Reshaping the Asia Pacific Economic Order (Pacific Trade and Development Conference (Papers))

Reshaping the Asia Pacific Economic Order Relationships and alignments among the nations of the world’s most populous and productive region, the Asia Pacific, are in flux. Current global political, economic and security uncertainty, heightened by the events of 11 September 2001 and the subsequent US ‘war on terror’, has fuelled a reassessment by many Asia Pacific countries about the structure and form of future economic and political cooperation and development. This book, featuring contributions from some of the most eminent and influential economists and political scientists in the region, examines the forces reshaping the Asia Pacific economic order, and where they lead. Reshaping the Asia Pacific Economic Order examines issues such as the origins of the shift towards policy-driven integration, the new structures that might eventually emerge on both sides of the Pacific, the ways that the changes will affect the progress of economic integration and how cross-Pacific relations will therefore be affected. Drawing from papers presented to the 29th Pacific Trade and Development conference in Jakarta in December 2003, the theme of the book is the management of economic cooperation: it explores the transition to a new set of institutions for economic cooperation or changes in existing forms of cooperation, and the likely outcome of attempts to make that transition. Ultimately the goal is to effect change in domestic policies, because it is a country’s own policies of openness that largely determine the benefits it will derive from economic integration and development. Hadi Soesastro is Executive Director of the Centre for Strategic and International Studies in Jakarta and Adjunct Professor at the Australian National University. Christopher Findlay is Professor of Economics in the Asia Pacific School of Economics and Government at the Australian National University.

Pacific Trade and Development Conference Series Edited by Hadi Soesastro and Christopher Findlay

Titles published by Routledge in association with the PAFTAD International Secretariat and the Australia-Japan Research Centre, The Australian National University include: Business, Markets and Government in the Asia Pacific Edited by Rong-I Wu and Yun-Peng Chu Asia Pacific Financial Deregulation Edited by Gordon de Brouwer and Wisarn Pupphavesa Asia Pacific Economic Cooperation/APEC: Challenges and Tasks for the 21st Century Edited by Ippei Yamazawa Globalization and the Asia Pacific Economy Edited by Kyung Tae Lee The New Economy in East Asia and the Pacific Edited by Peter Drysdale Competition Policy in East Asia Edited by Erlinda M.Medalla Reshaping the Asia Pacific Economic Order Edited by Hadi Soesastro and Christopher Findlay

Reshaping the Asia Pacific Economic Order Edited by

Hadi Soesastro and Christopher Findlay

LONDON AND NEW YORK

First published 2006 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor & Francis e-Library, 2006. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to http://www.ebookstore.tandf.co.uk/.” Publishers note: This book has been prepared from camera-ready copy provided by PAFTAD International Secretariat. © 2006 PAFTAD International Secretariat for selection and editorial matter; individual chapters, the contributors All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-33740-9 Master e-book ISBN

ISBN 10: 0-415-34985-0 (Print Edition) ISBN 13: 9-78-0-415-34985-0 (Print Edition)

Contents List of figures

vii

List of tables

viii

List of contributors Preface List of abbreviations 1 Peter Drysdale and PAFTAD Ross Garnaut and Hugh Patrick 2 Overview Hadi Soesastro and Christopher Findlay 3 The international trade order: cooperation for economic development Bernard Hoekman 4 Truncated globalisation: the fate of the Asia Pacific economies? Ross Garnaut and Ligang Song 5 Asia Pacific economies and the Doha Development Agenda Bijit Bora and Muhammad Chatib Basri 6 APEC in the emerging international economic order: lame duck or catalyst? Andrew Elek 7 Rise of East Asian regionalism Chia Slow Yue and Mari Pangestu 8 The Free Trade Area of the Americas: how deep an integration in the Western Hemisphere? Gary Clyde Hufbauer and Sherry Stephenson 9 East Asian regionalism—undermining or underpinning Asia Pacific integration? Robert Scollay 10 The rise of services trade: regional initiatives and challenges for the WTO Philippa Dee and Alexandra Sidorenko 11 The movement of people in the Asia Pacific region Mei Ling Sieh Lee and Fon Sim Ong

xi xiii xv 1 5 15 41 75 88 112 130 166 184 208

12 Asia Pacific regional architecture and financial market integration Wendy Dobson 13 Politico-strategic dimensions of economic cooperation in the Asia Pacific Andrew MacIntyre and Hadi Soesastro Index

224 243

252

Figures 3.1 Income and openness, all countries

20

3.2 Income and openness, one-third most regulated countries

21

4.1 GDP-PPP growth, 1985–2001

47

4.2 Changing share of some East Asian economies in world total labour-intensive manufactured exports, 1970–2000

49

4.3 Share of labour-intensive products in total exports, 1970–2000

49

5.1 Annual real export growth rate

76

6.1 The effects of different facilitation arrangements

103

9.1 Average annual trade flows of major Asia Pacific regions with APEC economies, 2000–02

169

9.2 APEC economies: main intra-regional and inter-regional export flows in the Asia Pacific region, 2000–02

169

Tables 3.1

MFN tariffs by region, late 1980s and 2003

17

3.2

Prevalence of core non-tariff barriers in developing countries, 1989–94 and 2000

18

3.3

Major developing country users of antidumping, 1995–2002

19

3.4

Trade shares of products affected by agricultural subsidies (1995–98 average; per cent)

22

3.5

Average tariffs in final US antidumping duty determinations

24

4.1

Exports of East Asia, North America and the European Union, 1985–2002

51

4.2

Exporting regions’ shares of import markets, 1965–2002

53

4.3

Export/GDP ratio for regional economies by destination, 1965– 55 2002

4.4

International comparison of shifting patterns of export specialisation in selected industrial sectors, 1970–2000

56

4.5

Contribution of parts and components to export growth, 1992– 2000

57

4.6

Intra-industry trade indexes by destination, 1985 and 2000

58

4.7

Bias, complementarity and intensity indexes for major country groups, 1985 and 2000

60

4.8

China plus Hong Kong’s share of exports of major countries and regions, 1996–2002

63

4.9

China’s major trading partners, ranking, total trade, growth rate 63 and trade shares, January–September 2003

4.10 China’s share of world export and import growth, 1996–2002

64

4.11 FDI inflows in East Asia

65

5.1

Exports of manufactures of selected economies, 1990–2003

77

5.2

Imports of manufactures of selected economies, 1990–2003

78

5.3

Growth rates of exports by product category, 1985, 1995 and 2001

79

5.4

MFN statutory applied tariff for agricultural products

80

5.5

MFN statutory applied tariff for non-agricultural products

82

6.1

Options for trade and investment liberalisation and facilitation

99

7.1

Importance of East Asia in world trade

113

7.2

Regional, trilateral and bilateral trading arrangements in East Asia

119

7.3

Comparative sizes of emerging FTAs in East Asia, 2001

121

8.1

Western Hemisphere income per capita

133

8.2

Free trade agreements

136

8.3

Customs unions

141

9.1

Shares of world GNP, 2002

167

9.2

Trade among APEC economies, 2000–02

168

9.3

Welfare effects of ASEAN-plus-three, ASEAN-China and ASEAN-Japan FTAs

173

9.4

Welfare effects of ASEAN-plus-three FTA and APEC liberalization

175

10.1 Disposition of employment in selected APEC economies

185

10.2 Trade in services by mode of supply

186

10.3 Leading exporters and importers of commercial services in the Asia Pacific region

186

10.4 US trade in services by partner region, 1996

187

10.5 Description of barriers to trade in banking and legal services

188

11.1 Migrant workers from major labour-exporting countries in the Asia Pacific region, 1976–98

211

11.2 Migration flows to the Middle East and Asia from major labour-exporting countries in the Asia Pacific region, per cent of total recorded emigration

211

11.3 Thai migrant workers by region

212

11.4 Inflow of documented migrant workers, Malaysia

212

11.5 Estimates of the stock of legal and illegal immigration in selected countries

215

11.6 Temporary entrants to the US by geographic origin (categories most relevant to mode 4), 1999

219

12.1 East Asia: Economic and demographic indicators, 2001

225

12.2 Exchange rate arrangements in East Asia, 1997 and 1999

228

12.3 Regional forums for financial cooperation, East Asia, 2002

231

12.4 An index of openness in financial services, 1997

236

Contributors Muhammad Chatib Basri is at the Institute for Economic and Social Research Faculty of Economics at the University of Indonesia. Bijit Bora is currently a Counsellor in the Economic Research and Statistics Division of the World Trade Organisation. Chia Siow Yue is Senior Research Fellow at the Singapore Institute of International Affairs and Regional Coordinator of the East Asian Development Network. Philippa Dee is currently a Visiting Fellow at the Asia-Pacific School of Economics and Government at the Australian National University. Wendy Dobson is a Professor at the Rotman School of Management in Toronto. Andrew Elek is a Research Associate of the Asia Pacific School of Economics and Government at the Australian National University. Christopher Findlay took up the position Professor of Economics in the Asia Pacific School of Economics and Government at the Australian National University in October 1999. Ross Garnaut is Professor of Economics at the Research School of Pacific and Asian Studies and Professor of Economics at the Asia Pacific School of Economics and Management, the Australian National University. Bernard Hoekman is Research Manager of the International Trade Group in the Development Research Group of the World Bank. Gary Clyde Hufbauer is the Reginald Jones Senior Fellow at the Institute for International Economics in Washington DC. Mei Ling Sieh Lee is Professor in the Department of Marketing and Information Systems at the University of Malaya. Andrew MacIntyre is Director of the Asia Pacific School of Economics and Government at the Australian National University. Fon Sim Ong is a researcher in the Faculty of Business and Accountancy at the University of Malaya. Mari Pangestu is a Director on the Board of the Centre for Strategic and International Studies, Jakarta. She was its executive director from 1997–98. Hugh Patrick is R.D.Calkins Professor of International Business, Director of the Centre on Japanese Economy and Business at the Columbia University Graduate School of Business, and Co-Director of Columbia’s APEC Study Centre. Robert Scollay joined the University of Auckland Economics Department as a lecturer in 1979 and was appointed director of the New Zealand APEC Study Centre in 1995. Alexandra Sidorenko is a Research Fellow at the National Centre for Epidemiology and Population Health. Hadi Soesastro is the Executive Director as well as a senior economist at CSIS. He is an Adjunct Professor at the Research School of Pacific Asian Studies (RSPAS), the Australian National University.

Ligang Song is a Fellow and Director of China Economy and Business Program in Asia Pacific School of Economics and Government at the Australian National University. Sherry Stephenson is Deputy Director for Trade of the Organisation of American States where she provides analytical support to the Free Trade Area of the Americas negotiations.

Preface The Pacific Area Forum on Trade and Development (PAFTAD) Conference series has been at the frontier of analysing challenges facing the economies of East Asia and the Pacific since it was first established in January 1968 in Tokyo. The theme of the twentyninth conference, held at the Jakarta’s Centre for Strategic and International Studies, on 15–17 December 2003, was the examination of forces that have been reshaping the Asia Pacific economic order since the early 1990s. The papers presented at the conference are gathered together in this volume. Work on the ‘economic order’, at least in East Asia, has tended to focus on marketdriven economic integration (sometimes called regionalisation), and how policy action or international cooperation can support this process. In this regard the WTO and APEC, and their interaction, have been at the centre of efforts to provide an institutional framework for this integration. In the Americas there has been a different focus, with economic integration driven more by active policy intervention (or ‘regionalism’) than markets, as in East Asia. Yet in recent times an interest in policy intervention has become more evident in Asia. The questions this book seeks to answer are the origins of the shift toward policydriven integration, what new structures might eventually emerge on both sides of the Pacific, the ways in which that shift will affect the progress of economic integration and how cross-Pacific relations will therefore be affected. This discussion directs attention to the fact that economic cooperation and security are complementary. A distinguished group of economists from around the region gathered in Jakarta at PAFTAD 29 to discuss all these questions, from the perspective of the experience of Asia and the Pacific. The presentation and discussion of papers was followed by their revision for publication in this book in the rigorous PAFTAD tradition. We are very grateful to all the contributors to this work—paperwriters, discussants and referees—who have collaborated so enthusiastically to bring this research to early publication. Our debt to the authors of chapters in the volume is obvious. In addition, Hugh Patrick, Peter Drysdale, Peter Petri, Shujiro Urata, Pang Eng Fong, Wisarn Pupphavesa, Long Yongtu, William James, Andrew Steer, Suhadi Mangkusuwondo, Edward Chen, Wook Chae, Victor Villafane, Narongchai Akrasanee, Suchittra Chamnivickom, Mahani Zainal-Abidin, Gordon de Brouwer, Miranda Gultom, Vo Tri Thanh, Toshiki Kanamori, Djisman Simandjuntak, Huang Renwei, Dorodjatun KuntjoroJakti and Jusuf Wanandi all made substantial contributions to the clarification of issues and refinement of ideas at the conference and in the process of preparation of the papers for publication. And without the particular help of the PAFTAD International Steering Committee, this work would not have been completed. At all stages of the management of this project, Marilyn Popp and Adrian Rollins gave their usual excellent and devoted service.

