Future Perspective on EAFTA and China's Strategy

I have joined a task force which is aiming to present a report on the future perspective of a free trade arrangement (FTA) across East Asia. There are several events which have encouraged a new wave of regional trade arrangements (RTAs) in Asia. First, the single market which emerged in Europe in 1992 has generated new ideas in Asia regarding the possibility of a single market across the East Asian region. Second is the slow progress of the Doha round of the World Trade Organization (WTO). Third, business pressure has become very strong in East Asia, thus pressing governments to go further with national economic development. Fourth, harmonization of standards and policies has become important in realizing a new wave of ideas. Political activity in East Asia has gone beyond national borders, and it is time for the new wave of RTAs to materialize into established economic partnerships.

In order to discuss why there should be an East Asian free trade agreement (EAFTA), it is necessary to look historically at different economic stages which have suggested the movement towards economic integration in East Asia. Thus far, there have been three waves in East Asia which have supported economic integration in the region. The first wave was Japan's foreign direct investment (FDI) in the 1980s to the Association of Southeast Asian Nations (ASEAN) following appreciation of the Japanese yen. This process forced Japanese companies to have an outward strategy and to invest in Asian countries. The second wave was the "four dragons'" (Hong Kong, South Korea, Singapore and Taiwan) FDI in East Asia from 1990. With the United States no longer contributing to these nations' economies, the workforce increased the cost for labor, forcing people to go outside of the domestic market. Many investments have come from the "four dragons" within the East Asian region. The third wave was China's economic emergence and its continuous growth despite financial crisis. FDIs are flowing into China, which has made it a center of new investment and trade since the late 1990s. These three stages of growth make the East Asian regional economy highly integrated already.

There are several reasons why this foundation should lead to an eventual EAFTA. For one thing, the current market-based integration has its own weaknesses as it now stands. For example, East Asia is now acting through a unilateral liberalization approach which, although having given some benefit to each country, is quite different from one country to another. These differences cause market-based production networks to lag. Another weakness of the current integrated market is the presence of non-tariff areas. There are so many of these areas which ultimately are making business quite expensive. There is also a lack of institutional arrangement and consolidation, which was evident in the past financial crisis in China. This lack of institutional arrangement makes the regional economy very vulnerable. Thus, while East Asian economies have become somewhat integrated, there are still several barriers which prevent new production, trade and investment from networking more easily across the region.

Although the need for a more firm integrated approach to the East Asian market is apparent through these weaknesses, the economic priorities for each country involved are different. Multilateral efforts, both in and across other regions, are being made with no standard economic priority to create a uniform or standard procedure for an EAFTA. ASEAN should serve as the hub of this future arrangement. There is a concern as to how to sustain the growth of the East Asian economy. Although generally many are hopeful about East Asia's economic growth, there are still several factors remaining to consider. Based on these multilateral efforts, a need for a more integrated approach to East Asia's economy is apparent. Fortunately, we now have a political initiative. Last year, three economic ministers decided to set up the Joint Expert Study Group to see how feasible a more integrated approach could be. This is often called the feasibility study. Hopefully this study group will play an important role in creating an EAFTA report that will serve as a benchmark.

From the Joint Expert Study Group, research shows that there are several different models which can be used for a more integrated approach to the East Asian market. All of these models show an EAFTA to have the greatest potential for producing economic gain for each country in the region. An EAFTA will be based on the current multilateral arrangements which would be integrated to suit the whole market. In order for this integration to occur, there will have to be some recognition of individual trade arrangements, while also having a system within which these arrangements can be consolidated.

A computable general equilibrium (CGE) approach, which models absolute amounts of gain, shows that under any other method of FTA with ASEAN (ASEAN-China, ASEAN-China-Japan, or ASEAN-China-Korea) money will ultimately be lost by at least one of the countries. Only under an EAFTA can all three countries benefit financially.

