Prospects and Problems for East Asian Regionalism: A comparison with Europe

Date January 31, 2003
Speaker Richard BALDWIN( Professor, Graduate Institute of International Studies, University of Geneva)


I recently had a revelation that led to my research on Asian regionalism: Conferences in Asia are starting to remind me of conferences in Europe in the early 1990s. There seems to be a new Asian patriotism emerging among the elite, as a reaction to the 1997 financial crisis.

With this as background, my talk today will attempt to answer three questions: What can we learn form the European experience? Where is Asian regionalism going? And what should Japan do about it?

In the early 1950s, the evolution of European regionalism began with a single west European trade arrangement called the Organization of European Economic Cooperation (OEEC), which comprised of 17 countries. But in the late 1950s, Western Europe split into two camps: the federalists and the intergovernmentalists.

In 1958, the EEC was formed by the six federalist states. This arrangement included deep economic and some political integration. Meanwhile, agriculture was treated separately (through the CAP), though the members believe in free trade in principle. In 1960, as a reaction, the other West Europeans formed the European Free Trade Association (EFTA). Due to protectionism, agriculture was excluded. The UK led this arrangement but the EFTA was administered by a one-nation, one-vote formula, which seemed unbalanced. The members were given access to a pooled market and in return had to add their market to that pool.

So, during the 1960s, you had two non-overlapping circles. One was the EEC6, the other the EFTA7 (led by the UK). The EEC was more than twice the size of the EFTA market. By 1960, it was apparent that the EEC was growing rapidly and it was real. Between-bloc discrimination appeared, but since the EEC was larger, the EFTA firms lost more. This phenomenon started what I call the Domino Effect.

What is the Domino Effect? If you imagine a simplified world, from the political economy view of national trade policy, government policy is shaped only by special interests, and exporters are powerful interest groups. A nation's decision to sign an FTA balances the pro and anti FTA political forces. Preferential liberalization among a nation's trade partners strengthens pro-FTA forces. How?

Suppose two of one nation's trade partners sign an FTA. This FTA would hurt the nation's exports to both nations and trade diversion occurs. The nation's exporters are now more interested in an FTA to remove discrimination, creating a new political force. The size of the political interest depends on the size of the partner markets and the degree of discrimination. Thus the size of the partner markets affects the strength of forces for joining an FTA, which affects the decision to join, in turn, affecting the size of the partner markets.

In Asia, there would be a similar effect for investment diversion. Japanese firms favor location in nations with duty-free access to Japan. So ASEAN members will care about Japanese regionalism. Japanese and Chinese interests converge when Japanese companies locate in China, which changes the political forces inside the country.

Going back to the European story, trade diversion created new political forces in nations excluded from the big market. As a result, the UK applied to join the EEC in 1961. As members applied or joined, the outsiders faced discrimination in a bigger market, further strengthening the forces for joining. Other remaining outsiders joined. The UK application triggered new applications from Denmark, Norway, and Ireland.

In 1973, EEC enlargement triggered a second Domino Effect. The threat of new discrimination led to signing of FTAs between the EEC and all remaining EFTA members. This made Western Europe a virtual free trade area for manufacturers, marking the first phase of the collapse of the two camps into one. Later when the USSR broke up, all Central Europeans apply. The final result was that the two blocs collapsed into one.

The lesson for Asia today is that you cannot have two FTA blocs near each other. Once regional integration starts, it is hard to resist. As an analogy, Japan's position is like the UK's position in Europe in the 1950s: it is the biggest market but a reluctant regionalist. China is like France was because China is triggering integration for political reasons.

Real regionalism has not yet started in East Asia. ASEAN economies are too small for AFTA to matter; like the Benelux coming together, it does not change the world trade map. Two sparks to start regionalism are likely-one from China-AFTA integration or one from a Japan-Korea FTA. Both would change the world trade map. The Domino theory predicts that either will produce an East Asia wide free trade area for manufacturers, but with different endpoints.