The PAFTAD program, and PAFTAD 29, is supported by a consortium of international donors and serviced by the PAFTAD Secretariat at the Australian National University in the Asia Pacific School of Economics and Government (APSEG). We record the PAFTAD International Steering Committee’s sincere gratitude and our own personal thanks to our donors, whose support continues to make this important work possible. They include the Ford Foundation, the Canadian International Development Research Centre (IDRC), the Japanese Research Institute of Economy, Trade and Industry (RIETI), the Korea Institute of International Economic Policy (KIEP), the Australian Government’s Aid Agency AUSAID, the Asia Foundation, Toronto University, Victoria University (Canada), the National University of Singapore, the Taiwan Institute of Economic Research, Columbia University (New York), the Centre for Strategic and International Studies (Jakarta), Seranee Holdings (Bangkok), the East-West Centre (Hawaii), Brandeis University, the Philippine Institute for Development Studies, the Institute of Southeast Asian Studies (Singapore) and the Australian National University. Sarah Leeming did editorial wonders with the manuscript and Minni Reis did her usual fine job on preparation and pagemaking of the text for publication. Our thanks also go to Stephanie Rogers, Helen Baker, Laura Sascha and the team at Routledge, with whom it is always a pleasure to work. This book is an important collection of essays on the emerging economic order of the Asia Pacific. It opens up a set of questions for further research and, hopefully, makes a useful contribution to thinking about issues that now confront policymakers concerned with the disparate forces reshaping the region. Christopher Findlay and Hadi Soesastro April 2005

Abbreviations ABAC

APEC Business Advisory Council

ACP

African, Caribbean and Pacific economies

ADB

Asian Development Bank

AEC

ASEAN economic community

AFAS

ASEAN Framework Agreement on Services

AFTA

ASEAN Free Trade Area

AGOA

African Growth and Opportunity Act

AIA

ASEAN Investment Area

AMS

aggregate measure of support

APEC

Asia Pacific Economic Cooperation forum

APSEG

Asia Pacific School of Economics and Government

ASEAN

Association of Southeast Asian Nations

ASU

ASEAN Surveillance Group

BIS

Bank for International Settlements

BOP

balance of payments

CAFTA

US-Central America Free Trade Agreement

CARICOM

Caribbean Community

CER

Closer Economic Relations Agreement

CGE

computable general equilibrium

CMI

Chiang Mai Initiative

CUSFTA

Canada-US Free Trade Agreement

EAEG

East Asian Economic Group

EAFTA

East Asian Free Trade Area

EAI

Enterprise for the Americas Initiative

EASG

East Asian Study Group

EAVG

East Asian Vision Group

EBA

EU Everything But Arms

ECOTECH

economic and technical cooperation

EFTA

European Free Trade Association

EMEAP

Executives’ Meeting of East Asia and Pacific

EU

European Union

EVSL

early voluntary sectoral liberalisation

FATS

Foreign Affiliates Trade Statistics

FDI

foreign direct investment

FTA

free trade agreement

FTAA

Free Trade Area of the Americas

FTAAP

Free Trade Area of the Asia Pacific

G20

Group of Twenty

GATS

General Agreement on Trade in Services

GATT

General Agreement on Tariffs and Trade

GDP

gross domestic product

GNP

gross national product

GSP

Generalised System of Preferences

GTAP

Global Trade Analysis Project

IAP

individual action plan

ICT

information and communications technology

IMF

International Monetary Fund

IT

information technology

ITC

International Trade Commission

LDC

least developed country

MAPA

Manila Plan of Action

MERCOSUR

Southern Cone Common Market

MFA

Multifibre Arrangement

MFG

Manila Framework Group

MFN

most favoured nation

MNC

multinational corporation

NAFTA

North American Free Trade Agreement

NIE

newly industrialised economy

OAS

Organisation of American States

OECD

Organisation for Economic Cooperation and Development

OPTAD

Organisation for Pacific Trade and Development

PAFTAD

Pacific Area Forum on Trade and Development

PECC

Pacific Economic Cooperation Council

PPP

purchasing power parity

PTA

preferential trading arrangement

RCA

revealed comparative advantage

RMU

Regional Monitoring Unit

RTA

regional trading arrangement

SDT

special and differential treatment

SEC

Securities and Exchange Commission

SMAAP

Single Market Agenda for the Asia Pacific

SPARTECA

South Pacific Regional Trade and Economic Cooperation Agreement

TILF

trade and investment liberalisation and facilitation

TN

Trade NAFTA visa

TRIPS

Trade-Related Aspects of Intellectual Property Rights

TRQ

tariff-rate quota

TTTA

Trans-Tasman Travel Arrangement

UK

United Kingdom

UN

United Nations

UNCTAD

United Nations Conference on Trade and Development

UNDP

United Nations Population Division

US

United States

VAT

value-added tax

WCO

World Customs Organisation

WTO

World Trade Organisation

1 Peter Drysdale and PAFTAD Ross Garnaut and Hugh Patrick Peter Drysdale has been a key figure in all of the PAFTAD conferences from the first in Tokyo thirty-six years ago, to the latest, from which this book is drawn, in Jakarta in December 2003. He has participated in all but one of the twenty-nine conferences. Through all of these years he has worked from a base at The Australian National University (ANU), as a lecturer and then Professor in Economics, and since 1980 as Executive Director of the Australia-Japan Research Centre. Peter retired from The Australian National University at the end of 2003. The editors of this book thought it appropriate to mark the occasion by dedicating the book to Peter. Of course, retirement does not mean the end of long hours in the office and good work. He continues for the time being as Director at the PAFTAD Secretariat at the ANU and remains closely in touch with the people and ideas that have been his life’s work. At the first PAFTAD conference in Tokyo in 1968, when Peter was a newly minted PhD, he served as the intermediary between Professor Sir John Crawford, then Australia’s senior trade policy academic with a strong interest in Japan and the Asia Pacific region, and Professor Kiyoshi Kojima, Peter’s Japanese mentor and the conference organiser. In this role Peter was the person who, with host organisation colleagues, made certain the conference ran right—a role he has played ever since. From that first conference, Peter, Kiyoshi Kojima and Hugh Patrick served as the de facto executive committee for PAFTAD under the godfatherly guidance of John Crawford and Saburo Okita, even though at the time no one expected it to become more than a one-off series of meetings. And PAFTAD almost ended with the second conference, at the East-West Centre in Hawaii, to which participants from the developing Asian market economies had been invited for the first time. The Australian participants offered to host a third conference in Sydney in 1970 on foreign direct investment, a matter of great policy concern both in Australia and more widely. However, the organising committee had difficulty raising funds and the proposed conference almost collapsed. Virtually single-handedly, Peter persevered; the funds were raised and the conference was a great success. The Canadian participants in Sydney proposed a fourth PAFTAD in Ottawa, and from then one or more members have always offered to host the next conference. Throughout the 1970s PAFTAD continued to function in an informal, ad hoc fashion, relying fundamentally on Peter’s intense, indefatigable commitment to the emerging concept of Asia Pacific economic interaction and cooperation. The International Steering Committee was formed from those participants of various economies willing to take on leadership responsibilities. Peter has continuously served as Australia’s representative. By 1983 it was evident that PAFTAD had such a significant intellectual and policy analysis role that longer-term funding was secured and the PAFTAD Secretariat was

Reshaping the Asia pacific economic order

2

established at the ANU, not surprisingly and very fortunately with Peter Drysdale as Director. And direct he has done—often informally and behind the scenes in his wellknown intense style, and quite up front when necessary. PAFTAD would not exist today without him.

ASIA PACIFIC ECONOMIC COOPERATION The PAFTAD conference series, from its origins in Tokyo, explored the potential for closer economic cooperation among private and official actors in the Asia Pacific region. It helped build and sustain the intellectual and to some extent official networks that later shaped the early steps toward closer cooperation. Peter was an energetic, persistent and effective builder and protector of the Asia Pacific networks of economists. The PAFTAD series was at first the main focus of these networks, which later developed a life of their own, formally through the Pacific Economic Cooperation Council (PECC) from the time of the first Pacific Economic Community seminar in Canberra in 1980 and later the Asia Pacific Economic Cooperation (APEC) forum, and informally through increasingly intense interaction among individual scholars and research institutions. There is some irony now that early discussions within PAFTAD on forms of regional cooperation in the Pacific were built around a discriminatory free trade area. Peter contributed to the exploration of that idea, and participated in the growing realisation that differences in history, institutions and politics in the Pacific called for alternative ideas. Some of this accumulated wisdom has been neglected in recent years, with the result that cooperation among Asia Pacific economies has drifted into shallow water. The good thing about good ideas is that they retain their intrinsic value through the fads and fashions that inevitably obscure their relevance from time to time. The realities of the Asia Pacific region will ensure the continued significance of the concepts of Asia Pacific cooperation with which Peter has been closely identified. In the 1970s the US government, while supporting the formation of the European Community, rejected other regional preferential approaches, as was made clear at the first PAFTAD conference. The burgeoning Japanese economy was America’s main interest in East Asia at the time. Conceptualisation of a broader Asia Pacific economic policy approach, and institutions to support it, was only nascent in Washington. However, Senator John Glenn, a member of the US Senate Committee on Foreign Relations, instructed the Congressional Research Service to commission a study examining the dynamic economic relationships developing in the Asia Pacific, importantly of course those with the United States. In 1978 Peter Drysdale was a visiting scholar at the Yale Economic Growth Center, where Hugh Patrick was a member. Peter insisted that he and Hugh educate Congress by preparing a careful, thorough economic study considering possible Asia Pacific institutional arrangements. Out of that study, titled ‘An Asian-Pacific Regional Economic Organisation: An Exploratory Concept Paper’, the concept of the Organisation for Pacific Trade and Development (OPTAD) was launched. OPTAD was to be much smaller and leaner than the OECD. The timing of this study was propitious: it contributed to a new Congressional interest in exploring means for Asia Pacific economic cooperation. The

