Asian Trade and Investment: Patterns and Trends 1

1 Asian Trade and Investment: Patterns and Trends 1 Prema-chandra Athukorala Hal Hill Arndt Corden Division of Economics Research School of Pacific and Asian Studies Australian National University prema-chandra.athukorala@anu.edu.au hal.hill@anu.edu.au January 2008 Draft paper for presentation to the Workshop on Emerging Trends and Patterns of Trade and Investment in Asia, February 1-2, 2008, as part of the Ninth Global Development Network Conference, Brisbane. 1 The authors are grateful to Nobuaki Yamashita and Tran Quang Tian for excellent research assistance and to the Australian Centre for International Agricultural Research (ACIAR) for financial support.

2 Asian Trade and Investment: Patterns and Trends 1) Introduction Since the 1970s Asia, and particularly East Asia, has been the region with the fastest rates of economic growth, structural transformation and commercial integration in the world. Several countries have lifted themselves from dire poverty to OECD living standards, while several more are confidently moving along this trajectory. From very different starting points and at different rates, all countries have become more open and integrated into the global economy. Discriminatory trading arrangements were, fortunately, slower to develop in this region, and therefore this commercial integration has been overwhelmingly market driven. The region s trade and investment policies and patterns reflect both this diversity and these monumental changes. The aim of this paper is to examine and offer an analytical interpretation of these patterns, in the context of three general, conditioning factors: rapid growth and structural change, the host countries commercial policy environments, and institutional and technological factors governing global trade patterns. Inevitably, the rise of major and highly export-oriented economies imposes strains on the international trading system, and it potentially provokes a backlash from the established competitor nations. It may also lead to a misunderstanding of the processes and implications of these patterns, and hence the danger that inappropriate policy responses could harm the global public good of an open international trade and investment system, and choke off the historic process of poor countries growing out of poverty.

3 It is important to examine these trade and investment flows over a reasonably long period of time. The rates of growth and structural change have been rapid, and there have been successive waves of policy reform, some incremental, others big bang. The purpose of this paper is to document the process of global integration of countries in Asia with emphasis on emerging developments in world trade and cross-border direct investment and their implications for national development policy making and regional economic cooperation initiatives. We conduct the analysis on a decade-by-decade basis. Such a periodization fits reasonably conveniently with the timing of growth dynamics and the waves of reform. The country coverage is all the major international trading economies of East and South Asia. By 1970, only Japan and the four Asian NIEs, all resource-poor economies, had decisively and successfully adopted outward-looking development strategies. By 1980, the ASEAN Four had begun to embark down this path, with Malaysia a clear leader, followed by Thailand. By 1990, almost all of East Asia had enacted major trade and investment liberalizations. Led by Japan, the five more advanced Asian developing economies had begun to graduate quickly out of the earlier specialization in labourintensive manufactures, in the process opening up major new export opportunities for follower countries, especially those with open trade and investment regimes. China was now emerging as a major international actor. The changes were occurring more slowly in South Asia, with Sri Lanka by far the fastest liberalizer. Moreover, major non-asian developing country exporters had emerged, such as Brazil, Chile and Mexico in the Americas, and Mauritius in Africa. But the main focus of the world in the early 1990s was on the East Asian Miracle (World Bank 1993), comprising the seven mostly smallmedium economies of the region, and the attendant notion of the Pacific Century. By 2000, East Asia continued to be the world s major engine of export growth, with what turned out to be a relatively minor interruption, in aggregate, from the Asian economic crisis. China was emerging as the fastest growing exporter and a major hub for international production networks, overtaking the now slow-growth Japan in that role. India had begun to liberalize and grow rapidly for the first time in its independent history.

4 Its trade growth began to accelerate, albeit relatively slowly compared to China, and from a very low base. Bangladesh and Vietnam became significant exporters for the first time, as did some of the faster reformers in Eastern Europe. These trends continued during the first few years of the 21 st century. China s historically rapid transformation, underpinned by its accession to the WTO, reinforced its position as the region s and the world s principal export growth engine (Garnaut and Song, eds, 2006). The East Asian Miracle of the early 1990s had morphed into the Asian Miracle, and the world now had to dance with the two Asian giants. If the two decades from 1980 were increasingly known as the Pacific Century, the period since 2000 has been labeled the Asian Century The rules governing global trade architecture have been in disarray in recent years, and potentially damaging discriminatory trade arrangements have proliferated. However, for manufactures at least, there has been enough unilateral liberalization in enough countries to result in the margins of preference associated with these arrangements being relatively modest. In addition, various partial reforms in many countries, typically in the form of special economic or export processing zones, effectively enable firms to bypass these clumsy, politically driven arrangements. A key theme running though this paper is the implications of international fragmentation of production that is, the geographic separation of activities involved in producing a good (or service) across two or more countries for the debate on regional versus global integration of these countries. While the cross-border exchange of parts and components ( fragmentation trade ) is now a global phenomenon, there is evidence that it is far more important for economic growth and structural transformation in the East Asian economies than elsewhere. Intra/extra regional patterns of fragmentation trade and trade in related final goods ( final trade ) are unlikely to follow the same geographic patterns. Therefore, trade shares calculated using reported trade data can lead to misleading inferences, both concerning the relative importance of countries and regions and also their growth dynamics.

