East Asia FTA and Economic Cooperation?

5 .1 Rationale and Challenges of a Region-wide FTA and Economic Cooperation

Asia is a huge and diverse economic region, and it would be best to examine an FTA for East Asia first, before embarking on the larger and more ambitious pan-Asia FTA or Asia Pacific FTA.

The region-wide approach is superior to the sub-regional and bilateral approaches in FTA formation, in both the static welfare effects (trade creation and trade diversion) and the dynamic effects from increased competition, economies of scale, and utilization of economic resources.

There are geopolitical and economic reasons for establishing a region-wide FTA and fostering economic cooperation in East Asia:

• Political gains: The ASEAN experience has shown the usefulness of economic cooperation and integration in reducing geopolitical tensions and conflicts. A large grouping would also increase the East Asian voice in international organizations and international fora.
• Modeling results: Various modeling studies¹³ have shown that a larger region-wide FTA would result in more economic benefits than smaller FTAs. The region-wide FTA, with the removal of barriers to trade and investment and freer flows of capital and labor, would facilitate regional production networks and supply chains, and incentivize individual countries to undertake reforms and economic restructuring to better meet the challenges of globalization, as well as regionalism and protectionism in the Americas and Europe.
• Investment effect: A larger and integrated market, together with lowered investment barriers, would facilitate and incentivize the entry of more foreign investments in resources, manufacturing, services, and infrastructure development, thereby improving regional connectivity.
• Counter the noodle bowl effect: A region-wide FTA holds possibilities for establishing compatible ROO, product and technical standards, and conformance requirements, thus, avoiding the fragmentation of markets and the negative noodle bowl effect from the proliferation of multi-layered and overlapping FTAs. It is recognized that establishing compatibility across the large number of plurilateral and bilateral FTAs would be difficult in practice and that it may be necessary to progress step-by-step.

There are also various obstacles in the way of a region-wide FTA and economic cooperation:

• Is there a common political vision? Countries in East Asia need to be convinced that there is a common destiny and that the political and economic gains of economic cooperation and integration outweigh the costs of surrendering national sovereignty to build common institutions and common rules and disciplines. One lesson from the failure of the Free Trade Area of the Americas negotiations is the importance of avoiding a lack of common political vision among the larger participants (Stephenson 2007). In East Asia, while ASEAN has gone some way towards the objective of building an ASEAN community, countries in Northeast Asia are still plagued by historical mistrust and current economic rivalry.
• How to handle the wide development gaps? A region-wide FTA would encompass a wide mix of economies at different levels of economic development, and industrial and technological competence. It would be difficult to reach a consensus on the scope and speed of achieving a high quality FTA and economic partnership. Among the poorer and less efficient economies, producers, and suppliers, concerns have been raised of marginalization; hence, governments are reluctant to open up their less competitive farm sectors, labor intensive industries, and small- and medium-sized enterprises without adequate safeguards and financial and technical assistance for capacity building. Among the richer and more competitive economies, there is public resistance to financial transfers through taxation in the absence of political and social integration (as in the case of the EU). Still, there are positive aspects to regional diversity. For one, it offers complementarities and prospects of specialization and efficient regional production. It would also enable the smaller and less developed East Asian economies to be part of regional and global production networks and supply chains in East Asia and enjoy the spillover effects from regional dynamism and growth.
• How deep is intra-regional economic linkage? East Asian trade and investment activities are oriented towards markets and investors outside the region, particularly towards North America and Western Europe, although there has been rapid growth of intra-regional trade in recent years. Table 13 [ PDF 38.9KB | 1 page ] shows intra-regional trade in 2007. Only Indonesia has intra-regional exports exceeding 50% under the East Asia Free Trade Agreement (EAFTA), and only Australia, Indonesia, Malaysia, and Singapore have intra-regional exports exceeding 50% under the Comprehensive Economic Partnership for East Asia (CEPEA). However, dependence on intra-regional imports is significantly higher. All EAFTA members except the PRC and Japan have intra-regional imports exceeding 50%, while all CEPEA members except the PRC, India, and Japan have intra-regional imports exceeding 50%. Further, as noted in ADB (2007), product fragmentation in East Asia has resulted in intra-regional trade being dominated by trade in parts and components (72.7%), while trade in final goods is still largely destined for non-regional markets (78.8%).
• The recent quick transmission of the US financial and economic crisis to East Asian economies through the collapse in demand for the region's exports has put paid to the de-coupling thesis. There is a growing realization among East Asian policy makers that the pre-crisis export-led model is unsustainable and that East Asian countries have to rebalance growth towards regional and domestic demand. East Asia appears to be recovering from the current crisis faster than North America and Western Europe and this, together with the rebalancing of growth, should lead to deeper intra-regional trade and investment linkages.

