Challenges posed by Asian Free Trade Agreements

As FTAs have spread across Asia, concerns over such agreements have increased. A cursory analysis of the growing number of political debates, media stories, policy studies, and conference reports on Asian FTAs indicates that a host of challenges exist for regional integration. It is not possible in this short paper to address all the economic, political, and legal issues arising from the subject of integration. From a pragmatic perspective and with a view to making suggestions, five key challenges associated with Asian FTAs merit further examination: (i) improving firm-level use of FTAs, (ii) tackling the Asian “noodle bowl” problem, (iii) promoting comprehensive coverage of agricultural trade, (iv) increasing WTO-plus elements, and (v) forming a region-wide FTA. New evidence from firm surveys, analysis of agreements, and CGE models can be useful in addressing some of these challenges and indicating the way forward.

3.1 Challenge 1: Improving Firm-Level Use of FTA Preferences

Improving preference use at the firm level is probably the most important challenge associated with Asian FTAs. Well designed and comprehensive FTAs provide numerous benefits, including preferential tariffs, market access, and new business opportunities. One might assume that firms would desire to avail of such benefits once a given FTA is in effect. Previous studies at the country and industry levels, however, suggest that FTA preference utilization rates—based on shares of export value enjoying preferences—are low in East Asian countries and that FTAs are underutilized (Baldwin 2006; World Bank 2007). A firm-level study of Japan's FTAs also reported modest preference utilization rates and related this to the low volume of trade with FTA partner countries (Takahashi and Urata 2008). Accordingly, Asian FTAs are often viewed as discriminatory and a drain on scarce trade negotiation capacity in developing countries (Bhagwati 2008).

Five comprehensive surveys of exporting firms conducted in 2007–2008 by ADB and several partners in Japan, Korea, Philippines, Singapore, and Thailand shed light on the use of FTA preferences.⁸ Although data on shares of export value enjoying preferences were not available from the enterprise surveys, it was possible to estimate utilization of FTA preferences based on the incidence of firms—i.e., the share of sample firms in a given country—that use FTA preferences. Figure 4 [ PDF 41.4KB | 1 page ] shows this measure for firms that use and plan to use FTAs. East Asian exporting firms tend to utilize FTA preferences more frequently than previously thought and may even be increasing their utilization rate. Of the 609 East Asian sample firms, 22% use FTA preferences. When plans for using FTA preferences are also factored in, 44% of all East Asian firms either use or plan to use FTA preferences. Japanese and Thai firms are the highest users of FTA preferences, while firms from Korea, Philippines, and Singapore make relatively less use of preferences. Plans for heightened preference use are present in all five countries—in particular Korea, Japan, and Thailand. While these findings are encouraging, room for improvement exists in FTA preference use at the firm level.

T-tests indicate that the most striking difference between FTA preference users and non-users in East Asian countries is a significant difference in firm size. Japan stands out for its base of large multinational corporations. The average number of employees among Japanese firms using FTA preferences is 30,104, while this number is 1,098 in Singapore, 591 in Thailand, and 395 in the Philippines. The average number of employees among non-users is 7,020 in Japan, 291 in Thailand, 269 in the Philippines, and 142 in Singapore. Accordingly, a classic firm size effect seems to underlie the pattern of FTA preference use in the East Asian sample. The results suggest that using FTAs entails large fixed costs—e.g., learning about FTA provisions, tailoring business plans to complex tariff schedules, and obtaining certificates of origin—and larger firms are better able to muster the requisite financial and human resources than small- and medium-sized enterprises (SMEs).

The reasons that the majority of East Asian sample firms do not currently use FTA preferences are not widely known. The ADB surveys generated responses from 325 East Asian sample firms on the reasons for non-use of FTA preferences. Surprisingly, a lack of information on FTAs is the most significant reason for non-use of preferences as reported by 45% of firms surveyed. Low margins of preference (26%) and delays and administrative costs associated with rules of origin (25%) were the second and third most common reasons cited. Other notable reasons for non-use include: use of other schemes such as export processing zones and the Information Technology Agreement for exporters, which also provide incentives for exporters (11%), and non-tariff measures in partner countries (9%) that inhibit exports and, hence, use of FTA preferences.

