Session IX: Trends in the RTA/FTA Architecture of the Asia-Pacific Region

Proliferation of FTAs in East Asia1

Shujiro Urata

Waseda University I. Introduction East Asia has been witnessing a sudden and rapid expansion of regional economic cooperation programs in recent years. Regional economic cooperation programs take a variety forms such as financial cooperation, information technology cooperation, largely under the ASEAN+3 (China, Japan, and Korea) framework. Although there has not yet become a region-wide program, free trade agreements (FTAs) have been actively pursued by many East Asian countries both bilaterally and pluri-laterally. This note discusses the recent proliferation of FTAs in East Asia and it attempts to analyze the factors behind such development. It also identifies the obstacles to the formation of East Asia FTA and discusses the ways to overcome such obstacles. II. Recent Developments of FTAs in East Asia East Asia was not active in the formation of regional trade agreements (RTAs), which include FTA and customs union, until recently (Table 1)2. Indeed, ASEAN Free Trade Area (AFTA) was the only major FTA until Japan and Singapore enacted JSEPA in 2002. AFTA was established in 1992 with six ASEAN member countries, Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Brunei. New ASEAN members, Cambodia, Laos, Myanmar, and Vietnam joined AFTA in the latter half of the 1990s, and currently AFTA has 10 member countries. Besides AFTA, ASEAN as a group as

1 For the presentation at PECC Trade Forum to held in Jeju, Korea on May 23-24, 2005. 2 In the GATT/WTO, regional trade agreements (RTAs), which violate one of its basic principles of non-discrimination, are permitted under GATT Article XXIV with several conditions, which include liberalization of substantially all the trade of the members, not increasing trade barriers on non-members, and completing the RTA process within ten years. For developing countries, more lenient conditions are applied under the enabling clause. An FTA is considered to be a shallow form of regional integration, because it only removes tariff and non-tariff barriers among the members, while a customs union is a deeper integration, as it adopts common external tariffs on non-members, in addition to the removal of tariff and non-tariff barriers on trade among the members.

well as its members individually have become active in FTA discussions with other countries in recent years. One of the FTAs involving ASEAN that has received most attention recently is that with China. ASEAN and China started FTA negotiations in January 2003 and they signed an agreement on FTA concerning trade in goods in November 2004. They are scheduled to begin FTA negotiations concerning trade in services and investment in 2005. ASEAN also began FTA negotiations with Korea and Japan separately in 2005. Some ASEAN members have become active in establishing bilateral FTAs. Singapore enacted or signed several FTAs with countries such as New Zealand, Japan, Australia, the USA, the EFTA, and began negotiations with countries including Korea and India. Thailand has also become active in establishing FTAs, as it is currently under negotiations with the USA and Japan. The Philippines and Malaysia began negotiations with Japan in 2004. Indonesia is expected to begin negotiations with Japan in 2005. Compared to ASEAN countries in Southeast Asia, the economies in Northeast Asia including China, Japan, Korea and Taiwan had not been active in FTAs until recently. Despite increasingly strong interest in FTAs by Northeast Asian economies, there are only few FTAs that have been enacted so far, which include Japan-Singapore, Korea-Chile, China-Hong Kong and China-ASEAN. China’s active FTA strategy has received a lot of attention. China joined the World Trade Organization (WTO) in 2001 and established an access to the world market, and it started to pursue regional strategies by using FTAs. China signed a framework agreement on comprehensive economic cooperation with ASEAN in November 2002. China and ASEAN concluded negotiations on FTA in 2004. In addition to ASEAN, China has informally proposed Japan and Korea to establish a trilateral FTA including these three countries. China enacted an FTA (Closer Economic Partnership Agreement: CEPA) with Hong Kong. After enacting FTA with Singapore in 2002, Japan enacted FTA with Mexico after overcoming obstacles from agriculture sector in Japan in 2005. Japan is currently negotiating FTAs with Korea, Malaysia, the Philippines, Thailand and ASEAN. Furthermore, it is planning to start negotiations with Indonesia and to start a study with India. Korea started having an interest in FTAs before Japan. In 1998 Korea disclosed a plan to start FTA negotiations with Chile, and it also set up a joint-study group at private level on FTA with Japan. Korea started negotiations with Chile in 1999, and Korea-Chile FTA was enacted in 2004 after difficult negotiations on liberalization of agricultural imports because of strong opposition from Korean farmers. Korea is

