Policy Issues and Implications

5-1. Maximizing the Benefits, and Minimizing the Costs, of FTAs

There are both benefits and costs associated with the formation of FTAs. Given that almost all East Asian economies are currently pursuing FTAs, a realistic approach would be to encourage them to design FTAs in a way to maximize benefits and minimize potential costs. This requires that FTAs induce domestic structural reforms and be made consistent with WTO rules.

Benefits and costs of FTAs. FTAs, if designed properly, can achieve dynamic gains by generating greater trade and FDI among the members, through liberalization of trade in goods and services and facilitation of trade and FDI market access. FTAs can help achieve deeper economic integration through the "WTO-plus" agreements, including many areas not covered by the WTO negotiations and areas in which it is difficult to make substantial progress in a multilateral framework (OECD, 2003)—investment provisions, intellectual property rights, labor mobility, environmental issues, and regulatory harmonization. FTAs between FDI source and recipient economies would allow the latter to obtain advanced technologies, realize external economies, promote trade, industrialization, employment and economic growth. These dynamic gains can generate trade and FDI with non-members as the members grow faster as a result of FTAs. These benefits are large if FTAs can induce difficult domestic structural reforms. Once such structural reforms are pursued, it is much easier for the country to provide greater market access to non-members through WTO or other FTAs.

One of the most serious costs of FTAs is that they discriminate against non-members, particularly small, poor, developing economies which cannot join FTAs as they do not have much to offer and hence cannot attract interest of others. The costs of FTA negotiations could also be large for small, poor economies with limited negotiations capacity—such as the CLMV countries—particularly when gains from FTAs are unevenly distributed across various participating countries. The proliferation of many overlapping FTAs with different rules of origin and standards can create the risk of Asian "noodle bowls," thereby reducing incentives for businesses to utilize the intended freer trade arrangements. This may particularly be the case for SMEs which may face higher administrative and business costs as their capacity to deal with them is limited.

With or without the success of the WTO Doha Round, trends for more FTAs will continue. This is a reality. Hence, there is an even more urgent need to make FTAs a stepping stone toward greater liberalization of trade and FDI and toward further regional and ultimately global integration. For this purpose, East Asia needs to design best practice FTAs so that their benefits can be maximized and costs minimized. The region must also manage the proliferation of FTAs so that they function as a means for reducing domestic protection and expanding trade and FDI. For this purpose, FTAs must enforce substantial domestic structural reforms so that the domestic industries can cope with greater competition from abroad.

WTO consistency, breadth and depth. In addition to domestic structural reforms, each FTA must be made consistent with GATT Article XXIV and GATS Article V through adopting: lowest tariff rates among members; large membership; comprehensive coverage of liberalization measures (goods, services and investment); simple and non-restrictive rules of origin; and harmonized regulatory and institutional frameworks.

The larger the number of participating countries in an FTA and the wider the coverage of liberalization measures and policy issues addressed, the more benefits there are for an FTA.

Hence, there is a need to broaden FTAs in terms of country coverage and, from this perspective, aiming for an ASEAN+3 or an ASEAN+6 FTA is proposed. There is also a need to deepen FTAs in terms of liberalization measures and policy issues and, from this perspective, inclusion of a wide range of trade in goods (both manufactured and agricultural) and services as well as "WTO-plus" issues—i.e., investment, labor migration, intellectual property rights, competition policy, non-restrictive rules of origin, and dispute settlements—would be preferable.

There usually exists a trade-off between the breadth and depth of an FTA, that is, as the number of countries participating in an FTA rises, the scope of measures and issues to be addressed in the FTA may be limited. In other words, an FTA with a limited number of countries can relatively easily achieve deep economic integration, while an FTA with a large number of countries may have to compromise on depth. Therefore a good balance must be sought between breadth (number of participating countries) and depth (measures to be addressed) in an FTA.

Consolidating East Asian FTAs: ASEAN+3 FTA or ASEAN+6 FTA? The presence of multiple, overlapping FTAs can create the risk of Asian "noodle bowls" as the multiple rules of origin and various standards increase the administrative and business costs of utilizing freer trade arrangements. This suggests that coordination of rules of origin and harmonization of standards at the global level would be most desirable. Hence, multiple FTAs need to be consolidated into a single world-wide FTA to reduce the business costs. But given the politically difficult task of global (WTO) trade liberalization, consolidation into a single East Asia-wide FTA can make a significant positive contribution. Then the question is: what is the natural group for East Asian FTA consolidation?