Peter drysdale and PAFTAD

3

raised consciousness that the United States had vital economic interests in this region surely contributed to its government’s active involvement in PECC and then, upon its establishment, in APEC. Hugh is quick to admit that, without Peter’s insistence, determination and hard work—attributes in all aspects of his career and indeed all endeavours—that project would never have been completed. The PAFTAD godfathers assumed a new role in 1979, when Japanese Prime Minister Ohira, motivated by a keen interest in promoting closer interaction among Asia Pacific economies, appointed Saburo Okita as his foreign minister. Ohira and Okita visited Canberra at that time, and a meeting with Prime Minister Malcolm Fraser led to a request from the two prime ministers for The Australian National University to host a Pacific Community Seminar to explore the concept of Asia Pacific cooperation. Okita conveyed the request to John Crawford, Peter Drysdale and Ross Garnaut. Peter played a crucial role in bringing together intellectuals, officials and business people from North America, East Asia, Australia, New Zealand and the South Pacific to Canberra for the meeting that became the launching pad for the Pacific Economic Cooperation Council (PECC). PECC remains an important centre of tripartite (business, academic and official) interaction in the Asia Pacific region. When Australia sought to strengthen its capacity to participate effectively in PECC in 1983, Prime Minister Bob Hawke appointed Peter as the first chairman of the Australian Pacific Economic Cooperation Committee. Peter’s own inclusive approach to society was important in ensuring that the emerging institutions of Asia Pacific cooperation were open to all who wished to participate. Peter’s approach helped to establish that Asia Pacific cooperation should include North America rather than be exclusive to the western Pacific. It also helped to ensure the People’s Republic of China be included as reforms expanded that country’s hopes for productive interaction around the Pacific, rather than be confined to what were already market economies (and later that bridges be built to the Soviet Union, Russia, Vietnam and North Korea). It helped to ensure that places were preserved for Taiwan and Hong Kong, as the growing economic weight of mainland China made this more complicated than it had been at the beginning. As a teacher Peter has had an unequalled influence on the development of the economics profession in areas related to Asia Pacific economic interaction and cooperation. Peter was the first Australian economist with an interest in Japan that Hugh Patrick had ever met when Peter, then an ANU PhD student undertaking research for his thesis, was one of a group of Hitotsubashi students who visited his home in Tokyo in 1964. Patrick remembers him as tall, thin and shyly gregarious with a great laugh, deeply involved with his research and healthily sceptical. Now leading American economists working on Japan are closely aware of the large cadre of Japanese-speaking Australian economists, all of them at some time Peter’s students. As Peter’s own research interests extended through the Pacific, so did the cadre of his ex-students in Southeast Asia, Korea and China, on both sides of the Taiwan Strait. Peter’s intellectual contributions to the discussion of Asia Pacific economic cooperation have been extensive and influential. We look forward to his work continuing for many years. July 2004

Reshaping the Asia pacific economic order

4

2 Overview Hadi Soesastro and Christopher Findlay Why has regional economic cooperation among economies in Asia and the Pacific taken the form and evolved the way that it has? This is the core question of this collection of papers, which also seeks to identify the next steps in regional cooperation; that is, strategies for reshaping the Asia Pacific economic order. The book begins by providing a framework to review the principles behind regional economic institutions. Then follows an examination of the parameters within which regional cooperation takes place, an explanation of the original interest in a Pacific approach to cooperation and a commentary on recent developments. The activities of the World Trade Organisation (WTO) and Asia Pacific Economic Cooperation (APEC) forum, key institutions in which various modes of regional cooperation are evident, are examined. Developments in regional trading arrangements in East Asia and the Western Hemisphere are also reviewed. This book seeks to explain the forces driving interest in preferential bilateral agreements, which despite being relatively new are now proliferating. The likelihood of hub-and-spoke structures emerging from these preferential agreements is highlighted. The emergence of China as a hub in East Asia poses challenges for Japan and the United States. A similar structure is evident on the other side of the Pacific. Options for dealing with the problems associated with this outcome are identified. Other chapters review specific issues in the reform of services trade, labour movement and financial services. The discussion of financial services covers longer-run options for deeper market integration in the region, including new currency arrangements. The final chapter reviews political and strategic dimensions of regional cooperation and its link to the choice of arrangements for economic cooperation.

FRAMEWORK The primary beneficiary of policy reform is the economy undertaking the reform. The links between a country’s own policies and the extent to which it benefits from trade means that, as Bernard Hoekman stresses in Chapter 3, trade policy is a critical part of national strategies on economic development and poverty reduction. A formal, negotiated approach to international cooperation in this context serves a number of purposes. It provides a vehicle for demonstrating commitment to a particular set of policies, a forum for regulatory cooperation and a mechanism for mutually beneficial bargaining. International cooperation also helps deal with the spillovers from

Reshaping the Asia pacific economic order

6

other countries’ trade policy choices. As Hoekman explains, an economy’s terms of trade is affected by the policy choices of their trading partners. Formal agreements can help deal with the negative externalities of choices such as agricultural subsidies and protectionist manufacturing policies, and establish mutual interest in solving these problems. Hoekman asks whether there is one form of agreement that covers all the relevant issues? He answers in the negative, and then poses the challenge of reaching an efficient allocation of tasks across different ‘instruments of cooperation’. A basic development challenge is to identify which type of cooperation is most efficient for particular issues. Hoekman observes that the comparative advantage of international institutions differs and makes a case for greater coherence in the allocation of tasks among institutions. This choice is made within a set of parameters determined by existing economic relationships as well as prevailing political economy constraints. It also depends on the strategic context in which these choices are made. Institutions are instruments for reshaping the economic order. The choice of which task should be pursued in which forum will depend on the nature of the economic relationships: in this region, as Ross Garnaut and Ligang Song argue in Chapter 4, the approach of open regionalism was consistent with the parameters of the economic relationships. Inappropriate institutional choices, they also argue, disrupt these relationships and retard development. Hoekman identifies four ‘rules of thumb’ for making these choices: • market access issues (tariffs, subsidies, antidumping) are best considered in the WTO; • international mechanisms to exchange information on good practices and develop rules for behind the border, trade-related policies could be very beneficial for improving the policy and regulatory infrastructure in developing countries: the voluntary approach used in the Pacific may be more effective than binding rules enforced through trade sanctions; • deeper integration measures might be included in trade agreements to help overcome political-economy constraints on reform, but the costs and benefits need to be assessed and measures presented to account for disparities in capacity and differences in policy priorities; and • the WTO has a major role to play in defending the most-favoured nation (MFN) principle, as deeper integration is pursued in preferential agreements.

THE KEY INSTITUTIONS OF REGIONAL DEVELOPMENT Garnaut and Song point to some of the key features of regional economic relationships in the Pacific; that is, the economic context for choices about economic cooperation. Garnaut and Song argue that ‘open regionalism’ was always the only feasible guiding principle for economic cooperation in the Asia Pacific region. Garnaut and Song focus on key features of regional development, such as the capacity to catch up to developed country standards, the trade orientation of economies in the region, the structural change associated with growth and the changes in trading patterns that follow from structural change. Open markets are critical to support the adjustment in market shares in importing countries and the shifts in export specialisation.

Overview

7

A more recent event is the growth in component trade and intra-industry trade as production chains become more finely divided. Chia Siow Yue and Mari Pangestu (Chapter 7) describe the development of a regional production centre and note the changes in patterns of trade and investment associated with this phenomenon. There has been rapid growth of intra-industry trade in components within the region, but intraindustry trade outside the region has been concentrated in finished products. While production and consumption increasingly have had a large intra-East Asia component, both are still more broadly based geographically than in other regions. East Asia tends to trade globally. Garnaut and Song document the region’s adjustment to the internationalisation of the Chinese economy. The impact of China’s growth on the exports of other East Asian economies is likely to be significant across a range of markets. The impact on its own imports is likely to be narrower, concentrated especially on resource-based products. China’s growth creates opportunities for its trading partners, but also triggers adjustments and new trading patterns that can create political tensions. The sustainability of growth depends on the ways international institutions are used to deal with these political pressures. The most important of these institutions, say Garnaut and Song, is the WTO. In Chapter 5, Bijit Bora and Muhammad Chatib Basri review the interests of the East Asian economies in the current WTO negotiations and provide an update on the issues on the table in the Doha Round, including the decision to limit attention to trade facilitation among the group of Singapore issues. They support the view that the region has much to gain from full and effective participation in the negotiations. They stress, for example, the market access interests of East Asia in both developing and OECD countries. They note the extent of the gaps between bound and applied tariff rates for some economies in the region, and the negotiating options this creates. Bora and Basri point to the value of a regional identify in WTO negotiations, and the returns to establishing a common position on some negotiating topics. ASEAN once showed a strong capacity in that respect, but its influence as a group is waning. China’s influence, on the other hand, is rising. Andrew Elek, in Chapter 6, makes the case that the goals and broad coverage of APEC, the key institution in the region embodying the principle of open regionalism, remain relevant. He argues that APEC has a significant track record, but that its operation could be more effective. Elek suggests a new APEC work program comparable to the EU’s Single Market agenda. Members could implement a far more extensive program of trade and investment facilitation and do more work on liberalisation topics that are not covered in the WTO. The diversity in the Pacific means that this ambitious agenda would have to be implemented in a way that was different from that adopted in Europe. The work proposed by Elek would be important for dealing with ‘behind the border measures’ that affect access to markets by both domestic and international suppliers, especially in services. Reform of this type creates challenges for domestic institutions, such as competition policy authorities and regulatory agencies. This is where APEC has a key supporting role to play—the success of the program proposed by Elek relies on APEC’s strength in running capacity-building programs. Many of Elek’s suggestions for items on the APEC agenda address problems with regulations and standards. Given the size of the gains offered, these reforms should be applied as widely as possible. At the same time, changes can be made in a way that allows some APEC members to move faster than others on implementation, as long as

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there are overriding principles that sustain the openness of those initiatives. Again, APEC can contribute in reaching understanding on those sorts of principles. The two-way relationship between APEC and the WTO is relevant to the regional economic order. Bora and Basri note the scope for greater efforts to translate APEC’s work into the WTO framework. Elek comments on how the WTO might develop principles on facilitation to which APEC could refer, and how APEC’s work on liberalisation (including capacity building, information sharing and timetables on reform) can reinforce the WTO program.

THE MOVE TO PREFERENTIAL AGREEMENTS FTAs are very different in design to previously accepted principles of economic cooperation in the region. What has happened to those principles and why have FTAs proliferated in East Asia and the Pacific? In this volume, Elek, Garnaut and Song, and Chia and Pangestu discuss the origins of this shift in orientation. Critical to this reorientation of regional economic diplomacy was a shift in strategy by Japan, which then found roots in ASEAN. Australia’s choices significantly reinforced the effects in the region of the change in tack by Japan. These shifts in thinking spilled over into efforts by China to join preferential arrangements. Japan’s move was a response to the North American Free Trade Agreement (NAFTA) and also the United States’ reaction to the East Asian financial crisis. Australia’s drift into this policy approach was prompted by the interest in consolidating its relationship with the United States on all fronts—economic linkages have been deliberately tied to the strategic and security relationship. Australia learnt a lot from its genuine and deep integration with New Zealand and tried to set up a similar process with ASEAN. When rebuffed by ASEAN, Australia sought arrangements with individual countries in the region. It is now also seeking an FTA with China and revisiting the FTA initiative with ASEAN. Japan’s decision to seek bilateral, discriminatory trade deals has had a significant effect on thinking in the rest of the region. Chia and Pangestu explain how the shift in approach became evident in ASEAN, following a combination of events including disillusionment with the WTO and APEC processes. ASEAN also has interests in building an economic community that plans to be a common market ‘minus’ arrangement, in order to be globally competitive with China and more recently India. They explain how the reaction of the rest of the world to the East Asian financial crisis led to wider East Asian cooperation on both trade and financial policy. This reinforced the defensive reaction to NAFTA and the prospect of a Free Trade Area of the Americas (FTAA). Where do these rounds of action and reaction lead? Proponents of the FTA strategy argue that instead of just entrenching protectionist deals in bilateral agreements, such agreements liberalise trade by converging on the WTO. Chia and Pangestu review principles that increase the probability of this outcome, stressing the importance of a clear road map and developing a common political and economic vision of the interests of the economies involved.