currently negotiating FTA with Singapore, ASEAN and Japan. An idea of FTA covering East Asian countries has emerged. At the Leaders’ Summit meeting of ASEAN+3 in 1998 the leaders agreed to set up an East Asia Vision Group (EAVG), and in 2000 established an East Asia Study Group (EASG). The mandate for EAVG, composed of intellectuals, was to study long-term visions for economic cooperation. EAVG presented the leaders with recommendations in 2001, including establishment of an East Asia FTA (EAVG 2001). EASG, consisting of government officials, in 2002 provided assessments of the EAVG recommendations and acknowledged the role of East Asia FTA for the promotion of trade and FDI in East Asia. Despite these recommendations an East Asia FTA has not become a concrete agenda item at leaders' meetings. Obviously, agreeing on an East Asian FTA at this time is politically very difficult, mainly because of strong opposition from non-competitive sectors in each member. However, the activities of EAVG and EASG were followed-up by establishing the ’Network of East Asian Think-Tanks (NEAT)’ in 2003. NEAT, which is supported by the governments of the ASEAN+3 countries, is to continue dialogue and deepen mutual understanding. Meetings were held in 2003 and 2004 to discuss issues related to the East Asian Community, of which an East Asia FTA is an important component. Recently the Joint Expert Group was set up to conduct a feasibility study of East Asia FTA under the initiative of China. They had the first meeting in Beijin in April 2005. Before ending this section on recent regionalization moves in East Asia, it should be noted that many of the FTAs discussed in the section have characteristics of wide and comprehensive coverage. As such, some of the FTAs established in East Asia are termed as Economic Partnership Agreement (Japan-Singapore EPA), or Closer Economic Partnership Arrangement (China-Hong Kong CEPA), and others. These new types of FTAs typically include facilitation of foreign trade, liberalization and facilitation of foreign direct investment (FDI), and economic and technical cooperation, in addition to trade liberalization, which is included in traditional FTAs. It may be worth noting that the basic philosophy of these new types of FTAs is similar to that of Asia Pacific Economic Cooperation (APEC) forum, whose three pillars are (1) liberalization and (2) facilitation of foreign trade and foreign investment, and (3) economic and technical cooperation. III. The Factors behind the Proliferation of FTAs in East Asia

One can identify various factors that led to rapid expansion of FTAs in East

Asia. There are several factors that are common to many countries, while there are some specific factors that may explain the motives of FTA for individual countries. We identify the motivating factors that are more or less common to many countries in East Asia in this section, and examine the factors that are specific to individual East Asian countries in the next section.

First, rapid expansion of FTAs in other parts of the world has prompted East Asian economies to form FTAs, in order to maintain and expand market access for their exports. The number of FTAs started to increase rapidly around 1990 and the rate of the increase accelerated in the mid-1990s. By the mid-1990s the world’s leading economies except those in East Asia had become a member of FTAs. Indeed, world’s two largest economic regions, North America and Western Europe, each formed FTAs. Faced with these situations, many East Asian economies became concerned about their export markets.

The formation of the North American Free Trade Agreement (NAFTA) had significant impacts on East Asian countries for several reasons. One is the change in US policy to regard FTA as an important trade policy. The US was regarded as a country that strongly committed to multilateralism in trade policy under the GATT. As such, an enactment of NAFTA signaled the increasing importance of regionalism to East Asian countries. The negative impacts of the NAFTA on East Asian countries in the form of a decline in exports to the US and a decline in FDI from not only the US but other countries made East Asian countries realize the importance of establishing FTAs to deal with these negative impacts.