5 Among other issues canvassed, we also comment on the debate as to whether the emergence of China as the world s fastest growing industrial economy will crowd out other countries opportunities for integrating into the regional and global economy through fragmentation-based specialization. The paper is organized as follows. First, in section 2 we briefly develop a framework that guides the subsequent analysis. We argue that the key factors that shape countries participation in the global economy are openness to trade and investment, and the capacity to participate in international production and buying networks. For the latter, we take as proxies the quality of physical infrastructure, the presence of regulatory barriers at the border, and the extent of labour market distortions. The first two variables are sometimes summarized in various international comparisons of logistics quality, as in for example the number of days required for goods to be shipped from factory to final (export) destination. Next, in section 3 we examine general patterns of trade since 1970, for Asia as a whole, for the major sub-regions, and by country. This examination includes trade flows over time in aggregate, by major partners, and by major commodity groups. We draw attention to the phenomenon of network trade, that is the trade in parts and components under the umbrella of MNEs and international buying networks, and the implications this has for the analysis of trade flows. In section 4 we investigate investment patterns. These are less well documented than the trade flows, but the general picture of rising FDI interdependence is clear enough. We also draw attention to the comparative performance of Asian developing countries attracting and managing FDI, and comment on the alleged crowding out effects of China s rise to be the largest developing country recipient of FDI. Drawing these two sections together, section 5 focuses on the trade-investment nexus. The implication of these twin trade and investment liberalizations is that the FDI determinants and motivations undergo a major transformation, from what we term rent-

6 seeking to efficiency-seeking FDI. That is, the old tariff factory FDI gives way to cost-minimizing investments as part of globally integrated production networks. We also cast doubt on the assertion that it is possible to liberalize trade while maintaining a restrictive FDI regime. Section 6 summarizes our arguments and draws out some general inferences. 2) Host Country Policy Environments (Some data to follow for this section) This section develops an analytical framework that attempts to explain comparative export performance and composition. That is, the dependent variables, discussed in greater detail in the next section, are export growth rates, or global trade shares, and export composition, particularly the extent to which a country has become enmeshed in global production networks. Our framework identifies three broad sets of policy measures and outcomes. The first is openness, to international trade and investment. This is the most important, and an obvious pre-requisite for participation in the global economy. Trade openness is usually measured either as a revealed or policy variable. The former is typically total trade relative to GDP, while the latter is measured by average tariff rates, the dispersion in these averages, and the extent of NTBs. A more sophisticated measure, rarely available for cross-country purposes, is effective rates of protection. All these measures have their shortcomings. The caveats associated with the use of trade/gdp ratios are well-known: it is a comparison between a net and a gross concept, and a country s export figures are inflated when it engages in extensive parts and components trade. Another limitation for cross-country comparisons is that the ratios

7 need to be adjusted for size, in recognition of the fact that small countries by definition will trade more than larger ones. Trade policy barriers can be compared across countries when there is little reliance on NTBs. However, the presence of NTBs greatly complicates the analysis. Estimates of their coverage (relative to imports or production) may be misleading since they do not account for the intensity of the barriers or their distortionary effects. Tariff rates may also vary considerably, depending on whether applied or bound rates are used, or effective rates (ie, total customs revenue as a ratio of the total value of imports). Trade policy comparisons also need to allow for partial reforms. Most countries attempt to compensate exporters for duties paid on imported inputs. These typically take the form of duty exemptions or drawbacks, or the establishment of export processing zones. These compensating interventions are rarely incorporated in to international comparisons. Bearing these caveats in mind, we employ average tariffs, an estimate of NTB incidence and trade/gdp ratios. These enable us to assert with reasonable confidence whether an economy is broadly open. Table 1 shows average tariff rates since 1980 for 15 Asian economies, together with various comparators. Several key conclusions are evident. First, there is a universal trend towards lower tariffs, with the apparent exceptions Nepal and Vietnam to be discussed shortly. In some countries, the declines have been very large, more than halving since the 1980s in India, China, the Philippines, Thailand, Taiwan, Japan and Korea. Where these declines have clearly been accompanied by falling NTBs, as for example in the Philippines, the trade liberalizations have been very significant. In comparative terms, average Asian tariff levels are clustered around developing country norms, indicating that other regions have essentially caught up to Asia in this respect.

