Proliferation of FTAs in East Asia

Date April 8, 2005
Speaker URATA Shujiro(Faculty Fellow, RIETI / Professor of Graduate School of Asia-Pacific Studies, Waseda University)
Commentator NAMENAME(titletitletitle)
Moderator TANABE Yasuo(Vice-President, RIETI)


Until the East Asian financial crisis in the late 1990s, East Asia was very successful in achieving rapid economic growth in the postwar period and thereafter. One reason for successful economic growth in East Asia was the interaction and rapid increase of trade and investment. Although some countries such as China were able to escape the damage caused by the crisis, many have not recovered to pre-crisis levels. One reason that many countries are interested in free trade agreements (FTAs) and economic partnership agreements (EPAs) is to regain growth momentum to achieve high economic growth.

Regionalization is the concentration of economic activities in a particular region. The benefits of such a concentration of activities are greater than the costs in terms of information exchange and good human resources. Conversely, the costs include congestion and high land prices.

Regionalization can be measured in various forms. Looking at how regionalization is taking place in East Asia and around the world, intra-regional trade in East Asia accounted for 8.4% of world trade in 1990. That has increased to 13%, which is a sign of regionalization. Another way of looking at regionalization is to consider the share of intra-regional trade in each region's trade. In East Asia the ratio of intra-regional exports to total exports increased from 40% in 1990 to 51% in 2003. Focusing on imports, it is interesting to see that the share of intra-regional imports of total imports for East Asia increased from 48% to 60% from 1990 to 2003. These figures show that intra-regional trade increased in importance in East Asia, particularly on the import side. In the North American Free Trade Agreement (NAFTA), there are similar developments. In the European Union (EU), although the level of regionalization is quite advanced, the trend is in the opposite direction and intra-regional trade is declining in importance. However, for East Asia, East Asia is more important as an import source than as an export destination. As is often observed, firms located in East Asia import parts and components from within the region, assemble the products, and sell them outside the region.

There are two types of regionalization: market-driven and institution-driven. Until recently, regionalization in East Asia has been promoted mainly by market forces. However, in recent years, the elements of institution-driven regionalization have been increasing in importance. In other parts of the world, institution-driven regionalization has been important for the EU, whereas NAFTA started out as market-driven regionalization, but institution-driven regionalization has also become important.

As to the factors that have led to market-driven regionalization in East Asia, East Asia was successful in achieving economic growth, which in itself promotes regionalization. East Asia's rapid economic growth owed much to substantially increased trade and investment in the region. The reason for this increased trade and investment is that many East Asian economies pursued liberalization in trade and foreign direct investment (FDI) policies under multilateral or unilateral frameworks. However, there are still various trade and investment barriers in East Asian countries and that is exactly why Japan and other countries are interested in establishing FTAs - in order to overcome these barriers.

In recent years, institution-driven regionalization has become more important in East Asia. There are several frameworks that can be characterized as regional institutions engaging East Asia. For example, the Asia-Pacific Economic Cooperation (APEC) forum was set up in 1989. Under the APEC framework, trade and FDI liberalization and facilitation, as well as economic and technical cooperation, have been attempted. In addition to the APEC framework, there are other bilateral and multilateral frameworks. FTAs have become very important trade policy tools for many East Asian countries. In addition to trade agreements, financial frameworks such as the Chiang Mai Initiative have also become important to avoid a financial crisis similar to that of the late 1990s.

There are also other institutional frameworks. For example, the Association of Southeast Asian Nations (ASEAN) has existed for many years and it has set up the ASEAN Free Trade Area (AFTA) and so on. Starting in the late 1990s, ASEAN+3 (ASEAN plus China, Japan, and Korea) became active in discussing various policy measures. There are also +3 activities. Compared to the situation before the financial crisis, there are a number of regional and plurilateral arrangements being pursued in East Asia.

In terms of the trend for FTAs in East Asia, the AFTA was the only major FTA in the region up until the late 1990s. By 2002, AFTA had reached the first stage in successfully establishing a free trade area, although there remained many areas to be liberalized. In the 21st century, there are many FTAs being enacted, negotiated or studied. One that attracted a lot of attention was the Japan-Singapore EPA (JSEPA), which was one of the first FTAs in the region involving a Northeast Asian country, and the first for Japan. The China-ASEAN FTA also drew the attention of policymakers from many countries, including Japan.

The FTAs being formed in East Asia have several special characteristics, including their comprehensiveness. An FTA by definition means that member countries abolish the barriers on trade among themselves, but they maintain trade barriers against nonmember countries. FTAs in East Asia in recent years, however, also include investment liberalization, trade and investment facilitation, as well as economic and technical cooperation. Indeed, trade and investment liberalization, facilitation, and economic and technical cooperation are the "three pillars" of APEC. As such, the kinds of FTAs and EPAs being discussed and formed in East Asia are very similar or consistent with the philosophy of the APEC forum.