ASEAN is clearly a natural "hub" for the creation of an East Asian FTA as key production networks are rooted in ASEAN and major economies are linking to ASEAN via ASEAN+1 FTAs. The timeline for the ASEAN Economic Community has also been brought forward to 2015 from 2020. An East Asian FTA may be built upon ASEAN+1 FTAs as a building block, and FTAs among subsets of non-ASEAN countries (i.e., the PRC, Japan, Korea, Australia, New Zealand and India) will also be useful in forming a single East Asian FTA with ASEAN as its core.

Our CGE results indicate a large income gain from an ASEAN+3 FTA and an even larger gain from an ASEAN+6 (East Asia Summit) FTA. Hence, East Asia is recommended to aim for an ASEAN+6 FTA as the region's goal. However, one of the challenges of this approach is likely to be the differing levels of openness and market-orientation of the broader membership. Table 13 [ PDF 6.9KB | 1 pages ] provides three proxy indicators (average import tariffs, time for import and time to start a business) to represent openness and market-orientation of the member countries. India is a relative latecomer to economic reforms, which began in the 1990s (see WTO, 2007) and, as a result, has relatively high import tariffs (15.7%) and longer time required for import to take place (41 days) than the averages for ASEAN (9.5% and 32 days, respectively) and for Northeast Asian economies and Australia-New Zealand. The time taken to start a business in India (35 days) is also higher than for more developed economies in the region (e.g. Singapore, Japan, Korea, Australia, New Zealand). Accordingly, differences in openness and market-orientation between India and other ASEAN+6 FTA partners may prolong negotiations and reduce the scope of FTA coverage/liberalization. Further structural reforms in India will be required before it initiates formal ASEAN+6 FTA negotiations. Hence, the appropriate sequencing could be to start with an ASEAN+3 FTA and then move to an ASEAN+6 FTA as conditions are created for ensuring sufficient depth of integration within ASEAN+6 countries.

The CGE computation also indicates a negative impact of an ASEAN+3 or ASEAN+6 FTA on the US which, though small, need to be addressed by maintaining openness. After the completion of an ASEAN+3 or ASEAN+6 FTA, East Asia may be ready to connect itself with North America (as well as with Europe).

5-3. Providing Complementary Support

The ambitious economic integration initiative among ASEAN nations—through acceleration of the AFTA process and creation of the ASEAN Economic Community—and the formation of various ASEAN+1 FTAs and a future ASEAN+3 or an ASEAN+6 FTA would increase the efficiency and competitiveness of ASEAN as a whole, because these arrangements provide the benefit of scale economies and dynamic efficiency. To be successful, individual ASEAN members need to create favorable climates for competitive, private firms to prosper, while allowing weak, inefficient firms to exit through pro-competition policies, effective insolvency procedures, and a reduction in structural rigidities in their economies. Domestic industrial restructuring is surely needed to enable them to climb up the value-added product ladder. A shift to a knowledge-based economy is crucial for Malaysia and Thailand, and institutional and governance reforms and restoration of a good investment climate should be priorities for Indonesia and the Philippines.

Low-income ASEAN countries (CLMV; Cambodia, Lao PDR, Myanmar and Viet Nam) must strengthen the structural, institutional foundations of their economic systems—through building both hard infrastructure such as transportation and telecommunications facilities and soft infrastructure such as legal, judicial and governance systems—and develop skilled human resources. With its open FDI-trade regime, Viet Nam has been following China's development path while still in need of improved governance, rule of law and institutions for a well-functioning market economy. Though Cambodia is beginning to participate in the regional and global production networks—particularly in textiles and apparel—it must strengthen the fundamental underpinnings of the economy, particularly its legal institutions and public sector, to benefit from WTO entry. Lao PDR faces similar, perhaps more demanding, challenges. Myanmar clearly needs to improve its governance regime.

The international community is encouraged to provide various types of financial and technical support to enable ASEAN countries to cope with such demanding challenges. Many economies need: trade-related infrastructure (national or cross-border transport, logistics, etc., for trade expansion); support for trade facilitation and customs modernization and for enhancing SME trade and finance; and support for capacity building on trade policymaking, reform, and negotiation. They also need technical support for improving information transparency and educating businesses and the public about the potential benefits of FTAs. The greatest challenge is to narrow the development gaps within ASEAN between its advanced members and less advanced members (CLMV), so that ASEAN can accelerate its own economic integration process—to forge the ASEAN economic community and deepen its economic relationships with the plus-three or plus-six countries.

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