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Garnaut and Song argue that the proliferation of FTAs could truncate the globalisation that has been at the centre of East Asian development. They stress the negative welfare effects of trade diversion, the distortions associated with rules of origin, the impacts that small group FTAs have on the political economy of multilateral reform, and the tendencies to proliferation in this process. There is a contradiction between the use of FTAs and the increasingly fine specialisation in supply chains in East Asia. FTAs, they say, exaggerate not mediate the adjustment with China, and even consistency in literal terms with WTO rules is not enough to avoid these problems. There are lessons for East Asia from the FTAA negotiations, which are reviewed by Gary Clyde Hufbauer and Sherry Stephenson in Chapter 8. They note the proliferation of bilateral trade agreements in North and South America, but also the sense of disappointment in economic performance after a period of significant reform, including unilateral reform. The FTAA was launched at the end of 1994, when regional agreements were proliferating, with an ambitious aim of reaching an agreement among a diverse set of thirty-four economies. Stephenson and Hufbauer stress the wide coverage of the agreement and summarise progress in a number of areas. Empirical research on the gains from cooperation helped the enthusiasm for the FTAA endure, but countervailing forces emerged. These included disillusionment with globalisation in Latin America and doubts about the intentions of US trade negotiations. In November 2003, following a US and Brazilian proposal, FTAA negotiators agreed to split the process into two tracks. The agreement was to remain comprehensive, but groups of members could agree on additional liberalising measures. Stephenson and Hufbauer question how this approach will be implemented, and indeed at the end of 2004 there was still no further progress. Stephenson and Hufbauer note that the United States is now the hub for many spokes. Only MERCOSUR members, which led the movement to redirect the FTAA, are not engaged. The consequence may be the consolidation of US influence in the Western Hemisphere, which is what the group was trying to avoid. In Chapter 9 Robert Scollay reviews much of the empirical research on the trade policy debate, beginning with a review of bilateral FTAs which generally have small welfare effects when pairs of small countries are involved, and generate large gains for a small country partnering with a large group and small negative effects for trading partners excluded from the arrangement. As Scollay points out, these negative effects motivate the domino effects already noted here. He finds that multilateral nondiscriminatory liberalisation is superior to all other regional initiatives. Scollay points to an important trade-off. The larger the group of East Asian economies involved in a discriminatory arrangement, the greater the gains to the members but the larger the losses inflicted on non-members. For example, ASEAN-plus-three generates the largest gains for the participants, but also imposes large costs on excluded countries— Australia, New Zealand and Taiwan. The position is reversed in a non-discriminatory liberalisation. China and Japan also gain more from this outcome, East Asia as a whole is better off, but ASEAN gains less than under the discriminatory ASEAN-plus-three arrangement. These results elucidate some of the origins of East Asian cooperation, especially in the context of the other political interests stressed by Chia and Pangestu. Scollay reports some results from modelling hub-and-spoke scenarios. He compared agreements involving the US and thirteen other economies on a stand-alone basis with

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the simultaneous implementation of the agreements (that is, a hub-and-spoke structure). The smaller economies gain more from a stand-alone agreement but larger proportionate welfare gains go to the United States in a hub-and-spoke structure. It is possible that once a hub-and-spoke structure becomes clear, and the disadvantage of being a spoke becomes apparent, then the spokes will have incentives to negotiate among themselves. Whether they can match the position of the larger hub, given the political constraints on small group negotiations, remains to be seen. Hub countries may also be seeking to establish a set of alliance partners on issues in other forums: China, emerging as a hub in East Asia, has an interest in achieving market economy status, while the United States wants to establish principles on digital products and a number of other issues that at some point it can try to push into the WTO, surrounded by its bilateral partners. However, hub countries are not necessarily better off. They too can suffer exclusion from the markets of other hubs. Some commentators point to a three-hub world around the United States, the European Union and China. In that environment China risks significant loss of access to markets in the developed countries, and the United States will also have to worry about discrimination in East Asia. Bargaining between the hubs might follow, but whether the hubs would bring their spokes along with them remains to be answered. Scollay also asks whether a benign adjustment can be expected, considering a number of practical and theoretical obstacles. The former includes the political difficulties of including sensitive sectors that have been excluded from bilateral agreements. He is also concerned that multiple hub-and-spoke structures will result in competition between the various ‘model’ agreements associated with the hubs. Scollay refers to the literature on the diminution of incentives to take in new members. The obstacles to progression suggest the importance of leadership by one or a group of economies if these dilemmas are to be resolved. What are some ways of dealing with the problems identified so far? One track is to try to reconstruct the FTAs themselves. This could be called reform from within. It might include rules on accession or the alignment of rules of origin and the transition to more liberal versions of those rules. There is much work needed to find how this might be done, but reform of the FTAs on their own terms will be difficult because, as Garnaut and Song explain, the same internal political forces that drove their features in the first place would limit their reform to a more liberal position. APEC has adopted a set of model rules; Garnaut and Song say there is no harm in that, but they do not hold high hopes that the models will be influential. Eventually the risks, and costs, of diversion in the current FTAs will become clearer and the losers from that process will become increasingly concerned. Maybe they can be mobilised to override the interest of two other groups—those exporters who have captured rents from preferential access, and those import-competing producers who have been quarantined so far—to extend the coverage of FTAs and join them together. But it is not clear how long this would take to occur. The alternative is to try to arrange reform from outside the FTAs by getting the WTO process on track. ‘Nothing would be as helpful as timely success in the Doha Round of multilateral negotations,’ say Garnaut and Song. Progress means putting together a coalition that pushes those interests in the negotiating process. There is also work to be

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done on the set of positions that will bind the coalition together but, just focusing on manufactured products, this group of economies could put on the table attractive offers to bind tariffs and cut bound tariffs, as well as commitments on other matters, that would help stimulate a response from the United States and the European Union in the negotiating process. Garnaut and Song make the case for Chinese leadership. They suggest East Asian economies agree that preferential agreements be put on hold for the duration of the Doha Round. If negotiations persist, then a variant on this proposal is to develop an understanding from the outset that whatever tariff cuts are discussed will be transferred into WTO commitments and implemented without discrimination against other partners. One problem might be that China’s involvement weakens its ambition of putting pressure on the United States, since it guarantees that this pressure will disappear once WTO negotiations close. But the terms on which the existing commitments can be multilateralised are issues in the current round.

SERVICES ISSUES Services policy can be divided into two components, one focused on rules on access to markets by domestic and foreign suppliers, and the other the complementary regulatory processes. Different approaches to reform can be considered for these policy elements. The main interest here is the role of various forms of international cooperation, and Philippa Dee and Alexandra Sidorenko examine this topic in Chapter 10. Adjustment costs imposed by reform can be sustained in political terms when offset by countervailing support from exporters who gain access to markets in trading partners, which are secured through international commitments. This is the case for reciprocity—it is an argument made in the context of the removal of tariffs on imports. The case for reciprocity is weaker when the effect of the policy under consideration is to increase costs, as Dee and Sidorenko explain. In that case even the incumbent may gain from reform, and there is less requirement to mobilise countervailing political forces in the home economy. Restrictions in services sectors can act to make these sectors too small, so that liberalisation leads to further entry (both domestic and foreign). The gains to new entrants in services sector (and the employment generated) may be sufficient to offset opposition to change by incumbent and previously protected suppliers. This application of international cooperation is, however, not straightforward, as Hoekman explains. One reason is that skills are required to implement these regulatory processes. Hoekman suggests differentiation among developing countries according to the resource intensity of the implementation process. The benchmark practices should, however, be adopted by the time these countries reach critical criteria (e.g., a certain level of development). These implementation processes should be made explicit and supported by technical assistance—temporary exemptions that are similar to the special and differential treatment applied to developing countries. Clearly, there is work to be done on the criteria to be applied to the selection of eligible countries and policies. Commitments on services could be made in the multilateral process or in small group preferential negotiations. There has been a surge of interest in the application of preferential arrangements to services trade liberalisation.

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Static gains from preferential liberalisation in goods markets are ambiguous, but it has been argued that when services barriers are cost increasing and not revenue generating then a gain is possible from preferential services reform. Even so, non-preferential liberalisation is likely to produce even larger gains than a preferential approach. For some policy measures, liberalisation measures are difficult to implement in a preferential manner. Agreements made in bilateral negotiations may have to be implemented without discrimination because of the nature of the policy instruments. Rules on competition policy and the protection of intellectual property are examples. If so, agreements are ‘multilateralised’ as soon as they are implemented. The significance of policy measures in preferential negotiations which have these characteristics, and whether their non-discriminatory nature is maintained or subsequently undermined, are topics for further work. The question also arises of why the original negotiations on these measures have to be embodied in a preferential structure in the first place. As Dee and Sidorenko explain, losses from preferential liberalisation are likely when a policy change is agreed with a trading partner who is not the world’s best producer and when the measures being changed are tariff-like, that is, rent creating. Foreign entry may lower prices, but in the presence of remaining barriers to other suppliers, may allow the foreign supplier to capture rents. Unless the price fall is large enough (that is, unless the entrant is a sufficiently good performer), the liberalising country could face a net loss. Furthermore, because of the nature of services production, the new supplier may be difficult to dislodge even when barriers to other entrants are lowered. For these reasons, the sequence of preferential liberalisation matters more for services than for goods. These factors prompt Dee and Sidorenko to observe that many proposals for preferential reform are proposals to redistribute rents rather than provide genuine assistance with reform. The movement of people is becoming more important as a mode of supply, but also more challenging in part because of the security environment. There was always a need to regulate the movement of people, because of concerns about controlling long-term stays. Mei Ling Sieh Lee and Fon Sim Ong identify a variety of types of movement in Chapter 11 and argue that migration will continue to grow from a wider range of countries. At the same time the growth of illegal migration, as well as concerns about security, have led to a tightening of rules and regulations on people movement. The assessment of the significance of the flow is made more difficult by the lack of data. Mei Ling Sieh Lee and Fon Sim Ong note the range of approaches to the regulation of the movement of people, in particular the differences in the treatment of illegal immigration. In that context, they stress the value of cooperation on these issues. They note the capacity to use the provisions of the General Agreement on Trade in Services (GATS) for these purposes, but also the tardiness with which governments have taken up that option. The ASEAN Framework Agreement on Services (AFAS) might also be used, but its application so far has been limited. More frequent is the treatment of labour movement in bilateral agreements, although the coverage of such agreements does not match the patterns of people movement. The authors make the case that choices about modes of cooperation on these questions would be easier with better quality information. Most of the chapters in this volume concern the management of cooperation in trade and investment policy. In Chapter 12 Wendy Dobson identifies the parallel set of issues in financial cooperation. Domestic financial reform and exchange rate regimes are the basic building blocks of financial and monetary integration, she argues. She reviews

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progress in financial reform in the region and the transition in exchange rate regimes away from fixed rates to varying degrees of flexibility. She also examines work within the region on financial arrangements and reviews a number of studies that find advantages in reductions in uncertainty about exchange rates among East Asian economies. But she questions whether economies in the region are willing to sacrifice domestic policy autonomy to allow mobile capital to sustain exchange rate stability. She then examines two complementary tracks to reach higher degrees of cooperation—bond market development and further cooperation on domestic financial reform. However, she also stresses that a critical element of cooperation on financial reform is benchmarking, ideally supported by institutions, which again raises the questions of the willingness to submit to peer review. Dobson reviews the relative roles of regional and global institutions. After examining the role of the International Monetary Fund (IMF), she concludes there is a role for a regional institution that can draw more readily on local knowledge, marshal peer pressure and, if credible, help prevent contagion. A regional institution that complements the IMF could be designed, although the definition of complementarity needs attention. Questions also remain about the ASEAN-plus-three institution as the vehicle for that role. The architecture within the group remains unsettled; for example, the relative importance of China plus ASEAN compared to Japan and Korea, and also China’s limited capacity to take a leadership role, given its own reform challenges.

