Regional Trade Agreements in East Asia: Will They Be Sustainable?*

Transcription

1 Asian Economic Journal 2009, Vol. 23 No. 2, SUstainability of Trade Agreements Regional Trade Agreements in East Asia: Will They Be Sustainable?* Innwon Park Received 27 April 2008; accepted 18 December 2008 By assessing the sustainability of regional trade agreements (RTAs) for East Asia, we quantitatively evaluate the likely impact of proposed East Asian RTA strategies on the East Asian economies and the world economy with respect to consumption, production, volume of trade and terms of trade effects by applying a multi-country and multi-sector computable general equilibrium model. These strategies include: (i) the ASEAN Free Trade Area (AFTA: a being-left-alone strategy); (ii) an ASEAN Hub RTA (a hub-and-spoke type of overlapping RTA strategy); (iii) the AFTA versus a China Japan Korea RTA (a duplicating or competing RTA strategy); and (iv) an ASEAN+3 RTA (an expansionary RTA strategy). We find that an expansionary ASEAN+3 RTA could be a sustainable policy option because the members gains would be significantly positive, with more equitably distributed gains between members than when using other strategies. The effect on world welfare would also be positive and the negative effect on nonmembers would not be very strong. More interestingly, if the East Asian countries cooperate with Pacific Basin countries to form an APEC-level RTA, such as a free trade area of the Asia-Pacific, the extension of the regional trade bloc might be considered a more desirable policy option than the proposed East Asian RTAs for East Asian economies, even though countries excluded from the free trade area of the Asia Pacific are worse off. Keywords: regional trade agreements, sustainability, computable general equilibrium model, East Asia, ASEAN+3. JEL classification codes: C68, F15, O53. doi: /j x I. Introduction East Asia has been making very rapid progress in market-driven regionalization. 1,2 Since the financial crisis occurred in 1997, East Asia s effort to achieve regional economic cooperation has been very aggressive, resulting in a proliferation of * Park: Division of International Studies, Korea University, Anam-Dong, Seongbuk-Gu, Seoul , Korea. iwpark@korea.ac.kr. The author is grateful to David Greenaway, Richard Pomfret, Suthiphand Chirathivat, Josef Yap, seminar participants at the University of Nottingham, Kuala Lumpur Campus and the 4th Conference of East Asian Institutes Forum organized by the Korea Institute for International Economic Policy, and an anonymous referee for helpful comments and suggestions. This research was supported by the research fund of the Center for International Commerce and Finance in Graduate School of International Studies at Seoul National University, Seoul, Korea.

2 ASIAN ECONOMIC JOURNAL 170 regionalism in East Asia. In particular, negotiating regional trade agreements (RTAs), mostly the result of the formation of bilateral free trade areas (FTAs) like Singapore Korea and Japan Malaysia FTA, and some plurilateral or multilateral FTAs like ASEAN China and ASEAN Korea FTA, is now commonplace in the region. Accordingly, several studies have dealt with East Asian regionalism, focusing on why it is proliferating, what the likely impact of East Asian RTAs will be, and whether East Asian RTAs can lead the world economy to global free trade or not. 3 However, they do not ask whether the existing or proposed East Asian RTAs will be viable in the long run. In other words, none of the existing studies quantitatively analyze whether the RTAs for East Asia are sustainable in a globalizing world. An effective RTA should create a significant enough positive welfare effect on all the participating member countries and should result in equitably distributed gains from free trade between members. 4 Next, what is the sufficient condition for sustainability? An RTA should create enough static and dynamic effects on world welfare to ensure nondiscriminatory global free trade, as Bhagwati (1993) indicates. Otherwise, the RTA will easily stall and be ineffective as time passes. Last but not least, an RTA will be more sustainable if it does not seriously damage nonmembers. 5 Even though most existing studies have not considered the sustainability of RTA, there are some exceptions. The global welfare gains from East Asian RTAs are tested by Lee and Shin (2006), using a gravity regression analysis, and by Park (2006), who applies a computable general equilibrium (CGE) model analysis for East Asian economies as a whole. However, these studies do not evaluate the welfare effects on individual economies in East Asia or the possible welfare improvements through equitable distribution of the gains between participants as a result of RTA. Our work, that is, evaluating whether particular East Asian RTAs are sustainable, is an attempt to fill this gap by quantitatively evaluating the likely impact of possible East Asian RTAs. Each of the East Asian countries may consider the following four different RTA strategies: (i) no further effort to liberalize the regional market and then 1. In this paper, we narrowly define East Asia by including ASEAN 10 countries in Southeast Asia and China, Japan and Korea in Northeast Asia. In addition, we treat the ASEAN 10 countries as a single economy. Therefore, there exist 4 individual East Asian economies in this paper; namely, the ASEAN+3, which includes ASEAN, China, Japan and Korea. 2. For market-driven regionalization, see Urata (2006). For more recent overviews of East Asian regionalism, see ADB (2008) and Kawai and Wignaraja (2008). 3. For proliferating RTAs in East Asia, see JETRO (2003), Lu (2003), Kawai (2004), Feridhanusetyawan (2005) and Lee and Park (2005). 4. Theoretically, Kemp and Wan (1976) prove the possibility of Pareto-improving customs unions if there is a system of internal transfer of gains from free trade only between members, along with a common external tariff scheme. 5. As point out by the referee, the seriousness of the damage, that is, the significance of the negative effect on nonmembers, is a matter of subjective judgment. We clarify the significance (X) as follows: strongly (or significantly) negative if X < 1%, negative if 1% X < 0.1% and insignificant if 0.1% X < 0%.