Accordingly, use of FTA preferences can be encouraged by raising awareness of (i) FTA provisions, including phasing out tariff schedules; (ii) margins of preference at product level; and (iii) administrative procedures for rules of origin (ROOs). Business associations and governments could make information on how to use FTAs more transparent, particularly for SMEs. Practical ideas include frequent seminars with SMEs, television programs directed at businesses, and dedicated websites and telephone help lines. More generally, institutional support systems for businesses, particularly for SMEs, need to be improved. Existing support systems for exporting under FTAs are of varying quality and take-up rates. Significant public and private investment is required in East Asia to improve coverage of support services, upgrade service quality, and reduce bureaucratic impediments to service use. Business and industry associations will have to play a greater role in providing members with support services for exporting under FTAs. Attention might focus on upgrading the technical standards, quality, and productivity of SMEs so that they can participate more fully in regional production networks driven by large firms.

3.2 Challenge 2: Tackling the Asian “Noodle Bowl” Problem

ROOs are another potentially challenging aspect of Asian FTAs. These are devices to determine which goods will enjoy preferential tariffs in order to prevent trade deflection among FTA members. For manufactured goods, ROOs comprise three types: (i) a change in tariff classification rule defined at a detailed harmonized system level; (ii) a local (or regional) value content rule, which requires a product to satisfy a minimum local (or regional) value in the country (or region) of an FTA; and (iii) a specific process rule, which requires a specific production process for an item (Estevadeordal and Suominen 2006). An influential strand of literature argues that Asian FTAs have complicated ROOs, sparking concerns about what the attendant rules and administrative procedures would imply for the cost of doing business (Manchin and Pelkmans-Balaoing 2007; Tumbarello 2007). This literature claims that restrictive ROOs in Asian FTAs deter the use of FTA preferences, while complex ROOs raise transactions costs for firms. With the rapid spread of FTAs throughout Asia, this literature further suggests that multiple ROOs in overlapping FTAs pose a severe burden on SMEs, which have less ability to meet such costs. Originally termed a “spaghetti bowl” of trade deals (Bhagwati 1995), this phenomenon has become widely known as the “noodle bowl” effect in Asia. Others suggest that the depiction of Asian FTAs as a complicated noodle bowl is misleading. On the contrary, it has been argued that Asian FTAs may be creating an order of a different sort by building the foundation for a stronger regional trading system (Petri 2008).

To what extent are multiple ROOs perceived as a problem by businesses in Asia? The ADB firm surveys provide interesting insights into this issue. Specifically, the surveys provide enterprise perceptions of whether dealing with multiple ROOs in the region's FTAs would significantly add to business costs. The main findings suggested by the surveys are given below.

First, at the present level of concluded FTAs in the region, the evidence suggests that multiple ROOs impose a limited burden on firms in East Asia. Of the 465 firms that responded to the question on this issue, 124 firms (27%) said that multiple ROOs do significantly add to business costs. Meanwhile, the bulk of the sample firms did not think that they were a problem at present. However, the aggregate figure masks interesting country-level variations in perceptions. Singaporean firms had the most negative perceptions regarding multiple ROOs (38%), while Korean firms had the least negative perceptions (15%). In between these two extremes were Japanese, Philippine, and Thai firms with negative responses of 31%, 28%, and 26%, respectively. National FTA strategies, industrial structures, and the quality of institutional support may underlie differences in perceptions of ROOs across Asian countries.

