FTAs and EPAs Deserve Renewed Recognition for their Roles

URATA Shujiro
Faculty Fellow, RIETI

The breakdown of the Doha Round negotiations at the World Trade Organization (WTO) has made it difficult to pursue worldwide trade liberalization. At the same time, there is a strong likelihood that the number of free trade agreements (FTAs) will increase as a means of liberalizing trade among like-minded countries. However, FTAs are a discriminatory trade policy that gives preferential treatment to specific countries and contradict the nondiscrimination principle of the WTO, which prohibits discrimination among members. Thus, FTAs are allowed as an exception only under certain conditions. In light of this background, this article examines the role of FTAs in the face of the daunting prospect for WTO negotiations and considers what FTA strategy Japan should pursue.

The tendency for FTAs to flourish when worldwide trade liberalization talks hit a snag is nothing new. The number of FTAs reported to the General Agreement on Tariffs and Trade (GATT), the predecessor of the WTO, increased sharply in the early 1990s when the Uruguay Round negotiations got bogged down (Figure).

Number of FTAs in the World

This trend of increasing FTAs was started by Europe and the United States at a time when both occupied significant positions in world trade: Europe was in the final stage of market integration that had begun in the 1950s; and the U.S. was establishing the North American Free Trade Agreement (NAFTA) with Canada and Mexico to protect itself against the prospect of shrinking export opportunities from the emergence of a closed, integrated market in Europe.

These events triggered a domino effect and FTAs soon spread to other regions. East Asian countries such as Japan, China, and South Korea, despite lagging behind countries in other regions, have accelerated their FTA efforts since the turn of the century. However, unlike Europe and North America, East Asia has yet to establish an FTA encompassing its entire region.

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Even if the WTO negotiations had continued proceeding smoothly, a number of factors still exist that would accelerate moves toward FTAs. The WTO establishes trade rules and promotes trade liberalization, but international economic activities in other areas, such as direct investment and international labor migration, have been expanding rapidly in recent years. While issues concerning these areas cannot be handled under the framework of the WTO, many recent FTAs cover diverse areas ranging from trade facilitation that includes improving the efficiency of tariff systems, to the liberalization and facilitation of investment and economic cooperation. Many FTAs have become comprehensive agreements that are referred to as economic partnership agreements (EPAs).

Another factor behind the promotion of FTAs/EPAs is the relative advantage they hold over the WTO with respect to both degree of liberalization and pace of negotiation. Whereas liberalization under the WTO is to reduce tariffs, FTAs seek to achieve a higher degree of liberalization by eliminating tariffs. FTA negotiations, which involve a limited number of countries, are much less time-consuming than WTO negotiations, which require unanimous consent among more than 150 member countries and regions. In addition to the economic objectives discussed above, another contributing factor to the increase in FTAs/EPAs is the growing number of countries that now use them to accomplish noneconomic objectives such as building friendly relationships.

Liberalization through FTAs serves as a catalyst for domestic structural reform since expansion in exports resulting from liberalization boosts production in efficient sectors, and expansion in imports reduces production in inefficient sectors. Through this process, a country's economy grows and consumer benefits increase. In the case of EPAs, their impact on economic growth and consumer benefits is even greater. Economic growth and increasing benefits to consumers contribute to social and political stability, which in turn enables further economic prosperity.

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However, before the benefits of FTAs can be fully realized, many challenges need to be addressed.

First, while an FTA brings various benefits to its members, it causes damages to non-member countries. As FTAs are concluded between countries interested in one another, countries considered unattractive in both economic and noneconomic terms are often excluded from these agreements. For small underdeveloped economies, exporting to the big markets of developed countries is a key to economic development. However, their small market size leaves them at a disadvantage and they are rarely chosen as an FTA partner by developed countries, thus impeding their opportunities for economic development.

FTAs also tend to produce unequal benefits among member countries due to differences in bargaining power that are often reflected in the resulting agreement, for instance, on liberalization commitments. In cases where a developed country negotiates an FTA with a developing country, the developed country, which has greater bargaining power, would receive greater benefits from the conclusion of the FTA than the developing country. Furthermore, the areas covered within an FTA tend to be limited to those that are relatively easy to liberalize for member countries. Sensitive areas are often excluded from an agreement, and thereby the FTA's effect to boost economic growth would be limited.

