Creating a Seamless Market in East Asia. Hank LIM

Transcription

1 Creating a Seamless Market in East Asia Hank LIM 1

2 Introduction Since the 1990s, the number of regional and bilateral free trade agreements (FTAs) has increased dramatically. It is an economic phenomenon that is happening in the Asia- Pacific region and other parts of the world. What are the underlying economic reasons for the emergence of regional and bilateral free trade agreements. What do they expect to gain from these FTAs? In the neo-classical economic theory, it has been established that multilateral free trade would maximise economic benefits and minimise costs in individual countries and globally at the same time. However, in reality even when the multilateral modality is functioning well, free trade has never been realised at the level of an individual country. Policy decisions on FTAs are made not only to pursue pure economic welfare but also to achieve other objectives according to domestic political and strategic preferences. Under these circumstances, the General Agreement on Tariffs and Trade (GATT) system has been working relatively well towards the purpose of achieving freer trade in the world. At the same time, the GATT and its successor, the World Trade Organization (WTO) allowed regional and bilateral trade arrangements to be formed with some conditions under Article XXIV and Article V and such other provisions as an exception to its basic principles of multilateralism and non-discrimination. Promoters of free trade agreements argue that the momentum of trade liberalization has to be maintained in order to avoid back-sliding and disguised protectionism, especially in the developed economies. Even with the launching of the Doha Development Round, there are increased risks that the process of trade liberalization may be slow and procrastinated because of diverse conflicting interests among the WTO members. Moreover, these countries claim that FTA formation will contribute an important role in promoting or complementing multilateral liberalization. They argue that FTA can make global liberalization easier as they allow countries to open 2

3 their markets to a few countries before opening their markets multilaterally through WTO negotiations and exposing them to the full force of international competition. It is correct that regional and bilateral FTAs eliminate trade barriers between the contracting parties. However, there is no assurance that and intricate web of FTAs necessarily promotes smooth economic transactions among the countries inside because FTAs are discriminatory in nature and the web would complicate tariff rates and rules applied to the same products. In recent FTAs, the web also complicates the rules on new areas such as trade in services, investment, competition policy, government procurement and migration. The creation of hubs and spokes would not resolve the problem as trade barriers will remain between spokes and the extent of each spoke s access to the hub market is likely to vary. These costs arising from FTAs through discrimination and complication may impede the opening up and liberalization of market. In addition, there is enough empirical evidence to suggest that countries increase outside (MFN) tariffs following the implementation of FTAs. In other words, the hubs and spokes system could make multilateral-based market liberalization more difficult to implement. Theoretically, it remains controversial whether regional and bilateral FTAs would lead to market liberalization as claimed by those countries that promoted regional and bilateral market liberalization. In the East Asian region, there has been a flurry of activities on regional and bilateral FTAs. First of all, ASEAN Free Trade Area (AFTA) is fully operative in January 2003 with respect to the original six ASEAN members with different dates of full implementation applicable to the four new ASEAN members of Cambodia, Myanmar, Laos and Vietnam (CMLV). Bilaterally, Singapore has initiated FTAs with New Zealand, the European Free Trade Area (EFTA), Japan, Australia and the United States and in continuing discussions and negotiations with its other major trading partners. What are the underlying economic imperatives for Singapore to pursue bilateral FTA relentlessly? Notwithstanding of the full operation of AFTA, the rate of trade growth between Singapore and its ASEAN trading partners has been less than previously expected. Partly this is due to regional economic environment in Southeast Asia after the Asian Financial 3

4 Crisis in 1997 and following a series of setbacks and crises. Following the 911 attacks on the World Trade Center in New York, Southeast Asia has been perceived as a major breeding ground and sanctuary for Muslim fanatics who are against market capitalism and Western influences. As a result, foreign direct investment (FDI) has been reduced significantly to China to take advantage of its booming economy. Partly because of rapid shifting of economic comparative advantage in favour of China and other emerging economies such as Eastern Europe. ASEAN is currently being challenged to response developing a number of FTAs with other countries and regions, and has already begun negotiations with China. At the same time, individual ASEAN economies are also pursuing bilateral agreements with a number of the same countries and regions. If these development progress in parallel and negotiations also in parallel in the absence of a common framework, there is a danger that ASEAN will end up with having a series of framework which are different and in the end could be inconsistent with each other and lead to negative implications. One such undesirable effect is higher costs of doing business and discriminatory trade occurring because of the spaghetti bowl effect of regulations. Another is that ASEAN does not become the hub and the framework is driven more by the non-asean partner and thus not maximising the potential benefits for ASEAN. Regional Economic Integration Since the Asian financial crisis, there has been growing positive sentiment towards formalising regional co-operation in East Asia, beginning with financial cooperation as part of the response to the crisis and more recently in the formation of bilateral and regional trade arrangements. The impetus varies between regional trade arrangement (RTA) but a number of motivating factors may be behind this trend. These factors include regional response to the aftermath of the Asian financial crisis, the China challenge and the slow progress in WTO and other regional agreements and co-operation schemes and as a response to widening and broadening economic integration in Europe and North America. This is indeed a departure from the previous strong sense stance against regionalism. In general there has been less progress on regional integration in 4

5 East Asia unlike the European Union (EU) and North America Free Trade Agreement (NAFTA). This could be the result of competition and antagonism between Japan and China and an absence of an overwhelming geopolitical challenge that helped post-war Europe to integrate. In the aftermath of the crisis, various proposals on East Asia regional co-operation have emerged starting with an East Asia wide free trade arrangement or closer partnership proposed in 2000 by East Asia Vision Group. However, none of the regionwide proposal has been successful. Instead what has happened is a number of proposals to achieve a RTA with ASEAN, with the ASEAN-China FTA initiative emerging as the most concrete and major undertaking. The agreement has a regional and bilateral component. At present it is restricted to tariffs on goods although negotiations in other areas as non- tariff barriers, services and investment will begin this year. Progress towards its realisation appears to be driven by the Chinese. This initiative is of major political and economic significance to both China and ASEAN. ASEAN has recently signed an agreement with Australia and New Zealand, the AFTA-CER Closer Economic Partnership (CEP). There is an agreement to start the process towards realising an ASEAN-Japan Closer Economic Partnership (AJCEP). During the October 2002 APEC Meeting, the US also proposed an Enterprise for ASEAN Initiative which have bilateral trade, investment and facilitation agreements (TIFA) as the basis. At the Phnom Penh ASEAN Summit, India is also proposing a free trade area with ASEAN. At the same time, a number of individual ASEAN economies are pursuing bilateral agreements with a number of these dialogue partners. From an economic point of view, several studies have shown that such initiatives will bring greater benefits to its members if it involves a larger grouping. In other words, the ASEAN + 3 forum should be more desirable than a series of ASEAN +1 arrangements. However, in practice it will be difficult to achieve this, given the very 5

6 diverse economic interests. In view of the above developments, the arrangements between ASEAN and individual economies in Northeast Asia (China. Japan and South Korea) or the ASEAN +1 format appear to be more feasible than an overall arrangement amongst all ASEAN +3 members. Yet, it also needs to be noted that a series of ASEAN +1 arrangements are more difficult to manage and could over stretch the limited resources of ASEAN. The trend seems to indicate that ASEAN has inadvertently taken the route of developing economic co-operation framework based on ASEAN plus one framework, combined with a series of bilateral arrangements. Therefore, it would appear that ASEAN had been placed in the position of being the "hub" for East Asia regional co-operation. This is a very strategic and potentially powerful position. ASEAN has gained this position perhaps by default as none of the Northeast Asian countries can gain such a leadership position and because it is not likely that for a foreseeable future a Northeast Asian regional structure can emerge. Structure and nature of Regional FTA Agreements The trend of FTA currently is for a broad or comprehensive agreement that can accommodate the interests of its members as well as the interests of the partner economy, and which is the building block towards the multilateral trading system. A broader framework with comprehensiveness is beneficial because it provides the necessary flexibility to ASEAN. Comprehensive Economic Partnership (CEP) agreements would include liberalisation elements (the traditional FTA components) as well as facilitation (standards, customs) and general cooperation elements (human resource and technology cooperation). Another important element to consider is how to introduce elements into the FTA that would make it a model in terms of ensuring that the preferential liberalisation is a building block towards the multilateral trading system. For example, in AFTA schedule of tariff reductions is reflected in their unilateral tariff reductions on an MFN (mostfavoured-nations) clause basis and with the ASEAN Investment Agreement that is to be 6