Second, the surveys suggest that larger firms in Asia have more negative perceptions of multiple ROOs than SMEs, which was an unexpected finding (Figure 5 [ PDF 46.1KB | 1 page ]). The relationship between firm size and concerns about multiple ROOs presents an interesting puzzle for research. Econometric analysis to resolve the puzzle shows that large established firms tend to export to multiple markets and change their business plans in response to FTAs. Therefore, they are more likely to complain about issues of multiple ROOs (Kawai and Wignaraja 2009b). In contrast, smaller firms tend to export to a single market and hence do not have much basis for complaining. While inter-country and intra-firm size variations exist, there does not seem to be much variation in perceptions across sectors.

Third, most firms want to be able to choose between ROOs included in FTAs. The surveys suggest that firms are supportive of having alternative ROOs for the same product for several reasons: (i) if they cannot reach the value content requirement, having another ROO enables them to avail of FTA preferences; (ii) as the application for the value content rule may require confidential information on costs, suppliers and many firms are often reluctant to divulge such information; and (iii) some ROOs may be better aligned with the technology and production process of particular industries.

The finding of a limited burden imposed by multiple ROOs does not mean that policymakers should be complacent about the issue. As the number of concluded agreements increases, it is possible that multiple ROOs may become more of a problem for firms. Supportive measures—such as encouraging rationalization of ROOs and upgrading their administration—are needed to mitigate the negative effects of the Asian noodle bowl in the future. Widespread gains are possible from pursuing a simplified approach to ROOs in East Asia involving harmonized ROOs, cumulation of value contents, and coequality of ROOs. Likewise, adoption of international good practices in ROO administration would be useful. This may include introduction of a trusted trader program, as is the case with NAFTA, that would allow successful applicants to self-certify their own certificates of origin, a switch to business associations issuing certificates of origin for a fee, increased use of information technology-based systems of ROO administration, and training programs for SMEs.

3.3 Challenge 3: Promoting Comprehensive Coverage of Agricultural Trade

A third potential challenge for Asian FTAs may be the extent of coverage of goods trade. Some suggest that the coverage of goods trade differs markedly among Asian FTAs, while agricultural products are largely excluded due to pressures from powerful farm lobbies or social concerns over the rural sector, where poverty is predominant in developing countries (Feridhanusetyawan 2005). As a result, there is a sub-optimal level of liberalization in agricultural products and even conflict with the spirit of GATT article XXIV, which provides exemption to the WTO's most favored nation clause, or nondiscriminatory treatment. Consistency with GATT article XXIV requires FTAs to eliminate trade barriers on “substantially all trade” in originating goods from members within a reasonable period of time, which is sometimes referred to as the “substantially all trade” rule.

Two problems have hampered empirical research on the coverage of agricultural goods trade in Asian FTAs. First, little systematic data and analysis is available on the treatment of agricultural products across Asian FTAs. Second, clear criteria for the “substantially all trade” rule do not seem to exist. With the development of new databases on Asian FTAs—e.g., ADB's Asia Regional Integration Center database—new sources of FTA data are now available. Furthermore, tariff lines for agricultural products can be used as a basis to gauge the criteria of substantially all trade.

A simple three-fold classification system was used to categorize Asian FTAs according to tariff line coverage of agricultural products. Given the complexity of provisions for agriculture in many agreements, and the availability of tariff schedules and exclusion lists at the product level, a combination of coverage of product lines and exclusions was used to assess each agreement. The classifications are as follows:

• Comprehensive coverage—at least 85% of all agricultural product lines in a given agreement are covered, or not more than 150 product lines are excluded. FTAs with these features for agricultural products are taken as covering substantially all trade.
• No or limited coverage—agricultural products are completely excluded in the agreement, or less than 100 product lines are included.
• Some coverage—more agricultural products are included in FTAs than “comprehensive coverage,” but less products are covered than “no or limited coverage.” Agreements with such coverage typically include more than 100 agricultural product lines, but less than 85% of agricultural product lines. These agreements may also exclude over 150 agricultural product lines.