How, then, can this integrated approach transition from a theoretical model into a concrete economic system? There are two different possible arrangements. One of these arrangements includes Northeast Asia plus Southeast Asia (NEAFTA initiative + AFTA). As for NEAFTA, currently an initiative proposed by China about three years ago was a China-Korea initiative. Korea finally decided recently that they would like to start working with China on this study. In terms of a China-Japan initiative, China is very interested. We have some studies already and I am currently involved with another study with the Japan External Trade Organization (JETRO). Hopefully this study will be finished by next year. In terms of actual policy making, however nothing is clear yet. The Japanese government seems to want to conclude an investment treaty as a test for China's sincerity. As a result of the aforementioned negotiations taking time to finalize, it is unclear about when an NEAFTA can be launched.

The other arrangement that is being explored as a possible approach to the EAFTA is the three "10+1" FTAs, including China-ASEAN, Japan-ASEAN and Korea-ASEAN. China started this in 2001 and concluded trading goods agreements last year, beginning implementation from July. Service investment is being negotiated and the hope is to be finished with negotiations by next year. Japan is concluding the bilateral arrangements and will then move to Japan-ASEAN. Korea has just set up a governmental organization and started consultation. So the momentum for the 10+1s would function together harmoniously. Ideally, all three of the 10+1 FTAs can be completed by 2007 and then may be started by 2008. Hopefully an initiative based on the Joint Expert Study Group report will become influential and serve as the foundation for initiating the three 10+1s arrangement in 2008.

EAFTA has already valuable progress. One is that we can put together different values which have been created by different efforts. An example of these values is the Japan-Singapore close economic partnership (CEP) model, calling for a high standard of harmonization. Another value is that of the China-ASEAN FTA (CAFTA), which started with a CEP including an Early Harvest Program which focused on the liberalization of agricultural trade in goods. Lastly, another value is expressed through AFTA which shows a gradual time target and community building. If all of these values are brought together, there will be a foundation for a comprehensive CEP gradualism that will lead East Asia into an FTA.

Major points regarding the framework agreement of a CEP in 2008 include: an early harvest program, preferential treatment to Cambodia, Laos, Myanmar and Vietnam (CLMV); a time framework for EAFTA negotiation; and economic cooperation priority areas. Because this regional arrangement will be different from the traditional concept of what an FTA normally means, we must integrate liberalization, facilitation, cooperation and a harmonization of laws.

The EAFTA must be prepared with two main spirits in mind: (1) to accept the common interests among the countries and to be willing to compromise, and (2) to find a way to bring the management of these countries' economies closer together. The future role of the FTA is to provide an integrated framework which can allow different economies to cooperate and use standard rules that value high macroeconomic coordination. In addition, the parallel development scheme of the FTA needs to build up financial monetary cooperation.

There are some major concerns, however, regarding the establishment of an EAFTA. For instance, there is a question of whether the time goal should be set to make East Asia become a liberalized and integrated region by 2020. Three recommendations to meet this goal are: (1) to have an East Asia Summit, (2) to have an East Asia FTA, and (3) to have East Asian financial monetary cooperation. The time target for these projects is very important, and different liberalization processes should be implemented for different countries and sectors. The EAFTA should have comprehensive liberalization including goods, services, investment and non-tariff measures (NTM). It should also include labor mobility. EAFTA also implies a harmonization of customs, procedures and standards; also an integrated rule of origin, a regional dispute settlement mechanism.

In terms of China's economic status, although China may be benefiting the least according to on the modeling result of the effects of an EAFTA, it is clear that China will actively participate in the process. However, China's participation is evident through China's three strategies. First is through WTO commitments. China continues to make the WTO a priority in the process of global liberalization. Second are the neighboring regional arrangements being seen as an economic priority for China. This includes the Asia-Pacific Economic Cooperation (APEC), the Shanghai Organization and Northeast Asia as well. There is a dual strategy for maintaining Northeast Asia as an economic priority. One part of this strategy is engaging with Northeast Asia through the "10+3" framework, and another is engaging with countries across all of Northeast Asia including Russia. The third strategy is bilateral agreements. The bilateral agreements which have already been partially completed are those under CAFTA. Bilateral agreements still under negotiation include China-New Zealand (2004), China-Chile (2004), China-Australia (2005), China-Pakistan (2005, with the Early Harvest Program beginning 2004), Cooperation Council for the Arab States of the Gulf (GCC) (2004) and the South African Custom Union (2004). Bilateral arrangements under preparation are China-Iceland (2005), China-South Korea (2005), China-Brazil (2005) and China-India (2005).