7 achieved by 2010, and providing a 2020 deadline for providing the same terms to non- ASEAN members. In addition, minimising the spaghetti bowl effect is also important to ensure that there is no trade diversion due to discriminatory. In the environment of possible overlapping FTA regional and bilateral agreements, it is necessary to avoid protracted negotiations. Therefore, it is important to attach time lines for both the negotiation process and the achievement of the FTAs. If the FTA is to be meaningful for capacity building and preferential access, then the timetable needs to be compared with multilateral and other regional commitments. In order to facilitate and accelerate the FTA process and achievement, it can start the process with facilitation and cooperation programmes. This would mean unbundling the Comprehensive Economic Partnership and start with non-controversial elements likely to reach agreement very quickly. Yet, at the same time pursuing trade liberalisation negotiations and possible early harvest in parallel. Within this broader framework, progress in the FTA element will be assessed as part of the overall development. In short, ASEAN can bring the separate arrangements with China, Japan CER, the US and India under a Comprehensive Economic Partnership framework. This will greatly reduce the problems and difficulties for ASEAN to manage its external relations and regional cooperation in East Asia. The ASEAN Economic Community (AEC) was proposed at the ASEAN Heads of Government Meeting in Phnom Penh in November The concept is based on the ASEAN Vision 2020 that, among other things, envisions a more economically integrated ASEAN. The AEC concept takes into account existing economic integration programmes such as the AFTA, the ASEAN Framework Agreement on Services (AFAS) and the ASEAN Investment Area (AIA). Viewed broadly, the AEC initiative is a logical step and a roadmap to an economically integrated ASEAN market. It is important to note that ASEAN Leaders have established an Initiative for ASEAN Integration (IAI) in November 2000 in which original more developed ASEAN members extended technical assistance to new members in human resource development, institutional and physical infrastructure. Without development assistance to Cambodia, Myanmar, Laos and 7

8 Vietnam (CMLV) as specified in IAI, further trade liberalization and other enhanced forms of FTA would be very much diluted and reduced its regional political, economic and social significance. Market liberalization in the region in which there exists diversity in stages of growth must take into account the provision of regional public goods such as development assistance to less developed members, best practices in good governance and institution-buildings. Without establishing those practices, sustainable development and viable market liberalisation in the region would be at risk. East Asian Community In 1997, the ASEAN+3 process was established to employ various measures geared towards the expanding and deepening cooperation between Northeast and Southeast Asia. Recognizing the growing regional interdependence and aware of the benefits and opportunities of greater cooperation, ASEAN+3 leaders adopted a Joint Statement on East Asian Cooperation in In its wake, the East Asia Vision Group (EAVG) and the East Asia Study Group (EASG) were set up to assess the viability of an East Asian Community and to provide recommendations. The vision towards developing an East Asian Community goes well beyond that of an FTA. In the proposed twenty two key recommendations by the EAVG, cooperation and integration of East Asian states spans six fields. These include: economic, financial, political/security, environmental/energy, social/cultural/educational and institutional cooperation. Of the 57 measures proposed by the EAVG, the EASG excluded 31. Annex: 1 provides a brief overview of the 26 accepted measures. In the field of economic cooperation, the EAVG suggested the formation of an East Asian Free Trade Area (EAFTA) to be achieved well ahead of the Bogor Goal of trade liberalisation set by APEC. The formation of an EAFTA would occur through the consolidation of all existing bilateral and sub-regional FTAs in the region. To oversee the development of the EAFTA, a ministerial committee would be established. 8

9 A rough framework was also established to roughly define the characteristics of the EAFTA. To begin with, it was proposed that the CMLV countries would be given preferential treatment and GSP status would be established for them. This is aspect is not difficult to achieve as the +3 countries have already given preferential status to these countries. Moreover, within AFTA, the CMLV are provided with later time schedules for the reduction and abolition of their tariffs. An East Asian Investment Information Network (EAIIN) was also proposed to facilitate intra-regional investment flows by providing comprehensive and up-to-date information on investment opportunities in the individual East Asian economies. The EEAIN would complement current information providing initiatives such as in ASEAN s ASEAN Investment Area (AIA), the ASEAN- Japan Center activities, etc. Moreover, it was proposed that the AIA be expanded and possibly evolve to become an East Asian Investment Area (EAIA). Subsequently, the EAVG also proposed that East Asian economies would assist and cooperate in four priority areas: infrastructure, IT, human resources development, and ASEAN regional economic integration. The last of the four priority areas is particularly interesting. The Declaration states its support for the ongoing efforts of ASEAN s economic integration through initiatives such as AFTA, AIA, and preferential import treatment for new member countries. Support for these areas along with the proposition to expand along the lines of the AIA and other ASEAN initiatives implies that AFTA is viewed as a model for the development of the EAFTA. Broadly speaking, if bilateral and ASEAN+1 initiatives especially, are compatible and develop in similar form to AFTA, consolidation will perhaps be more manageable. This is possible given the infancy of the ASEAN+1 agreements, such as the ASEAN-China Comprehensive Economic Cooperation (AC-CEC) and the ASEAN-Japan Comprehensive Economic Partnership (AJCEP) 1. In order to do this, however, East Asian states need to consider the establishment of an EAFTA as a long-term goal. 2 At this juncture in time, the notion of an East Asian Community is still in its embryonic stages. However, cooperation at the ASEAN+3 level has already begun to 1 Korea and ASEAN are currently also considering the possibility of an FTA 2 Final Report of the East Asia Study Group (2002) 9

10 take concrete shape. One effort currently underway is the Chiang Mai Initiative whose goal is to construct a regional financial mechanism geared at preventing a future financial crisis. This is a mechanism devised by the ASEAN+3 group to establish bilateral swap arrangements as a virtual safety 3. Although the first concrete measure have been established, the progression of a seam market in East Asia in the form of the EAFTA is still wrought with multitudinous obstacles and challenges. A Seamless Market in East Asia There are many aspects that make regional integration in East Asia complicated and difficult to achieve. The diverse economic levels, geopolitical issues, historical experiences, cultures social norms and environmental issues create a complicated underlying, patchwork of regional infrastructure that belies the apparently dynamic trading system in the region and makes the concept, seamless daunting and unachievable. On the other hand, within East Asia itself, many companies operate across national borders and the trend towards intra-industry trade (IIT) or regional production networks is a fast increasing phenomenon making a case for regional integration much more tenable. Table 1 shows that that the overall IIT generally strengthened for most economies in the region. 3 Please refer below under the heading Financial Cooperation for an expansion on the CMI. 10

11 Intra-industry trade consequently fuels intra-regional trade because IIT produces gains from international trade, over and above those of comparative advantage alone as it allows countries to take advantage of larger markets 4. Moreover, IIT can also simultaneously decrease the number of similar goods produced within a country while increasing the variety of goods available to consumers. By specializing in fewer products, a country can achieve greater economies of scale, usually with higher productivity and lower costs. This implies greater complementarity within the region. This would be more effectively facilitated by increased regional trade liberalisation and facilitation. Yet, the definition of a seamless market for the new age regionalism in East Asia is complicated. It no longer merely consists of the absence of traditional tariff and non-tariff barriers between countries in an agreement. A seamless East Asian market through the process of regionalism would to begin with, remove virtually all barriers and other forms of discrimination between member countries, covering virtually all trade based on rules of general application rather than sector specific outcome-oriented commitments, and have terms of access for non-members that are at least not worse than prior to the 4 Ng & Yeats (2003) 11