5.2 Possible Roadmaps to a Region-wide FTA

At the minimum, a region-wide FTA would be defined as EAFTA (or ASEAN+3). However, there is the alternative scenario of CEPEA (or ASEAN+6)). There are also proposals for an APEC FTA or an expanded Trans-Pacific Strategic Partnership to prevent a split down the Pacific.

EAFTA (East Asia Free Trade Area or ASEAN+3) Option:

ASEAN+3 cooperation started as an initiative for monetary and financial cooperation in the wake of the ASEAN financial crisis. The grouping adopted the Chiang Mai Initiative in 2000, which was aimed at fostering regional financial stability and resilience. On trade and investment cooperation and integration, there was the 2001 Report of the East Asia Vision Group and the 2002 Report of the East Asia Study Group. The latter report was adopted at the ASEAN + 3 Summit in 2002 and contains medium- and long-term measures such as the convening of an East Asia Summit and an expert group to study the feasibility of an East Asia FTA. The East Asia Summit was convened in Kuala Lumpur in December 2005. The expert group was appointed in 2005 and submitted its first report in mid-2006 and its final report in 2009. The final report stressed the need to adopt a common ROO.

EAFTA could be achieved by the following:

• Merging ASEAN agreements with a Northeast Asia FTA: ASEAN is in an advanced stage of implementation of AFTA (goods), AFAS (services), and AIA (investment). There is no comparable PRC–Japan– Korea trilateral FTA agreement, while bilateral options are still in the early consultation and feasibility study stage. While the past political relations of PRC, Japan, and Korea constituted a serious barrier, there appears to be a warming of political ties and an increasing willingness to cooperate. The issue of agriculture (which has troubled the Doha Round) between the two sub-regions is difficult to resolve. A merger of the ASEAN bloc with the Northeast Asian bloc would highlight the asymmetric economic power between the two sub-regions.
• Merging the ASEAN+1 FTAs: This would be ASEAN-centric since there are FTA agreements linking ASEAN with PRC, Japan, and Korea (as well as Australia–New Zealand CER and India) and key production networks are rooted in ASEAN. On the positive side, these ASEAN + 1 agreements would have an agreed common framework and liberalization schedule, reducing possible areas of divergence and disagreement. A negative scenario is also possible, as the lack of a common template for these agreements would result in a noodle bowl that would be difficult to unravel.

CEPEA (Comprehensive Economic Partnership in East Asia or ASEAN+6) Option:

The first East Asia Summit was held in Kuala Lumpur, Malaysia in December 2005¹⁴ followed by summits in Cebu, Philippines in January 2007, and in Singapore in November 2007. The summit was attended by the ASEAN+3 countries as well as by Australia, India, and New Zealand. Japan regards ASEAN+6 as an appropriate group for East Asia's trade and investment cooperation and in April 2006 proposed CEPEA.

The CEPEA option has several advantages. It would result in a larger trade creation effect than EAFTA. Including Australia, India, and New Zealand would reduce the leadership competition between the PRC and Japan in an East Asia FTA. However, this option would also have difficulties in that most ASEAN countries as well as Australia, PRC, and New Zealand have comparative advantages in agriculture, while India, Japan, and Korea are highly protectionist in agriculture. The less developed ASEAN countries are concerned about opening up their economies to competition from the PRC, Japan, and Korea as well as Australia, New Zealand, and India without prior capacity building to improve their supply-side competitiveness. Hence, the less developed ASEAN countries prefer to argue for cooperation and facilitation measures before committing to liberalization measures.