3 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 171 the existing ASEAN Free Trade Agreement (AFTA) will be activated in the region (being-left-alone strategy); (ii) the ASEAN+1 approach will likely build an ASEAN Hub RTA web, including an ASEAN+China, an ASEAN+Japan and an ASEAN+Korea FTA (hub-and-spoke type of overlapping RTA strategy); 6 (iii) the Northeast Asian three countries will form their own separate RTA competing against ASEAN, that is, the AFTA versus a China-Japan-Korea FTA (duplicating or competing RTA strategy); 7 and (iv) ASEAN, as a whole, and the three Northeast Asian countries cooperate with each other to form an East Asian FTA, that is, ASEAN+3 RTA (expansionary RTA strategy). 8 In terms of our evaluation of the sustainability of East Asian RTAs, what is the most desirable RTA strategy among the four policy alternatives? To answer this, we should consider the interests of all the parties involved, individually and altogether. In this paper, we describe our quantitative examination of the sustainability of proposed East Asian RTAs with respect to the abovementioned three conditions: (i) country-specific gains; (ii) distribution of gains between members; and (iii) global welfare gains. More specifically, we quantitatively evaluate the likely effect of the proposed strategies on the East Asian economies with respect to the equivalent variation of welfare, real GDP, exports, imports and income terms of trade by applying a multi-country and a multi-sector CGE model. 9 The CGE model analysis has the advantage of measuring the welfare effect directly and of comparing the possible outcomes of different scenarios while maintaining logical consistency even though the complicated ex-ante simulation methodology sometimes misspecifies the model economy. The present paper is organized as follows. Section II provides a brief discussion of the main characteristics of East Asian RTAs and of the debated issues regarding proliferating RTAs in East Asia. Section III introduces the CGE model adopted, the data used, and some ex-ante scenarios. Section IV quantitatively measures the effects of the proposed East Asian RTA strategies and evaluates the sustainability of the RTAs. Section V presents concluding remarks with policy implications. II. Regional Trade Agreements in East Asia II.1 Main characteristics of East Asian regional trade agreements Both intra-regional and inter-regional trade agreements are proliferating in East Asia, as shown in Table 1. As briefly described in Park and Park (2008), 6. For the general concept of the hub-and-spoke RTA, see Lloyd (2002), Umemoto (2003) and Baldwin (2004). 7. If there is a first mover advantage, as suggested in Freund (2000), forming a new RTA will be preferable to joining an existing RTA. 8. See Baldwin (1993) for the domino effect of regionalism. 9. For East Asian RTAs with CGE models, see McKibbin (1998), Scollay and Gilbert (2001), Urata and Kiyota (2003), McKibbin et al. (2004), Sulamaa and Widgrén (2005), Zhai (2006), Park (2006), Kawai and Wignaraja (2007, 2008) and Lee and van der Mensbrugghe (2007).