SUMMARY Andrew MacIntyre and Hadi Soesastro in Chapter 13 summarise the trends in economic relationships in the region. They identify three broad changes: the rise of preferential trading arrangements, the emergence of meaningful financial cooperation and the growing momentum for East Asian-only regional cooperation. Key questions in this book have been what is the significance of these changes; are they likely to endure; and do they presage a swing towards an increasingly inwardlooking pattern of economic cooperation within East Asia, at the cost of cooperation across the Pacific? In other words, is there likely to be a change in the regional economic order? Some of the changes identified could lead to a less open commercial environment and even a more inwardly oriented East Asia. But Soesastro and MacIntyre argue that three factors make this unlikely. One is that trends in trade cooperation and financial cooperation are not the same. Where the former is taking an increasingly preferential character suggestive of a turn inward if unchecked, this is not the case in the financial sector. Second, there are likely to be major obstacles to East Asian trade cooperation. Agricultural protection by Japan and Korea is one of these. The plethora of cross-cutting FTAs further complicates the prospects for meaningful trade cooperation. Third, there are important strategic considerations that are likely to limit movement in a strongly inward direction. The key factor is the region’s relationship with the United States. Despite irritations about US policies and concerns about unilateralism, all see the United States as a balancing force to China. As long as US-China relations remain

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fundamentally sound, events are likely to evolve positively. They are longstanding competitors in strategic terms, and if this relationship moves in an antagonistic direction, then there will be deep implications for regional cooperation. Overall, these authors expect continued flux in the pattern of regional economic cooperation, featuring further experimentation with combinations of participants and institutional frameworks. A key concern in this respect is the development of APEC. Having drifted in the late 1990s APEC will now emerge as a crucial regional forum, according to Soesastro and MacIntyre. Its evolution in this direction will not be without difficulty. APEC’s involvement with political and security issues is likely to become more explicit, but the United States will need to exercise considerable care in handling these issues within APEC if it is to avoid alienating East Asian states. The potential gains from the reinvigoration of APEC as a forum in which heads of government can confer on the big issues of the day are so great that it is likely to endure, they say. Events in East Asia can be reconciled with the development of APEC, although at present they appear to be pulling in different directions. Soesastro and MacIntyre observe that China, more than any other country, has profound interest in the region not turning too far inward. The apparent extent of integration should not be overstated, as recent work on the growth of the component trade in the region has revealed. In a further reference to a theme of this volume, which is the linkage between economic parameters and the design of institutions of cooperation, Soesastro and MacIntyre argue that open regionalism makes sense. This is because, notwithstanding the deepening economic interdependence within the region, Asia remains the most outwardly oriented of the major regional groupings.

3 The international trade order: cooperation for economic development Bernard Hoekman

INTRODUCTION International trade is important for development. It helps increase and sustain growth—a precondition for reducing poverty—by giving firms and households access to world markets for goods, services and knowledge, lowering prices and increasing the quality and variety of consumption goods, and fostering the specialisation of economic activity into areas where countries have a comparative advantage (Bhagwati 1988; Irwin 2001). The primary determinant of the benefits from trade is a country’s own policies. Establishing the appropriate trade and complementary domestic policies is consequently a critical dimension of national development and poverty-reduction strategies. National policies may also be affected by or conditioned on what other countries do. Thus, measures that restrict market access may lower (raise) the prices of exports (imports) and may have direct negative effects on the terms of trade and indirect effects on investment incentives and the growth potential of developing countries. High rates of subsidisation and trade barriers for agricultural products in developed countries increase world price volatility, lock developing countries out of major markets and can lead to import surges that have a detrimental impact on farmers and rural communities. Both the design and implementation of national policies and the existence of international externalities caused by foreign countries’ policies provide rationales for international cooperation. Trade agreements may offer focal points for better policies, as well as mechanisms to commit to implementing such policies. They are also vehicles through which to address negative externalities caused by the policies of trading partners. The ability to use trade agreements for these purposes depends on both a good understanding of national interests (what are ‘good policies’?) and the negotiating power of nations (how to induce others to change their policies?). Developing countries may be less well placed to negotiate good deals than more advanced industrialised countries. Perceptions that the rules of the international trade game are skewed against the interests of poor producers and consumers have given rise to efforts to rebalance trade agreements. The decision to name the 2001 WTO round the Doha Development Agenda is one reflection of this. The increasing participation by developing countries in preferential trading arrangements (PTAs) is another, as are recent initiatives on the part of rich countries to provide deeper preferential access to their markets for the poorest nations— in particular the least-developed countries (LDCs) and sub-Saharan African nations. There are fundamental inconsistencies and tensions between these alternative approaches. PTAs and trade preferences are inherently discriminatory, distorting global

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resource allocation and thus welfare. PTAs have for many years now been a major element of the trade policy of the European Union, with the United States and East Asia taking a much more agnostic, if not hostile, view. However, in recent years both the United States and many East Asian countries have become active proponents of PTAs. This shift toward greater discrimination in world trade does not bode well for excluded nations. Non-discrimination is critical for development and global poverty reduction for the simple reason that most poor countries will be excluded from individual PTAs, and all countries will be affected by the associated potential misallocation of resources. A trend toward ever more discrimination and ‘managed trade’ is therefore worrisome. A rise in protectionism may not be a high probability but is not inconceivable. Large macroeconomic imbalances now prevail in the world economy, and pressures to intervene in trade are mounting in major countries. So far this has not happened on a significant scale—the absence of a large increase in trade protection during the East Asian crisis in the late 1990s, the 2000 stock market meltdown in OECD countries, and episodes of major exchange rate misalignment are noteworthy. However, multilateral cooperation cannot be taken for granted. The premise of this chapter is that a rethink is needed of what trade agreements can and should deliver from a development perspective. A number of questions motivate the discussion: What is best done where? Where is a ‘one size fits all’ approach appropriate when it comes to rules of the trade game? To what extent does it makes sense (improve welfare) to extend trade agreements to cover non-trade policy issues? A basic challenge is to allocate priorities across different instruments of cooperation, recognising the prevailing political economy constraints that affect policy decisions. An important factor in this regard is that some issues put forward for negotiation lend themselves better to quid pro quo bargaining than others. For example, deep integration is generally harder to negotiate than market access. As a result the focus of discussions is often on harmonisation. An important question is whether this is beneficial. A corollary issue is whether any agreements on regulatory issues will be effective in generating the political support needed to reduce or eliminate remaining major trade-distorting policies— agriculture, contingent protection, limits on the (temporary) movement of people. Recent developments suggest that PTAs may not be very effective in addressing these remaining hardcore market access barriers. The Free Trade Area of the Americas (FTAA) negotiations illustrate the problem: the United States is unwilling to discuss agricultural policies, a key ‘offensive’ interest of large countries such as Argentina and Brazil, which in turn leads to an unwillingness on the part of the latter to put services liberalisation on the table (a major offensive interest of the United States). To give an EU example, reportedly the European Commission has become less enthusiastic about deepening EuroMediterranean Partnership Agreements to include services because of an unwillingness to discuss the temporary movement of service suppliers in a PTA context. The resistance by the European Union to negotiate on agricultural policies in the PTA context is well known. What follows argues that the World Trade Organisation (WTO) is the best-available instrument through which to remove trade-distorting policies that affect world prices for goods and services. PTAs may be better suited to achieve cooperation on ‘behind the border’ policies, especially when it comes to regulation-intensive issues such as trade facilitation and the investment climate. However, an important task for the WTO is to

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defend the principle of non-discrimination by scrutinising the operation of PTAs and seeking to extend PTA-based liberalisation on a most-favoured-nation (MFN) basis. The MFN principle is the cornerstone of the WTO as it not only guarantees greater global efficiency, but also ensures that trade is less ‘politicised’ and that all countries have similar market opportunities. The WTO cannot be the only source of such pressure—as important is information provision and analysis by independent bodies and stakeholders to ensure that the benefits of cooperation are realised and spread equitably. A theme of this chapter is that the principle of special and differential treatment (SDT) for developing countries in trade agreements, if recast in a way that ensures that agreements are seen to support development, could increase their relevance from a development perspective. One element of such a recast approach could be to accept (encourage) cooperation on ‘new’ issues (non-traditional trade-related policy areas) that does not rely on binding rules and the threat of trade sanctions to enforce them. When it comes to regulatory issues and reducing the transaction costs associated with differences in domestic policies or weaknesses in infrastructure, a voluntary approach to cooperation may prove more effective. The chapter starts with a brief discussion of the domestic challenges confronting the poorest developing economies seeking to benefit from expanded trade and the external policies that may constrain trade growth. Then the discussion turns to consider the questions posed above regarding regional and multilateral trade cooperation.

DEVELOPMENT AND TRADE: THE AGENDA AT THE NATIONAL LEVEL Despite significant liberalisation by many developing countries, traditional trade policies continue to imply significant anti-export biases in a number of regions, most notably South Asia. Average (unweighted) tariffs in the Middle East and sub-Saharan Africa are in the 20 per cent range (Table 3.1). Although tariffs remain non-negligible, the ‘border agenda’ in many low-income countries is more institutional than related to trade policy. Non-tariff barriers have come down substantially in most countries (Table 3.2), but inefficiencies in public administration often are a serious impediment to trade. Transaction costs related to customs clearances and logistics might deter investments in activities that are time sensitive or must be integrated into global production networks that operate on the basis of just-in-time supply chain management. Exporters must have access to imported

Table 3.1 MFN tariffs by region, late 1980s and 2003 (simple averages) Region East Asia/Pacific Eastern Europe/Central Asia Latin America/Caribbean Middle East/North Africa South Asia Sub-Saharan Africa

Late 1980s 18.8 10.2 22.4 17.3 68.9 25.1

2003 10.4 8.9 12.0 14.8 19.8 17.6

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All developing countries 25.4 13.5 Least developed 28.4 16.4 Low income 31.7 15.8 Middle income 21.8 12.7 Source: World Development Indicators, World Bank, various years; IMF tariff data.

Table 3.2 Prevalence of core non-tariff barriers in developing countries, 1989–94 and 2000 (per cent of tariff lines affected) Region

1989–94

2000

Latin America and the Caribbean (13, 18.3 15.3 17) Eastern Europe, Central Asia (11) n.a. 3.4 East Asia and the Pacific (7, 9) 30.1 5.5 Sub-Saharan Africa (12, 17) 26.0 2.3 Middle East and North Africa (4, 8) 43.8 8.5 South Asia (4, 3) 57.0 13.3 Notes: Numbers in parentheses indicate the number of countries for which data are available for 1989–94 and 2000, respectively; owing to differences in country coverage, data are not strictly comparable across years by region; n.a. means not available. Source: Global Monitoring Report 2004, World Bank.

intermediate inputs at world market prices in order to be competitive. In countries where tariffs continue to be needed for revenue mobilisation this requires well-functioning customs regimes that refund taxes paid on imported inputs or, preferably, allow exporters to import inputs duty free (so-called temporary admission or green channel treatment). Many countries do not have well-functioning drawback regimes, creating anti-export bias. Finally, in a number of (mostly) middle-income countries, there has also been an increase in the use of contingent protection—antidumping and safeguard actions. Measured on a ‘per dollar of imports affected’ basis, many of the largest developing countries are now more intensive users of antidumping than the advanced countries (Table 3.3). Although it is often argued that such safeguard instruments are needed to allow countries to pursue trade liberalisation, the country incidence of these actions is biased against other developing countries and imposes substantial costs also on the economies invoking such protection. The behind the border trade agenda A supporting legal and regulatory environment is also important. Elements of the associated behind the border trade agenda include policies and institutions that support the ability of national firms to compete internationally. Meeting international standards for quality, health and safety is increasingly a precondition for contesting international markets. Many low-income countries are not adequately equipped to deal with rapidly tightening product standards and labelling requirements, and may confront major

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investment requirements to do so. The same is true of services. Reducing the cost of services that affect trade may be a precondition for benefiting from trade liberalisation. Services are activities where there is often need for some type of regulation to address market failures or achieve social (non-economic) objectives. Many

Table 3.3 Major developing country users of antidumping, 1995–2002 Country/economy Antidumping Initiations initiating initiations per US dollar of imports Index (US=100) Argentina 176 2,549 South Africa 157 2,006 India 273 2,197 Brazil 98 580 Indonesia 39 90 Mexico 56 144 Korea 48 126 Malaysia 22 106 Source: World Bank staff, based on notifications to the WTO.

of the ‘backbone’ services that are critical to development—transport, energy, telecoms, finance—increasingly have become industries where network externalities are important. Regulation to ensure that markets are contestable needs to focus not only on traditional types of entry barriers (outright bans, licensing, etc.) but on the ability to connect to the network at a reasonable price, apply the relevant technologies, and so on. Designing and enforcing policies to achieve this is not trivial. In many cases, regulatory thinking and economic analysis is still evolving rapidly when it comes to network industries, and technological developments may make specific types of interventions redundant or counterproductive. Initiatives to modernise and strengthen private and public service institutions that support trade—access to credit, assessment systems for product standards—and to enhance access to key services inputs (transport, telecoms, finance, etc.) should be pursued in the context of an overall national strategic framework that identifies where the payoff to reform and public investment is largest. In many cases greater competition (contestability of markets) will be an effective mechanism to reduce prices and increase the variety of goods and services. But a necessary condition for such effects to materialise is that firms and workers are able (have the incentive) to enter into and exit out of specific activities. Trade (and trade liberalisation) may do little to stimulate growth in economies with excessive regulation. A recent study by Bolaky and Freund (2004) illustrates this: they find that increased openness to trade is positively correlated with income across all countries (Figure 3.1), but that it is associated with a lower standard of living in heavily regulated economies (Figure 3.2).1 Excessive regulations reduce

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incomes because resources are prevented from moving to the most productive sectors/firms following liberalisation. Once the impact of trade on growth in more regulated economies is controlled for, the evidence that trade positively affects growth is stronger than what has been found in previous studies. While cross-country regression analysis of this type is always subject to caveats regarding the direction of causality and problems of endogeneity, these findings are consistent with a large body of micro-econometric country studies that find that entry and exit of firms (turnover rates) is a key determinant for positive productivity effects of trade openness (see, e.g., the studies in Roberts and Tybout 1997). The policy conclusion suggested by this work is that trade liberalisation needs to be complemented by measures to facilitate reallocation of factors of production, in particular policies to promote domestic competition and labour market flexibility. Before turning to the question of the issues that may be best allocated to trade agreements and the appropriate design and coverage of such agreements from a national policy viewpoint, it is useful to discuss the other role of trade agreements: as mechanisms to address terms-of-trade externalities.