It was possible to apply this classification system to 50 concluded Asian FTAs⁹ and the results are shown in Figure 6 [ PDF 40.3KB | 1 page ]. Some examples may be illustrative. For example, the Korea–Chile FTA is taken as a comprehensive agreement for agricultural goods as Korea excludes only 21 agricultural products from the agreement, including rice, apples, and pears. ASEAN is also regarded as a comprehensive agreement as members exclude only 20 agricultural products on average.¹⁰ The ASEAN–Australia and New Zealand FTA follows the AFTA model where most tariffs on agricultural products are bound at 0% upon the FTA's entry into force or phased to 0% by 2020. Exclusions from tariff commitments have been kept to a minimum including rice, sugar, and maize. Using this approach, 25 Asian FTAs (50% of the total) can be regarded as comprehensive in terms of coverage of agricultural products, while another 13 (26%) have some coverage of these items (see Appendix Table 4 [ PDF 49KB | 1 page ] for examples of FTAs with substantial coverage of agricultural products). The remaining 12 (24%) have limited or no coverage. Additional work is needed to refine the criteria for assessing the coverage of agricultural products in Asian FTAs according to the “substantially all trade” rule and to develop new criteria based on the value of total trade.

Better coverage of agricultural trade in Asian FTAs is needed and a gradual approach to liberalization seems optimal for developing economies. This is a key element of the continuation of the liberalization agenda for trade in goods. An important future step would be to include provisions on agricultural products in all prospective agreements. This would serve as a signal for producers to adjust to competition and improve productivity. A next step would be meeting the benchmark for comprehensiveness by ensuring coverage of at least 85% of all agricultural product lines in a given agreement and minimizing exclusions to not more than 150 product lines. This can be done by adopting a negative list approach to agricultural products with a few sensitive items. Issues for the future would include a realistic tariff elimination schedule, a transparent sanitary and phytosanitary regime, and reform of subsidies.

3.4 Challenge 4: Increasing WTO-Plus Elements

Asian FTAs are under increasing scrutiny for their scope, i.e., inclusion of new issues that go beyond the WTO framework. The WTO system that emerged from the Uruguay Round in the mid-1990s consisted of substantive agreements on goods and services. The subsequent WTO Doha Development Round initiated in 2001 has focused on liberalization in agriculture and non-agricultural market access. The four Singapore issues were conditionally included in the work program for the Doha Round, but were dropped at the WTO Ministerial Conference in Cancun in 2004. WTO-plus agreements and new age FTAs, which are comprehensive FTAs that address the Singapore issues, are becoming more common globally (Fiorentino Crawford, and Toqueboeuf 2009). An increase in WTO-plus elements in the landscape of Asian FTAs has been identified as a pressing challenge for economies. Studies suggest that Asian FTAs vary considerably in their scope with some sophisticated agreements alongside limited FTAs (Banda and Whalley 2005; Plummer 2007).¹¹ Yet, systematic cross-country evidence on the scope of Asian FTAs is lacking, particularly with regard to more recent agreements.

Figure 7 [ PDF 42.6KB | 1 page ] shows the scope of concluded Asian FTAs at the national level according to (i) narrow agreements that primarily deal with good and/or services, and have few WTO-plus elements; and (ii) broad agreements with many WTO-plus elements. The scope of concluded agreements reflects a combination of economic interests, economic strength, and negotiation capacity. See Appendix Table 5 [ PDF 128.3KB | 2 page ] for details.

Three leading participants in Asian FTAs—Japan, Korea, and Singapore—strongly favor a WTO-plus approach to FTAs. Appendix Table 6 [ PDF 530.2KB | 3 page ] summarizes coverage of selected FTAs by participant. All of Japan's agreements and most of Singapore's and Korea's are WTO-plus. Likewise, Thailand and Malaysia largely follow a WTO-plus format. Poorer economies, such as Cambodia, Lao PDR, Myanmar, and Viet Nam, as well as the Philippines and Indonesia, which rely heavily on ASEAN for their respective FTA strategies, are party to a mix of WTO-plus and other agreements.