FTAs are not without problems; one area of concern involves import tariff exemptions under an FTA that are applicable to goods originated from any country that is party to that particular FTA. However, the definition of "rules of origin" differs from one FTA to another, and as more FTAs are established the world's trade system has become increasingly complicated. This phenomenon is referred to as the "spaghetti bowl" effect and it is drawing criticism to FTAs for being restrictive on trade. The increasing presence of FTAs has also been criticized for diverting interest from the WTO, which may result in further delays to WTO liberalization negotiations.

These problems need to be placed under consideration during the FTA negotiating process. However, one counterview sees the increase in FTAs as being helpful with respect to moving WTO negotiations forward. Domestic resistance to trade liberalization is the biggest obstacle to trade negotiations, whether at the WTO or in FTAs. Therefore, some people believe that when resistance is weakened through FTAs, negotiations at the WTO will make progress. If problems associated with FTAs - damage to non-member countries, inequality between FTA member countries, the so-called spaghetti bowl effect, etc. - grow worse as the number of FTAs increases, it is conceivable that the importance of WTO trade liberalization may be re-examined under a new light and eventually lead to progress in the negotiations.

Let's look at one specific example of this. When the Uruguay Round negotiations were deadlocked in the 1990s, one reason why negotiators were able to break that impasse and bring the round to a successful end was the acceleration of moves toward regional economic integration through FTAs and other means. The last remaining issue of the Uruguay Round negotiations was a disagreement between the U.S. and the European Union over agricultural liberalization. Around that time, the U.S. was leading initiatives toward establishing NAFTA in North America, the Asia-Pacific Pacific Economic forum in Asia Pacific, and the Free Trade Area of Americas in the American Continents.

The EU was trying to thwart the progress of the U.S.-led regionalization efforts, but at the same time it realized the importance of promoting worldwide trade liberalization in order to minimize damage should the U.S.-led regionalization efforts been successful. Accordingly, the EU accepted proposals that had been put forward by the U.S. in the Uruguay Round, thereby guiding the multilateral liberalization talks to a successful end.

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In 2007, Japan's trade with its EPA partners, including those with which an EPA had been signed but not yet implemented, accounted for about 15% of its total trade, which was a relatively low level compared to the same statistic reported by the U.S., South Korea, and so forth. However, Japan is keenly interested in economic integration in East Asia, and it has been working toward the realization of its vision to establish a comprehensive economic partnership agreement (CEPEA) under the ASEAN+6 framework that encompasses the member states of the Association of Southeast Asian Nations plus Japan, China, South Korea, Australia, New Zealand, and India.

By promoting EPAs, Japan aims to achieve two objectives: 1) expand export and investment opportunities for Japanese companies; and 2) advance domestic structural reforms. Japan is also promoting economic cooperation to support economic growth in other East Asian countries that have a strong impact on the Japanese economy.

In the bilateral EPAs Japan has concluded with other East Asian countries, it took advantage of its strong bargaining power to open up the markets of its counterparties while maintaining the trade barriers protecting its uncompetitive agricultural market. Not only has this impeded the growth of the Japanese economy by decelerating domestic agricultural reform, it has also hampered economic growth throughout East Asia by inhibiting exports from other countries in the region. In ongoing EPA negotiations with Australia, however, Japan will not be able to protect its agricultural market as Australia has strongly demanded that protective barriers be removed from this area. Meanwhile, a perception widely shared among WTO members is that the liberalization of Japan's agricultural market is a matter to be agreed to in the Doha Round negotiations. Therefore, once the negotiations resume, Japan will not be able to reject it.

Liberalization under the WTO framework is the most desirable way to realize trade expansion and economic growth for Japan and the rest of the world. Given the ongoing difficulty of the WTO negotiations, however, FTAs would be an effective tool to promote trade liberalization and even greater benefits could be derived from comprehensive EPAs. Essential to promoting FTAs/EPAs is the political leadership required to recognize the benefits of these agreements and press forward on reforms to open up the agricultural market, which has been a major obstacle in negotiations. It must be acknowledged that Japan, by making progress in the liberalization of its agricultural market, would be able to contribute to the resumption and successful conclusion of the Doha Round negotiations.

>> Original text in Japanese

* Translated by RIETI.

August 19, 2008 Nihon Keizai Shimbun

September 3, 2008