Lastly, China-Japan economic relations are highly interdependent based on regional market production network, but are vulnerable. China and Japan have different priorities in terms of regional trade arrangements (RTA), especially considering bilateral agreements. Regarding the East Asian community building (EAC) and the East Asian Summit (EAS), there are concerns regarding Japan's sincerity to devote itself to the real East Asian identity. Whether China and Japan share the political will to promote a proper EAFTA strategy is also a question to be considered. Much will depend upon the roles and responsibilities of political leaders in both countries.

Q: I have three questions. My first question is that, assuming there is Japan-ASEAN and China-ASEAN and Korea-ASEAN, how would you come up with the rules to govern the trade and investment among China, Japan and Korea? The second question is related. Within East Asia, China, Japan and Korea are the biggest economies. So, in the absence of any agreement among the three countries to govern trade or investment, how can an EAFTA proceed without having the core members come up with the agreements they want on the rules which govern their investment and trade? The third question is regarding what you mentioned about the possible investment on treaties among China, Japan and Korea. Currently, the Chinese government's response is that, considering the development stage of China, investment treaties would be premature. If that is so, then how is it possible to proceed with an EAFTA at the current stage?

A: The reason why I say that the three 10+1s are feasible is because they have already been reasonably discussed. We can make these FTAs a starting point to negotiate a regional EAFTA. Of course each of the three will be different which is why there would be a value in having just one EAFTA as a foundation rather than trying to put all three together. With the rule of origin, although I am not sure about Japan or Korea, it seems that China followed this ASEAN rule of origin with 40% value added locally. So if this rule could be accepted as a rule which applies to all of East Asia and which specifically applies to the three 10+1s, then there can be a move to a regional rule of origin.

There is a natural question of how to move China, Japan and Korea into one economically sound region without rearrangement of individual economies. That is why I refer to the three 10+1s. Consider the Japan-China investment treaty. Japan is more concerned about its investment in China, while China is more concerned about access to the trade market in Japan. These two concerns have to be put together, not ignored. This is why I believe that the first step should be a facilitation framework agreement, first between China and Japan in order to touch upon the major concerns. This is an example of how a larger regional framework can be built: by creating cooperative dialogue which will not minimize concerns among the three 10+1 FTAs while simultaneously bringing all three countries into a larger framework.

Q: I am a little dubious about the results of this model, with China benefiting less than the other countries. How did you come up with these results? That is the first question. Secondly, I think that FTA has a political aspect as well. You mentioned why China hurried to conclude the FTA with other countries. I think that one very important point is that China seeks political prestige in addition to economic gain through these FTAs. That is my feeling. Concerning this, thirdly, who do you see sitting in the "driver's seat" in the ASEAN community? We thought that in order to get to some consensus, that ASEAN should agree and take initiative. Actually in the 1980s and 1990s, cooperation in the Pacific area has proceeded rather rapidly. But if China dominates the leadership of this project, what will be the result?

A: Well, we will use the same database, and there may be some slight differences. Generally, however, when you analyze the results, if you have an integrated and liberalized market, then Japan has more competitive advantages in more sectors than Korea or China. Therefore, Japan should gain more from a larger liberalized market than the other two countries. That is the general analysis in this model. In other modeling, however, you can also see similar results.

The policy makers do not create policy solely based on modeling results. China's benefit will be much larger than the modeling results from a dynamic effect which will take place under the EAFTA for two reasons: (1) the reform process in China will press Chinese companies to improve and, (2) China will invite more shareholders of foreign companies. This is a process which is continuing through liberalization. Another area which has potential for China and which is of interest for business leaders is the increasing outflow of investments. For these reasons, regardless of the results which the model shows, China will still be very active.

Concerning ASEAN's role, China will be active but I do not think that China can "dominate." It seems that there is a phenomenon now which makes it seem as though China is almost too active. China's concern is chiefly different than Japan's in terms of development. Japan is probably thinking more about harmonization of laws and standards. China is more concerned about the assured access of markets for the future. So countries play different roles for the future of the EAFTA. China's economic development still highly relies upon others, especially on the investments from abroad, including those from Japan. Therefore, for example, with only 20% value added in China, I do not think that China can "dominate." The number one priority for China is still market access. There are other factors such as the increase in oil price, ample supply of raw materials and energy, etc.