CGE Modeling Results for EAFTA and CEPEA:

CGE simulation studies are useful in quantifying the income effects of eliminating import tariffs on goods trade and liberalizing cross border trade in services through FTAs.¹⁵ A serious shortcoming in CGE simulation is the inability to incorporate the dynamic investment effects of FTAs. It is common knowledge that all ASEAN countries view the positive investment effects as a major benefit of signing on to FTAs. Another shortcoming of CGE modeling is the inability to incorporate ROO and NTBs that are likely to afford more protection for domestic industries than tariffs. Thus, Kawai and Wignaraja (2007) caution that CGE studies are best used in conjunction with other empirical tools such as analysis of the complex structure of FTAs and enterprise perception studies of the benefits of FTAs. Kawai and Wignaraja's 2007 CGE study incorporates trade in services and trade facilitation. Their scenarios for EAFTA (ASEAN+3) and CEPEA (ASEAN+6) as well as for ASEAN–PRC, ASEAN–Japan and ASEAN–Korea are shown in Table 14 [ PDF 25.9KB | 1 page ].

Among the three ASEAN+1 scenarios, ASEAN–PRC has the largest income effect on ASEAN, while ASEAN–Korea has the smallest. Although all ASEAN countries benefit, there is a wide variance in income effects, with the largest found in Thailand. In the ASEAN–PRC FTA, Japan and Korea suffer from negative trade diversion; in the ASEAN–Japan FTA, the PRC and Korea suffer from negative trade diversion; while in the ASEAN–Korea FTA, the PRC and Japan suffer from trade diversion.

EAFTA and CEPEA offer larger gains than the ASEAN+1 scenarios. EAFTA gains to FTA members are significant at US$228 billion, while gains from CEPEA are higher at US$285 billion. However, the two scenarios have different impacts on member countries. For ASEAN, the gains are bigger under CEPEA, and under both scenarios, the largest percentage gains are by Thailand followed by Viet Nam and Malaysia; and the smallest gains are by Cambodia, Lao PDR, and Myanmar. For PRC, Japan, and Korea the gains are bigger under CEPEA and under both scenarios, Korea has the largest percentage gains. As non-members, Australia, India, and New Zealand experience losses (trade diversion effects) under EAFTA, with the largest percentage loss by Australia. However, they gain as members in the CEPEA scenario, with New Zealand having the largest percentage gains.

Burdensome and Multiple Rules of Origin:

ROO are crucial in determining the true degree of liberalization of trade in manufactures. Some rules are deliberately restrictive to shelter domestic producers from competition from FTA partners. Restrictive ROO make it difficult for exporters to enjoy the tariff preferences. One indicator of this is the extent of utilization of tariff preferences by exporters. ROO can often be more important than tariff preferences in determining the degree of market access provided by the FTA. Costs imposed on exporters by ROO in record keeping and documentation, production down time, and switches to more expensive input mixes can more than offset the cost advantages of tariff preferences. Among manufactures, textiles and garments tend to be affected by restrictive and stringent ROO.

For manufactures, there are commonly three types of ROO to measure substantial transformation and qualification for FTA tariff preferences. These are value added content (VC), CTC, and specific process rules. There are also variations within each type of ROO. The VC rule is very demanding on sourcing, and cost information is required on a continuous basis; changing cost structures and exchange rates may result in not satisfying the required VC. There are also variations in regional VC rules arising from differences in the percentages of regional VC required, differences in the way regional VC is calculated, different cumulation provisions, and differences in the way that for some products the regional VC rules are combined with a specific process requirement. The CTC rules offer exporters much greater certainty, as tariff classifications do not change and there is complete certainty of satisfying the ROO. However, a single CTC rule based on the HS tariff lines may not be suitable for every product to measure substantial transformation. Hence, comprehensive application of the CTC rule typically requires the ROO for each tariff category to be specified, resulting in extremely lengthy ROO schedules. Variations in CTC rules arise from the different levels at which the change in customs classification is defined and the differences in the ways that CTC rules may be combined with specific processes or regional VC rules that must be satisfied simultaneously.