4 Table 1 Major regional trade agreements including countries in East Asia as of September 2008 Implemented (year into force) Signed (year of signing) Under negotiation Under consideration Bilateral and intra-regional China Hong Kong (2004) China Pakistan (2006) China Singapore China India China Macao (2004) Japan Philippines (2006) Japan Korea China Korea Japan Malaysia (2006) Thailand India (2004) Japan India China Thailand Japan Thailand (2007) Japan Vietnam Japan Taiwan Japan Indonesia (2008) Korea India Singapore Bahrain Japan Brunei (2008) Singapore Kuwait Singapore Sri Lanka Singapore Japan (2002) Singapore Pakistan Singapore UAE Singapore India (2005) Singapore Qatar Thailand Pakistan Singapore Korea (2006) Thailand India Bilateral and inter-regional China Chile (2006) China New Zealand (2008) China Australia China Island Japan Mexico (2005) Korea US (2007) China Peru Korea Australia Japan Chile (2007) Singapore Peru (2008) Japan Australia Indonesia Australia Korea Chile (2002) Thailand Peru (2005) Japan Canada Singapore Morocco Singapore Australia (2003) Japan Swiss Singapore Egypt Singapore Jordan (2005) Korea Canada Thailand Chile Singapore New Zealand (2001) Korea Mexico Singapore US (2004) Singapore Canada Singapore Panama (2006) Singapore Mexico Thailand Australia (2006) Thailand US Thailand New Zealand (2005) Malaysia Australia (2005) ASIAN ECONOMIC JOURNAL 172

5 Plurilateral and intra-regional AFTA (1992) ASEAN Japan (2008) ASEAN India ASEAN+3 (or +6) ASEAN China (2005) China GCC ASEAN Taiwan ASEAN Korea (2007) Japan GCC China Japan Korea Singapore GCC Plurilateral and inter-regional Korea EFTA (2006) ASEAN CER ASEAN EFTA Singapore EFTA (2003) Korea EU ASEAN EU ASEAN US Korea MERCOSUR Singapore EU Thailand EFTA Notes: AFTA, ASEAN Free Trade Area; ASEAN+3 (or +6), ASEAN plus China, Japan and Korea (or India, Australia and New Zealand); CER, Closer Economic Relations between Australia and New Zealand; EFTA, European Free Trade Association; GCC, Gulf Cooperation Council; MERCUSOR, Southern Common Market. Source: Park and Park (2008). SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 173

6 ASIAN ECONOMIC JOURNAL 174 the RTAs that include countries in East Asia have some distinguishing characteristics. First, the trend of reducing or eliminating trade barriers between members is relatively new in East Asia. Most of the East Asian countries, especially countries in Northeast Asia, have been well-known to prefer nondiscriminatory multilateral liberalization efforts rather than discriminatory regional liberalization policies. However, after realizing the importance of regional economic cooperation as a result of the East Asian financial crisis in 1997, East Asian countries have changed their policy stance from favoring a global approach to favoring a regional approach. As in Table 1, among the 34 RTAs implemented or signed that include East Asian countries, 33 RTAs were implemented after the crisis. Only the AFTA was established prior to the crisis. Second, most of RTAs in East Asia have taken a form of bilateral negotiation similar to the worldwide trend of seeking a lower and easier negotiation cost even though the gains from freer trade are limited. Third, there has been no distinction between intra-regional and inter-regional partnerships. Recent innovations in information and communication technology have resulted in significantly reduced transaction costs and have made geographical distance relatively less important. Pre-RTA economic interdependence has been important in the consideration of the right partners to approach for the formation of RTA. Fourth, with respect to the partnership issue of RTA, most East Asian RTAs have taken the form of huband-spoke overlapping RTA, which could cause a spaghetti bowl phenomenon. 10 In particular, ASEAN, Singapore and Thailand have been very aggressive in pursuing leading roles in the formation of RTA. Fifth, there has been very slow progress in the expansionary path of RTA, which could trigger a domino effect of regionalism. II.2 Why are regional trade agreements proliferating in East Asia? Recognizing the necessity for regional economic cooperation for regional economic stability and revitalization of the regional economic dynamism post-east Asian financial crisis could be one of the most important market-driving forces in East Asia. The intra-regional trade share in ASEAN+3 has been steadily rising, increasing from percent in 1990, to 37.3 percent in 2000, 38.9 percent in 2005, and 38.3 percent in Furthermore, the strong incentives for a country to be RTA leaders make both individual Southeast Asian countries and ASEAN as a whole aggressively seek to initiate multiple negotiations for RTA. At the same time, the fear of being left behind in the worldwide movement toward regionalism has made most Northeast Asian countries jump on the wagon. 10. See Bhagwati et al. (1998) and Panagariya (1999) for the spaghetti bowl phenomenon caused by overlapping RTA. 11. See table 1 in Kawai (2007).