12 regional agreement 5. However, in order for the benefits to be fully harnessed, countries must undertake both unilateral and collaborative efforts to propel the region towards deep integration. It should be a New Age agreement incorporating a broad scope of measures and reforms rather than a traditional one. The road to a seamless market in the region requires an array of efforts including liberalisation, facilitation, structural reform, innovation and regional cooperation in a variety of areas. East Asian economies must undertake many more steps before it can truly be called a seamless regional market. Concerted efforts are required to suggest best practices or encourage the implementation of minimum standards. This also increases the opportunity for greater FDI into the region with fewer procedural costs to be incurred. East Asian regionalism should be promoted in the form of open regionalism to complement regional trade and investment flows. Moreover, in order to move forward, needs a comprehensive framework agreement like JSEPA or ASEAN-China FTA proposal to enable joint implementation by all members and ability to make long-term policy goals. AFTA already appears to be the model of development as implied by the EASG report. However, it is still necessary to promote East Asian Regionalism in parallel to bilateral and sub-regional approaches if future consolidation is to occur. This requires governments to have comprehensive and transparent reporting of information on consultation processes in order to make the smaller agreements consistent with East Asian Regionalism 6. Liberalisation, facilitation and structural reform As economic liberalisation in the various areas of trade, investment and services goes, few would deny that the ideal process to greater development, greater gains and greater welfare lies in the process of multilateral liberalisation. Of course while such ideals should still be pursued, there are myriad difficulties that abound with such a pursuit. In the course of such difficulties, although not solely because of them, East Asian countries have in recent years pushed forward towards a flurry of bilateral and regional trade agreements and have come to the negotiating table in recognition that difficult 5 Low (2001) 6 Yamazawa (2002) 12

13 restructuring may be necessary, both for greater gains as well as fewer losses from being left behind. Moreover, East Asian countries have taken care to ensure that their new agreements are consistent with the provisions of the WTO 7. Yet there is no denying that regional efforts themselves come with their own host of problems. Although new preferential trade agreements (PTA) have been largely consistent with WTO provisions, there has also been a tendency to take advantage of the ambiguities that allow countries to avoid liberalizing sensitive areas 8. Yet due to the export-oriented and pro-fdi development process that East Asian countries have embarked on, and taking into consideration China s considerable restructuring and lowering of tariff barriers after its WTO accession, most East Asian economies have for the most part, with the exception of sensitive products, unilaterally lowered tariff barriers across the board. A crucial point to consider is whether the series of PTAs that are being signed and negotiated can act as stepping stones to a greater East Asian-wide agreement and ultimately remain open to the rest of the world. JSEPA, for example, is an innovative way of accommodating Japan s politically sensitive agricultural sector. The agreement was to simply agree to the existing WTO commitments in this area while promoting other areas such as services liberalisation 9. In this instance, although JSEPA was crafted with the intention of paving the way for other regional and sub-regional trade agreements, its exclusion of agriculture, a crucial sector to many of the poorer economies in the region, makes it difficult to adopt. This is especially evident in the haltingly slow progress of negotiating agreements with countries such as Thailand and Philippines. Moreover, from a regional level, it is necessary to assess whether the varying agreements create a spaghetti bowl effect a pattern of intersecting and overlapping PTAs, involving multiple PTA membership by individual East Asian economies, in which the provisions of the individual agreements may often be inconsistent with one 7 Elek (2003) 8 Elek (2003) 9 Low (2003) 13

14 another 10. In order for bilateral and subregional PTAs to be building blocs, they should insofar as possible not be based on inconsistent and irreconcilable models that may inhibit convergence. Preferential Trade Agreements in East Asia Intra-regional trade and growth in East Asia is largely accrued to the flying geese pattern of regional development. In the late 80s and into the 90s, Japanese manufacturers made major investments in Southeast Asia and moved many of their production facilities to the region. This was the pattern of industrial development in the East Asian region and was the form of regionalisation for at least the past two decades. However, since the early 1990s, this pattern of development has slowed down significantly and become largely invalidated. To begin with, Japan s economy has been, for a decade or so, immersed in its own financial and economic problems. It has been trying unsuccessfully to restructure its own economy and recover from economic stagnation and declining asset values Subsequently, the rise of China, its rapid industrialisation and transformation, and its recent accession to the WTO has changed the dynamics of East Asian regionalisation and will continue to do so in the coming years. As a huge, continental economy with an enormous domestic market, China is already transforming the previous pattern of the flying geese industrial division of labour into an East Asian regional system consisting of inter-crossing and overlapping divisions of industrial location and sourcing in the region 11. It is within this regional climate that many East Asian countries have scurried to form a series of PTAs in attempts to revitalize their slow growth economies 12. Spaghetti-Bowl? The rising number of preferential trading agreements, either bilateral or regional, pose a risk to the development of a seamless market in East Asia. More in depth assessment as to whether the PTAs will create a spaghetti bowl effect is important. At this juncture, the newer agreements have many areas that have yet to be negotiated such as competition policy and whether negotiations will result in inconsistent measures has 10 Scollay (2003) 11 Lim, Yeo, Hwang & Chia (2003) 12 The exception is the ASEAN Free Trade Agreement (AFTA) which was formed in

15 yet to be fully determined. As it stands, an ASEAN-Japan FTA is likely to be modelled after JSEPA. The ACFTA has not yet been fully mapped out in many areas such as rules of origin and competition policy although negotiations on many areas have already begun. From the developments, however, one important point emerges. Although the differences in the PTAs may not be inconsistent with one another at this point in time, they clearly serve to create a complicated network of arrangements which can significantly slow the process of regional liberalisation and facilitation amongst a wider East Asian group. Rules of origin in particular are can prove to be a potential source of inconsistency. The increasing costs that result from the spaghetti bowl effect would undermine some of the benefits of trade liberalisation. ASEAN Free Trade Agreement (AFTA) In 1992, AFTA was formed with the objective of increasing reducing barriers between ASEAN members to become more economically competitive for FDI 13. In 1992, the Common Effective Preferential Tariff Scheme (CEPT) was signed to oversee tariff reductions between ASEAN countries. In 1995, the ASEAN Framework Agreement on Services (AFAS) was signed with the purpose of reducing barriers in services between the member states. In 1998, ASEAN members came together to establish the ASEAN Investment Area to encourage and promote investment into the ASEAN region through the adoption of regional investment strategies. The scheme aims to promote greater investment liberalisation, more efficient division of labour and industrial activities across the region, thereby creating opportunities for greater industrial productivity and cost competitiveness 14. In the area of tariff reductions, the six original signatories have reduced tariffs on all products listed in their inclusion list (IL) to 0-5 percent. Moreover, since 1 st January 2003, 99.55% of products in the 2003 IL of the ASEAN-6 have been reduced to the 0-5% tariff range. The remaining products with tariffs above 5% are those that have been transferred from the Sensitive List (SL) and General Exception List (GE) in The 13 Bowles (1997) 14 ASEAN Annual Report (2002-3) 15

16 ASEAN-6 have achieved significant results in tariff reductions between members since the CEPT Scheme began in The current average is 2.39% down from the 12.76% in In the case of the CMLV, the 0-5% tariff level is assigned the following schedules: Vietnam 2006, Lao PDR and Myanmar 2008, Cambodia The aim is to have all tariffs abolished by 2010 for the ASEAN-6 and 2015 for the CMLV with flexibility on sensitive products until In the area of trade facilitation, a wide range of programmes have also been adopted most notably in the reduction of non-tariff barriers, streamlining customs procedures and nomenclature, harmonising standards and mutual recognition arrangements 15. In 1997, the ASEAN Customs Vision 2020 was developed to provide a framework for customs development through simplification, transparency, efficiency and mutual assistance 16. In November 2000, the Initiative for ASEAN Integration was launched to sharpen the focus of collective efforts in the areas of infrastructure, human resource development, ICT, trade liberalisation and facilitation so as promote equitable development and alleviate poverty among the CMLV countries. 15 Nesadurai (2003) 16 Wilson et al. (2002) 16