8 Second, within Asia, the East Asian economies are generally more open than those of South Asia. In 2004, India and Pakistan had the highest average tariffs, with the Indian figure being three times that of China. Within East Asia, there is no significant north/south divide. Hong Kong and Singapore have of course always had negligible protection. The others range from these lows up to 10%. Importantly, though not adequately recorded here, the East Asian economies were much quicker than those of South Asia (with the partial exception of Sri Lanka) to adopt partial reforms that enabled exporters to operate on an effective free-trade footing. Third, the figures for the late reformers need to be interpreted with caution. For example, the absence of any major change in Vietnam s average conceals the fact that the process of formal tariffication commenced only in the mid 1990s, and that the major trade policy reforms have (appropriately) entailed a shift from NTBs to tariffs (Athukorala, 2006d). In the case of Burma, the low tariffs mean little when the state interferes extensively in most aspects of commercial life and when there is extensive smuggling. Table 2 collects various estimates of effective protection for six East Asian economies. The data are not necessarily comparable across countries, and they obviously cannot claim to be comprehensive, but they do reinforce the above conclusion of major trade reforms. For the five Southeast Asian economies, average effective protection for the last year is generally about one-third of that of the first year, and they are converging to reasonably low figures. The decline in Vietnam has been very rapid. The reform process has continued since the last year of the data in all countries, albeit at a slower pace with the exception of Vietnam. Two additional general points on trade policy are relevant. First, it is important not to lose sight of historical dimensions. Japan, Korea and to a lesser extent Taiwan (though not Hong Kong and Singapore) based their development strategies on neomercantilist principles, involving a single-minded projection of national firms into foreign markets combined with import substitution in protected domestic markets. This

9 approach was feasible as long as these countries were relatively few in numbers and their market shares in other countries remained small. Moreover, the global geo-strategic environment was also supportive, as such a strategy was tolerated in this cold-war era by the then dominant USA. But such an approach is no longer feasible in a world of many and large developing country exporters, and in the absence of the earlier strategic imperatives. It is also incompatible with contemporary broad-based multilateral trade arrangements under WTO (see Lee and Roland-Host (1998), who develop this point). Second, historically Asia has not been enthusiastic towards preferential trading agreements (PTAs). Until recently, the only functioning PTA in the region was the ASEAN Free Trade Agreement, and its predecessors. The latter was in any case mild in its impacts, owing to relatively liberal rules of origin, many of the concessions being multilateralized, and rapidly diminishing margins of preference in the face of unilateral liberalizations. However, in the 1990s, the advent of the European Union and the rise of regionalism in North America led to some rethinking in the region. More recently, the aggressive promotion of PTAs, particularly by the US, has begun to undermine this commitment to unilateral liberalization, with potentially damaging consequences. The proliferation of PTAs has now become arguably the major trade policy issue in the region. 2 Cross-country comparisons of openness to FDI are less amenable to quantification. As with the trade regime, there are revealed and policy indicators. The former refer to FDI inflows or stock, relative to GDP or GDFCF. The attraction of stock measures is that they reflect the accumulated history of foreign investors involvement in the economy. However, they do not enable turning points to be identified, when the policy regime has become more open. FDI flows may be lumpy or volatile, and therefore need to be averaged over several years. As to the denominator, it is generally preferable to use GDFC since it facilitates direct comparison with domestic investment magnitudes. 2 See Menon (2007), Plummer (2007) and Baldwin (2007) for discussion of these issues.

10 As we show below in Table 13, there are vast differences in revealed FDI openness, as indicated by the ratio of FDI to GDFCF since 1970. In the 1970s, only four Asian countries recorded a ratio above 5%: the three countries with very open FDI regimes, the two city states and Malaysia, together with Indonesia, the latter owing to its newly open-door policy combined with the resource boom of that decade. In aggregate over that period, Southeast Asia was the most open region, and South Asia by far the most restrictive. Little changed in the 1980s, with the top three destinations remaining the same, while the Philippines moved into fourth place. Inflows to China were growing, but still relatively small. India remained essentially off-limits to FDI. The 1990s marked a turning point, when flows increased and several countries liberalized. Significantly, these liberalizations survived the Asian economic crisis, although in Indonesia political turbulence deterred investors for half a decade. For the decade as a whole, the top three continued to be the largest recipients among the established destinations. But China suddenly became a very large recipient, averaging over 14% for the decade as a whole. The three latecomers in Indo China attracted extremely large volumes, in excess of 30% for the decade, reflecting both their sudden openness and also a lingering ambivalence towards their domestic capitalist classes. Inflows to India began to rise, but were tiny about 2% - compared to East norms. Its three largest neighbours attracted larger though still modest flows. Since 2000, these patterns have more or less continued: the two city states are still by far the largest recipients; Malaysia, Thailand and Vietnam are in the 10-20% range; China is around 9%; India has been rising steadily, though for the decade thus far is still only about half the China ratio; and some high figures have been recorded for traditionally small recipients such as Cambodia and Pakistan. In sum, FDI policy could be summed up as: (a) general, region-wide liberalization, with no significant case of backtracking; (b) East Asia in aggregate has been far more open that South Asia, and it still retains a clear edge; (c) Southeast Asia has generally more open than Northeast Asia, but with exceptions in both regions, and the differences are anyway narrowing.