There are also variations in documentation and certification requirements. In some FTAs, origin must be importer-certified, while in others the requirement is for exporter-certification. The latter also differentiates between exporter–self-certification and certification by a designated official agency.

The majority of FTAs have adopted a combination of ROO rather than relying on a single rule. The simplest ROO are found in AFTA and the ASEAN–PRC FTA which both specify a 40% regional VC across all manufacturing sectors. Inconsistent ROO among multiple and overlapping plurilateral and bilateral FTAs in East Asia result in market fragmentation and the noodle bowl effect, which both add to business transaction costs, although an empirical study on Singapore by Chia (2008) shows the effect is not as serious as claimed by some authors such as Baldwin (2006).

Nonetheless, a convergence of ROO would facilitate trade (Scollay 2007) It would be best to have a common template at the negotiating stage, although this poses severe difficulties because of different positions and sensitivities of potential FTA partners. Reaching consensus on a common ROO for existing FTAs across industries and products will be a very difficult task. One possible solution is for PRC, Japan, and Korea to follow the ASEAN (AEC) ROO template as far as possible to achieve EAFTA. The other alternative is to converge as far as possible the ROO in the ASEAN+1 FTAs.

EAFTA or CEPEA?

• The East Asian and ASEAN economies are politically divided on their preference for either EAFTA or CEPEA. Kawai and Wignaraja (2007) argue that proper sequencing could start with ASEAN+3 (EAFTA) and then move on to ASEAN+6 (CEPEA). However, there are several challenges to be met:
• Once the template is set by the ASEAN+3 countries, it would be difficult for accession by Australia, New Zealand, and India to result in ASEAN+6. Hence it would be necessary to agree on a common template for ASEAN+6 countries, with a later time frame for negotiations for ASEAN+6.
• If the level of integration is confined to trade and investment, then progression from ASEAN+3 to ASEAN+6 over a period of time does not pose a serious problem as the more protectionist members would eventually conform. However, monetary and financial integration, community building, and a common political vision that includes Australia, India, and New Zealand would require a longer time frame.
• ASEAN must act as the regional hub. It is a non-threatening sub-group trusted by Australia, PRC, India, Japan, Korea, and New Zealand and can balance the hegemonic ambitions of the large countries. However, to counter the pull of extra-ASEAN economies from the ASEAN core, the ASEAN countries need to further deepen their own economic integration process.
• Substantial regional and international support is needed in the form of aid for trade and the building up of the capacity of the low-income ASEAN countries to overcome resistance to further market opening and to strengthen their supply-side capacity to take full advantage of the integrated regional markets.
• There are serious problems with consolidation and/or convergence of the various ASEAN, ASEAN+1 and bilateral FTAs in East Asia with respect to the scope and coverage of trade and services, lists of exclusions, rules of origin, technical barriers and product standards, mutual recognition of service providers, FDI, and other WTO-Plus provisions.
• Relationships with the US and EU are important for the region. One possible approach for East Asia is to strengthen economic ties with the US through East Asia–NAFTA or an Asia Pacific FTA, and with the EU through the Asia-Europe Meeting process. On the part of East Asia, there are reservations among some countries of an FTA with the US; likewise, on the part of the US there are possible reservations of an FTA that includes the PRC. Myanmar remains a problem in US and EU relations with ASEAN and East Asia.

An APEC FTA Option?

APEC was established in 1989 to promote voluntary and unilateral trade and investment liberalization in the APEC region, so as to attain the Bogor goals of free and open trade and investment for developed country members by 2010 and for developing country members by 2020. From time to time, however, there have been proposals for a formalized APEC FTA, particularly as the prospects of realizing the Bogor goals recede and there is geopolitical concern of a split down the Pacific should East Asia proceed with its own region-wide FTA. However, to the extent that APEC still excludes some ASEAN countries, the Free Trade Area of the Asia and Pacific (FTAAP) would split ASEAN and so would not be desirable from the ASEAN perspective, unless Cambodia, Lao PDR, and Myanmar became members before the start of negotiations.