7 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 175 Disappointing outcomes after multilateral institutions efforts for global free trade, such as the stalled Doha Development Agenda negotiation under the WTO and the sluggish achievement of the Bogor Goals under APEC, have also pushed East Asia s pursuit of regional cooperation. Leadership competition between China and Japan is an important political factor behind the proliferation of East Asian regionalism. II.3 Whither East Asian regional trade agreements? Carefully analyzing the recent change in the regional trade pattern of East Asia, Urata (2006) finds an increasing trend of intra-regional trade, trade in the manufacturing sector, vertical intra-industry trade, and trade in manufacturing parts and components between countries in East Asia. Considering the recent changes, we may expect that: (i) the rising pre-rta intra-regional trade volume will cause a stronger trade creation effect; (ii) the increasing volume of trade in the manufacturing sector will improve economic efficiency through the formation of a more competitive regional market environment; (iii) the increasing vertical intra-industry trade will result in bigger short-term gains from economies of scale; and (iv) the resulting trade in manufacturing parts and components that is closely connected to the supply chain and higher productivity growth expected from an international division of labor will also enhance economic efficiency and bring about greater gains from regional free trade. In sum, the expected positive effects of the recent changes in the region will create more favorable conditions for the formation of RTAs in East Asia. Through estimation using a gravity regression analysis, Lee and Park (2005) and Lee and Shin (2006) support the facts observed in East Asia. They argue that most East Asian RTAs will create more intra-bloc trade, will not divert extra-bloc trade, and will lead to global free trade. However, there are some important impediments to consider. The currently proliferating East Asian RTAs have been initiated mostly by the private sector, which is oriented toward profit-seeking, unlike in Europe, where RTAs have generally been formed based on political and ideological harmonization. This makes the formation of an institutional framework for regional integration difficult in East Asia. In addition, the hub-and-spoke type of many overlapping RTAs in East Asia could result in the spaghetti bowl phenomenon of discriminatory trade blocs, which have the potential to inhibit global free trade. Park (2006) and Lee and van der Mensbrugghe (2007) quantitatively evaluate the effects of some proposed East Asian RTAs by applying a static and a dynamic CGE model analysis, respectively. Their findings strongly support the ASEAN+3 RTA as the best policy strategy for East Asian countries to take. In particular, Park (2006) proposes that East Asian RTAs should take expansionary paths to establish global free trade rather than competing to achieve the first mover advantage. Baldwin (2004) and Zhai (2006) also highlight the negative welfare effect expected from overlapping RTAs in East Asia. Kawai (2007) and Kawai and Wignaraja (2007) suggest that either an ASEAN+3 (the East Asian

8 ASIAN ECONOMIC JOURNAL 176 Summit countries) or an ASEAN+6 (including Australia, New Zealand and India) FTA would be economically desirable in East Asia and would maximize the positive gains from trade liberalization and minimize the negative noodle bowl effects of regionalism. 12 III. Computable General Equilibrium Model III.1 Model and data What will be the effect of the proposed East Asian RTAs on each of the East Asian countries considered in this paper: China, Japan, Korea and the ASEAN nations? Are there any sustainable RTAs? The answers to these questions can be found by assessing the macroeconomic aggregate effects of the proposed East Asian RTA strategies by applying a traditional static CGE model simulation technique. We have adopted a trade-linked multi-sector and multi-country CGE model to measure the impact of East Asian regional economic integration efforts on welfare, real GDP, exports and income terms of trade. We have carefully selected those four aggregate variables to measure the effectiveness of proposed strategies according to type of RTA for each economy considered. The equivalent variations in welfare have been selected mainly for the consumption effect. Real GDP is used for the production effect. Exports have been chosen for the volume of trade effect. Income terms of trade are another important measure of welfare change. 13 In addition, to support our findings, we report the effect on imports and bilateral trade patterns. The CGE model we describe in this section is the GTAP6inGAMS model developed by Rutherford (2005). 14 The model has three economic agents: producers, representative consumers (private and public) and trading partners. The GTAP6inGAMS model is a traditional static Arrow Debreu general equilibrium model in which the zero profit condition and market clearance define the equilibrium. The GTAP6inGAMS is a modified version of the GTAP model version 6 developed for GAMS users. Most of the model specifications are the same as the GTAP model. The differences between the GTAP model and GAMS version of the model are as follows. First, the GTAP model is based on a constant difference elasticity demand system, but the GAMS model uses Cobb Douglas preferences. Second, the GTAP model assumes that global capital is endogenously allocated by regional rates of return. However, for 12. They, however, propose to achieve the bigger trade blocs by utilizing ASEAN as the hub for the integration (e.g. the three sets of ASEAN+1 FTA), which is not desirable based on the empirical analysis in the present paper. 13. An income terms of a trade measure, the purchasing power of exports in terms of imports (the ratio of the value of exports to the price of imports), can be a better measure of income or welfare effect of price changes in international trade, especially for developing countries, relative to the net barter terms of trade. See Chacholiades (1990, pp ). 14. The explanation of the CGE model used in this paper is derived from Park (2006).