11 There have been various attempts to quantify FDI policy openness. These are typically based on investor surveys or other subjective assessments of economic freedom. There are now also some more rigorous measures based on specific, measurable criteria. We refer to one of these, by Hill (2008), who constructed an index for xx countries based on the restrictions that applied to FDI with respect to repatriation of profits, maximum permitted ownership shares, and the number of sectors closed to foreign investors. (Expand) Finally, there are various general indicators of commercial policy openness, either in the form of international rankings or binary 0/1 estimates. The best known of these is the Sachs-Warner (1995) series. It has the attraction of clear analytical foundations, a long time series, and comprehensive coverage. However, it is a somewhat blunt characterization of policy regimes. An alternative, widely used data set is the index of economic freedom generated by the Heritage Foundation. This encompasses a set of factors, 50 in total, relating to trade, product and factor market restrictions, together with the legal and institutional foundations that support economic freedom. Table 3 shows the Asian country rankings for 16 economies and four years over the period 1995-05. Comparative rankings over time need to allow for the expanded country coverage over this interval. Within Asia, the data again confirm the superiority of East Asia over South Asia, with the four Asian NIEs together with Malaysia and Thailand consistently ranked the highest; the two city-states are the highest in the world in all four surveys. China is always ahead of India, although the margin is not great and both are always in the bottom half of the rankings. The differences between Northeast and Southeast Asia are again not significant. One general observation is that, with the exception of the city-states, most Asian countries have slipped in their rankings, even allowing for the expanded country coverage. Is this of concern? The changes reflect at least two factors. First, there is the emergence of fast-reformers elsewhere, particularly among the former communist

12 economies of the old Soviet empire. Second, the pace of reform in East Asia over the past decade has been slower, especially among the three Southeast Asian crisis-affected economies, Indonesia, Malaysia and Thailand, the relative rankings of which have declined the most. Nevertheless, this ranking exercise is at best indicative, and it also reflects the development paradigms of the US institution preparing the data. Communist states such as Vietnam fare extremely poorly, in spite of the sweeping reforms of the past two decades, and even when they are obviously commercially attractive to foreign investors. Malaysia has always ranked rather poorly in these exercises owing to the (negative) weight accorded to its long-running affirmative action program. China s consistently low ranking appears to be at odds with its many significant policy liberalizations. Moreover, these exercises do not take account of East Asia s early mover advantage, in which MNEs became deeply embedded in the region s economy well before other developing regions. The second set of policy indicators relates to the infrastructure, both hard and soft, required for open economies to successfully participate in international production networks. The hard infrastructure relates to the facilities that enable goods and services to be transferred quickly and at low cost across and within international boundaries. These typically include ports, airports, roads, telecommunications and utilities. The soft infrastructure refers principally to the regulatory barriers to trade flows, and includes the efficacy of customs services, the harmonization of standards and so on. Various logistics studies attempt to provide a consolidated estimate of the magnitude of these barriers, both in terms of time and cost. The third set of variables relate to labour markets and human capital. One approach would be to estimate efficiency wages across countries, that is, nominal wages, adjusted for productivity, in a common exchange rate. However, obtaining accurate estimates is not easy. An alternative is to include some measure of labour market distortion, to reflect the effects of intervention that result in wages not being set at market-clearing rates. A second measure includes a proxy for human capital quality, the most widely used of which is the Barro-Lee years of schooling data set. A range of

13 alternative measures could have been included, included age-specific enrolments, expenditure on education, and international examination results. But these measures are generally closely correlated. In the case of labour markets, it is important to note that their efficient operation underpinned East Asia s outward-oriented growth. Because wages were not artificially inflated, comparative advantage was created and sustained in labour-intensive manufacturing until a state of full employment was reached. Only then did real wages rise significantly, in almost all countries accompanied by significant, broad-based investments in human capital (Ranis 1993, Athukorala and Manning 1989). However, countries in South Asia, especially India, have so far failed to combine trade and investment liberalization with significant labour market reforms. It also needs to be noted that twin crises in Indonesia and the Philippines, involving both economic and political collapse, undermined labour market policy, pushing it away from the East Asian model and towards the Indian approach. (Data on these to follow) As is the case with any discussions of the policy framework, a number of other variables are obviously important and could have been included in this analysis. The most obvious is macroeconomic management, including exchange rate policy. It is very unlikely that an open economy can be maintained without reasonably good macro policy (Little et al, 1993 et al). Some Asian economies have experienced periods of macroeconomic instability, for example, Indonesia, the Philippines, and Vietnam. However, these have been short-lived, and have not derailed the general trend towards openness. For this reason, we do not believe it is necessary to include an indicator of macroeconomic management. For similar reasons, indicators relating to general policy stability, predictability and credibility, as well as institutional quality and property rights, are not included since they are arguably embodied in our revealed openness indicators. There are no systematic longitudinal measures that aggregate all these indicators into a summary ranking index. But a useful summary comparative point of reference is