Figure 3.1 Income and openness, all countries

Source: Bolaky and Freund (2004).

Figure 3.2 Income and openness, onethird most regulated countries

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Source: Bolaky and Freund (2004).

TERMS OF TRADE EXTERNALITIES: THE MARKET ACCESS AGENDA As has been emphasised in recent research (World Bank 2003), there is still a large traditional market access agenda that confronts developing countries. Policies in trading partners—both high-income and other developing countries—continue to impose negative externalities. This is particularly true of OECD agricultural policies. Given that agriculture still accounts for 20+ per cent of output and employment in many developing countries, and the fact that most poverty is rural, improving the agricultural terms of trade is critical for development. This is also important for political reasons—absent agricultural reform in the North, the relevance (credibility) of the WTO for many developing countries is limited, and the ability of policymakers in developing countries to implement own reforms reduced. Agriculture The inclusion of agricultural policy disciplines in the Uruguay Round has justifiably been hailed as a major achievement. However, the commitments that were made—the ban on quantitative restrictions, the resulting tariffication of border protection in this sector, the minimum market access commitments implemented through tariff-rate quotas (TRQs), the agreement to lower export subsidies and reduce the aggregate measure of support (AMS)—did not do much to lower agricultural protection. The effective level of protection diminished little. Total net transfers from consumers and taxpayers to farmers in OECD countries equalled 76 per cent of the farm gross value added in 1986–88; in

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2000, after implementation of all Uruguay Round commitments, they still amounted to 62 per cent of gross value added. Although the producer nominal protection coefficient (the ratio of prices received by producers to the border price) fell from 58 per cent to 35 per cent between 1986–88 and 1999–2001 in the OECD, the number of active farmers declined over this period as well. As a result, support per farmer has continued to rise in many OECD countries—by 31 per cent in the United States and 60 per cent in the European Union (Anderson 2003; Messerlin 2002). Highly distorting agricultural support policies in many OECD countries have major implications for developing countries, including LDCs. Indeed, 18 per cent of LDC exports on average comprise goods that are subsidised in at least one WTO member, compared to 3–4 per cent for other countries (Table 3.4). A similar observation holds for imports—9 per cent of LDC imports involve products that are subsidised, compared to 3– 4 per cent for other countries. Numerous analyses have documented the detrimental effects of OECD policies on developing countries. For example, OECD protection rates for sugar are frequently above 200 per cent (Mitchell 2003), and producers receive more than double the world market price. OECD support to sugar producers of US$6.4 billion per year roughly equals the total value of developing country sugar exports. US subsidies to cotton growers totalled US$3.9 billion in 2002; three times US foreign aid to Africa. These subsidies depress world cotton prices by some 10 per cent. In West Africa, where cotton is a critical cash crop for many small farmers, annual income losses for cotton growers are about US$250 million a year (Baffes 2003).

Table 3.4 Trade shares of products affected by agricultural subsidies (1995–98 average; per cent) Country

Domestic support Export subsidies Exports Imports Exports Imports

All countries (143) 3.6 3.7 Industrial countries 3.1 3.3 (23) Developing countries 4.2 4.2 (90) Least developed 17.8 8.9 countries (30) Source: Hoekman, Ng and Olarreaga (2004).

4.4 4.0

4.4 3.9

5.0

5.0

16.7

13.1

Although most attention has been put on subsidies, reducing border barriers is critical. Hoekman, Ng and Olarreaga (2004) find that a 50 per cent global tariff cut will have a much greater positive effect on the exports and welfare of developing countries than a 50 per cent cut in subsidies, even if the analysis is limited to the set of commodities that are currently subsidised by at least one WTO member. The reason for this is that tariffs are often very high for subsidised products, frequently taking the form of non-transparent specific duties. While minimum market access commitments negotiated during the Uruguay Round—implemented through TRQs—ensure some access, in many cases the TRQs are small, and the effect of the tariffs is to support high domestic price levels. This does not imply that domestic subsidy policies are unimportant. Continued largescale support for OECD farmers reduces the gains from own liberalisation in developing

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countries. What is called for here is decoupling of support from production to reduce the incentive to produce more and attenuate the impact of subsidy policies on world prices. Substantial reform of OECD agricultural support policies is not just important for developing countries in its own right—in that it generates direct benefits for the many economies that are (potential) net exporters—but is critical from a political economy perspective. OECD subsidy reforms are necessary to provide developing countries the political ‘space’ to permit own liberalisation.2 Manufactures: textiles and clothing and contingent protection Trade policies affecting developing country exports of non-agricultural products are generally more liberal than for agricultural products. For the majority of products MFN tariffs are very low. The exceptions pertain to certain labour-intensive sectors such as footwear and textiles and clothing where import duties are much higher—with tariff peaks that average 16–17 per cent in Canada, Japan and the United States3 and significant tariff escalation posing an impediment to poorer countries moving up the value chain. The textiles and clothing sector has also been ridden with quantitative restrictions on trade in recent decades. The 1995 WTO Agreement on Textiles and Clothing requires the abolition of all textile quotas by 1 January 2005. A challenge that will likely confront efficient exporters after that date will be to deal with the threat of contingent protection (safeguards and, especially, antidumping). Antidumping is a frequently used instrument in industrialised countries against both labour-intensive manufactures exported by developing countries as well as more capital-intensive industries in which developing countries have built a comparative advantage (e.g., chemicals and steel). These instruments are also used to manage imports of agricultural products—examples include imports of catfish and shrimp in the United States—but are mostly limited to manufactures. During the second half of the 1990s major developing countries such as Argentina, India and South Africa also began to use antidumping intensively. As mentioned, the intensity of antidumping in these countries is much higher than in developed countries: a higher proportion of their total imports tends to be affected (Table 3.3 and Finger 2002). The existence of antidumping creates substantial uncertainty regarding the conditions of market access facing exporters. Investigations have a dampening effect on imports (they are a signal to importers to diversify away from targeted suppliers). This has been of longstanding concern to East Asian countries in particular, especially China and Japan. The former now confronts the highest incidence of investigations and the highest average level of duties in the United States (Table 3.5).4 A similar conclusion applies to the other Quad members. Thus, China is also the most targeted country in EU antidumping cases, accounting for some 20 per cent of all investigations in recent years, with average duties of 40 per cent and in specific cases ranging to over 100 per cent (Liu and VandenBussche 2003). Services In contrast to tariffs, services trade and investment restrictions generally do not generate revenue for the government. Instead, they tend to raise costs

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Table 3.5 Average tariffs in final US antidumping duty determinations (per cent) Total

Developing Developed countries countries Lower Upper China Japan Other income income

1979–98 46 53 1989–98 58 66 only Source: Bown et al. (2003).

30 36

95 116

60 74

31 34

for users, imposing a ‘tax’ on the whole economy, as well as on excluded (or taxed) foreign suppliers.5 An implication is that much of the services agenda is a national one (i.e., identification of good policies). However, there is also an increasingly important ‘terms of trade’ agenda, involving both cross-border trade (one of the most dynamic types of trade in recent years), foreign direct investment (FDI) and the temporary movement of service suppliers (modes 1, 3 and 4 as classified in the General Agreement on Trade in Services).6 Research suggests that the potential gains to developing countries of a relatively small increase in access for mode 4 provision in OECD markets—equivalent to 3 per cent of the labour force—would be substantially greater than what could be realised through complete liberalisation of merchandise trade (Walmsley and Winters 2003). Developing countries also have a strong interest in locking in the liberal policies that currently are applied by most countries for mode 1 (cross-border trade)—the primary vehicle for outsourcing of business processing and other labour-intensive services (Mattoo 2002). Moving forward What can international cooperation (especially trade agreements) do to support both the national objectives (good policy) and the global (market access) agenda sketched out above? What follows discusses the potential and actual performance of PTAs and the WTO, and then returns to the larger question of the ‘comparative advantage’ of these institutions and possible complementary vehicles for international cooperation.

DISCRIMINATION: PREFERENTIAL TRADE There are two types of preferential trading arrangements that are of relevance to developing countries: non-reciprocal market access concessions (preferences) and reciprocal trade agreements. By their nature both discriminate against non-partner economies.

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Preferences Unilateral trade preferences granted by developed countries to developing countries have been an element of the trading system for centuries. Examples were the so-called Imperial preferences maintained by Great Britain for trade with its colonies and dependencies, the Generalised System of Preferences (GSP) established under UNCTAD auspices in the 1960s, and more recently, initiatives such as the EU Everything But Arms (EBA) program for LDCs and the US African Growth and Opportunity Act (AGOA). Much of the economic literature concludes that preferences do little good (World Bank 2003). Reasons for this include: • Countries benefiting from preferential access are subject to rules of origin. These may be so strict that countries are forced to pay the MFN tariff because they cannot satisfy the requirements. Research reveals that utilisation rates are often much less than 100 per cent (Brenton 2003; Inama 2002). • Coverage is often restricted. Goods in which developing countries have a comparative advantage often have the highest tariffs, and preferences for these products are frequently limited (Hoekman, Ng and Olarreaga 2002). • Preferences are uncertain and are subject to unilateral change or withdrawal and to nontrade conditionality (labour rights, environmental requirements, etc.). • Preferences can give rise to serious trade diversion as the set of goods that beneficiary developing countries produce and trade will tend to overlap with other developing countries that are not beneficiaries. • Even in cases where preferences have value—that is, they apply to highly protected sectors in donor countries and thus generate rents—in practice these rents will not accrue completely to the recipient country. Instead, a share of the rents, perhaps most of them, will be captured by importers, distributors and retailers (Olarreaga and Ozden 2004). • Preferences may impede own liberalisation by recipient countries by reducing domestic pressure to reduce anti-export bias (Ozden and Reinhardt 2003). • Much of what was summarised above in terms of the market access (externalities) agenda does not get addressed through preferences—examples are antidumping, access to services markets and agricultural subsidies. The best approach from a global welfare perspective is non-discriminatory abolition of trade barriers on goods and services of export interest to all developing countries. However, initiatives in the late 1990s—such as the AGOA and EBA initiatives— substantially deepened preferences for beneficiary countries that can satisfy eligibility constraints. At the same time they also raised concerns and resistance on the part of developing countries that were excluded—including East Asian economies. Rather than seek to maintain preference margins, developing countries need to feel convinced that there are greater benefits from (non-discriminatory) market access opportunities. A more appropriate (efficient) mechanism to assist recipients of preferences, and support diversification into new activities, is direct income support targeted at affected farmers and firms and decoupled from past production levels and measures. One way to make the