9 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 177 simplicity, the GTAP6inGAMS model exogenously fixes the global capital flows. The model described in the present paper uses a classification consisting of 7 sectors and 25 economies, as in Park (2006). 15 The model solution has been calibrated, with 2001 as the base year, using global trade, assistance and production data from the GTAP 6 Database. 16 The model has been implemented using the GAMS MPSGE. 17 The GTAP6inGAMS model is adopted because the CGE model is in line with the commonly used GTAP model and the solver, GAMS MPSGE, is simple and easy to handle. III.2 Scenarios As indicated by Lee et al. (2008) and Park (2006), the proliferating RTAs in East Asia will take any of the three paths: expansionary RTAs, where the membership of existing RTAs increase by attracting new members; duplicating (or competing) RTAs, where separate RTAs are created between nonmembers of existing RTAs and compete with existing RTAs; and overlapping RTAs, where some members are focusing on being RTA hubs, by forming multiple memberships with countries in the region. More specifically, the existing AFTA could be successfully expanded to a bigger trade bloc, such as an ASEAN+3 RTA. That is, ASEAN, as a whole, and the three Northeast Asian countries could cooperate with each other to form an East Asian FTA. In contrast to the optimistic cooperation scheme in East Asia, some RTAs looking for the first mover advantage, such as those between China, Japan and Korea, will be formed in the near future, and will compete with existing RTAs such as the AFTA. However, considering the recent regional economic environment in East Asia, the ASEAN+1 approach will build an ASEAN Hub RTA web in East Asia, including an ASEAN+China, an ASEAN+Japan, and an ASEAN+Korea RTA separately, which will have overlapped membership. To quantitatively measure the impacts of the proposed East Asian RTAs on welfare, output production and trade flows for each of the participating countries, members as a whole, nonmembers and the world economy, we empirically designed and tested four scenarios. For each of the scenarios, both import tariffs and export taxes between members were eliminated, but the trade 15. The seven sectors are: agricultural products, food products, extractive industry, light manufacturing, heavy manufacturing, technology-intensive manufacturing, and services. The 27 economies are: Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam, the rest of Southeast Asia, China, Japan, Korea, Hong Kong, Taiwan, Australia, Brazil, Canada, Chile, India, Mexico, New Zealand, Peru, Russia, the USA, the European Free Trade Association, the Western European countries, and the rest of the world. 16. The GTAP 6 Database is a global database representing the world economy for a given reference year (2001). For more detailed information, see Dimaranan (2006). 17. MPSGE (Mathematical Programming System for General Equilibrium analysis) is a subsystem within GAMS. See

10 ASIAN ECONOMIC JOURNAL 178 barriers between members and nonmembers were retained. 18 The scenarios we have examined are: AFTA: An FTA among the ASEAN countries as a reference (the being-left-alone RTA strategy) ASEAN Hub: Three separate FTAs, including an ASEAN China, an ASEAN Japan and an ASEAN Korea FTA, assuming that the AFTA is effective (the hub-and-spoke type of overlapping RTA strategy) AFTA versus [China-Japan-Korea]: Two separate FTAs including the AFTA and a China Japan Korea FTA (the duplicating or competing RTA strategy) [ASEAN+3]: An FTA among ASEAN, China, Japan, and Korea (the expansionary RTA strategy). For the base solution of the model economy, we ran the CGE model without changing its initial condition and derived general equilibrium values for each of the economies in the model. Next, we reestimated the model under different scenarios and recalculated the equilibrium values for each case. Then, we compared the different equilibrium values with the initial base solution in terms of percentage deviation from the base to evaluate the experimental impacts of each scenario on each country. 19 IV. Sustainable Regional Trade Agreements in East Asia: Scenario Analysis IV. 1 Sustainable regional trade agreements in East Asia Table 2 provides a comparative summary of regional economic effects of the proposed East Asian RTAs by type of RTA. The aggregate effect of the currently effective AFTA had no significant negative effects on the discriminatory liberalization of the Northeast Asian neighbors, but produced significant enough positive gains to ASEAN members. However, if ASEAN members decide to pursue the ASEAN Hub scenario, which includes three sets of ASEAN+1 FTA, it could raise ASEAN s gains from free trade. ASEAN s welfare and GDP gains could be raised to more than three times that of the AFTA. The negative effects on excluded neighbors could be problematic, although the neighboring countries 18. The trade barriers include both tariff and non-tariff barriers. For import tariffs, trade-weighted ad valorem tariffs include tariff rate quotas and the ad valorem equivalents of specific tariffs. The export taxes cover ordinary export subsidies, export tax equivalents of Agreement on Textiles and Clothing quotas, price undertakings and voluntary export restraints. The protection rates in service sectors are assumed to be zero in the GTAP Database. For more detailed information, visit As the referee indicated, the base year for existing RTA, such as the ASEAN-China FTA, should be 2004 or 2005 (right before the year into force in Table 1). However, similar to other hypothetical scenarios in the present paper, the complete elimination of trade barriers between ASEAN and China are assumed and simulated. Of course, we acknowledge this data problem as a limitation.