17 Consequently, AFTA is also currently working towards the elimination of unnecessary and unjustifiable NTBs 17. A Task Force has also been established to work on improving and strengthening the CEPT Rules of Origin and its Operational Procedures. Japan-Singapore Economic Partnership Agreement Negotiations for the Agreement between Japan and the Republic of Singapore for a New-Age Economic Partnership (JSEPA) were launched in 22 Oct 2000 between the governments of Japan and the Republic of Singapore. This followed the positive recommendation by the Japan Singapore Joint Study Group, which had been tasked to study the proposed FTA. Substantive negotiations on key issues were concluded in October 2001 after 12 rounds and leaders of both countries signed the Japan-Singapore Economic Agreement for a New Age Partnership in on 13 January 2002 in Singapore. The agreement came into force on 30 November The agreement is very broad and includes liberalisation and facilitation in the following areas: Trade in goods, rules of origin, customs procedures, mutual recognition agreement, trade in services (including financial, courier and telecoms services), investment, movement of natural persons and government procurement. Moreover, the agreement also consists of partnership and cooperation in a wide range of areas including, customs procedures, paperless trading, intellectual property, competition policy, financial services, ICT, science and technology, human capital management and development, trade and investment promotion, development of small and medium enterprises, broadcasting and tourism. There are significant results from tariff elimination. For example, 77% of Japan s total tariff lines will be duty-free, which is a significant increase from its 34% level. The result is that 94% of Singapore s exports will enter Japan duty-free, up from its previous 84%. Moreover, Singapore will enjoy the benefit of 43% (3,851) additional duty-free products in comparison to non-members of the agreement. The potential savings from 17 ASEAN Annual Report (2002-3) 17

18 tariffs itself for Singapore will grow from S$60 million to S$330 million within 5 years of the agreement. Trade facilitation is also supposed to bring time and cost saving. Mutual Recognition, for example, ensures that both time and costs are not wasted through duplicate testing and certification procedures. Customs procedures will also undergo changes to a switch in the usage of ICT for clearance and the use of modern management tools, such as risk management, for cargo clearance processes 18. Perhaps one of the greatest gains may come from liberalization of the services sector. Japan has committed to liberalizing 86% of its services sector and Singapore has committed to 88.5%. This constitutes commitments greater than what either party has ever done in past agreements 19. The immediate problem with JSEPA is of course trade diversion. Singapore and Japan are newly industrialized and industrialized economies respectively. If trade is diverted from less developed economies in the region, this could have some impact on poverty, especially in neighbouring states. More importantly for the idea of greater regional cooperation initiatives is whether or not JSEPA can serve as a building bloc to an EAFTA. Firstly, of course, is the question of compatible and consistent policies with other PTAs in the region. There are some signs that inconsistencies have already developed 20. Secondly, is the question of whether JSEPA prepares Japan to accept wider liberalisation through lager trade blocs. If it does, then in view of developing an EAFTA, JSEPA would be a pragmatic first approach. On the one hand, Japan has been slow in negotiating other bilateral initiatives with other Southeast Asian countries such as Thailand and Philippines. Its sensitive agricultural sector is a deep thorn to the development of any trade arrangement that includes agricultural liberalisation. On the other hand, its step to develop an ASEAN- 18 Ng B.K. (2002) 19 Shum (2002) 20 Refer to section on Rules of Origin. 18

19 Japan Comprehensive Economic Partnership, within 10 years is a positive sign. Moreover, although for the large part, there were relatively few goods that Japan could not readily liberalise, it did eliminate tariffs in crucial manufacturing sectors such as petrochemicals and textiles, going beyond WTO requirements 21. Therefore it is still too early to tell whether JSEPA will be a benefit or an for the construction of an EAFTA. ASEAN-China Comprehensive Economic Cooperation (AC-CEC) In November 2000, Chinese Premier Zhu Rongji proposed the ASEAN-China cooperation and a Framework Agreement on the ASEAN China Comprehensive Economic Cooperation (AC-CEC) was signed in November The framework agreement (FA) for comprehensive economic cooperation is not in itself an FTA. Rather, it commits ASEAN and China both to start negotiations on an FTA to be established by 2010 for the ASEAN-6 and 2015 for the Cambodia, Myanmar, Laos and Vietnam (CMLV) group of ASEAN members with flexibility on sensitive commodities 22. The coverage includes trade in goods and services, investment liberalisation and facilitation and other areas of cooperation. An Early Harvest list of products was developed for early liberalisation so the benefits could be reaped even before the FTA is fully established. The FA states that China and ASEAN will begin tariff reductions in 2005 for products listed in the Normal Track. Products in the Sensitive Track would have the respective MFN rates reduced and eventually eliminated in accordance with the mutually agreed upon end rates and time schedule. The number of products in the Sensitive Track is also subject to a maximum ceiling. Subsequently, China has also offered the CMLV countries preferential treatment and has agreed to participate in the accelerated implementation of development cooperation arrangements in the Mekong Greater Sub-region and the ASEAN Growth Triangles. Moreover, China has also agreed to reduce its debt obligations and confirmed its co-financing for the Singapore-Kunming Railway Link 23. In the area of investment 21 Naoko (2002) 22 Chia (2003) 23 Chia (2003) 19

20 facilitation, some of the measures include but are not limited to the simplification of customs procedures and the development of mutual recognition arrangements. ASEAN-Japan Comprehensive Economic Partnership (AJCEP) In January 2002, Japan s Prime Minister Junichiro Koizumi proposed an Initiative for Japan-ASEAN Comprehensive Economic Partnership in order to strengthen broad ranging economic cooperation between ASEAN and Japan. This would also serve to complement other cooperative initiatives that were being pursued. A Joint Declaration was signed at the Japan-ASEAN Summit on 5 November The leaders decided that the implementation of measures for the realisation of the CEP, including elements of a possible FTA, should be completed within 10 years. A committee was established to develop a framework for the CEP. The Framework Agreement provides that in order to realize a CEP, a wide range of areas such as trade, investment, services should be covered in the form of liberalisation and facilitation measures. Moreover, it should incorporate elements for it to develop into an FTA while proceeding in the areas where implementation is possible. The aim is to complete the CEP within 10 years, taking into consideration the economic levels and resulting difficulties of sensitive sectors in each country 24. The Joint Declaration predicts an increase of about US$20.6 billion by 2020 for ASEAN exports to Japan and an increase of about US$20.22 billion for Japanese Exports to ASEAN. Trade Liberalisation: Is it still Important? Unlike the EU and even NAFTA, East Asia did not seek to promote intra-regional trade via the formation of customs unions, free trade areas and preferential trade agreements. In fact, the governments in East Asian economies usually opted for allowing market forces and the private sector to orientate trade rather than to work through 24 Aquino (2003) 20

21 regional agreements. The region has therefore largely embraced a trend of trade liberalisation through multilateral trade rounds and unilateral liberalisation assisted and encouraged by international organizations 25. This path has been largely successful and much of the reforms, due to their non-discriminatory nature, have largely led to trade creation rather than diversion in the region. Some analysts argue that East Asia would benefit more than any other region from global liberalisation and estimate the gains to be hundreds of billions of US dollars by Moreover, it is also argued that much of this liberalisation can be achieved through regional integration, largely due to the complementarity of production, imports and exports that stem from the region s diversity 26. However, the issue of trade liberalisation in East Asia requires clarification. To begin with, a large number of trade barriers across the board have already been lowered. 25 Agarwala & Prakesh (2002) 26 Krumm & Kharas (2003) 21

22 To the credit of the region, average tariff rates in most East Asian economies have fallen from their high levels of percent ( ) to 5-10 percent currently (Charts 2 & 3). As Agarwala & Prakesh argue, the easy gains from trade liberalisation have already largely been reaped. Generally speaking, this is true and removal of tariffs that are at the 5-10 percent level will not result in returns similar to past efforts of liberalisation. In spite of this, there is still a strong case to be made for trade liberalisation in East Asia and in particular through the medium of regional integration. A study performed by the World Bank 27 estimated that complete liberalisation of trade between 2005 and 2010 would yield a 2% income increase for East Asia. As numbers go, this is relatively small. However, such an estimate obscures the distribution of benefits across the different East Asian economies. In particular, the less developed economies that have relatively smaller domestic markets and are heavily dependent on regional export markets will have the biggest gains from trade. Moreover, although tariff reductions have occurred across many sectors, there is still a marked difference in the level of openness between sectors (Table 2). 27 World Bank (2001) 22

23 What is perhaps more significant are the areas in which trade liberalisation continues to take place. Currently, most of the barriers that still remain for trade in goods lie in the sensitive sectors of each economy. However, these areas can have significant effects on individual economies, especially the lesser developed countries in the region although there are some which can benefit the region as a whole. Therefore although the benefits of tariff reduction may not seem large when averaged across East Asian countries, the distributive effects of these benefits have a huge impact on less developed economies and poverty in particular. Sensitive Goods: Case for Agriculture Reduction in agricultural trade barriers is particularly important for reducing poverty in East Asia. Table 4.1 gives an estimate of the importance of agriculture for the livelihood of households in various East Asian developing economies. 23