What are the reasons that have led to the proliferation of FTAs in East Asia? First, many countries are interested in increasing market access for their products. That has become more difficult over time for several reasons. For one, there was a sharp increase in the number of FTAs in the rest of the world. The number of active FTAs reported to the World Trade Organization (WTO) in cumulative terms was 162 as of January 2005. The rate of increase accelerated in the 1990s and in particular since 1995, when the WTO was established. The WTO negotiations have not been moving as smoothly as people expected, and this slow progress has led to the rapid increase in FTAs. The countries interested in trade liberalization cannot rely on trade liberalization under the WTO. Outside of East Asia, many countries were forming FTAs. Therefore, in order to secure the market for their products, many East Asian countries thought it advisable to formulate FTAs themselves.

In this regard, NAFTA was very important. It was established in 1994 when the Uruguay Round was under pressure. When multilateral negotiations are struggling, countries tend to look for alternatives such as FTAs. When NAFTA was formed, many East Asian countries observed the behavior of countries in North America and saw the negative impacts of NAFTA on them, including increased imports to the U.S. from Mexico, as well as investment diversion. Faced with this situation, East Asian countries opted to formulate their own FTAs.

In addition, many countries, including Japan, were interested in promoting domestic policy reform through external pressure. Had the WTO round been moving ahead smoothly, countries could have relied on the WTO to put external pressure on domestic policymakers to promote domestic reform, but that kind of pressure was not present. Therefore, many countries looked at FTAs to promote domestic reforms.

The financial crisis in 1997 was a very important factor that led the East Asian countries to realize the importance of regional cooperation. One form of regional cooperation is to have an FTA. Now there is also competition among East Asian countries to formulate FTAs.

We can identify other factors that led to the proliferation of FTAs in East Asia, in addition to the market access and domestic reform motives of the countries. For example, Japan is interested in helping other countries in East Asia achieve economic growth through establishing FTAs. This is due to Japan's increasing economic dependence on East Asia. Therefore, Japan is interested in providing economic assistance to East Asian countries through FTAs and other economic partnerships. Furthermore, Japan believes that FTAs will put Japanese firms in a better position to perform their business activities. Many Japanese companies have already invested in East Asia, but they are complaining about the barriers they have to face. Through FTAs, Japan would like to create a more business-friendly environment for Japanese firms.

Concerning China, it is a slow starter in terms of having economic relations with ASEAN countries, so it would like to catch up with Japan in this respect. In other words, China would like to promote economic relations with ASEAN countries and other East Asian countries. One way to do this is to set up comprehensive FTAs.

As for Korea, it is hard to read Korea's FTA policies. They have very active and comprehensive FTA policies documented and have expressed their wish to have as many FTAs as possible, in particular in the Northeast Asia region. For that, reunification of the Korean Peninsula is a factor. Korea, moreover, being geographically located between China and Japan, would like to be in the driver's seat in making regional policies linking these two countries through FTAs.

ASEAN has been very active in promoting FTAs, and it is not easy to give a full description of the FTA policies for all the ASEAN countries because different member countries have different policies. For example, Singpore and Thailand are very active in promoting FTAs, while Indonesia has been slow. However, countries active in FTAs such as Singapore and Thailand hope to use them to maintain their bargaining power vis-a-vis the rise of China. Many countries are also interested in receiving economic assistance through the FTA framework, as FTAs being formed in East Asia are comprehensive and include economic assistance.

Japan's FTA strategy focuses on East Asia. East Asia is considered to be a high-growth region in economic terms, so it is beneficial for Japan to be closely linked with such a region. Another strategy is to have a comprehensive framework, which includes the harmonization of systems such as technical standards, antitrust policies, et cetera. One objective of having FTAs is to have an area where Japanese firms can perform their activities relatively freely.

Many studies on the impacts of FTAs have shown that FTAs have led to economic growth for the member countries, but maybe not for nonmember countries. Non-economic benefits can also be expected, such as increased mutual understanding, closer social ties, and political and social stability. One study looked at the possible impacts of an East Asia FTA on East Asian and non-East Asian countries. Members in the FTA experienced improved economic growth, while nonmembers experienced a decline in gross domestic product (GDP). This model, however, has several shortcomings: 1) it does not include FDI, an important part of EPAs or FTAs; and 2) it does not include movement of persons. There are several items which are important for FTAs that are not taken into consideration in the simulation, which understates the real impacts of the FTA.