11 Existing RTA Table 2 Effects of the proposed East Asian RTAs on the participating economies (percentage deviation from the base) Welfare (EV) Real GDP Exports Imports Income terms of trade Bilateral trade ASEAN China Japan Korea World AFTA ASEAN China Japan Korea World Overlapping RTA (hub and spoke) Welfare (EV) Real GDP Exports Imports Income terms of trade Bilateral trade ASEAN China Japan Korea World ASEAN Hub ASEAN China Japan Korea World Duplicating (competing) RTA AFTA versus China Japan Korea Welfare (EV) Real GDP Exports Imports Income Terms of Trade Bilateral Trade ASEAN China Japan Korea World ASEAN China Japan Korea World Notes: AFTA, ASEAN Free Trade Area; EV, equivalent variation; RTA, regional trade agreements. SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 179

12 Table 2 (continued) Expansionary RTA Welfare (EV) Real GDP Exports Imports Income terms of trade Bilateral trade ASEAN China Japan Korea World ASEAN+3 ASEAN China Japan Korea World Global RTA Welfare (EV) Real GDP Exports Imports Income terms of trade Bilateral trade ASEAN China Japan Korea World FTAAP ASEAN China Japan Korea World Notes: The income terms of trade measures the purchasing power of exports in terms of imports. See footnote 13. AFTA, ASEAN Free Trade Area; EV, equivalent variation; RTA, regional trade agreements; FTAAP, free trade area of Asia Pacific. ASIAN ECONOMIC JOURNAL 180

13 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 181 could increase their exports because of the income effect from the additional GDP gains of ASEAN, with the increase in bilateral trade volume between ASEAN and each of the three Northeast Asian countries. In terms of the negative effects that could be expected from AFTA or the ASEAN Hub scenario, the Northeast Asian neighbors might decide to form their own regional protection strategy against ASEAN by developing a China Japan Korea FTA. The trade warfare between the two regions could be harmful to the less-developed ASEAN economy and would enormously benefit the Northeast Asian countries, especially the smallest country, like Korea. However, this duplicating RTA competition might not be beneficial to the world economy. It will cause much lower welfare gains to the world economy than those with the existing AFTA and ASEAN Hub scenario. However, if the neighboring countries in both Southeast and Northeast Asia cooperate with each other to form an East Asian trade bloc, the ASEAN+3 FTA, all the participating countries would benefit, although there would be a negative welfare effect on China. The negative welfare effect of all the four proposed East Asian RTAs on China is a very interesting result which is also highlighted by Zhai (2006). It can be explained by the heavy and increasing intra-regional dependence of imported parts and components to China as a world factory. In addition, East Asian RTAs reallocate resources from the manufacturing industry to the agricultural industry within China and it may deteriorate economic efficiency of the Chinese manufacturing sector resulting in the deterioration of welfare as Zhai (2006) mentioned. In terms of the trade effect including volumes measured by the growth of exports and imports, the income terms of trade, and bilateral trade relations, all the proposed East Asian RTAs have a positive effect on participating countries and the world economy as a whole. Figures 1, 2 and 3 compare the relative size (percentage deviation from the base) of the ex-ante simulation analysis figured in Table 2 by type of RTA (AFTA, ASEAN Hub, AFTA versus China, Japan and Korea, and ASEAN+3), by economy (ASEAN, China, Japan, Korea), and by measure (equivalent variation of welfare, real GDP, exports, and income terms of trade), respectively. More specifically, Figure 1 compares the aggregate effects of the four proposed East Asian RTAs on the four regional economies in terms of the four measures. The Figure 1 illustrates which economy is the biggest gainer from each different type of RTA. The ASEAN gains the most from the existing AFTA and an ASEAN Hub scenario. This finding explains why most of the nonmembers of RTAs fear being left alone. This fear motivates nonmembers to jump on the RTA band wagon. This finding explains why countries are competing to be a hub and making a very complicated overlapping RTA map. There is no distinguishing difference in the effects of an AFTA between nonmembers of the RTA but the effects of an ASEAN Hub RTA will cause a relatively better effect on China. The competing Northeast Asian RTA and the expansionary East Asian RTA will distribute relatively more favorable gains to Korea and China when