Second, slow progress on multilateral trade liberalization under the WTO was one important factor that led to the proliferation of FTAs not only in East Asia but also in other parts of the world. Many countries, including those in East Asia became to realize the benefits of trade liberalization for the promotion of economic growth, as it led to rapid economic growth in the past. Despite the desire of many policy makers for promoting trade liberalization, trade liberalization under the WTO has become increasingly difficult. As the number of WTO members increased, their views on the pace and the extent of trade liberalization have become diverged. The increasing difficulty in reaching a consensus was a factor that delayed the start of the new round. Although an agreement was reached in Doha to launch a new round, the new round has faced difficulty in starting substantive negotiation. It was only July 2004 that the modality of the negotiations was more or less agreed. Faced with the difficulty in pursuing trade liberalization on the global scale, many countries in other parts of the world have opted to form FTAs with like-minded countries to pursue trade liberalization.

As a result of increasing FTAs in other parts of the world, East Asian countries started to feel that they are discriminated against in many markets in the world, as discussed above. To overcome such disadvantage and to secure markets for their exports, East Asian countries have become active in forming FTAs.

It should also be noted that many countries in the world including those in East Asia began to realize that the GATT/WTO rules cannot adequately deal with newly emerging international economic activities such as FDI, service trade, mobility of labor, and others. To put it differently, liberalization of border measures such as tariffs, which are main focus of the GATT/WTO, cannot provide foreign as well as domestic companies with the level-playing field. It is necessary go deeper beyond the border measures and to set up the rules covering domestic systems such as competition policy. Many countries share a view that GATT/WTO cannot provide such rules and opt for FTAs to deal with the problem.

Third, somewhat related to the point just made, East Asian economies have become interested in using FTAs as a way to promote deregulation and structural reforms in the domestic market. Many East Asian economies pursued deregulation and structural reforms in the 1990s, which contributed to rapid economic growth. Although the need for accelerating deregulation and structural reforms to further promote economic growth is recognized by many East Asian countries, it may not be easy for them to carry out deregulation and structural reforms as many economies are still recovering from the crisis, and as the room for further deregulation became limited as a result of earlier deregulation. Under these circumstances, many countries recognize the effective role of external pressures such as FTAs for the promotion of deregulation. Fourth, many East Asian economies have become interested in using FTAs to promote economic and other types of cooperation in East Asia. The financial crisis in the late 1990s in East Asia increased the awareness on the part of East Asian countries of the need for regional cooperation such as FTAs to avoid another crisis and to promote regional economic growth, because East Asian economies could not get as much assistance as they hoped from the countries outside the region to overcome the problems caused by the financial crisis. Indeed, as noted earlier, FTAs and prospective FTAs in East Asia include not only trade liberalization, but also trade and FDI liberalization and facilitation and economic and technical assistance under the name of EPAs. It should also be noted that regional cooperation in the area of finance has moved forward significantly, as many East Asian economies realized the need for such cooperation to avoid another financial crisis. Specifically, the Chaing-Mai Initiative, which consists of bilateral currency swap arrangements, was instituted by several East Asian countries.

Fifth, political factors have contributed to the increased interest in FTAs in East Asia. A rivalry between China and Japan for becoming a “leader” in East Asia has made them interested in using FTAs to strengthen their relationships with ASEAN and the NIEs. ASEAN and the NIEs themselves have become to use FTAs as a means to maintain their influence in East Asia. Since these political factors are different among East Asian countries, we will come back to these issues in the next section, where we examine FTA strategies of individual East Asian countries. IV. FTA Strategies of Selected East Asian Countries This section explores the FTA strategies of ASEAN, China, Japan and Korea. We attempt to identify special characteristics of their FTA strategies, which differ from the factors that are more or less common to all of these countries, discussed in the previous section. ASEAN Several motives can be identified behind ASEAN’s decision to establish AFTA in the early 1990s. One is rapid and substantial expansion of regional trade agreements in Western Europe and North America. Faced with emergence of trading blocs, ASEAN realized the need to integrate its internal market to maintain export markets for ASEAN members. Another factor that led to the formation of AFTA was the emergence of China. Recognizing the possible negative impacts of China on ASEAN in terms of attracting inward FDI and promoting export expansion, ASEAN countries established AFTA in order to create a large integrated market. The currency crisis in the late 1990s made ASEAN members realize the need to speed up the AFTA process in order to deal with the negative impacts of the crisis. As a result, the target year of the completion of AFTA was moved forward. Continued rapid economic growth of China, a stark contrast to low economic growth of ASEAN countries, provided added pressure on ASEAN to accelerate the AFTA process as well. Despite a consensus among ASEAN members on the need to achieve a truly free trade area as soon as possible, opposition from protected industries such as automobiles in Malaysia has been an obstacle. Besides AFTA, ASEAN has been actively involved with the formation of FTAs with non-ASEAN countries in East Asia. As noted above, China was the first country to approach ASEAN for the formation of FTA. In the beginning many ASEAN countries regarded China as a threat, because of China’s rising competitiveness, and thus ASEAN’s response was rather passive. However, their attitude toward China changed to regard China as an opportunity for the expansion of their business, as ASEAN realized