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implicit promises associated with preference programs explicit is to quantify the theoretical value of the preferential access (i.e., the difference between world and importing-country domestic prices times the domestic production of the beneficiary economy) and to transfer this to the government of the country concerned. This would have the advantage of ignoring factors such as rules of origin and market power of buyers in importing countries that substantially reduce the actual value of preference programs, while removing the bias against non-preferred developing countries. Preferential trading arrangements (PTAs) The growth of reciprocal preferential trading arrangements has been significant in recent years. Virtually all countries, both developed and developing, are now members of one or more agreements. Such discrimination can be costly. By reducing trade barriers for a subset of partners, countries generally increase the real cost of their imports, reduce the flow of technology from non-member countries and increase dependence on particular export markets. They may also make it more difficult to reduce barriers against non-preferred imports in the future. If so, PTA membership can hinder development. Trade diversion caused by PTAs may worsen excluded countries’ terms of trade as non-member suppliers become less competitive because they continue to pay tariffs while competing producers from member countries do not. Where there are economies of scale, regional integration may help lower member firms’ costs by expanding their ‘home’ market. Chang and Winters (2002) show that prices of exports to Brazil by non-members fell after MERCOSUR was formed. PTAs may also have a negative impact on investment in excluded countries, if investors interested in selling to the integrated market shift to a member country to avoid tariff barriers. One motivation underlying the increase in regional integration efforts is a desire to push the WTO toward faster and deeper action in selected areas, through demonstration effects (PTAs as ‘laboratories’) and by creating larger and more powerful blocs that operate within the WTO system to increase the support for movement in a desired direction.7 Regionalism driven by such motivations may not be beneficial for the world as a whole. The same is true of PTAs that are driven by a desire to obtain more secure access to major markets, or by a fear of being left out while the rest of the world signs PTAs. This is something that should be provided by the WTO—insofar as this is a major motivation for PTAs it is a symptom of a failure of the WTO to perform its function. A proliferation of PTAs motivated by discriminatory or insurance objectives can only be detrimental to the majority of developing countries that will be left out of PTAs for political or other reasons. Recent PTAs tend to be more open than earlier examples, many of which were designed to implement import-substitution strategies at the regional level. They also increasingly involve North-South cooperation. Research suggests that this is less likely to be welfare reducing for developing countries than South-South agreements (World Bank 2000), in part because under the latter, prices are more likely to continue to equal world prices plus the external tariff, precluding trade creation. Similarities in production and trade patterns among low-income countries make it harder to exploit economies of scale, while benefits from deeper integration may be greater owing to the access to markets in

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developed countries.8 As high-income economies are knowledge rich, they also provide greater access to technology than poorer trading partners, helping increase dynamic gains (Schiff et al. 2002). North-South integration may also provide Southern partners with an instrument to improve credibility with respect to their economic policies, and this may attract more FDI. Francois (1997) argues that NAFTA had such an impact for Mexico. However, a developing country is only likely to gain credibility if the agreement has an effective enforcement mechanism. In practice, this is likely to require that developing country members are sufficiently important for the Northern partner to monitor behaviour and take action if the agreement is not implemented. This is less likely for small countries that are geographically distant from the European Union or the United States. Most important for credibility are a country’s own policies—a PTA can be a useful ‘signalling’ device, but most of what will be needed requires unilateral actions relating to the investment climate broadly defined. Engaging in PTA negotiations can help reform-minded governments address microeconomic policy issues that otherwise are difficult to deal with. Indeed, this is an important precondition for maximising the potential benefits of engaging in PTA discussions.9 Many of the issues that have proven divisive in the WTO, such as investment or competition policies, are on the table in the new-vintage PTAs that the United States and the European Union are seeking to negotiate with developing countries: examples are the US-Central America Free Trade Agreement (CAFTA) and the European Union’s ongoing effort to negotiate Economic Partnership Agreements with African, Caribbean and Pacific (ACP) countries. This raises a serious potential concern insofar as these countries perceive disciplines in such areas as not being in their interest, but necessary to (continue to) obtain the benefit of preferential access to Northern markets. As far as developing country members of deeper PTAs are concerned, much depends on the coverage of agreements and in particular whether the regulatory disciplines for behind the border policies are appropriate in the sense that the benefits outweigh the costs of implementation. What does appear to be clear is that the quid pro quo being offered by the United States and European Union is not a willingness to reform agricultural support policies or remove antidumping threats.10 That said, there is a prima facie case that regional cooperation on regulatory issues may be more beneficial than a one-size-fits-all approach at the global (WTO) level. Partners may be more similar and have common legal or administrative systems. Regional agreements may also offer greater scope for differentiation by country by providing greater space for mutual recognition of standards, as there is likely to be greater mutual trust in enforcement than what prevails in a multilateral context. Enforcement mechanisms in PTAs on behind the border issues may be more flexible as well and allow greater scope for negotiation and information exchange. There may also be greater tolerance for ‘slippage’ because of the relationship between partner countries. Thus, there is often greater reliance on national enforcement mechanisms as opposed to WTO-type, binding dispute settlement processes that are linked ultimately to trade sanctions. Finally, North-South PTAs tend to be associated with transfers of finance and knowledge (technical assistance), helping to reduce implementation and adjustment costs. PTAs often allow a greater emphasis and focus to be put on mitigating losses from trade and related reforms for poorer member countries and assisting firms and households

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adapt to changed policies. High-income partners may also provide offers of assistance in the form of implicit ‘insurance’ as in the case of US financial intervention to assist Mexico during the ‘tequila crisis’. This is something that is lacking in the WTO context. All this may do much to explain why some PTAs involving countries that objected to the inclusion of issues such as investment and competition in the WTO, not to speak of even more controversial subjects such as labour and environmental norms, may include disciplines in these areas at the regional level. However, using PTAs as a framework for reducing the frictional costs of trade by harmonising regulations and standards, increasing the credibility of reform initiatives or acting as vehicles for governments to test the waters of freer trade is complex. In practice the extent of deep integration in PTAs is often limited, and is premised much more on mechanisms to encourage cooperation through dialogue and regular interaction of stakeholders than on binding rules that are strictly enforced through formal dispute settlement mechanisms. Given that PTAs differ greatly in content and coverage, the determination of the net effect on members requires a case-by-case assessment. It is likely that PTAs will tend to be welfare reducing for the world as a whole (compared with a non-discriminatory counterfactual) (Winters 2000). Many countries, especially those with the largest number of poor people, will not have access to major PTAs and will confront discrimination. Clearly, the less trade diversion occurs, the less cause for concern. On this front empirical work to date suggests complacence is inappropriate. Recent analysis by Dee and Gali (2003) concludes that most PTAs do not create additional trade, and that the majority of PTAs in a sample of sixteen caused net trade diversion, including major PTAs such as NAFTA, the European Union and MERCOSUR.

MARKET ACCESS, RULES AND ENFORCEMENT The PTAs that the United States and European Union strike up with interested developing countries may have benefits for the countries concerned, but have negative systemic effects. Aside from the discrimination that they give rise to, they will not do much, if anything, to address a number of the key remaining market access priorities for developing countries: trade-distorting agricultural support in the North, contingent protection, keeping cross-border trade in services open and liberalisation of the temporary movement of service suppliers. Most developing countries are simply too small to have the leverage to induce significant concessions by the major players in the PTA context. These are all issues that are better addressed through the WTO. From a global povertyreduction perspective, it is these issues that can have the greatest beneficial impact, suggesting a strong case for WTO members to move back to basics and focus first and foremost on improving market access—in both OECD and developing countries. As far as regulatory cooperation is concerned, what matters is getting the rules right so that all members benefit from whatever disciplines are agreed. Progress on both fronts can be facilitated by a recast approach to SDT and moves to a more voluntary approach toward cooperation on the deep integration agenda.

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Back to basics: market access There is a strong presumption that MFN is first best from a global perspective. The same is true for the removal of production-distorting subsidies, where reforms almost invariably have to be applied on a non-discriminatory basis. Market access is critical in creating the incentives to use trade as a vehicle for poverty-reducing growth, and is an area where much remains to be done. This agenda spans both industrialised nations and developing countries, and includes goods and services. Most of the potential gains from market opening are generated by domestic reforms. But action abroad is critical as well to support the growth prospects of developing countries. Liberalisation by OECD countries will have a direct beneficial effect, but the indirect effect may be even more important, in that it would remove situations where unilateral reform is impeded by the desire to keep negotiating chips for the reciprocity game in Geneva. However misconceived this is, it has arguably become a factor constraining the adoption of better policies. Elimination of industrial tariffs by OECD countries before a specific date, a major reduction in agricultural tariff peaks and escalation, a deadline for phasing out all export subsidies, decoupling agricultural subsidies from production, and a significant expansion of service sector commitments, including mode 4 service supply opportunities on a nondiscriminatory basis, would do much to eliminate the ‘development credibility’ deficit of the WTO. The challenge is how to get from here to there, especially in light of the proliferation in PTAs and recent deepening of non-reciprocal trade preference programs for LDCs. The reciprocity dynamics of the WTO require that developing countries offer enough to induce OECD governments to take on the interest groups that benefit from remaining protection. Developing countries can bring much to the table as regards market access. Reciprocity by developing countries is needed and desirable. Currently, in part because of the negotiating position taken by many developing countries, interest groups that should be supporting the WTO process are not. Service industries, for example, among those with the most at stake in the current round, appear to be investing more lobbying resources to promote PTAs. An important part of the political economy equation is to mobilise support for further trade reforms in developing countries, as this will be needed to induce stakeholders in OECD countries to mobilise the pressure needed to liberalise trade further, especially in agriculture. Whether developing countries can offer ‘enough’ is very much an open question, but it is a necessary condition for making progress. In addition to focusing centrally on market access barriers, the WTO negotiating agenda could include three other principles (Hoekman and Olarreaga 2003). First, increase the transparency of trade policy. For example, OECD countries are frequent users of specific or compound tariffs. These are less transparent in terms of protective effects—they often imply very high ad-valorem equivalents—and impose a heavier burden on exporters from developing countries because they tend to produce lowerquality (cheaper) products. A ban on specific tariffs would therefore be a desirable outcome.11 The same is true for tariff bindings. The levels at which tariff lines are bound are not easily accessible to non-government entities, including the private sector, civil society and researchers.12 Second, increase the predictability of trade policy by reducing uncertainty over the conditions of market access (e.g., through stronger rules for the use

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of contingent protection) and greater uniformity in the structure of protection (e.g., by eliminating tariff peaks).13 Third, and most important, establish targets for outcomes. Agreement on explicit end or focal points would help ensure that the outcome of global trade talks will be beneficial to all WTO members. The traditional approach of focusing on negotiating modalities and average reductions of x per cent in specific types of barriers could usefully be supplemented (indeed, supplanted) by agreement on end points. Given that the average OECD rates of protection for manufactures are already low, a good focal point here would be the complete elimination of tariffs by these countries by 2015—the target date for the achievement of the Millennium Development Goals. Similarly, a target should be set for the maximum level of protection in developing countries—say no more than 10 per cent by 2015. Such an approach would also simplify the negotiating process.14 Rule-making: minimum standards for core disciplines vs deep harmonisation Under the single undertaking rule, all countries desiring to join the new WTO in 1995 were forced to accept a variety of disciplines in areas ranging from customs valuation to subsidies, all of which had been developed by industrialised nations on a plurilateral basis in the past. Although it was recognised that certain agreements—most notably the TradeRelated Aspects of Intellectual Property Rights (TRIPS) agreement—were not necessarily in the interest of low-income countries and would certainly give rise to medium-run costs, many argued that this was more than offset by the inclusion of agriculture, the commitment to phase out the Multifibre Arrangement (MFA), and the creation of the WTO—an organisation with a stronger dispute settlement mechanism that would permit small countries to more effectively defend their rights (Hoekman and Kostecki 2001). The current Doha Round of trade talks is formally called the Doha Development Agenda. A major reason for this was a perception that the Uruguay Round was unbalanced. A key question is what policy disciplines are (would be) most beneficial to developing countries. It is useful here to distinguish trade policy from other policies. Trade policy The overwhelming tendency of the literature is that the case for using traditional trade policy instruments such as tariffs, quotas and quota-like policies such as trade-related investment measures to achieve economic development objectives is weak.15 Government interventions are justified where there are market distortions, but in most circumstances these should be addressed through interventions that directly target them. Trade policy will rarely do so. Even if trade policies are used, there is a clear efficiency ranking of trade policy instruments, with quotas and quota-like instruments being particularly costly. WTO rules that impose disciplines on the use of such instruments will benefit consumers and enhance welfare in developing countries. Similarly, there are benefits associated with binding tariffs—not least of which is that this is a negotiating coin in trade rounds—and abiding by WTO rules and criteria for taking actions against imports that are deemed to injure a domestic industry.