Historically, the PRC and India have been relatively cautious on scope, preferring agreements focusing on goods and services elements. More recently, however, both have begun to experiment by incorporating some WTO-plus provisions such as in the India–Singapore Comprehensive Economic Cooperation Agreement (CECA) and the PRC–New Zealand FTA. Thus, with a few exceptions, Asian economies are increasingly favoring WTO-plus agreements rather than narrowly limited agreements.

Some additional points are noteworthy about WTO-plus provisions in Asian FTAs (Kawai and Wignaraja 2009a). First, agreements between developed countries and developing countries generally take a WTO-plus format. Examples include the ASEAN–Japan FTA, US–Singapore FTA, US–Korea FTA, and PRC–New Zealand FTA. Second, Korea and Singapore tend to behave like developed countries in their agreements with many developing countries. This behavior is visible in the Transpacific Strategic EPA, Singapore–PRC FTA, and Korea–Chile FTA. Third, some existing FTAs are gradually being expanded to have WTO-plus coverage. Comprehensive agreements under negotiation include the ASEAN–Korea CEPA and the India–Sri Lanka CEPA.

The inclusion of WTO-plus provisions—particularly the four Singapore issues—would be desirable in all future Asian FTAs. For example, competition policy and investment provisions are integral ingredients in facilitating FDI inflows and the development of production networks. Inclusion of provisions on trade facilitation and logistics development would help lower transactions costs in conducting trade. Cooperation provisions—along the line of the APEC economic and technical cooperation (ECOTECH) agenda¹²—would stimulate technology transfer and industrial competitiveness. In their FTA negotiations, the US and EU prefer a single undertaking and the inclusion of these WTO-plus provisions. The US–Singapore and US–Korea agreements are cases in point. ASEAN is also considering an ASEAN Investment Agreement as a part of the process of moving toward an ASEAN Economic Community by 2015.

3.5 Challenge 5: Forming a Region-Wide FTA

Finally, there is increasing recognition in Asia of the merits in forming a region-wide FTA as a means to consolidate the plethora of bilateral and plurilateral agreements. Such an FTA would confer various economic benefits: (i) increase market access to goods, services, skills, and technology (ii) increase market size to permit specialization and realization of economies of scale; (iii) facilitie the FDI activities and technology transfer of MNCs; and (iv) permit simplification of tariff schedules, rules, and standards.

ASEAN—with the region's oldest FTA—is emerging as an integration hub for FTAs in East Asia. PRC, Japan, and Korea have implemented their respective FTAs with ASEAN. India and Australia and New Zealand are also following suit and implementing FTAs with ASEAN. With key ASEAN+1 agreements underway, the policy discussion in East Asia is focusing on competing region-wide FTA proposals—an East Asia Free Trade Area (EAFTA) among ASEAN+3 countries and a Comprehensive Economic Partnership for East Asia (CEPEA) among ASEAN+6 countries—that will guide future policy-led integration in the region.

Seeking to bridge ASEAN and its Northeast Asian neighbors, the EAFTA was an early vision of an East Asia-wide FTA. CEPEA has emerged through the realization that synergies could be gained by linking ASEAN+3 countries with India and Australia and New Zealand. An important challenge is to identify which of the two is more beneficial, between an EAFTA and CEPEA, in terms of economic welfare for Asia.

Some studies using CGE models have been conducted on the impact of prospective FTAs on East Asian economies (Gilbert, Scollay, and Bora 2004; Bchir and Fouquin 2006). CGE models have the advantage of being based on consistent structural equations that describe economic activity in each economy. While there has been some CGE work on an EAFTA and other alternatives, only limited work is available on the effects of a CEPEA and on a comparison between an EAFTA and CEPEA (a recent example is Lee, Owen, and van der Mensbrugghe 2009). Furthermore, such work tends to narrowly focus on an FTA involving goods only, while other aspects of East Asian FTA coverage—such as services and trade costs—are excluded. A more comprehensive set of CGE estimates is required to inform the policy debate.