China is a growing huge market and as China offered various attractive programs such as early harvest, or advanced trade liberalization, in agricultural products and economic assistance to new ASEAN members. Despite increasingly more positive attitude toward China as an FTA partner, ASEAN is interested in establishing FTAs with Japan and Korea, partly to balance strong influence of China. Indeed, ASEAN is keen on becoming a hub of FTAs in East Asia. Knowing the difficulty for both China and Japan to take an initiative for the establishment of East Asia FTA because of their historic and political problems, ASEAN has taken an initiative. It is also important to realize that ASEAN has been active in establishing FTAs with countries outside East Asia such as Australia, New Zealand, and India. One may interpret ASEAN’s active FTA strategies with non-East Asian countries to indicate that ASEAN is trying to maintain bargaining power in East Asia even after the establishment of East Asia FTA, which is likely to be dominated by China and Japan. Having discussed some of the motives behind active FTA strategy by ASEAN, it is important to realize variations among ASEAN members in their motivations behind their FTA strategies as well as their attitude toward FTAs involving ASEAN. Singapore and Thailand, which have been active promoters of FTAs, would like to use ASEAN’s FTAs with non-ASEAN members to put pressures on other ASEAN members to promote AFTA, while other countries are less forward-looking because they are concerned with possible negative impacts. China China’s active FTA strategy has received a lot of attention. China joined the World Trade Organization (WTO) in 2001 and established an access to the world market, and it started to pursue regional strategies by using FTAs. Several reasons can be found to explain China’s active FTA strategy in East Asia. Hai and Li (2003) pointed out two economic factors. One is to maintain and expand export markets and the other is reduced adjustment costs for trade liberalization as a result of substantial trade liberalization committed before its entry to the WTO. China started to have a concern about its export market because of the increase in FTAs and increase in protectionist measures against Chinese exports, particularly in the form of antidumping charges. Faced with these obstacles to the expansion of its exports, China considered FTAs as possible solution. It should be noted here that for China the cost of further trade liberalization declined as a result of its accession to the WTO, making China more forward looking toward FTAs. China’s choice of ASEAN as the first FTA partner is largely attributable to the

following two factors. One is relative ease in the establishment of FTA with ASEAN rather than Japan or Korea. China considers the establishment of regional market as an ultimate goal for East Asia. Considering difficulties with establishment of FTAs with Japan and Korea, China chose ASEAN because of similarities in their economic characteristics. Indeed, China regards ASEAN as attractive markets for their export and FDI because of ASEAN’s huge population and growing economy. The other reason for China to choose ASEAN over other countries is to secure supply of energy and other natural resources, which are badly needed to realize economic growth. In addition to economic factors, one identifies geopolitical factors behind China’s FTA strategy. China considers it very important to establish and maintain peaceful and stable relationships with ASEAN, in order to concentrate their efforts on economic growth. It should also be emphasized that China is keen on using FTA strategies in order to increase its influence in East Asia for economic and non-economic reasons. Japan Japan’s FTA strategies can be characterized as passive for several reasons3. First, Japan did not initiate FTA discussions until it proposed ASEAN to establish FTA in November 2002. Indeed, it was Singapore, Mexico, and Korea that proposed Japan to study possibilities of FTAs in the late 1990s. Until that time, Japan regarded trade negotiations under the multilateral GATT/WTO framework desirable, and thus it had a negative view on FTAs. Second, even though Japan initiated FTA with ASEAN, Japan did so in response to China’s FTA approach to ASEAN. Several motives of Japan’s FTA strategies can be identified. First, a greater access to foreign market is one of the important motives that aroused Japan’s interest in FTAs. For internationally competitive Japanese firms, it is very important to have more business opportunities when competing with foreign companies. For example, FTA with East Asian countries including Korea, Thailand, Malaysia and the Philippines would increase Japan’s exports to these countries, which are presently protected with high tariff and non-tariff barriers In addition Japanese firms could expand their business in FTA member countries via FDI as FTA includes not only trade but FDI liberalization.

