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Cambodia’s free trade agreement with China

16 September 2020

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The Cambodian government must ensure its free trade agreement with China has its people’s interests at heart, Heimkhemra Suy writes.

For Cambodia’s free trade agreement (FTA) with China to be a success, it must both improve the country’s economic competitiveness, and garner the kinds of Chinese investment that will produce local jobs.

The expected signing of an FTA between Cambodia and China builds off their existing trade relationship, valued at $7.4 billion in 2018, with China promising to push the countries’ bilateral trade to $10 billion by 2023.

But in order for the Cambodia-China FTA to improve Cambodia’s economic competitiveness, and for it to produce jobs for Cambodians and benefit ordinary people at large, the government must ensure the deal has their interests at heart.

Much of the case for FTAs rests on improving economic efficiency, allowing each signatory nation to carry out the economic activity in which they specialise, participate in international trade, and become better off than they would be by operating a more independent economy.

In the context of this agreement, Cambodia is poised to leverage and further develop its rice industry, in return for China’s economic efficiency in manufacturing. In this way, each party can benefit by investing further in areas where they have comparative advantage.

More specifically, an FTA offers an exporting country either reduced or no tariffs on its goods exported to another country, making prices more competitive and ideally expanding Cambodia’s exports to China.

In terms of rice —Cambodia’s primary goods export to China —buyers would be able to purchase the goods at a lower overall price as they are not paying tariffs under an FTA, increasing demand for Cambodian rice and providing more jobs and income to local farmers.

Then, the government could use economic gains and the surplus from its increased exports to purchase more of the products that carry a high opportunity cost to Cambodian producers — or products like electronic devices that local producers either cannot make, or cannot make efficiently.

Though the forthcoming FTA gives reason for optimism, Cambodia should pay attention to fairness in its bilateral relationship with China. Considering China exports much more to Cambodia than vice versa, with the powerhouse economy exporting more than $6 billion in 2018 to Cambodia’s $1.4 billion in exports, more Chinese producers stand to benefit from the tariff reductions than Cambodian ones.

The Cambodian government will also lose some tax revenue without import taxes on Chinese goods as a result of the FTA, though free trade proponents would argue that this loss could be balanced by gains from Cambodia’s increased exports to China. Then, in looking for a new source of tax revenue, Cambodia might be pushed towards implementing domestic consumption taxes — something that would transfer tax burden onto consumers in Cambodia.

The FTA might cement China’s economic dominance in Cambodia, but it appears that Cambodia has already become dependent on Chinese-produced raw materials to support the garment industry, as seen when dozens of factories suspended production near the start of the global COVID-19 pandemic. This was both because China could not export raw textile materials, and because international demand plummeted in response to the crisis.

China also supplies some 40 per cent of Cambodia’s foreign direct investment and holds half of Cambodia’s public external debt, valued at $7 billion in 2018. When the European Union announced in February that Cambodia’s ‘Everything But Arms’ (EBA) preferential trade status with it would be partially withdrawn effective this month, it intensified concerns among some analysts that China’s economic influence in the country would become even more pronounced.

Details of the Cambodia-China FTA are still under wraps, but Cambodia’s export statistics suggest that the deal would only make up for part of the damage of preferential trade status with the European Union, which was Cambodia’s second-largest trade partner in 2019.

Although China was Cambodia’s largest trade partner last year, some 95 per cent of Cambodia’s exports to the European Union were textiles, footwear, bicycles, and foodstuffs, including rice, while Cambodia mostly exports food and raw materials to China.

As a result, the FTA is unlikely to ease the strain of losing trade with Europe, and the International Monetary Fund has said it could lead to tens of thousands of jobs lost in the garment sector alone.

This means that for Cambodia, trade diversification is key. Reliance on one country has made Cambodia less elastic to external risks, seen in the shockwaves sent through the China-dependent tourism and garment industries in the wake of the COVID-19 pandemic.

If Cambodia hopes to get the best out of the China deal, its terms should be driven by Cambodia’s domestic demand and supply, either focusing on existing export products or promoting new products that could feasibly be exported.

Questions remain over whether this FTA would generate inclusive growth and benefit Cambodians. Further, there are concerns that additional Chinese investment may not bring jobs and therefore be of limited benefit.

Cambodian policymakers must do two things to make the most of this FTA. First, they must steer prospective Chinese investors towards contributing to local development and creating local jobs. Second, key local products should be identified and supported, so that Cambodian producers can compete with Chinese firms. Then, Cambodia will be poised to experience not just the risks, but also the benefits of freer trade with China.

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Updated:  26 November 2020/Responsible Officer:  Crawford Engagement/Page Contact:  CAP Web Team