There are several obstacles that stand in the way of FTAs. First, there are economic obstacles. There are groups of people or sectors that oppose FTAs or trade liberalization in general because they are hurt economically, such as workers who fear losing their jobs due to increased imports. There is thus strong opposition from such potentially negatively impacted groups. Other obstacles include political and security issues and the lack of political leadership. There are different political systems - China, Myanmar, and Vietnam have authoritarian systems, while other countries are democracies. Furthermore, there are different views of regional security, with some countries allied to the United States and others not. These political and security factors also stand in the way of establishing FTAs. Another factor is the existence of historical and social obstacles. Sadly, we are seeing problems stemming from historical issues between Japan and Korea and between Japan and China emerge in recent years, which represent serious obstacles to establishing FTAs.

Japan must also deal with the issues of agricultural imports and labor mobility. My personal views are in favor of agricultural liberalization and accepting professionals with some conditions, but not an open labor policy. According to the above-mentioned study, Japan would see a decline in production in the farming sector with an Asian FTA. Similarly, China would experience a decline in its transportation machinery sector, which it is very keen on developing.

Economic obstacles can and should be overcome by implementing programs to deal effectively with the structural adjustments caused by trade and FDI liberalization. The WTO allows a period of 10 years for such adjustments. This should be long enough to make the structural adjustments necessitated by trade liberalization. During this time, assistance should be given to those workers who are affected, albeit in an effective manner. Assistance may be in the form of income compensation or technical assistance. For developing countries that face domestic opposition, a comprehensive FTA or EPA could be a useful framework to provide assistance to those industries that may potentially be hurt by an FTA.

As for non-economic obstacles, it is important for countries to have more than just FTAs. FTAs thus far have not included cooperation programs covering such important areas as energy, food security, and the environment. East Asian countries have to cooperate on these issues. In order to overcome non-economic obstacles, it is important to deepen mutual understanding through closer communications and active exchange of people at all levels, such as exchange programs for high school and college students, politicians, and bureaucrats. There is also a need for strong political leadership and strong support from the general public. In this regard, education and advocacy are important, and the role of mass media has to be emphasized. At the moment, it is not clear whether the media is supporting FTAs or other market-opening policies.

Japan, being the most developed country in the region, should play a leading role in various areas it has the necessary resources to do so. It is also important for Japan to actively promote FTAs and liberalization for its own sake to improve efficiency and to counter the declining and aging population. Faced with these negative elements in the Japanese economy, efficiency has to be improved if living standards are to be maintained. For that, the economy has to be opened up. To achieve these objectives, Japan has to be active in engaging in many cooperation programs in human resources development, energy, environment, food security, et cetera. Japan also has to overcome its historical problems with respect to Korea and China, and it should lead discussions on how to formulate the roadmap to an East Asia FTA and other regional issues.

On the potential for an East Asia FTA, there are active talks ongoing, but it has not become official. There has even been talk of an East Asian Community, which was first suggested by Prime Minister Koizumi. Looking at these two frameworks, an East Asia FTA could be considered a medium-term goal and the East Asian Community a long-term goal. However, it is not clear what an East Asia FTA means or what the contents of an East Asia FTA or East Asian Community should be.

In setting up an East Asia FTA, being consistent with the WTO is a problem. WTO rules mandate that trade be substantially liberalized, a condition Japan sometimes finds difficult to satisfy. Japan has to be determined to liberalize all trade, including agriculture. Establishing consistent rules of origin has already become an issue. If different FTAs within the region have different rules of origin, it will be difficult to establish an East Asia FTA.

In conclusion, FTAs have potential benefits and policies to promote FTAs should therefore be adopted. On the other hand, FTAs by nature are discriminatory arrangements that have negative impacts on nonmembers. In order to deal with these negative impacts, countries have to make major efforts in successfully achieving trade liberalization at other levels, such as the WTO and APEC. Finally, to improve the quality of FTAs, not only for developed countries but also for developing countries, it is important for the WTO to take up discussions to improve the WTO rules.

Questions and Answers

Q: You stated that the benefits of regionalization exceed the costs, but what are the benefits? Are they just for the region or for the whole world? Can you expect a happy ending of FTAs leading to successful WTO negotiations?

A: I think that the benefits of regionalization can spill over to the rest of the world. Concretely, if there is high growth, the region will import products not only from the countries in the region but also from the rest of the world.

The model that I mentioned does not include certain important elements. If we have trade liberalization, we can expect improvements in efficiency, which were not included in the model. Even if the discussion is confined to trade liberalization, we should be able to get larger benefits, leading to benefits for the rest of the world.