24 Unfortunately, barriers in this area remain high especially in developed economies across the globe. Within East Asia itself, agriculture is a particularly sensitive sector for Japan as the farming sector has relatively high political clout. The range of market access barriers employed by countries consist mainly of three types. (1) Tariffs, (2) domestic support, and (3) export subsidies. In terms of benefit, the lowering of tariffs has a greatest welfare effect but the benefits of the other two cannot be underestimated either 28. Reducing barriers in this area is particularly beneficial if pursued by an East Asian FTA (EAFTA) as opposed to smaller initiatives. An EAFTA would raise the net agricultural exports of ASEAN and China. The effects on alleviating poverty in the region would therefore be significant. Of course, such policies would also reduce welfare in Japan and Korea. This will pose a significant problem to the ASEAN+3 process. 28 Bora (2003) 24

25 Yet in general, tariffs in particular can be effectively handled at the regional level within East Asia through PTAs. In order for East Asian integration to be successful, it is necessary for economies to deal with such sensitive sectors. Doing so will help to significantly decrease regional income disparity and allow poorer economies better means to deal with economic restructuring and trade facilitation. Moreover, it is important that the competitive areas in sensitive sectors are liberalized. Thus far, the tariff reductions for agriculture have largely been in non-competitive areas and hence gains from trade cannot be fully achieved. The issue of course lies in how to deal with sensitive sectors such as agriculture. According to GATT Article XXIV, countries are required to reduce barriers on substantially all trade. There has of course been large debate over the ambiguity of phrasing. The issue lies in whether the phrase should be interpreted as a quantitative issue (i.e. percentage of trade covered, or percentage of tariff lines) and if moreover, it allows for the exclusion of entire major sectors, such as agriculture. WTO members have failed to come to an agreement on this. 25

26 At the level of APEC, the guiding principles call for comprehensiveness and flexibility. Once again, these terms create ambiguities and contradictions for interpretation. On the one hand, comprehensiveness implies that all major sectors, including agriculture, should be included. Flexibility on the other hand implies that allowances should be made for sensitive areas 29. This can be achieved through developing broad and comprehensive inclusion lists with timetables such as in AFTA s CEPT Scheme. Another method would be through Early Harvest schemes such as what has been developed agreed upon for the establishment of an ASEAN-China FTA. Services Unlike liberalisation of goods, countries in East Asia are particularly resistant to the liberalizing service sectors although this trend is gradually changing. This is largely because with the exception of the developed economies in the region, most of the remaining East Asian countries lack a comparative advantage in this area 30. This in turn is largely due to the fact that many service sectors such as telecommunications, transportation and utilities are still dominated by inefficient state-owned enterprises or monopolistic private operators who usually have significant political clout. As a result, governments, recognizing the inability to compete, raise high barriers in many of these areas 31. Moreover, some countries view certain service sectors as areas pertaining to national security, such as labor movements. Such issues necessarily complicate matters. Services Liberalisation in ASEAN Services liberalisation in ASEAN came about after the 1995 ASEAN Bangkok Summit where ASEAN countries agreed to launch negotiations in seven service sectors: banking, tourism, air transportation, maritime transportation, telecommunications, construction and professional services. This was termed the ASEAN Framework Agreement of Services (AFAS). A positive list approach was used and members are required to place requests and offers on liberalizing their respective service sectors Scollay (2003) 30 The tourism industry and the movement of natural persons are perhaps the few exceptions to this trend. 31 Nikomborirak & Stephenson (2001) 32 Nikomborirak & Stephenson (2001) 26

27 Despite the agreement, AFAS has not been particularly successful and the actual commitments made are only marginally better than those made in GATS. Moreover, some commitments are in fact inferior to those under GATS, such as telecommunications. The market access barriers that are typically found in ASEAN countries, bearing in mind that many services are not traded, include investment restrictions (for example control of foreign equity share in domestic enterprises), type of commercial establishment allowed (branches, subsidiaries or joint ventures), scope of service and employment of foreign personnel. Such restrictions have resulted in inefficiency and competitiveness of ASEAN members services sector. What is perhaps most revealing is that even in areas where members are relatively competitive, high protectionist barriers still remain, such as Singapore and its maritime industry. Apart from ASEAN, Singapore s particular resistance to liberalisation in this industry is also evident in the various agreements: (1) Singapore-NZ, (2) JSEPA, and (3) USSFTA 33. Services Liberalisation in China The range of commitments for services liberalisation that China has agreed to in negotiating its WTO accession is perhaps the most thorough ever undertaken in the GATT 34. Many critical sectors such as telecommunications, logistics, and finance have been opened to competition and these industries will likely see an increase in efficiency as well as productivity with the transfer of technology and knowledge spillovers. It also provides greater opportunity for regional players. An important aspect of China s commitments is that they focus on market access and there is no discrimination between foreign and domestic suppliers. However, in the case of cross-border trade and in services consumed abroad, the number of sectors with guaranteed unrestricted access is smaller in comparison to other countries. Moreover, in establishment trade it is practically zero. These usually involve restrictions on ownership, business scope, or region. On the other hand, China has already made substantial progress in certain sectors such as logistics. In 33 Scollay (2003) 34 Mattoo (2002) 27

28 order for the full gains to be achieved in many of the already liberalized areas, China will have to deal with its regulatory reforms. Services Liberalisation in South Korea Since 1996, there has been significant services liberalisation in South Korea although there is wide variation in the degree of liberalisation across service sectors. Most notable are its construction sector which is 95% open to foreign participation 35. Another prominent area is telecommunications. Korea is the only country to have committed to liberalizing almost all telecommunication services sub-sectors 36. On the other hand, certain areas remain relatively closed such as education services, certain transport services, etc. The financial services sector has seen some opening up in the area of foreign participation via commercial presence. However, capital markets liberalisation is still slow due to fear of sudden and uncontrollable movements of capital. Services Liberalisation in Japan In Japan, although there have been a series of policy initiatives launched and aimed at increasing the productivity and international competitiveness of the services sector, suppliers of services are still considerably protected from foreign competition through internal regulations, state-ownership and the government s tolerance of anticompetitive practices 37. Financial services and professional services for example remain relatively closed although both areas are under review for liberalisation under the AJCEP. Benefits of Regional Services Liberalisation In spite of apparent resistance to services liberalisation in certain countries and sectors, there is a strong case to be made for services liberalisation in East Asia, particularly if pursued at a regional level with a wider grouping such as the ASEAN+3. To begin with, there is strong evidence pointing at large productivity gains associated with efficient services. Moreover, competitiveness in high-value, differentiated 35 APEC IAP Study Report Korea Lintjer (2002) 37 Hayes (2000) 28

29 agriculture and in manufacturing is dependent on efficient services 38. Yet as mentioned above, East Asian countries fear the removal of protectionist policies, especially in the area of services. Lowering barriers through regional trade agreements is a means to improve the efficiency of protected services sectors through regional exposure and hence reap the wider benefits in manufacturing and high-value agriculture. This will not only increase competition but will also allow for the exploitation of economies of scale and also induce knowledge spillovers. In the long run, through such gradual exposure, these firms can even become competitive enough to compete on the world market. However, it is more beneficial for countries to expose the services sector to a wider region-wide group such as ASEAN+3 as opposed to a bilateral or smaller group. This is not only due to the greater competition found in larger groups but is in large part due to the high sunk costs involved that are usually characteristic of the services industries 39. As Matoo and Fink argue, the prospect of a PTA prompts investment geared towards supplying the markets of partners. These investments have a lock-in effect and for small countries this implies reduced bargaining power in future negotiations. Moreover, once such investments are made, liberalisation on a wider scale (i.e. larger regional group or multilateral liberalisation) may become less attractive for a country than PTAs with a smaller group. Subsequently, in oligopolistic markets, a regional route to multilateral liberalisation may offer greater benefits than direct multilateral liberalisation because the initial privileged access provides a first-mover advantage and an opportunity to create region-wide distribution networks (a sunk cost) so as to limit future exports by outside firms. Thus, member nations earn higher profits in each others markets from the regional path to the multilateral path and are no worse off in third markets. The justification behind this is that the gains to members of the group are greater than the losses of excluded countries and thus total world welfare is still higher. 38 Krumm & Kharas (2003) 39 Matoo & Fink (2002) 29