One path would be that China-AFTA trade is liberalized with no WTO discipline. The result would be fragmented and non-transparent preferences, a bias towards the wishes of Chinese exporters, and the possibility that China may resist enlargement. Step two would be that Japan and Korea ask to join the bloc to avoid discrimination and the ad hoc arrangement becomes the foundation for an East Asian FTA.

The second path would be for the bloc to start with a Japan-Korea FTA with WTO discipline. The result would be zero tariffs on substantially all trade in the Japan-Korea market. The combined GDP would be 17 percent of world income. Step two would be that China and the ASEAN members ask to join. The Japan-Korea FTA becomes the foundation for an East Asian FTA. This path would be better for the trading system because it would be WTO disciplined.

There are three possible models for docking arrangements. One is the hub-and-spoke type (bilaterals with Japan). This would be bad for China and the ASEAN members. There are also historical problems with having Japan as the hub. Another model is the NAFTA type (a matrix of bilaterals creates a virtual free trade area). But there is no hegemon in East Asia to force consistency. A final model is the European free trade association type; this is my preference because market access is pooled and new members get zero tariff access to other members' markets. There could be an intergovernmental structure.

Japan should avoid the UK's mistake of wishful thinking (that the EEC would fail). Instead, Japan and Korea should design the foundation of the regional bloc in consultation with China and ASEAN. But there is no use in starting the FTA before it looks inevitable otherwise no one will take it seriously. Finally, designing docking arrangements makes the FTA look less threatening to China and ASEAN.

Questions and Answers

Q: Why do you believe that China's FTA would lack WTO discipline?

A: I am presuming China's agreement will not be consistent with GATT Article 24. What people say before negotiations is often different from what they say after. If China's FTA with ASEAN were consistent with Article 24, China would end up having better market access to Indonesia than Malaysia has, and Malaysia would not like that. Finally, the Chinese are not necessarily free traders.

Q: Back to the European story, why couldn't the members of EFTA simply join the EEC and retain their EFTA membership?

A: It would have been impossible for them to remain in the EFTA because the EEC was a customs union and, therefore, had a common external tariff.

Q: In Asia, it looks like a hub-spoke arrangement is already forming in the form of economic partnership agreements around Japan as the hub. A China-ASEAN spark looks less realistic given the diverse membership and interests of ASEAN. So I predict a Japan-Korea FTA leading Asian regionalism with Japan as the hub in a hub-spoke arrangement. In terms of political relationships, I see Japan as more like the Germany of Asia. Korea is like Benelux as Japan's first ally. New Zealand and Australia would be the UK, and maybe Singapore would be Italy?

A: I disagree. The UK and France were only on the same side of the War by necessity. They are not natural allies. Regional integration usually proceeds with hub-spoke arrangements because exporters get excited about access to the largest market, but they do not lobby for access to the smaller markets or "spokes." But this is bad for the spokes because the small markets become isolated.

Q: Does your thesis point to Asian regionalism rather than something more global? Japan is looking at Mexico and Chile. The spokes could be global?

A: There are 150 FTAs registered at the WTO. But you can focus on just six of them and understand what is happening in world trade. An exclusion index of approximately 25 percent is needed to create the domestic pressure for liberalization.

Q: We cannot predict if Korea-Japan or Japan-AFTA will be first. So the endpoint could vary. I do not like the hub-spoke arrangement because Japanese companies that move goods across Asia would not enjoy the FTA's benefits?

A: A Japan-AFTA FTA would lead to a more negative burn path because it would more likely reflect idiosyncratic Japanese interests than would a Japan-Korea FTA. In Europe, countries signed bilateral "Europe Agreements." Cumulation made goods treated by common rules of origin even without an FTA.

Q: Political realities could trump preferences in Asia?

A: Asian regionalism will accelerate multilateral liberalization by reducing the protectionist forces and strengthening the free traders (exporters).

*This summary was compiled by RIETI Editorial staff.