14 ASIAN ECONOMIC JOURNAL 182 Figure 1 Aggregate effects of East Asian regional trade agreements by type of regional trade agreement (% deviation from the base)

15 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 183 Figure 1 (continued)

16 ASIAN ECONOMIC JOURNAL 184 Figure 2 Aggregate effects of East Asian regional trade agreements by economy (% deviation from the base)

17 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 185 Figure 2 (continued)

18 ASIAN ECONOMIC JOURNAL 186 Figure 3 Aggregate effects of East Asian regional trade agreements by measure (% deviation from the base)

19 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 187 Figure 3 (continued)

20 ASIAN ECONOMIC JOURNAL 188 we measure the size of the rectangles. The ASEAN will benefit least of the competing and expansionary RTA strategies. Figure 2 illustrates Table 2 by highlighting which scenario is the best for each of the economies in East Asia in terms of the four measures. For the sake of the ASEAN, the ASEAN Hub RTA is the best and competing with the Northeast Asian neighbors is the worst scenario. For the three Northeast Asian countries, the ASEAN+3 RTA will be the most desirable RTA but it is not much better than the Northeast Asian RTA between the three countries competing against the AFTA. Both the AFTA and ASEAN Hub RTA will be the worst scenarios for the countries in Northeast Asia. Figure 3 illustrates the effect of the East Asian RTAs on the four measures representing each country s gains from free trade. In terms of the welfare effect, there is no Pareto-improving RTA among the four different scenarios possible in East Asia. Reallocating resources from an existing AFTA to any alternative trade bloc may hurt at least one economy in the region. It is mainly because of the strong substitution effect cased by the change in relative prices, especially large country like China. The case of income terms of trade shows the same pattern. However, in terms of the real GDP reflecting the strong income or growth effect relative to the substitution effect, the expansionary ASEAN+3 RTA can be a sustainable scenario where the shift from the AFTA to the bigger trade bloc can make all the participating economies better off. For export promotion raising trade volume, both the ASEAN Hub and the ASEAN+3 RTA can be counted as sustainable RTA strategies. More interestingly, if we expand the regional liberalization effort toward a global level including the Pacific Basin partners, that is, a Free Trade Area of the Asia-Pacific (FTAAP), the APEC RTA can be a more desirable policy to proposed East Asian RTAs for East Asian economies, especially considering the positive welfare gains to China. 20 However, the desirable APEC FTA for the East Asian economies has proven to be less attractive for the global economy than the ASEAN+3 FTA when we consider countries excluded from the FTA as shown in Table 3. Even though the positive effects on the world economy including both members and nonmembers are estimated to be higher than those of the proposed East Asian RTA strategies, the negative effects on nonmembers are much stronger. IV.2 East Asian regional trade agreements in a globalizing world Will the proposed East Asian RTAs be beneficial to the members as a whole and the world economy? If not, the proposed East Asian RTAs may not be effective and sustainable. As presented in Table 3, all the proposed East Asian RTAs raise 20. Our findings fit very well with some of the rules of thumb in Harrison et al. (2003). They argue that: (i) countries excluded from Preferential Trade Arrangement almost always lose; and (ii) that multilateral trade liberalization results in significantly larger gains to the world than exist with the current network of regional arrangements.

21 Table 3 Effects of the proposed East Asian regional trade agreements on regional and global economies (percentage deviation from the base) Existing RTA Welfare (EV) Real GDP Exports Imports Bilateral trade Members (ASEAN) Nonmembers World AFTA Members (ASEAN) Nonmembers World Overlapping RTA (hub and spoke) Welfare (EV) Real GDP Exports Imports Bilateral trade Members ASEAN CJK Nonmembers World ASEAN Hub Members ASEAN CJK Nonmembers World Duplicating (competing) RTA AFTA versus China Japan Korea Welfare (EV) Real GDP Exports Imports Bilateral trade Members ASEAN CJK Nonmembers World Members ASEAN CJK Nonmembers World SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 189