30 Although it cannot be denied that multilateral liberalisation is the optimal means of achieving efficiency, a wide regional arrangement can allow for greater policy space. This is because it takes into consideration the diversity in the region as well as the sociopolitical and geopolitical issues that abound whilst still allowing for gains from liberalisation. More specifically, it allows smaller states greater bargaining power and a greater sense of security as well. This could potentially result in greater and more effective efforts to institute much needed reforms and policies. Finally, in order to effectively realize the gains from services liberalisation, it is necessary for countries to institute reforms with broad development objectives in mind such as effective regulation in the event of market failure and pro-competitive regulation. Trade Facilitation Coverage of most of the newer PTAs extend beyond liberalisation to include aspects of trade facilitation as well. Even the older arrangements such as AFTA have included aspects of trade facilitation into their agreements. Trade facilitation can broadly be defined as an effort to pursue greater convenience in international trade through the simplification of economic activities such as the movement of goods and services across borders 40. Broadly speaking, this means the reduction and eventual elimination of nontariff barriers. More specifically, as defined in an APEC report 41, it is an attempt to lower the costs of administration, standardisation, technology, information, transaction, labour, communication, insurance, and financing, as well as reduce time costs related to those procedures. These time and cost reductions are addressed through issues such as customs procedures, standards and conformance, quarantine, government procurement and e-commerce. Some PTAs also include provisions on anti-dumping, safeguards, countervailing measures, labour and environmental standards. Trade facilitation also includes behind-the-border issues such as competition policy, intellectual property, and harmonisation of business and tax laws. Agreements that include a wide coverage of facilitation measures have come to be termed closer economic partnerships. 40 APEC (2002) 41 APEC (2002) 30

31 Benefits of Trade Facilitation for East Asia The benefits of trade facilitation are numerous. First, reducing or eliminating nontariff barriers through trade facilitation supplements the lowering of tariffs and results in an increase in the world trade volume. This is beneficial for foreign investors as well as economies in the region. It is also similar to a tariff reduction in that trade facilitation induces a fall in trade costs. It creates more trade and increases gains from freer and easier trade. Second, trade facilitation reduces the opportunity costs of international specialisation. This will lead to even greater intra-firm and intra-industry trade in East Asia through the vertical integration of multi-national corporations. This in turn will directly lead to an increase in trade of intermediary goods and services and, indirectly, lead to an increase in foreign investment, which will improve welfare and produce economic growth. In short, trade facilitation will increase outsourcing opportunities and expand the fragmentation of production activities across borders. Welfare will improve through this process. In particular, the expansion of outsourcing and transfer of technology across borders will assist in the industrialization of developing economies in the region. These effects will further complement the increasing trend towards regional production networks. Third, trade facilitation, such as harmonised customs procedures and standards of conformance, will improve regional governments efficiency in administration and may enhance transparency. On top of this, government revenue from customs procedure related activities may also increase. Harmonisation also has a significant effect on trade, especially in the area of manufactured goods 42. Fourth, trade facilitation will reduce the possibility of international disputes between developed and developing economies arising from differences in customs 42 Wilson et al. (2002) 31

32 procedures and operating systems. This will reduce the costs of resolving disputes and lead to an increase in world trade. Fifth, greater employment of e-commerce, such as the automation of transactions and the adoption of electronic payment systems, will generate greater gains through a reduction in transaction costs and enhanced competition in the world market. Sixth, trade facilitation will also help small and medium enterprises (SMEs), especially in developing countries, to become more competitive through regional exposure and subsequently become internationally competitive. This will in turn produce more gains from trade, promising economic growth, especially in developing economies. Seventh, welfare increase can also be achieved by developing economies through trade-related regulatory reforms which lead to improvements in health and safety related areas. Eighth, further economic development is expected from the facilitation of traderelated labour movements through improvements in working environments and the accumulation of human capital in developing economies. In an analysis performed by APEC, results indicated that the effects of trade facilitation are far superior and more practical that the effects of trade liberalisation. According to the most conservative figures in a survey performed by APEC, a 50% improvement in trade facilitation would result in an average trade cost reduction effect of between 2.9%, for industrialized and newly industrialized economies including Japan, Singapore, Hong Kong, China, Korea and Chinese Taipei, and in the case of industrializing economies including Malaysia, Indonesia, Philippines, Thailand and Vietnam, 3.5%. Moreover, the distribution of gains from trade liberalisation appears to follow the following trends. Firstly, relatively less developed East Asian economies that have relatively smaller domestic markets and are more dependent on regional export markets enjoy bigger gains from freer trade. Secondly, however, the distribution of the 32

33 beneficial effects of trade facilitation depends on the intra-regional trade share and trade dependency. The higher intra-regional trade share an economy has and the higher its trade dependency, the bigger its GDP growth gains from trade facilitation. Table 4 below indicates that the five largest regional exporters now account for 80% of intra-trade with China as the dominant supplier originating almost one-third of this exchange. The five smallest regional exporters (Brunei, Cambodia, Laos, Mongolia and Vietnam), on the other hand, have a combined trade share of under 2%. Moreover, the data suggests that the relative size differences have been increasing. Over the period from , the share of the current five largest countries in regional trade rose by almost 10%, mainly due to China and Korea 43. Although this implies that the less developed East Asian economies benefit less from trade liberalisation, there are still benefits to be gained. 43 Ng & Yeats (2003) 33

34 Consequently, most East Asian economies, including and especially the developing economies, have experienced an increased dependency on regional trade. Table 5 below indicates that on the whole, East Asian average intra-trade shares for both exports and imports increased significantly over the period. What is more significant is that even though poorer East Asian economies have a smaller intra-regional trade share, they have much higher trade dependency ratios than more developed economies in the region and therefore still make significant gains from trade facilitation. This supports the findings by APEC (stated at the beginning of the paragraph) that industrializing economies benefit the most. Moreover, seven out of fourteen East Asian countries now draw on regional suppliers for 50% or more of their total imports. Laos and Cambodia, 34

35 for example, currently source about 90% of their imports regionally and 60% of Laos exports go to other East Asian countries. Harmonisation Harmonisation policies are a vital aspect of facilitating the efficient exchange of goods, services and investment within the region. Harmonisation has three key benefits. 35

36 The first is lower transaction costs associated with doing business involving different policies across jurisdictions. Part of this cost reduction includes the reduced uncertainty about doing business across borders that apply different standards. The effects of such uncertainty tend to be especially prominent in areas that involve complicated projects, like cross border mergers and acquisitions, where administrative delays can be time consuming 44. The second benefit is an increased efficiency of markets due to improved allocation of resources which translates to gains for both producers and consumers. In essence, it involves government convergence on policies or requirements. Harmonisation is a complex issue in regional trade agreements because it does not only involve the harmonisation on a single aspect. Agreeing on the objectives such as efficient allocation of resources is probably the least problematic. There are also common principles (rule of law, transparency, non-discrimination, national treatment, etc.), common methods of analysis (e.g. market definition and analysis, identification and analysis of entry barriers), and common enforcement procedures 45. This leads to the third benefit of harmonisation especially at the regional level. Without cooperation in areas like competition policy and dispute settlement mechanisms, offenders become difficult to deal with when they lie outside a particular jurisdiction. A corollary of this is that a competition policy for example may not be effective if the administrative area is smaller than the encompassing market. In the case of a cartel, for example, a country linked through trade to another will have difficulty keeping prices down if the cartel raises prices in the other country. 46 Rules of Origin (ROOs) Establishing the origins of products is necessary for applying basic trade policy measures such as tariffs, quantitative restrictions, anti-dumping and countervailing duties and safeguard measures. It also important for requirements relating to origin marking, 44 Yusuf (2003) 45 Lloyd et al. (2001) 46 Levinson (1996), mentioned in Shahid (2003) 36