14 provided by the World Economic Forum s Global Competitiveness Report. The GCR produces two competitiveness indices, one related to growth and influenced by the macroeconomic environment, institutions and technology; and the other, more micro in orientation, focused on business. The latter is broadly similar to the World Bank s annual Doing Business survey. The results for 2005 are presented in Table 4. While no great importance should be attached to the minutiae of individual rankings, the general picture is clear enough, and it also affirms East Asia s continuing superiority over South Asia, with mixed rankings again in the Northeast v/s Southeast Asia comparisons. That is, the four Asian NIEs plus Malaysia, Thailand and China are the top seven in both series. India and China are similar with respect to growth competitiveness, but as expected China leads on business competitiveness. 3) Trade Patterns Our coverage of trade flows commences in 1969/70, when developing country industrial exports first became highly topical, and by which time most but not all developing countries were reporting their trade statistics. We then report trade statistics decade by decade, with two-year averages to allow for annual fluctuations. For the purpose of analyzing overall trade trends and changes in commodity composition we combine the data reported under the revision 1 and 2 of the Standard International Trade Classification (SITC, Rev. 3) for the period from 1969/70 to 2005/6. 3 To analyze the growing importance of regional production networks in determining trade patterns, we rely on detailed (5-digit) data reported under SITC Rev. 3 for the period 1989 to 2006, by which time most (but not all) of the late-comer exporters are also included. In its original form (SITC, Rev. 1), the UN trade data reporting system did not provide for the separation of parts and components from final manufactured 3 Throughout this paper, data are presented for two-year averages to smooth out the impact of yearly fluctuations in trade.

15 goods. The version introduced in the late 1970s (SITC, Rev. 2), which was fully implemented by most countries only in the early 1980s, adopted a more detailed commodity classification that provided for the separation of parts and components within the machinery and transport sector (SITC 7). However, considerable overlap between some advanced-stage assembly activities and related final goods within the sector made it difficult to separate fragmentation-based trade from total trade (Ng and Yeats 2001). Revision 3, introduced in the mid-1980s, marked a significant improvement over Revision 2. In addition to redressing the issue of overlap within SITC 7, it provided for the separation of parts and components trade in the miscellaneous goods sector (SITC 8). These two sectors together accounted for around 70 per cent of total world manufacturing trade (defined as goods belonging to SITC 5 through 8 less SITC 68 (non-ferrous metals)) during the period under study. The data for total merchandise trade used here are net of oil and gas trade (SITC 3). Among the Asian countries covered in this study oil and gas account for a significant share of exports only in Malaysia and Indonesia. 4 In both countries there has been a dramatic shift in export composition of exports away from crude oil and non-oil primary products to manufacturing. As regards country coverage, Asia is defined here to encompass the economies of South and East Asia. East Asia includes Japan, and developing East Asia (DEA), which covers the newly industrialized economies (NIEs) in North Asia (South Korea, Taiwan and Hong Kong), China and members of the Association of Southeast Asian Nations 4 The following statistics reveal this declining trend: Share of oil and gas in merchandise exports (%) 1969/70 1979/80 1989/90 2005/06 Indonesia 24.5 58.8 40.0 25.7 Malaysia 3.8 45.0 17.2 11.0

16 (ASEAN). 5 Developing Asia (DA) refers to South and East Asia except Japan. Hong Kong and China are treated as one geographical entity. But data are reported separately for the two economies for comparative purposes. This is justified not only because Hong Kong was reverted back to Chinese sovereignty, but also because the two economies have increasingly been closely interlinked through trade and investment following China s market oriented reform initiated in the late 1970s (Fung 1998). The combined share of Asian countries in world non-oil exports recorded a threefold increase, from 11.1% to 33.4%, between 1969/70 and 2005/6 (Table 5). 6 The region accounted for over 40% of total increment in world exports over this period. East Asia dominated this impressive export growth story. Notwithstanding notable export expansion in recent years, South Asia still accounts for a mere 1.4% of total world trade, equivalent to less than 5% of Asia s total trade. Among the nine largest DEA economies only Hong Kong, Indonesia and the Philippines have smaller world trade shares than India, by far the dominant South Asian economy. In the 1970s and 1980s, Japan dominated the region s trade, accounting for over two-thirds of its exports and imports. The picture has changed dramatically over the past two decades, as DEA s share increased from 13.4% in 1989/90 to 25.1% in 2005/06. The rise of China has been the dominant factor behind this structural shift, but the other countries in the region have also increased their world market shares. Thus, on first inspection, there is no indication of China crowding out its neighbours. We return to this issue below. In the global context, Asia s market share gains have come predominantly at the expense of developed countries. The combined share of other developing countries (that is, all developing countries less Asian developing countries) has increased persistently, though of course at a slower rate than DEA. 5 For expositional convenience, the term Developing is retained, even though of course several East Asian economies now have OECD-level incomes. Note also that, as always in these exercises, although Singapore is geographically part of Southeast Asia, it arguably belongs to the four NIEs in some analytical sense. We have left it in Southeast Asia since it continues to be the region s trading hub. 6 Hereafter, we will use the terms total world exports/trade and total world non-oil exports/trade interchangeably and to mean the same thing. Trade and investment magnitudes throughout the paper are measured in current US dollars unless otherwise indicated.