Furthermore, if WTO rules are improved, that will facilitate the process going from FTAs to global liberalization. If we can improve the WTO rules on FTAs or customs unions, then all the countries that have FTAs will abide by these rules, making it easier for countries to move from FTAs to global liberalization.

Q: Japan has substantial investments in Southeast Asian countries. When it comes to dismantling certain tariffs in those countries, it seems like Japan is negotiating with Japan. Corporate headquarters have an interest in opening those markets, but they want to protect their own business interests there. How do you see this issue? What is the magnitude of the issue and what does it imply for decision-making?

A: There are groups that benefit and those that are hurt by policy change, even within the same industry. There are groups of companies opposed to liberalization or FTAs, even if they are in competitive industries like electronics or automobiles. However, these are minority groups because most people realize that the overall trend is toward liberalization, which they will inevitably have to face in the future. Also, many companies import parts and components for assembly, for which they want relatively low or free tariffs. They are the ones who benefit the most and have a strong voice in favor of FTAs.

Q: First, could you bring us up to date on the ongoing negotiations? Also what would you advise the non-players in the region, namely the EU and North America, to do with everything that is going on in this region?

A: According to media reports, Japan and the Philippines are very close to signing an agreement. For the Japan-Thailand negotiations, the ball is on the Thai side. The issue of agriculture has been settled, so the question is whether Thailand can liberalize its steel market and so on. The same goes for the Japan-Malaysia FTA. Japan-Indonesia negotiations will start very soon, and Japan-ASEAN will start next week.

In terms of advice, the United States has been very active in trying to set up FTAs with Asian countries, which would be my advice to the U.S. and EU. The eventual goal for countries around the world is global trade liberalization. One effective way to achieve that is for non-Asian countries to have high-level FTAs with Asian countries to pressure East Asian countries to perform better.

Q: The United States has been active in promoting the double-track approach of regional FTAs and NAFTA, so I think that they are the teacher. What do you think?

A: Yes, I think so and I do hope that they will have very high-level FTAs. If the U.S. can show us a model, that will pressure the Japanese government to have high-level FTAs.

Q: Have you tried to make simulations of the impact on GDP growth for agriculture and labor if Japan opens these sectors?

A: Labor mobility was not included in the simulation and that is something that economic model builders should work on. The agriculture sector in Japan is quite small and its macroeconomic impact is almost negligible. However, liberalization in agriculture is not just symbolic, it has certain impacts. If we can liberalize that, we can generate and mobilize the dynamism lost in the Japanese economy.

Q: Are the coordination mechanisms in Japan sufficient to deal with the issues that Japan needs to deal with? If not, do you have any recommendations?

A: Although there needs to be more, there have been some improvements. There are occasions where foreign counterparts find it difficult to negotiate with the Japanese, because the Japanese side consists of three or four representatives who may have different opinions. While the Ministry of Agriculture, Forestry and Fisheries and the Ministry of Health, Labour and Welfare protect their sectors, the Ministry of Economy, Trade and Industry (METI) and the Ministry of Foreign Affairs have more liberal views. I hope that METI will put more pressure on the other ministries. The Prime Minister's Office can play an important role here, and I would like to see more action from the Prime Minister or his office.

Q: What, in your definition, is an East Asian Community?

A: The East Asian Community is a long-term objective. The European Community took 50 years or so to establish. Unless the countries have similar living standards, it is not realistic to create a community. Many countries have to achieve economic growth to create an East Asian Community. An East Asia FTA can be an influential framework to achieve this. This has to be a comprehensive framework with economic assistance, liberalization and facilitation. The significant question is the target date. ASEAN is talking about a community by 2020, so East Asia should try to establish a comprehensive FTA before 2020, maybe by 2015.

Q: Are you envisaging differences in the contents of negotiations between ASEAN and China, ASEAN and Korea, and ASEAN and Japan?

A: ASEAN and China have concluded the negotiation on trade liberalization of goods, and the FTA is waiting to be ratified. ASEAN-Korea started recently and ASEAN-Japan will start next week. While all aim to conclude a comprehensive framework, under the ASEAN-China FTA, they have something called the "early harvest" arrangement. This means that even before concluding the FTA, they started liberalizing trade in certain agricultural goods. That is something developing countries can do but developed countries cannot. Other than these differences, the overall frameworks are very similar.

Q: Are labor standards and environmental standards not a factor in Japan? If not, why not?

A: So far, they have not been a factor. Imposing these conditions is not something that Japan will look for in trade negotiations. Japan follows the International Labor Organization (ILO) framework. Concerning environmental issues, there are programs for cooperation. It is different from the environmental standards that the United States is considering. Japan does not believe in imposing such conditions on trade.

*This summary was compiled by RIETI Editorial staff.