The market access motive has been important for its FTA with East Asian countries, as they are expected to grow economically in the future. The market access motive clearly played an important role for Japan in pursing FTA with Mexico as well. Thanks to the NAFTA and EU-Mexico FTA, EU and US firms can export their products 3 See, for example, Urata (2003) for discussions on Japan’s FTA strategy.

to Mexico without facing high tariffs, while Japanese firms face high tariffs to export their products to Mexico. These observations indicate that the pressure from the business sector played an important role in promoting FTAs for Japan.

Another motive for Japan to pursue FTAs is to stimulate structural reforms that are essential to revitalize the currently stagnant Japanese economy. In the past Japan had made use of international frameworks (e.g., GATT and OECD) and external pressures (especially, pressures from the United States) to reform its domestic structures through trade liberalization. Indeed, structural reform contributed significantly to improve competitiveness of Japanese manufacturing sector. However, in the latter half of the 1990s, liberalization was getting more difficult under the WTO framework because of slow progress in trade liberalization.

Faced with a lack of external pressures, especially from the WTO’s multilateral trade negotiations, Japan became interested in FTA as one of the policy options to promote structural reform. Japan came to look at FTA in a positive perspective, because it found that the EU and NAFTA were seemingly successful in promoting structural reform in these countries.

Possible contribution for the promotion of economic growth in East Asia is yet another motive for Japan’s FTA strategy, whose focus is East Asia. This motive can be understood by the contents of FTAs sought by Japan. Japan has pursued to establish comprehensive FTAs, which have not only trade and FDI liberalization and facilitation, but also various types of economic cooperation such as human resource development and development of small and medium-sized enterprises. With these economic cooperation programs Japan hopes to promote economic growth in East Asia, which would lead to not only economic prosperity but also social and political stability.

Finally, similar to the case of China, Japan uses FTAs as a means of conducting regional policy. In particular, Japan is interested in establishing an environment under which Japanese firms can conduct business freely. By successfully concluding FTAs, Japan would like to see not only free trade and investment environment through trade and FDI liberalization in East Asia but also a region with harmonized systems in business areas of technical standards, patent systems, and others through trade and FDI facilitation.

Before ending the discussion on Japan’s FTA strategy, it should be noted that opposition from non-competitive sectors such as agriculture as well as from labor unions against liberalization of labor market for nurses and medical care providers has made it difficult for Japan to pursue its FTA strategy.

Korea As noted above, Korea was the first country in Northeast Asia that started having an interest in FTA Being sandwiched between China and Japan not only geographically but also economically and politically, Korea is keen on maintaining its position as a balancer between the two countries. Indeed, Korea has been an active advocate of an FTA involving China, Japan, and Korea. It should also be noted that Korea is interested in establishing a cooperation mechanism in Northeast Asia with China and Japan, which would contribute to facilitate the unification of South and North Koreas. One can identify several reasons for this4. First, Korea saw its exporting environment worsen as the number of FTAs around the world grew rapidly. Because Korea’s economic dependence on exports is quite high, Korea realized the need to secure its export market by establishing its own FTAs, Another motive for establishing FTAs is to promote FDI. Similar to the case of Japan, FDI inflows to Korea had been very small, partly because of its protection policy. Recognizing positive benefits such as technology transfer from FDI, Korean government became interested in attracting FDI. Such positive view on FDI increased its popularity, as Korea became to attach greater importance to FDI to promote economic growth after experiencing the crisis in the late 1990s. Korean government hoped to attract FDI by establishing FTAs with high income countries, which are capable of undertaking FDI financially and technically. Similar to the situation in Japan, strong opposition from non-competitive sectors has slowed down Korea’s pursuance of FTA strategies. Opposition groups differ depending on the FTAs. In the case of Korea-Chile FTA it was the agriculture sector, while in the case of Korea-Japan FTA manufacturing sectors, particularly small and medium sized companies, are reported to have been strongly opposing. V. Concluding Remarks East Asian countries have been active in forming FTAs with other East Asian countries. Many East Asian countries consider the formation of an East Asia FTA as an intermediate goal and deeper economic integration like the EU as an ultimate goal. The motive behind these policies is potential benefits in both economic and non-economic aspects from these arrangements. However, various obstacles do exist, as was noted in the previous sections. This concluding section discusses the possible ways to overcome these obstacles and to establish an East Asia FTA (EAFTA). 4 See Cheong (2003) for the discussions on Korea’s FTA strategies.