37 public procurement and statistical purposes 47. The argument behind establishing ROOs is to prevent trade deflection where non-members ship through member states to avoid duties. ROOs are very important to the creation of a seamless market in East Asia. The proliferation of bilateral and subregional trading agreements creates the possibility of a spaghetti bowl effect. If bilateral and subregional trade agreements are to serve as building blocs for a future EAFTA, it is necessary to ensure consistency of ROOs amongst the different agreements to avoid spaghetti bowl effect. It is important that ROOs be as neutral as possible and that product specific ROOs be avoided 48 to prevent complications for either accession or as a building bloc for an EAFTA. The general principles for determining ROOs are usually as follows: Only goods originating from parties of an FTA can benefit. Thus, it is important for ROOs to assess a product s national origin. In order to qualify as originating, the product must either be wholly obtained, or in the case of manufactured products, must have undergone substantial transformation. The principle behind the ROO is that in the case of manufactured goods, the country of origin is the final place where substantial transformation has occurred. There are 2 main criteria for determining substantial transformation. (1) Change in tariff classification (CTC), (2) value added rule (VA) which consists of the local content rule and the process rule. Each rule can be applied in isolation, in the alternative or in tandem. The increasing fragmentation in production processes through the evolution of intra-regional trade through regional production networks is creating greater complexities for the architecture of conventional ROOs. In newer PTAs, such as JSEPA, for example, conventional ROOs have evolved in the interpretation of the last country where a 47 Brenton 48 Simandjuntak (2003) 37

38 substantial transformation has taken place. This can occur in two ways. (1) Outward Processing (OP) and (2) integrated sourcing initiative. Outward processing was developed in recognition of OP as a unique production pattern in Singapore. It takes into consideration the fact that part of the manufacturing process may be outsourced to neighbouring countries. The result of this is that higher value-added production shifts to Singapore, while labour-intensive and low value processes are outsourced in the region The second variation is the ISI such as in the US-Singapore FTA where ISI applies to non-sensitive, globalised sectors, such as IT. Under this scheme, certain IT components and medical devices are not subject to ROOs, when they are shipped from non-members to members 51. Currently, in assessing the various PTAs within East Asia, there appears to be some inconsistencies and differences in the formulation of ROOs. For example, under AFTA, tariff concession under the CEPT Scheme is available for products with at least 40% ASEAN content by value. JSEPA on the other hand adopts the Change in Tariff Classification Criteria and partially adopts the Ad-Valorem Criteria as its ROOs. More specifically, this means that product specific rules of origin apply or otherwise, the originating content must be no less than 60% of the total value 52. This necessarily creates complications and makes harmonisation of ROOs difficult for region wide initiatives. One possibility for East Asian regionalism is to extend AFTA s ROOs to ASEAN+3 agreements as AFTA s current ROOs enhance integration in ASEAN. This would ensure that simplicity is maintained and that facilitation objectives do not become compromised. Given that other aspects of AFTA are being used as a model and even as a starting point, extending the use of AFTA as a model will simplify integration in many respects as the least developed countries in the region belong to the ASEAN group and reform would be the most difficult for them. 49 Low (2003) 50 This aspect has been crafted into all of Singapore s FTAs. 51 Low (2003) 52 ASEAN Secretariat Joint Report of AJCEPPEG ( 38

39 Dispute Settlement Mechanism The increasing pace of integration in East Asia has resulted in increased interaction and intensification of competition between businesses. However, as Low puts it, many East Asian economies have approached globalization without globalism 53 in that institutionalization in the region was not the medium of development and the modicum of international interaction. International relations were pursued in ad hoc fashion that entailed a pragmatic and strategic approach to ensure that individual states and former colonies remained in strong possession of their sovereignty. As such, cross-border disputes were not typically handled through a legalistic process but rather through a largely consultative method that typifies much of East Asia s approach to international issues. Moreover, the tendency to mix security with the economics of free trade 54 also necessarily complicates issues. The increased interaction would invariably lead to a greater number of trade disputes. Without a proper dispute settlement mechanism, there will be greater costs of doing business both in time and monetary value. There should be cooperation on how to equitably settle disputes and implement industrial cooperation in time for early settlement. Competition Policies Competition policy encompasses all government policies that promote competition in all areas such as international trade, FDI, privatization and intellectual property. Examples of competition policies are competition laws and deregulation. The primary concern of competition authorities is with competition within borders, such as the exemption of export cartels in OECD countries. Yet three points in particular make the regional harmonization of competition policies crucial. Firstly, competition is an important element for ensuring the efficiency of markets. For East Asia in particular, a commitment to competition is especially needed to help inefficient industries, mostly arising from past industrial policy, to become more efficient. On top of this, the shift towards knowledge-based industries by more developed countries in the region would be 53 Low (2001) 54 Low (2001) 39

40 better facilitated by increased competition. Consequently, in order for firms to survive, grow and attain profits, they need to become increasingly innovative. Without concerted efforts to ensure competition, firms will lack the initiative to innovate. Yet, the prevalence of state-owned firms in East Asia is not compatible with harmonisation of competition policy. Secondly, East Asian countries increased intra-regional interdependence arising primarily from regional production networks makes the importance of effective, harmonised competition policies increasingly relevant. The differences among the member countries in national competition policies, laws and law enforcement may give rise to inefficient allocation of resources and consumption in the region. The implies lower profits and gains from greater regionalization. Thirdly, there is also cross-border element to competition policy. Due to the fact that many of the domestic competitors are foreign-owned companies and business practices such as cartels, market allocation and mergers may extend beyond national borders, giving rise to concerns in more than one country over business conduct 55. As such, in order for regional trade flows to occur more efficiently and for the region to attract greater FDI, there is a need to harmonize competition promoting policies such as trade or investment liberalisation, deregulation, privatization and competition law. Unfortunately, harmonizing competition policies in East Asia will be difficult for several reasons. Firstly, the growing number of bilateral and sub-regional trade agreements complicates policy coordination. Unless countries enter into such new, smaller agreements with an eye to larger initiatives such as APEC or ASEAN+3, the variant and more localized policies will impede harmonization efforts. Secondly, weak response to APEC s competition policy initiatives indicates a lack of commitment in the region. Even within the smaller regional group of ASEAN, regional-wide competition policy or law has not been developed. Thirdly, historical circumstances and varied market systems have resulted in varied objectives as well as means of regulating and ensuring 55 Lloyd et al. (2001) 40

41 competition 56. Lloyd and Associates have categorized four general groups within East Asia according to degree of evolution of competition policy in each state. 1.Group One: Economies that view competition policy as necessary for effective cooperation of economies in the region Brunei, Chinese Taipei, Hong Kong, Malaysia, Singapore and Thailand. 2.Group Two: Economies which regard development of the internal market as the main objective of their competition policy China, Vietnam. 3.Group Three: Economies which in ensuring the will to promote competition in their markets, emphasize the protectionist aspect: Consumer protection or SME protection Indonesia, Philippines. 4.Group Four: Economies which perceive the improvement and strengthening of the enforcement of competition laws as their main objectives Japan, Korea. Even within a group, there are differences as to the means of implementing competition policy. Singapore, Hong Kong and Brunei for example, have not expressed any intention of introducing comprehensive competition laws. They view deregulation and market liberalisation as the ideal means of achieving efficient, open and competitive markets. Moreover, in some East Asian economies, competition policies that have been introduced are geared more towards ensuring that domestic firms can be internationally competitive as to ensuring that anti-competitive actions are minimized. Nonetheless, there is a general recognition amongst East Asian economies of the importance of the principle of competition. Moreover, there is a general convergence on the necessity of regulation. The fact that East Asia has reached this stage is mostly a result of increasing cross-border exchange and pragmatism. Financial and Monetary Cooperation 56 Lloyd et al. (2001) 41