Figure 8 [ PDF 61KB | 1 page ] shows the results of a CGE exercise for economies in Integrating Asia. The EAFTA scenario provides for free trade among the 10 ASEAN members, PRC, Japan, and Korea. The CEPEA scenario broadens the EAFTA scenario to include India, Australia, and New Zealand. Four model features are noteworthy: (i) strong microeconomic foundations and detailed interactions among industries, consumers, and governments across the global economy; (ii) medium- to long-run investment effects by allowing for trade to affect capital stocks through investment activities; (iii) use of the Global Trade Analysis Project (GTAP) database (version 6.3) through to 2017,¹³ which projects trade and production patterns to represent a post-Uruguay Round world using the phaseout of the Agreement on Textiles and Clothing, the implementation of the remaining WTO commitments under the Doha Round, and enlargement of the EU to 27 members; and (iv) a stylized FTA that includes goods, services, and some aspects of trade cost reduction. The model's baseline is 2017 and the simulations show changes from this baseline. As the formation of a region-wide FTA may take time, setting up the model and dataset in this way provides for more realistic scenarios.

Three overall results can be highlighted from the CGE exercise in terms of percentage change from 2017 baseline income: (i) a region-wide FTA, whether an EAFTA or CEPEA, offers larger gains to world income than the current wave of bilateral and plurilateral FTAs; (ii) the CEPEA scenario, which is broader in terms of country coverage, offers larger gains to the world as a whole in terms of income (US$260 billion, measured in constant 2001 prices) than the EAFTA scenario and (iii) third parties outside either an EAFTA or CEPEA lose little from being excluded from a region-wide agreement. Our overall findings broadly echo those of Lee, Owen, and van der Mensbrugghe (2009), whose sophisticated CGE exercise incorporates tariff reduction, trade cost reduction, and endogenously determined productivity levels. These authors also suggest that the CEPEA scenario (US$201 billion) yields larger gains than the EAFTA scenario (US$177 billion), and that insiders gain while losses to outsiders are negligible.

• Some interesting national level results in terms of percentage change from 2017 baseline income emerge from this exercise (see Figure 8 [ PDF 61KB | 1 page ]):
• For ASEAN's more dynamic members, projected gains are significant under the CEPEA scenario: Thailand (12.8%), Viet Nam (7.6%), Malaysia (6.3%), and Singapore (5.4%). For the rest of ASEAN—Cambodia, Indonesia, Philippines, and remaining ASEAN economies—the gains are less than 3.0%.
• Among Northeast Asian countries, Korea experiences the largest gains under the EAFTA (6.2%) and CEPEA (6.4%) scenarios.
• India, Australia, and New Zealand experience losses under the EAFTA scenario and gains under the CEPEA scenario. The losses under an EAFTA are less than 0.5% for each, while under a CEPEA, gains are 2.4% for India, 3.9% for Australia, and 5.2% for New Zealand.
• Third parties like Hong Kong, China and Taipei,China experience small losses from being excluded from both EAFTA and CEPEA.

The CGE analysis indicates that a region-wide agreement in East Asia, particularly a CEPEA, provides welfare gains over the present wave of bilateralism.¹⁴ The gains to members of such an agreement are notable, while losses to non-members are relatively small. Accordingly, arguments for and moves toward CEPEA are supported by economic modeling. The CGE analysis also reveals that some members gain more than others and this issue may need to be addressed in policy discussions. There is a case for further narrowing development gaps by providing financial and technical support for low-income countries, particularly with respect to trade-related infrastructure, customs modernization, enhancing SME development, and capacity building.

Download this Paper [ PDF 532.2KB| 40 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.