17 Rapid export growth in Developing Asia (DA), mainly driven by the DEA group, has been underpinned by a pronounced shift in export structure away from primary commodities and toward manufactures (Tables 5 and 6). By 2005/06 manufactures accounted for 92% of total exports from Asia, up from 78.3% three decades ago. Given the nature of their resource endowments, Japan and the four Asian NIEs (Hong Kong, Taiwan, Korea, and Singapore) relied very heavily on manufacturing for export expansion from the very beginning. However, beginning in the 1970s, a notable shift towards manufacturing is observable across all countries, at varying speeds and intensity. Between 1979/80 and 2006/7 the share of manufacturing in total exports of developing Asian countries increased from 63.0% to 92.0%. The shares of ASEAN and South Asia respectively increased from 31.5% to 67.3% and 55.5% to 80.3% between these two time points. Among individual countries Indonesia, Vietnam, and Pakistan (and of course the very small late-comer Indo China economies) have a significantly lower share of manufactures in their exports, reflecting both their comparative advantage and their later adoption of export-oriented industrialization strategies. Asia s share in total world manufacturing exports increased from 19.5% in 1979/80 to 36.6% in 2005/6. This increase came entirely from the DEA economies, since the share of Japan fell sharply over this period (from 11.4% to 7.8%) and South Asia still accounted for a tiny share, around 1%, at the end of the period (Table 6, Figure 1). China s rise has been the key factor behind the rapid growth of manufacturing exports from developing Asia, but exports from Taiwan, Korea, and the ASEAN countries have also recorded impressive growth. Within manufacturing, machinery and transport equipment (SITC 7), the three sub-categories of information and communication technology products 7 have played a pivotal role in this structural shift. The share of Asia in world machinery and transport equipment exports increased from 11.9% in 1989/90 to 41.3% in 2005/06, with DEA accounting for over four-fifths of the increment. By 2005/06, over 67% of total world 7 Hereafter referred to as ICT, comprising the sum of office machinery (SITC 75), telecommunication and sound recording equipment (SITC 76), and electric machinery (SITC 77).

18 ICT exports originated from Asia, up from 49% in 1989/90. The share of machinery and transport equipment in the export structures of some of the more industrialized economies of East Asia is particularly high. By contrast, that for Indonesia, Vietnam and all of South Asian is much smaller (Table 7). Asia s share in the other main product categories has also increased over time, though at a slower rate. Of particular interest here is the notable increase in region s share in miscellaneous manufacturing. This mostly consists of standardized labour-intensive manufactured goods, in particular clothing and footwear. China has accounted for much of this increase but, in contrast to ICT exports, the geographic participation has been broader. A number of low-wage countries in Southeast and South Asia, including Indonesia, Vietnam, India, Sri Lanka, Bangladesh, and Cambodia (the latter included under Other ASEAN countries ) have all recorded impressive gains in market share. The information presented in Table 8 helps understand changes over time in the export ranking of Asian countries compared to other developing countries. To be discussed. There has been growing concentration of exports among the top ten countries over time. The share of the top 10 increased from 71.4% in 1969/70 to 84.2% in 2005/06. The rapid expansion of exports from the leading DEA countries has been the dominant cause of this increased concentration. The impressive increase in China s share in total developing country exports, from 8.6% in 1969/70 to 15% in 1989/90 and then to 38.5% in 2005/6, is particularly noteworthy. However, a close look at the table points to the fragility of the now-popular inference (Jomo 2007, Collier 2007), sometimes referred to as the new export pessimism, that East Asia s dominant position precludes other countries from success in export expansion. In particular, there have been notable changes in the relative position of many countries in their overall ranking and these shifts can be meaningfully related to effective domestic policy reform. Of particular note is that the relative position of India plummeted between 1969/70 and 1989/90 before recording a mild recovery following the policy reforms in the early 1990s. Malaysia and Thailand moved from the second and third