One of the obstacles has to do with structural adjustment that arises from the formation of EAFTA. More specifically, non-competitive sectors have to face increased competitive pressure from FTA partners. One possible way to deal with the needed structural adjustment is to implement scheduled trade liberalization in sensitive sectors as a part of FTA agreement. GATT/WTO allows the FTA members to take ten years to complete FTA. East Asian countries should use the breathing space to facilitate structural adjustment through appropriate adjustment policies. For example, potentially impacted workers should be given financial, technical and other types of assistance to improve their capability, so that they can obtain more productive jobs. If such program is successful, trade liberalization through FTA can be pursued smoothly to result in the benefits for all the countries. Indeed, the needed assistance should be provided by the members as a part of economic assistance programs under EAFTA. For example, in the case of educating and training workers for upgrading their skills, more developed members such as Japan and the NIEs can provide useful assistance to other countries. In addition to the economic obstacles, several non-economic obstacles do exist. One is a political obstacle. East Asia has countries with different political system. Most countries have democratic political system, but China and Myanmar have authoritarian regime. While many countries have security alliances with the US, China is still considered as a possible threat to these alliances. These issues may be dissolved as economic development is achieved and as international exchange among these countries is enhanced to result in sharing common views toward political system and regional security. Different views on history involving the Northeast Asian countries, namely, China, Japan and Korea are obstacles to EAFTA. Closer economic and social relations will contribute to reducing the gaps in their views on historic and other issues, to contribute to the formation of EAFTA. To overcome economic and non-economic obstacles, East Asian countries need to deepen mutual understanding among the people at all levels, from top leaders to young people, to increase awareness of the importance of integrated regional market and regional political and social stability. Leaders’ meetings should be held at least annually to increase their mutual understanding. Frequent television-conferences can be used to supplement face-to-face meetings. Policy makers, who are responsible to formulate policies, should establish close communication links. Bureaucrats, business people, academics, students, and others should also increase their exchange. Policy makers and bureaucrats have to discuss the issues on EAFTA such as its contents and the roadmap. For students and academics exchange programs should be established.

Having discussed the need for deepening mutual understanding for the establishment of East Asia FTA, it should be emphasized that strong political leadership is a crucial factor that would realize new and drastic policies such as East Asia FTA. Finally, East Asian countries should not regard completing integration of regional market in East Asia under an FTA as a goal, and they should regard it as a step toward achieving global free trade under the WTO. This is very important as an EAFTA has possible negative impacts on non-members such as the U.S., the EU and other countries. To avoid EAFTA becoming a stumbling bloc for global free trade, East Asian countries should make every effort to promote multilateral trade negotiations under the WTO and establish FTAs with countries outside East Asia.

References Hai, Wen and Hongxia Li (2003) “China’s FTA Policy and Practice” in Yangseon Kim and Chang Jae Lee eds. Northeast Asian Economic Integration: Prospects for a Northeast Asian FTA, Korea Institute for International Economic Policy, Seoul, Korea. Cheong, Inkyo (2003) “Korea’s FTA Policy: Progress and Prospects “ in Yangseon Kim and Chang Jae Lee eds. Northeast Asian Economic Integration: Prospects for a Northeast Asian FTA, Korea Institute for International Economic Policy, Seoul, Korea. Shujiro Urata (2003) “Japan’s Policy toward Free Trade Agreements” in Yangseon Kim and Chang Jae Lee eds. Northeast Asian Economic Integration: Prospects for a Northeast Asian FTA, Korea Institute for International Economic Policy, Seoul, Korea.