remaining term of office will require extraordinary leadership by the President and the Congress, whatever the outcome of the U.S. presidential election, Fortunately, the Congress has already passed Trade Promotion Authority (TPA), so-called "fast track" legislation to require a simple up-or-down vote on the TPP with no possibility of amendments or a filibuster to block the legislation. President Obama signed this into law on June 29, 2015.

The TPP has been accurately characterized as the most important U.S. trade agreement since the North American Free Trade Agreement of 1995, which liberalized trade among Canada, Mexico, and the United States. Another possible analogue to the TPP is the European Single Market, eliminating barriers to the movement of goods and services within the European Union. While both of these free trade agreements have led to substantial liberalization of trade, the participating countries are located much closer to each other than the participating countries of the TPP.

The Information Technology Agreement (ITA), eliminating all tariffs and taxes on information technology products like computers and communications equipment among the participating countries around the world, is the closest analogue to the TPP. This agreement originally involved 29 participants when it went into force in 1997, but now involves 82 members, including the United States, Japan, and China. The ITA recently expanded to include many more products and new tariff reductions began on July 1, 2016.

The economic case for the TPP can be expressed in terms of the theory of comparative advantage. By assigning each product to the country where it can be made with a comparative advantage, trade produces the most efficient international division of labor. While this theory is at the core of international free trade agreements, many of the 30 chapters of the TPP are concerned with subsidiary issues like workers' rights and environmental policy. These issues are also the primary focus of the political debates surrounding the TPP.

The theory of comparative advantage has been greatly extended to encompass the rapidly growing importance of global value chains (GVC) in international trade. A GVC involves the fragmentation of production into a series of stages that make up the value chain. Value is added to the final product at each stage of the production process. Value chains have spread across international boundaries and involve hundreds of stages in dozens of countries, becoming global in the process.

The creation of GVCs has been made feasible by the rapid development of information and communication technologies. Managers rely on information transmitted and stored electronically to coordinate production and distribution across the many stages of a GVC. The recent proliferation of GVCs is also a response to the lowering of tariff and non-tariff trade barriers through the World Trade Organization (WTO), established in 1995. The WTO provides an institutional home for the ITA.

The production of the iPhone, designed by Apple Incorporated in Cupertino, California, is a leading example of a global value chain. The iPhone is covered by the ITA, so that exports of the product and imports of components and production facilities are not subject to tariffs or taxes by the 82 participating countries. The iPhone is assembled in China from components originating around the world by Foxconn, a Taiwanese firm. Foxconn specializes in sub-contracting production from firms like Apple and has more than a million employees in China.

It is tempting to think of exports of the iPhone from China as an appropriate focus for trade policy. However, the proportion of the value added by assembly in China is less than 7% of the total value of the iPhone. Leading Japanese companies are important contributors to the value of the iPhone. Toshiba has provided the flash memory that is at the heart of the iPhone. Japan Display has contributed to the display of the iPhone, Sony to the camera, and TDK to the audio.

Apple designs the iPhone, along with the iPad, the iWatch, and so on, but also designs and manages the GVCs for these products. The theory of comparative advantage applies at each stage of the GVC. Multiple suppliers compete for Apple's business by submitting bids for the components that make up the iPhone or for processing these components into sub-assemblies. Apple provides a list of its 200 most important suppliers on the corporation's website. However, Apple actually has more than 700 suppliers.

Apple provides research and development, product design, and software for the iPhone and captures the intellectual property. In addition, Apple plays an important role in the distribution of the iPhone to final consumers through Apple stores around the globe. However, much of the value added in production is through the design and management of the GVC that begins with electronic components and ends with delivery of the iPhone to the ultimate consumer. More than half of the value of the production and distribution of the iPhone is added by Apple.

Production processes all over the world are fragmenting into complex streams of individual tasks. Some tasks involve manufacturing components, others combine these into sub-assemblies, and the sub-assemblies are incorporated into a product like the iPhone. Since the components and sub-assemblies that make up the iPhone cross international borders many times, trade policy must provide the institutional framework for integrating the activities of hundreds of suppliers in dozens of countries. The ITA provides a highly successful example of an international trade agreement that has succeeded in meeting these exacting requirements.

At the risk of some over-simplification, the purpose of the TPP is to enable the participating Pacific Rim countries to take advantage of the steadily rising importance of GVCs. The reduction of barriers to trade in the ITA by reducing and removing tariffs and eliminating non-tariff barriers has created many new opportunities. These opportunities are especially important to the United States, the country of residence of many of the multinational corporations that design and manage GVCs.

Prime Minister Shinzo Abe of Japan has actively promoted the TPP, for example, in his well-received speech to the U.S. Congress in April 2015, emphasizing the economic and strategic benefits to the Unites States, Japan, and the other participants. Abe recently stressed the urgency of ratification of the TPP at the Hangzhou Summit Meeting of the G20. Japan's multinational firms are leading participants in the development and management of GVCs and provide many of the highly sophisticated technologies that are required. At the same time the Japanese labor force is shrinking. Through increasing participation in GVCs, Japan could revive productivity growth, which has languished for more than two decades.

In summary, the principle of comparative advantage that underlies the TPP has vastly increased in importance as a consequence of the rapid development of GVCs. The growing advantages of a more elaborate international division of labor have made the economic rationale for international agreements like the TPP far more compelling. This is already reflected in the strong support of the TPP by the governments of the participating countries, including the United States, Japan, and the other ten participants. It is also reflected in the recent expansion of the ITA to include a wider range of information technology products and many more participants. Ratification of the TPP by the United States will provide a legacy for President Barack Obama and will lead to many further steps to advance free trade around the world.

September 28, 2016

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