Bergsten (2007) has been a strong advocate of a FTAAP. He argues that an FTAAP would provide the largest single liberalization in history, and it would remove the problem of FTA proliferation and the noodle bowl effect in the Asia Pacific. It would also prevent competitive liberalization in the Americas and Asia and also the threatened split in the Pacific. Finally, it would provide a framework for the PRC and US to head off trade tensions and help revitalize APEC.

However, Arggarwal (2007) argues that successful negotiation of a high quality FTAAP is not politically feasible at present or in the near future. First, the US Trade Promotion Authority expired in July 2007. Growing protectionist tendencies were reinforced by the outcome of the November 2006 Congressional elections. There is also the highly controversial American trade deficit with the PRC. Priority interests in the PRC and Japan appear to favor an East Asia FTA. And even if there was a unity of vision among PRC, Japan, and US, the negotiations would take several years and would tie-up negotiating resources and cause postponement of other negotiations that are of high priority to some key APEC economies. In ASEAN, some countries are not at all prepared politically or otherwise to enter into an undertaking of the magnitude of FTAAP. Second, to be of high quality, the FTAAP must also cover highly sensitive sectors such as agriculture and complicated behind-the-border issues. However, the FTAAP is so large and diverse it encompasses many protectionist interests. To achieve a high quality FTAAP would be much more politically demanding than the goals of the Doha Round; hence, there is no particular advantage to the FTAAP. The FTAAP carries high risks of diverting rather than galvanizing the Doha Round.

Stephenson (2007) draws possible lessons for the FTAAP from the failure of the Free Trade Area of the Americas:

• A common vision is necessary among the major economies.
• The time frame of the negotiating process must not be too long.
• Objectives must be realistic and achievable.
• There must be minimal interference from other FTA negotiations.
• Chairmanship of the process should not be given to the major players.
• Prior understanding must be achieved on how to treat labor and environment.
• There must be a willingness and identified capacity to finance and support the negotiating process.

An Expanded Trans-Pacific Strategic Economic Partnership Option?

Launched in October 2002, the Trans-Pacific Strategic Economic Partnership (known as TPP or P4) encompasses four small and open Pacific economies. Chile, New Zealand, and Singapore signed the agreement in July 2005, followed by Brunei Darussalam a month later. The agreement came into force on 1 January 2006. Economically, TPP promotes trade and investment liberalization among four small and already very open APEC economies that are also engaged in other plurilateral and bilateral FTAs (except for Brunei Darussalam). So the value added effect of the agreement seems small.

The unique features of P4 are its trans-Pacific membership and its “big bang” approach of immediate and comprehensive goods liberalization. Singapore has MFN zero tariffs, New Zealand would immediately eliminate all tariffs; Chile would immediately eliminate 89.3% of its tariffs (the remaining, 9.57% within 3 years, and 1.13% within 6 years. There are breakthroughs in agricultural trade liberalization, which are notable as Chile and New Zealand are both southern hemisphere agricultural exporters. For services trade liberalization, TPP adopts the more liberalizing negative list approach. There is no investment chapter. There are cooperation commitments in various areas as well as a memorandum of understanding on labor cooperation and an Environment Cooperation Agreement.

TPP has an open accession clause. It could be the building block for an eventual FTAAP through an initial coalition of the willing. However, its “big bang” approach conflict with the realities of political and economic sensitivities that characterize many less open APEC economies. Further, the trade flows involved are very small; hence, the competitive liberalization effect of TPP is limited. TPP would appeal to a larger group of countries if some major economies such as the US, PRC, and Japan express interest in joining the group. At the APEC Summit in Singapore in November, US President Obama signaled US interest in engaging TPP members. Likewise Australia, Peru, and Viet Nam expressed interest.

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