19 deciles respectively to the top ten by 1989/90, and then consolidated their positions in the next one-and-a-half decades, notwithstanding their severe economic crises in 1997-98. Bangladesh and Sri Lanka have moved from the bottom to middle ranks over the past two decades. Moreover, data for the lower deciles of exporters (lower than reported here) reveal the emergence, and in some cases rapid growth, of newcomers (defined as those with exports of at least ). This again runs counter to the arguments of some authors noted above that the East Asian early movers, and now China and India, are crowding out opportunities for latecomers This latter point is of the utmost importance and is central to our arguments concerning the openness of the international trading system. That is, even countries with highly unfavourable initial conditions have been able to achieve export success following reforms. It is worth recalling that Bangladesh had been written of as a basket case in the 1970s and 1980s, that Sri Lanka has experienced a prolonged and vicious insurgency for most of the period under analysis, and that the Indo China countries were cut off from the global economy for a decade or more and also experienced severe losses of human capital. Network Trade (Extend this paragraph): The fast growth of machinery trade has been driven by rapid growth of international fragmentation of production in world trade and the increasingly deep integration of East Asian countries into the global production networks that proliferated as a result of these two, more or less simultaneous developments (Athukorala 2006, Kimura 2006, some more references to be added). (First Singapore. From the late 1980s NIEs began to expand their assembly activities in low wage countries in the region (McKendrick et al). More recently China has become the global assembly centre. With the emergence of China as the world s global factory, parts and component exports from other countries in the region to China have begun to expand rapidly. China has become increasingly specialized in final assembly.

20 The best available indicator of the intensity of fragmentation-based specialization is the share of parts and components in total recorded trade in machinery and transport equipment. 8 These data are summarised in Table 9. The share of parts and components in total imports of this product category increased from 32.5% in 1989/90 to 63.4% in 2005/6, with the import share of the three ICT products recording a much faster growth. By contrast, final goods (that is, total exports minus parts and components) have continued to dominate exports. Over the past decade the share of final goods in total machinery exports has remained around 70%, with only minor year-to year changes. (Check these figures) The share of East Asia in world component trade increased from 34% in 1989/90 to 40% in 2005/6. This resulted from an increase in the share of DEA from 16.5% to 28.1%, which more than counterbalanced a sharp decline in the share of the one-time regional giant, Japan, from 17.8% to 11.3%. Within DEA, all countries covered in our data tabulations have recorded increases in world market shares, with the ASEAN countries exhibiting faster increases compared to the regional average. Interestingly, the significant increase in the relative importance of DEA in fragmentation trade has taken place against the backdrop of a notable decline in the shares of both NAFTA and EU. The dependence of the East Asian countries as a group on component trade is much higher compared to all other regions in the world. In 2005/6, components accounted for 34.7% of total machinery exports of these countries. Within East Asia, the ASEAN countries, in particular Malaysia, Philippine, Singapore and Thailand, stand out for their heavy dependence on product fragmentation for export dynamism. In 2005/6, components accounted for 58.4% of the total exports of the six ASEAN countries, up from 46.7% in 1989/90. 8 Henceforth, for the sake of brevity, we use the term components in place of parts and components and machinery in place of machinery and transport equipment.

21 A comparison of export and import data reported in Panels A and B in Table 9 points to an interesting development in ASEAN s participation in world machinery trade. The increase in the ASEAN share on the export side has been accompanied by a mild decline in the region s share on the import side. It seems that the region has become increasingly specialized in the production of components. This development reflects a sharp increase in the region s component exports to China. The rapid expansion of China s role in world trade has brought about a notable shift in the regional division of labour, with ASEAN countries playing an increasing role in producing parts and components for the rapidly growing final assembly activities in China. Direction of Trade We have noted in the previous discussion the importance of fragmentation-based trade for emerging economic interdependence within East Asia. We now examine the implications of this new form of international specialization for the relative importance of intra-regional versus global economic integration, and the way in which latecomers in the region are hooking into the growth process through global integration. These two issues are central to the contemporary debate on growth dynamism and the process of intraregional versus inter-regional economic integration in East Asia, There is a vast literature on what may be termed standard trade data analysis, that is, essentially based on the traditional notion of horizontal specialisation, in which trade is an exchange of goods that are produced from start to finish in just one country. This literature unequivocally points to a persistent increase in intra-regional trade in East Asia, whether or not Japan is included or not, from about the early 1980s. 9 This evidence figures prominently in the current regional debate concerning the establishment of regional trading arrangements covering some or all countries in East Asia. In particular, 9 See for example Kwan 2001; Drysdale and Garnaut 1997; Frankel and Wei 1997; Petri 1993, Lee and Roland-Holst 1989.

