RIETI Report April 2005

The Evolution of FTAs in East Asia <RIETI Featured Fellow> URATA Shujiro

Greetings from RIETI

The cherry blossoms have already fallen, but Tokyo looks fabulous at this time of year. Hazakura cherry trees in leaf are at their best and azaleas have begun to bloom in a dazzling array of color from mauve to magenta, pale pink to fuschia to scarlet. Azaleas are a mid-spring favorite and can be seen in the mountains, in public and private gardens, and along the streets. While deciduous azaleas grow wild in North America, Europe and Asia, evergreen azaleas such as Rhododendron kaempheri (yamatsutsuji) and Rhododendron sataense (satatsutsuji) are native to East Asia. In the late 17th century, evergreen azaleas were first exported from Japan to Europe and were later brought to North America. Since then, the horticulturists in Western countries, particularly the U.S. and Belgium, have created many new hybrid varieties. Nowadays, the beauty of azaleas and thousands of other flowering plants is enjoyed around the world - one of the overlooked benefits of international trade.

East Asia has been vigorously promoting economic integration in recent years, and the pace of this integration has picked up in 2005. Mid-April alone has seen two major developments: Japan and Indonesia have agreed to bilateral talks for a free trade agreement (FTA) with the aim of completing the talks within one year. And Japan and ASEAN held their first round of formal negotiations for an FTA. Recently, "RIETI Report" spoke with Professor Shujiro Urata about the factors behind the growth of FTAs in East Asia, their possible impacts on the world trading system, and prospects for an East Asian Community.

RIETI Fellows Now

Professor Shujiro Urata has been a RIETI Faculty Fellow since RIETI's founding in 2001. An expert in international trade, international development, and industrial organization, Dr. Urata is a professor at Waseda University's Graduate School of Asia-Pacific Studies. He has served as an economist at the World Bank and as a research fellow at the Brookings Institution in Washington, DC. He has also authored and contributed to several books including Measuring the Costs of Protection in Japan, Institute for International Economics, (1995) (with Yoko Sazanami and Hiroki Kawai); "Japanese Foreign Direct Investment in Asia: Its Impact on Export Expansion and Technology Acquisition of the Host Countries" in Globalization, Foreign Direct Investment, and Technology Transfers, Nagesh Kumar (ed.), Routledge, N.Y., 1999; and "The Support System for Small and Medium Exporters in Japan" in Fulfilling the Export Potential of Small and Medium Firms, Brian Levy, Albert Berry, and Jeffery B. Nugent (eds.), Kluwer Academic Publishers, 1999.

*Interview

RIETI Report: Please tell us a little about your current research.

Urata: At RIETI I'm conducting a research project called the "Globalization of Japanese Firms." In this project, I'm working with three researchers, two of whom are RIETI Faculty Fellows. We are doing quantitative research on the behavior of Japanese firms in foreign countries and the impact of their overseas activities on their home offices. That's my main research at RIETI.

I'm also doing some research related to the globalization issue, especially foreign direct investment and foreign trade - looking at foreign investment and trade from developing countries' point of view. It is beneficial for them to attract foreign investment to support economic growth, and so the question is how they can attract foreign direct investment (FDI). In addition, they have to utilize foreign direct investment effectively and efficiently once they succeed in attracting it. So these are the issues that I'm looking at: foreign investment, foreign trade, their impact on economic development, and also on the issue of regionalization in East Asia, free trade agreements (FTAs), the East Asian Community, and so forth.

RIETI Report: The Japanese government seems to be pursuing FTAs more enthusiastically than in the past. What is driving the development of FTAs in East Asia?

Urata: There are several factors. One is the proliferation of FTAs around the world, particularly since the middle of the 1990s. If you look at the number of FTAs reported to GATT and the WTO, it increased quite sharply in the 1990s and has now reached 162. And many of them were formed not in East Asia but in other parts of the world. So East Asian countries, looking at the emergence of FTAs in other parts of the world, were of course concerned about their export markets because FTAs are discriminatory trade arrangements that provide preferential treatment to members, and discriminatory treatment against nonmembers. Many East Asian countries were not part of any FTAs at that time. So naturally they were interested in maintaining or increasing their market access to other parts of the world, and also in East Asia. They found FTAs to be an effective way of gaining or maintaining or increasing the market for their exports. FTAs in the rest of the world were spreading very rapidly and East Asian countries felt they were being discriminated against by these developments.

Number two, somewhat related to the first point, many East Asian countries were interested in trade and foreign direct investment liberalization, because they knew one of the factors contributing to the successful economic development of their countries was trade and FDI liberalization, which led to the expansion of exports. It also led to the expansion of FDI inflows, which in turn contributed to economic growth. So they were interested in trade and FDI liberalization. But as you know, in the late 1990s, the WTO was not really functioning as smoothly or as effectively as these countries wanted so they looked for other means to pursue trade and FDI liberalization and FTAs were one effective alternative.