42 Although justification for financial and monetary cooperation in East Asia is typically accrued to the Asian Financial Crisis and the ensuing weaknesses that were revealed, the reasons for greater cooperation and integration in this area is in fact much more complex and multifaceted. To begin with, the crisis occurred not only with speed but in magnitude. It is now widely accepted that the crisis was due to the high ratio of short-term private sector debt to international reserves. In particular, there was high volatility in short-term capital flows, especially bank debt, to and from international financial centres 57. The trend towards capital account liberalisation in the 1990s by Asian economies (Indonesia, Korea, Malaysia, Philippines and Thailand) meant that these economies were more open and vulnerable to international capital flow. Combined with the underlying weaknesses in the financial infrastructure of many Asian economies, weaknesses that were obscured and perhaps even ignored due to the Asian Miracle, it was a recipe for trouble. Although capital account liberalisation is an important aspect to facilitate greater investment in economies, there is growing acceptance that greater emphasis should be placed on active management of the capital flows, in particular short-term capital flows and portfolio investments. In the immediate aftermath, the resulting global initiatives that came about were not appropriate to the special circumstances of the region. The IMF s financial conditions, attached to its loans for example, were criticized as it emphasized the need for restructuring such as the break up of large industrial conglomerates and discouraging connected lending. The IMF was also insensitive to the role and importance that these arrangements in the Asian model of economic development 58. Hence, it frustrated many East Asian economies and served as a strong wake-up call to many of the countries in the region 59. The disappointment that ensued led to a sense of a need for a regional construct to deal with any such problems that might again arise. Understandably, the threads of similarity in many areas and the intricate geopolitical issues in the region will allow the 57 Dobson (2001) 58 Yusuf (2003) 59 Brouwer & Ito (2003) 42

43 neighbouring economies to have greater sensitivity in developing initiatives more suitable for the region. In line with this growing sense is the understanding that regional neighbours may share common problems, especially those that are at the same stage of development. By pooling effort and resources together, they could devise common initiatives and solutions to these problems. Recognizably, the economic diversity in the region is quite large, ranging from the developed economy of Japan to the NIEs such as Singapore and Korea, to the developing countries of Malaysia, Thailand, Philippines, Indonesia and China and finally to the least developed countries of Cambodia, Myanmar, Laos and Vietnam. It stands to question how such diversity can find commonality. However, many of these countries face similar problems such as undeveloped securities markets, bankdenominated financial markets and inadequate financial transparency 60. Moreover, geopolitical as well as economic reasons place the developed economies, such as Japan, in good and pragmatic positions, to provide assistance in many aspects of regional integration both to solidify its role in the region as well as to provide regional public goods that benefit all within the region. Moreover, external problems arising from individual countries financial policies may primarily have spillover effects on the region rather than the entire global community. This creates an added incentive and need for actors within the region to address such issues. In fact, left to their own devices, individual states often formulate policies based on their own domestic needs with little regard for the effects on neighbouring economies. This usually leads to beggar-thy-neighbour policies. Consequently, mutual cooperation can often generate larger benefits than if policies were pursued independently of one another 61. For example, a group approach towards developing conditionalities associated with the CMI can insure that there is consistency 60 Yusuf (2003) 61 Sakakibara & Yamakawa (2002) 43

44 across countries and can expand the range of initiatives upon which the funds can be used for 62. Transaction costs at the regional level will also be lower. More importantly, however, the changing trends in the region underlie a strong need for stronger financial systems. These trends include the increasing intra-regional trade through an increase in regional production networks and the adoption of information and communications technology (ICT). Regional production networks of both indigenous firms and multinationals cause intra-regional trade to expand as the value chain becomes segmented and production of parts is allocated to countries by comparative advantage. This sequence of outsourcing increases the openness and integration of economies in the region but also increases their susceptibility to external shocks. As for ICT, it is revolutionizing the way business is done it has globally been foremost and most quickly applied to the financial sector. This means that private capital flows occur much more quickly around the globe. As capital markets are perhaps the most significant means for which economic disturbances are transferred across borders, there is an increasing need to improve the safety and soundness of financial systems, especially in East Asia in order to accommodate and facilitate the positive trends that have been taking place. Although improving financial infrastructure is primarily a unilateral pursuit since countries need to address the varying weaknesses inherent in their own financial systems, individual government policies can be more consistently and effectively pursued through regional cooperation for the reasons listed above. Financial Cooperation in the Region Post Crisis In the period after the crisis, there was strong consensus towards developing regional financial cooperation initiatives. This began with the proposal for the Asian Monetary Fund (AMF) in 1997 by Japan. The AMF was to play a similar role to the IMF but was to be independent from it. The plan was abandoned due to the opposition from the US, IMF and China. It was argued that the AMF could potentially enhance the moral hazard problem and created a double standard between the two bodies (AMF and IMF). Politically, it was also a threat to US/IMF leadership in the region and with the huge 62 Presently, only about 10% of the resources available under CMI can be used without IMF programs. 44

45 economic dependence that the region had on the US, the proposal was quickly swept under the rug. In its place, another initiative called the Manila Framework Group (MFG) was established in November The primary purpose of the group was regional surveillance with the following initiatives: 1. A mechanism for regional surveillance as a complement to global surveillance by the IMF; 2. Economic and technical cooperation to strengthen financial systems and regulatory capacities; 3. Measures to strengthen the IMF s capacity to respond to financial crises; 4. A cooperative financing arrangement that would supplement IMF resources. However, although meetings for this group are still taking place, it is not apparent that it is taking strong steps forward nor is it particularly influential in the region. Rather, it has become a forum for the exchange of views and experiences 63. In October 1998, the New Miyazawa Initiative (NMI) was announced and implemented by Japan as a bilateral support mechanism to support Asian countries affected by the crisis. The support package consists of $30 billion, of which $15 billion is available to Asian countries in the medium to long term provided as either official development assistance (ODA) or untied loans. The remaining $15 billion is for short term capital needs during the process of implementing economic reforms. The objectives of the initiative are to support corporate debt restructuring, strengthen the social safety net, stimulate the economy and facilitate trade finance and assistance to SMEs. In the Second Stage, Japan pledged readiness to assist in mobilizing up to 2 trillion yen of domestic and foreign private-sector funds for Asia through assistance in fundraising in international and capital markets, as well as through assistance in investing Asian private- 63 Sakakibara & Yamakawa (2002) 45

46 sector enterprises via equity funds. Japan aims to utilize its abundant savings and promote active use of the Tokyo market 64. The NMI differs from the AMF in which the former focuses on bilateral initiative for recovery assistance as opposed to currency stabilization (latter). Also in October 1998, the ASEAN Surveillance Process was officially established. It was based on the principles of peer review for all member states and complementarity with global surveillance by the IMF. Such an arrangement may be an advantage as suggestions from within the group may be better received than from the IMF because such policy suggestions may also affect other members within the group 65. The objective was to strengthen cooperation through information exchanges, peer reviews and recommendations for action at both the regional and national levels. While the ASP continues to function, another initiative was established by the ASEAN+3 countries in May This was the Chiang Mai Initiative (CMI). It was developed with the purpose of being a regional financing arrangement that would supplement existing international institutions and is probably the most concrete and currently active regional financial arrangement that has emerged from the crisis. The CMI consists of 2 parts: I. An expansion of the ASEAN Swap Arrangement of 1977, and II. A network of bilateral swap (BSA) and repurchase arrangements among the ASEAN+3 members. The purpose of the BSA is to provide short-term, financial assistance in the form of swaps for balance-of-payments support and short-term liquidity support. It officially links the international reserves of all the 13 countries. The Repurchase Arrangements provide temporary foreign exchange liquidity through the sale and repurchase of appropriate securities to a country. Although the CMI swap arrangements occur bilaterally, it has a multilateral aspect within the ASEAN+3 grouping as creditor nations will coordinate how funds are to be 64 Sakakibara & Yamakawa (2002) 65 Soesastro (2000) 46

47 provided when one or more partners are in need of short-term liquidity. This implies that the greater the number of swaps, the more effective the arrangement. To date, twelve swaps have been successfully concluded and two are still under negotiation (Table 1). Beyond CMI Although the CMI is a positive first step towards financial cooperation in the region, there are institutional and political impediments that can threaten further expansion of the CMI. One of the most evident problems is that the ASEAN+3 countries have not properly devised a set of ultimate goals and long term objectives for the CMI arrangement. There is the question as to whether the CMI is going to be merely a regional liquidity support programme or a building bloc for future regional monetary and financial integration. As a liquidity support programme, the potential problem and cause for concern is whether the additional liquidity made available through the CMI is sufficient to stabilize exchange rates in the event of another crisis 66. In July 2002, the combined reserves of 66 Yusuf (2003) 47