Q: I have a few questions on China's FTA. One concern is the content of an FTA. Another one is the sequencing, and what is meant by "gradual" in terms of FTAs. First, on the content, although you say that comprehensiveness is important, from the discussions that we have just had in the presentation that you made, China is interested in FTA or market access first, whereas Japan is more interested in investment and intellectual property rights. Also, you suggested a trade and investment facilitation agreement (TIFA) to begin between China and Japan. Suppose that the Japanese government proposed an economic partnership agreement (EPA) or a CEP. What do you think that the response from China would be?

My second question is somewhat related to this. China's approach to the FTA is gradual, but Japan is interested in a single undertaking for the reasons which I just gave. If this becomes an issue in the EAFTA, how would you go about addressing the conflicting approaches? Related to this, I would like to know the contents of China's FTA with many countries like Australia or New Zealand. Those countries, like Japan, are very interested in investment. What are the likely contents of the FTAs within these countries?

When we talk about EPA in Japan, cooperation is a very important component. Is such cooperation such as energy cooperation included in the EAFTA? Also, is there some possibility that China and the U.S. might have an FTA established before Japan and the U.S.?

A: Concerning the China-ASEAN approach the reason why China started first is that it was feasible. China started with a group, rather than with individual countries. ASEAN's exports to China have grown very fast. These kinds of strategic opportunities are very important. Concerning China's gradualism approach, this is relative to the liberalization process. In terms of a U.S.-China FTA, I do not think that either government is considering that possibility yet. Even from the U.S. perspective, there is great difficulty in opening up fully to China. A lot of pressure would be put on China which diverges from the primary concern of gaining market access.

Q: You mentioned the role of the U.S. in East Asia. Suppose the U.S. signed an FTA with Korea. This would affect East Asia's integration. What is your opinion about this possibility?

A: The U.S. and Korea still have a long way to go before they decide to sign an FTA. If early FTA agreements were concluded, it would probably give some pressure for China and Japan to consider. However, EAFTA will not invite the U.S., otherwise it will become like APEC.

Q: On the last page of your presentation you mentioned vulnerability concerning China-Japan relations. Do you have some idea about what scenarios might overcome such vulnerability?

A: I am a member of China-Japan 21st Friendship Commission. We have discussed many times how to overcome the tension between China and Japan. From the Chinese perspective, I think it is up to Japanese leaders to make a decision on their relationship with China. China understands the importance of close Japan-U.S. relationship, but it should not be an alternative strategy of China-Japan relationship. Secondly, whether Japan is wholeheartedly devoted to the East Asia regional strategy has been questioned as well. It would be good for Japan to make their relationship with China a priority for the future; however, that does not seem to be the case right now.

Q: You made the Early Harvest Program with ASEAN. What is your current result from this arrangement? I have heard some complaints from the Thai government.

A: More countries from ASEAN are now participating in the Early Harvest Program. Thailand has a bilateral agreement with China under the Early Harvest Program framework. Thailand expected Thai exports to be greater in quantity and speed than that of Chinese exports into Thailand. Actually, it seems that the Chinese exports increased very quickly. Thailand suddenly felt pressure because of this. It seems now that the general export rate for China is higher, and Thailand officials probably did not expect that. Also, these calculations should be done by sector as well because each sector has a different picture.

Q: Is there any discussion on the possibility of something like a CEP between China and Taiwan, or betweenChina and Hong Kong?

A: Taiwan is in the midst of the East Asian production network. So Taiwan is indispensable for the sustainable growth of this total East Asian economic integration. Mainland China is very interested in making a CEP or even an FTA on two levels: one is bilateral with Taiwan, and another is to put Hong Kong, Taiwan and mainland China together. So I think these plans will be no problem for the Chinese government. The problem probably belongs to Taiwanese leaders. A one China value should be accepted by Taiwan authority. We have to wait this political environment. Taiwan should benefit from these prices.