Third, maybe the most important event of the late 1990s for East Asia was the financial crisis, which underscored the importance of regional cooperation, and also trade and FDI liberalization. Because once countries are faced with a decline in their domestic economies, of course, they look for overseas markets to promote economic growth. As I said earlier, the WTO was not functioning very effectively, but East Asian countries were interested in expanding exports. So they opted for FTAs to expand their exports and to increase interregional cooperation, which they realized was necessary in order to avoid another financial crisis.

A fourth factor was that many countries like Japan were interested in promoting domestic deregulation and policy reform. FTAs can be a very useful and important form of external pressure, which can help promote such domestic deregulation.

And finally there is the political rivalry among East Asian countries, in particular the China-Japan rivalry. When China agreed to start negotiations for an FTA with ASEAN, the following day Japan proposed an FTA or an economic partnership agreement (EPA) with ASEAN. And of course there is rivalry among ASEAN countries as well. Thailand and Singapore are very active in pursuing FTAs because by establishing FTAs with other countries, they can take a leading role in ASEAN in the conduct of its overall foreign trade policy. There is, I think, rivalry among ASEAN countries to become the leader. This intense element of rivalry in East Asia has encouraged many countries in the region to pursue FTAs. I think these are the most important factors.

RIETI Report: Critics say the spread of FTAs is undermining the principle of nondiscrimination at the WTO and sapping political support for broader multilateral trade liberalization. What are your thoughts on this issue?

Urata: Although I think that observation is partially correct, multilateral trade liberalization at the WTO and bilateral or regional trade liberalization under FTAs are not mutually exclusive. They can be complementary and lead to greater trade liberalization. If you look at the case of the Japan-Mexico free trade agreement, for example, Japan liberalized some of its agricultural trade at the request of the Mexican government. Japan, as you know, has been very hesitant to liberalize its agricultural products market at the WTO. So this modest change - and from my point of view it is an improvement - in terms of the government being willing to partially open up the agricultural market could lead to more liberalization at the WTO.

Also, many FTAs have components called "WTO-plus." The traditional FTA is an agreement to abolish tariff and nontariff barriers among members. But FTAs these days often include trade and investment facilitation. Facilitation includes things like improving customs procedures and speeding up the process of approval of FDI, which are not covered by WTO rules. Labor mobility, accepting nurses from the Philippines, for example, is another example of how FTAs with these WTO-plus elements go beyond what is required under the WTO. In that sense, FTAs and the WTO are complements rather than substitutes for each other. And ironically, the proliferation of FTAs may make policymakers realize the importance of multilateral trade negotiations and liberalization. There is a feeling among policymakers that they have to improve the WTO rules on FTAs, which are very inadequate at the moment.

One major problem deals with the rules of origin. Many FTAs have different rules of origin, which leads to the "spaghetti bowl" effect. These conflicting rules complicate the trading system, increase transaction costs for businesspeople, and may eventually lead to a reduction in foreign trade. So the problem is obvious. We have to make the rules of origin consistent for FTAs.

In general, we have to work to make FTAs and the WTO rules work together. Otherwise, we may see a recurrence what happened in the interwar period, when many countries started protecting their own markets and creating preferential arrangements only with colonies. That led to the so-called bloc regime, which in turn led to World War II. So we have to improve FTAs in such a way as to promote greater trade liberalization. There are ways to do it, but policymakers have to show determination.

RIETI Report: Do you think greater cooperation among East Asian economies will weaken the influence of the U.S., the EU, and others outside the region?

Urata: Well, regardless of the presence or absence of FTAs in East Asia, if you look at the statistics, the importance of the U.S. and other non-East Asian economies is declining for the region. In terms of proportion, the importance of China is increasing while that of the U.S. and the EU is declining. And with the growth of FTAs in East Asia, their relative position is likely to decline further. But what is important is not relative shares of trade, but absolute trade levels. And we really haven't seen an absolute decline in the value or volume of trade between, say, East Asia and the U.S. or East Asia and the EU. In other words, trade continues to grow in absolute terms. And as long as trade is growing, that should be accepted as a good thing.

Having said that, it is important for East Asians to trade with the U.S., the EU, and others. The U.S. and the EU are two important markets for final products produced in East Asia. Up to now East Asian countries have not been such good customers for one another's final products. The final destinations are outside the region for many products produced in East Asia. In that regard, we need to have strong ties with these other regions. And even if you have FTAs in East Asia, barriers faced by other countries or regions will not go up. That is the requirement for FTAs. You have to maintain or lower the tariff and nontariff barriers vis-a-vis nonmembers. As long as that requirement is satisfied - and I'm sure it will be satisfied - we don't have to worry about a proportional decline in the U.S. or EU positions in East Asian countries.