22 the proponents of the proposal to expand AFTA to encompass Japan, China and South Korea (the ASEAN+3 proposal), and more broadly towards an Asian Economic Community, often refer to deepening economic interdependence, as reflected in intraregional trade among these countries, as evidence of its likely success. Increasing trade integration is also cited as an indicator of the potential benefits of monetary integration in the region (Kwan 2001). However, the above discussion on the emerging patterns of intra-regional component trade casts doubts on the validity of these inferences. We have noted two important peculiarities of trade patterns in East Asia compared to global trade and trade patterns for the EU and NAFTA countries. First, component trade has played a much more important role in trade expansion in East Asia relative to the overall global experience and that of countries in other major regions. Second, trade in components accounts for a much larger share in intra-regional trade than it does in trade with the rest of the world. Given these two peculiarities, trade flow analysis based on reported trade data is bound to yield a misleading picture as to the relative importance of intra-regional trade relations (as against global trade) for growth in East Asia, and also ASEAN. This is because growth based on assembly activities depends on the demand for final goods, which in turn depends increasingly on extra-regional growth. Alternative estimates of intra-regional trade shares reported in Tables 10 and 11 help illustrate this argument. Table 10 provides data on inter-regional trade patterns estimated using data on total (reported) trade and trade in components. Intra-regional shares of net trade (that is, total trade minus components) are reported in Table 11. Trade patterns depicted by the unadjusted data affirm the received view that Asia, in particular East Asia, has become increasingly integrated through merchandise trade. (Add figures). However the picture shown by adjusted trade data are notably different. The two alternative estimates are vastly different for East Asia, particularly for

23 DEA and ASEAN. Both the level of trade in the two given years and the change over time in intra-regional trade shares are significantly lower for estimates based on final trade. For instance, the intra-regional share of total trade in DEA increased from 35.3% in 1989 to 49.4% in 2005/6. However, in terms of estimates based on final trade, the share increased from 31% to 36%. While the difference between intra-regional shares of final and total trade is observable for both exports and imports, the magnitude of the difference is much larger on the export side. In 2004 only 32% of final goods exported from developing Asia found markets within the region, compared to 50% in total exports. Moreover, for all East Asian countries Japan is a much smaller market than NAFTA or EU countries for final goods exports, accounting for less than 10%. It is also interesting to note that, unlike in the case of East Asia (or DEA and ASEAN), the estimated intraregional trade shares for NAFTA, EU and other regional groupings are remarkably resilient to whether component trade is included or excluded. While the difference between intra-regional shares in terms of unadjusted and adjusted data is observable for both exports and imports, the magnitude of the difference is much larger on the export side. For instance in 2005-6 only 41% of final goods exported from Asia found markets within the East Asian region, compared to 64% of their total imports. For ASEAN the relevant figures were 20% and 16% respectively. Moreover, for all East Asian countries Japan is a much smaller market for final goods exports, accounting for less than 10% in all cases in 2005-6, compared to the USA and the EU. It is also interesting to note that, unlike in the case of East Asia (or DEA and ASEAN), the estimated intra-regional trade shares for NAFTA, the EU and the other regional groupings are remarkably resilient to the inclusion or exclusion of component trade. In sum, the estimates presented in this section support the hypothesis that, where fragmentation-based trade is expanding rapidly, the standard trade flow analysis can lead to misleading inferences regarding the ongoing process of economic integration through trade. When data on assembly trade are excluded from trade flows, these estimates

24 suggest that extra-regional trade is much more important than intra-regional trade for continued growth in East Asia, whether or not Japan is included. Thus, the ongoing process of product fragmentation seems to have strengthened the case for a global approach to trade and investment policymaking rather than a regional one. 4) Investment patterns This section begins with an overview of the comparative performance of developing Asian countries as hosts to MNEs in a global context. It also examines the emerging patterns of source-country and industry composition of FDI flows, and makes inferences about the prospects for attracting FDI in the context of the contemporary debate on the possible crowding out effect on other Asian countries of China s emergence as an attractive location for FDI. Table 12 provides data on gross FDI (in current US dollars) to developing Asian countries in a comparative global context. In Table 13 the same data are presented as the percentage of gross domestic fixed capital formation (GDFCF) of each country/region in order gain some rough idea about the relative economic significance of FDI inflows. Total FDI flows to the regions are compared with total world flows and flows to developing countries in Figure 2. The data used here come from the World Investment Report of the UNCTAD, which is now the standard data source in this area. According to the standard definition, FDI consists of three components. These are: (a) equity capital, that is, the shares owned by the foreign direct investor (MNE) in its affiliates firms; (b) retained earnings, that is, the MNE s share (in proportion to its direct equity participation) of earnings not distributed as dividends by affiliates, or earnings not remitted to the parent company (such retained profits are reinvested by affiliates); and (c) intra-company loans or intra-company debt transactions (except that for working capital) referred to as short- or long-term borrowing and lending of funds between the parent company and affiliated enterprises. Not all countries record every component of FDI flows. For most countries, the data series on FDI capture only equity capital and inter-