22 Expansionary RTA Welfare (EV) Real GDP Exports Imports Bilateral trade Members ASEAN CJK Nonmembers World ASEAN+3 Members ASEAN CJK Nonmembers World Global RTA Welfare (EV) Real GDP Table 3 (continued) Exports Imports Bilateral Trade Members Nonmembers World FTAAP Members Nonmembers World Notes: In order to calculate the percentage deviations of members, nonmembers, and world as a group, each individual country s (see footnote 15 in page 9) deviations are measured and added for the corresponding group. AFTA, ASEAN Free Trade Area; CJK, China, Japan and Korea; RTA, regional trade agreements; FTAAP, free trade area of Asia-Pacific. ASIAN ECONOMIC JOURNAL 190

23 SUSTAINABILITY OF REGIONAL TRADE AGREEMENTS 191 world welfare between a minimum of 0.21 percent in the case of the competing RTAs, including the AFTA and the China-Japan-Korea RTA, and a maximum of 0.98 percent in the case of the ASEAN Hub RTA. The GDP gains range from 0.02 percent for the AFTA to 0.36 percent for the ASEAN+3 RTA. The world trade volume also rises. The expansionary ASEAN+3 RTA can be evaluated as the best strategy for maximizing world output and trade. For the members welfare, real GDP, and trade as in Table 3, the expansionary ASEAN+3 RTA is also the best strategy for East Asian participants in terms of creating bigger gains in many aspects and more evenly distributed gains between the Southeast and Northeast Asian members. In summary, considering the effects of the ASEAN+3 RTA on members, nonmembers, and the world economy relative to other alternative strategies, the expansionary East Asian RTA ASEAN+3 FTA can be effective and sustainable because the effect on members is significantly positive enough and more equitably distributed, the effects on the world welfare is positive enough, and the negative effect on nonmembers is not very strong. In particular, the ASEAN+3 FTA improves members real GDP by 1.86 percent and hurts nonmembers real GDP by 0.01 ( ) percent compared to 1.45 percent and 0.01 ( ) percent, respectively, in the case of AFTA. V. Concluding Remarks In our analysis of effective and sustainable RTAs in East Asia, we quantitatively evaluated the likely effect of the proposed RTA strategies on East Asian economies with respect to the equivalent variation of welfare, real GDP, exports, imports and income terms of trade by applying a multi-country and multi-sector CGE model: (i) the AFTA (the being-left-alone strategy); (ii) an ASEAN Hub RTA (the hub-and-spoke type of overlapping RTA strategy); (iii) the AFTA versus a China Japan Korea RTA (the duplicating or competing RTA strategy); and (iv) an ASEAN+3 RTA (the expansionary RTA strategy). From the ex-ante simulation analysis testing for the sustainability of the proposed East Asian RTAs, and as reflected in Table 4, we found that both the duplicating and expansionary RTA strategies of forming the Northeast Asian RTA separately from the existing AFTA and the ASEAN+3 RTA, respectively, were desirable for both the East Asian economies and the world economy. Even though the ASEAN Hub strategy appears to be a better policy option for ASEAN and the world economy, it is not necessarily a desirable strategy for the neighboring countries in Northeast Asia. We also found that there was no Pareto-improving RTA among the four different scenarios possible in East Asia because reallocating resources from an existing AFTA to any alternative trade bloc would hurt at least one member economy in the region. This is mainly because of the strong substitution effect caused by the change in relative prices, particularly in a large country like China. However, in terms of the production effect and trade volume effect, the expansionary ASEAN+3

24 Table 4 The sustainability test for regional trade agreements in East Asia Conditions for the sustainability test AFTA ASEAN Hub AFTA versus China Japan Korea ASEAN+3 Individual member economy Members on average Nonmembers on average World economy on average ASEAN Consumption (EV of welfare) Production (real GDP) Volume of trade (exports and imports) Terms of trade (income TOT) China Consumption (EV of welfare) Production (real GDP) Volume of trade (exports and imports) Terms of trade (income TOT) Japan Consumption (EV of welfare) * + + Production (real GDP) + + Volume of trade (exports and imports) Terms of trade (income TOT) Korea Consumption (EV of welfare) Production (real GDP) Volume of trade (exports and imports) * Terms of trade (income TOT) Consumption (EV of welfare) Production (real GDP) Volume of trade (exports and imports) Consumption (EV of welfare) * * Production (real GDP) * * Volume of trade (exports and imports) * Consumption (EV of welfare) Production (real GDP) * Volume of trade (exports and imports) * Distribution of gains Overall evaluation between members NE NE E Notes: + (positive), ++ (significantly positive), +++ (strongly positive), * (insignificant), (negative) where 0.1% + < 2%; 2% ++ < 4%; 4% +++; 0.1% < * < 0.1%; 1% 0.1%. E, equitably distributed; NE, not equitably distributed. ASIAN ECONOMIC JOURNAL 192

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