Other than Japan, East Asia is a developing-country region. And even in Japan we rely on the U.S. and the EU for technology, advanced products, machinery and so forth. So it is important to have a good relationship with these countries and regions in order to improve our productivity and technology. And I think policymakers in East Asia know that. So I am very optimistic about the East Asian trading relationship with the U.S. and the EU, which will not decline in absolute terms, but should increase, especially in the high-technology sector.

RIETI Report: How far do you see economic integration in East Asia progressing in the next 30 years? Is it likely we will see the development of an EU-style institution to foster greater economic and political cooperation in Asia?

Urata: Frankly, I don't see this region becoming something like the EU in 30 years. As you know, Japan has the highest income in East Asia. A country like Cambodia, Laos, or Myanmar has an income per-capita about one one-hundredth that of Japan. In the EU the gap is maybe one-tenth or less. You cannot have an EU-type regional institution unless the members have similar levels of income, and that cannot be achieved in 30 years.

It is important to have a long-term goal of developing an EU-type organization sometime in the future, but we cannot really specify when. It may take 50 years, but I think it is important to have such a goal in mind. But realistically speaking, in the next 30 years I don't see such an institution developing. It would be a much looser organization compared to the EU. An Asian Free Trade Area, I think, can be established - a comprehensive FTA including tariff and nontariff barriers and, in addition to that, free investment, free movement of labor, and cooperation programs among countries. But in order to have an EU-type arrangement you have to have a common economic policy, and maybe eventually a common currency. I don't think we have reached that stage in Asia. We have to start from a very low level of cooperation and gradually we can reach a higher level. It is an evolutionary process. But it is good for policymakers to have some kind of vision for the future, especially in view of the unfortunate recent developments in Japan's bilateral relations with China and Korea.

RIETI Report: Do you think current difficulties between Japan and China or Japan and Korea will harm the prospects for Japan's participation in FTAs?

Urata: At the moment FTA negotiations are only taking place between Korea and Japan. There are no FTA negotiations between China and Japan yet. I'm sure the recent tensions will have a negative impact on those negotiations and on our bilateral relationships in general. It is very unfortunate in terms of timing.

RIETI Report: In your research, you suggest economic assistance should be provided by more developed countries in Asia to less developed countries under a new type of FTA. How should Japan coordinate its ODA program with FTAs?

Urata: As I said earlier, new FTAs or EPAs should promote trade and investment. Of course poverty reduction or humanitarian aid should be done outside of FTAs for their own sake, but if ODA programs have a component that promotes trade and investment, that should be included in the FTA. That will make economic assistance and FTAs more consistent and effective.

If we look at the relationship between aid, trade and investment, METI and its predecessor, MITI, have long been interested in making these three policy components compatible. Providing economic assistance helps with infrastructure and human resource development. If this assistance improves the quality of infrastructure and human resources in the recipient country, that will lead to more FDI. And along with trade liberalization, one can provide assistance in the form of training personnel in recipient countries - teaching them about trading mechanisms and how to promote exports. This is capacity-building for export promotion. If you combine economic assistance with FDI and trade, the total impact will be much greater than if assistance is carried out in isolation. So coordination among these three - trade, investment and economic assistance - is very important for recipient countries. One effective way to create such a scheme for recipient countries is through FTAs. So in that sense, economic assistance that promotes trade and investment should be formulated within the FTA framework. If that can be done, economic assistance will be more effective.

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To read Professor Urata's paper, "The Shift from 'Market-led' to 'Institution-led' Regional Economic Integration in East Asia in the late 1990s", go to http://www.rieti.go.jp/jp/publications/summary/04020013.html

His latest paper, "The Role of Multinational Firms in International Trade: The Case of Japan" is available at: http://www.rieti.go.jp/en/publications/summary/05030010.html

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EVENTS INFORMATION

Brown Bag Lunch Seminars

Coming Soon
==========
All BBLs run 12:15 - 13:45, unless otherwise stated.

4/21 NOBEOKA Kentaro (Faculty Fellow, RIETI / Professor, Research Institute for Economics & Business Administration of Kobe University)
"The Competitiveness of Japanese Manufacturers in Modular Products: Limits of Combination Capabilities of Chinese Manufacturers in the Digital Appliances Industry" (in Japanese)

4/27 FUKUI Hideo (Professor, National Graduate Institute for Policy Studies (GRIPS))
"A Japanese Government Failure: The Law and Economics of Regulating Market Failure" (in Japanese)

5/12 NAKAO Takehiko (Director, Coordination, International Bureau, Ministry of Finance)
"New Trends in Development Assistance and Challenges to the Japan's ODA Policy" (in Japanese)

For a complete list of past and upcoming BBL Seminars, http://www.rieti.go.jp/en/events/bbl/index.html


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This month's featured article

The Evolution of FTAs in East Asia <RIETI Featured Fellow> URATA Shujiro

URATA ShujiroFaculty Fellow, RIETI

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