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Thus, a good case can be made for the core trade policy rules of the WTO to apply to all countries, developed and developing. Such core rules arguably span MFN, national treatment, the ban on the use of quantitative restrictions, and binding tariffs. These should apply to all members. Currently they do not, in part because of specific provisions in the GATT (e.g., Article XVIII) and in part because of the enabling clause (which, e.g., provides much greater leeway for developing countries to discriminate in favour of each other in the context of PTAs and allows for limited reciprocity in terms of binding tariffs).16 This does not make much economic sense, and has come at a cost in terms of reducing the perceived value of what developing countries can bring to the negotiating table. This is not to deny that weak institutional capacity and severe market imperfections combined with a lack of financial resources may require that developing countries pursue second-best trade policies. However, existing WTO provisions—safeguards, waivers and renegotiation of concessions—already provide ample scope to do so. Regulatory behind the border policies Most developing countries are latecomers to the multilateral trading system—a fact that explains why many present WTO rules predominantly reflect the status quo disciplines that apply in rich countries. Thus, the much greater latitude that exists in the WTO for the use of agricultural subsidisation, for example, reflects the use of such support policies in many developed countries.17 Similarly, the TRIPS agreement’s rules on intellectual property protection largely reflected the prevailing status quo in OECD members. To date, the TRIPS agreement has been the most far-reaching example of multilateral disciplines on the use of a domestic policy. This has proven controversial and has strengthened perceptions in many developing countries that the WTO contract is unbalanced. At the 1996 WTO Ministerial Conference in Singapore a number of additional domestic regulatory issues were put forward for possible inclusion in the WTO—including competition policy, investment policy and government procurement (the Singapore issues). In contrast to market access, demands for regulatory harmonisation may entail a zero- or negative-sum bargain (costs exceed benefits) for individual countries. If so, the only way to make the outcome welfare improving is to embed it in a larger negotiating framework where trade-offs are possible.18 Indeed, an argument for the inclusion of disciplines in such areas is that it may mobilise (political) support for concessions in areas such as agriculture. The 2003 Cancun WTO Ministerial Conference illustrated that seeking to expand the negotiating set by adding behind the border issues can be counterproductive. This strategy proved highly divisive, with poor countries in particular concerned that new multilateral rules might not be in their interest, would do little to promote progress on key market access issues and could give rise to major implementation burdens. At the end of the day, the case to launch negotiations on either economic (development) or tactical issue-linkage (negotiating) grounds was not seen to be compelling enough. Indeed, the presence of the Singapore issues arguably allowed intransigents to block progress on subjects of much greater immediate importance for developing countries. While it appears that these issues have been taken off the Doha table, calls for deeper integration will continue, ranging from coordinated application of national policies to the harmonisation of regulatory regimes. As mentioned, this is a major dimension of many

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PTA negotiations. From a development perspective what matters is getting the rules right and determining what venue or type of cooperation is appropriate, if any. This requires evaluating and understanding the implications of alternative rules and the comparative advantage of different types of institutions. This is not straightforward, especially when it comes to regulatory policies. Deliberations in trade negotiations (WTO or PTAs) often are not informed by economic analysis or a good understanding of the costs and benefits of specific proposals or rules, or how these costs and benefits are distributed across or within countries. The required engagement by stakeholders and economic analysis of the implications of proposed rules at the national level is frequently lacking. Given the resource and skill constraints that prevail in many developing countries, even if countries consider a set of (proposed) rules to be in their interest, there may be more urgent priorities for investment of scarce administrative and financial resources. This suggests both a need for more information on what makes sense and a need for differentiation among developing countries in determining the reach of negotiated rules. The need for this is greatest for resource-intensive disciplines; that is, those that require significant complementary legal, administrative and institutional investments or capacity to implement; and for rules that will potentially give rise to large net transfers from lowincome developing countries (e.g., the TRIPS agreement). The basic rationale for differentiation is that certain agreements or rules simply may not be immediate development priorities and/or require that other preconditions be satisfied for implementation to be beneficial. These preconditions can be proxied by the attainment of a minimum level of per capita income, institutional capacity, or economic scale.19 Several options have been proposed to take into account and operationalise country differences in trade agreements. They include:20 • Adopting a ‘rule of thumb’ that makes a group of countries eligible to opt out of provisions that entail substantial implementation costs until such time as they have passed certain development-related benchmarks or eligibility criteria. • An agreement-specific approach involving country-based criteria applied on an agreement-by-agreement basis to determine whether (when) agreements should be implemented. This could be linked to the provision of technical assistance and development of a national action plan for ultimately assuming the obligations concerned. • A country-based approach that places trade reform priorities in the context of national development plans, and relies on surveillance and monitoring to establish a mechanism under which countries are assisted in gradually adopting the norms concerned as part of a more general program of trade-related reforms. A common feature of these options is that they entail more narrowly defined eligibility for temporary exemptions from what are in principle binding rules and devote much more attention to determining the economic costs and benefits of implementation of these rules. None of the options will be easy to operationalise. Country classification inevitably creates tensions among governments as to which countries would be counted in and which out. What constitutes ‘resource intensive’, for example, and the extent to which specific agreements will give rise to large implementation costs are questions that will require analysis, both general and country specific. Countries or analysts may disagree about the magnitude of assessed costs and benefits. Determining criteria that could be

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used in the implementation context will require input from stakeholders, government agencies and development institutions. Voluntary cooperation as an alternative: the ‘Pacific model’ In some areas that are resource intensive in the sense used above, it is an open question whether it is appropriate (efficient, effective) to apply a model of binding disciplines enforced through the threat of trade sanctions. A necessary condition for this to be appropriate is a good understanding of the associated costs and benefits of the specific disciplines concerned. The historical norm for international cooperation in many areas has been to establish mechanisms through which countries (stakeholders) engage in a regular exchange of information, consider assessments of their policies in attaining stated objectives and identify the external effects of their policies on other countries. Examples of specialised institutions that have been created to address specific issues abound—the International Labour Organisation, the International Telecommunications Union, the Organisation for Economic Cooperation and Development, and so on. Sabel and Reddy (2002) provide a conceptual sketch of such a general ‘learning to learn’ framework that could be applied to trade agreements.21 This is an approach that can rely on peer review and information sharing, applied to specific policy areas such as trade facilitation and the provision of technical assistance. It is a form of cooperation that has been pursued in both a plurilateral (regional) context and multilaterally. The approach taken by the Bank for International Settlements (BIS) on financial regulatory standards or the World Customs Organisation (WCO) on customs procedures are additional multilateral examples. These bodies develop consensus standards on technical issues that members agree constitute good practice but participation and implementation is left to individual decisions by countries. There is generally limited scope for or efforts to make implementation mandatory, and in most cases no mechanism to enforce norms through binding dispute settlement. APEC is the major example in the Pacific region of a voluntary body that deals with a wide variety of trade-related policy issues, ranging from trade facilitation to competition policies. Often, informal cooperation is issue specific: the Global Competition Forum that operates under OECD auspices is an example. The forum brings together competition law enforcement officials from OECD and non-OECD countries to share information and technical assistance. Practitioners engage in a cooperative effort to improve national policies and converge, where appropriate, on common standards that are applied on a voluntary basis. The upsides and downsides of such voluntary cooperation are well known. The APEC experience has been the subject of comprehensive analysis, as have many of the other institutions that have developed over time, both formal and informal. While much can be done to improve standards and to identify options to reduce transaction costs and negative externalities, the pace with which countries adopt policies that conform to recommended principles will vary. The ‘learning’ or ‘focal point’ models that underlie voluntary cooperation help ensure that when implemented, policy changes have national ownership—there are constituencies that support adoption or changes in existing practices. The downside of such voluntary cooperation is that insofar as there is political economy resistance to adopting national welfare-enhancing reforms, it may not happen.

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The same is true of policies that create negative externalities—the incentives for countries to take the interests of partner countries into account will be weak. A consequence of this is that it is difficult to develop general principles regarding what type of cooperation should be pursued where, beyond the rules of thumb noted earlier: (1) market access issues are best pursued in the WTO; (2) a necessary condition for binding disciplines on domestic policies—be they in the WTO or in PTAs—is that all signatories have a clear understanding of the costs and benefits associated with implementation—both in terms of own domestic objectives and outcomes and in terms of addressing possible international externalities associated with domestic policies; and (3) any trade agreements that include deeper integration measures need to consider disparities in capacity and differences in policy reform and public investment priorities. While negotiation of binding rules enforced through the threat of trade sanctions ultimately may be the best way to strengthen domestic policies, a more deliberate sequencing of cooperation that starts with introducing some of the elements of a voluntary approach may be the best way forward. This could be done by delinking cooperation on new (‘behind the border’) issues in the context of a trade agreement (WTO or PTA) from trade-based enforcement mechanisms until such time as all members perceive such a linkage to be beneficial. Pursuit of such an approach could help make both the WTO and PTAs more supportive of economic development. It would do so by enhancing the ‘ownership’ of proposed rules, while at the same time recognising that a major rationale for embedding binding disciplines in trade agreements is to address either domestic credibility-cum-commitment problems or terms-of-trade externalities. Note that this is somewhat akin to the GATT of 1947, where the decision of whether to sign on to new rules was left to individual contracting parties to determine, but differs in that the mode of cooperation would (initially and, perhaps, long term) be non-binding even for participants. Insofar as national policies impose serious negative externalities on other countries, a voluntary approach will deliver limited returns. However, in many instances the terms-oftrade externalities associated with a policy domain will be limited due to the small size of developing countries—so that the primary rationale for them to engage in international cooperation will be national: improving domestic policies and performance. Even if this is not the case, a voluntary approach to specific issues that includes explicit analysis and assessment of policies will help generate information on the size and distribution of the costs and benefits of the status quo, as well as the likely net payoffs of reform. This in itself may help change a given political economy equilibrium. It should also reduce the uncertainty regarding the possible repercussions of a subsequent engagement to negotiate binding commitments in a given policy domain. The foregoing suggests one additional general principle. Information and analysis are important inputs into a well-functioning trading order. Greater monitoring and assessment of the impacts of policies would allow more informed and proactive engagement by civil society (think tanks, non-governmental organisations, consumers and taxpayers) in the policy formation and negotiation process. Progress has been made in the WTO in terms of surveillance and collection of basic data on trade policy, but little has been done to estimate the magnitude and incidence of costs of protection. Moreover, as mentioned, information on the basic building blocks of the WTO such as bindings of tariff-line levels are still not readily accessible to non-governmental actors. It is a truism

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that to reduce protection and protectionist pressures those that lose (pay) need to be aware of the costs of such policies. The suppliers of, and the clients for, such analysis and information are not necessarily governments, but the constituencies in individual countries who are affected by policy. In order for trade agreements to promote good policymaking in member countries, stakeholders must be able to be active in the domestic policy formation process. Strengthening information exchange and mutual (multilateral) dialogue, including through establishment of formal monitoring mechanisms, could be beneficial in facilitating cooperation on new, regulatory issues. If more is done to determine on an objective basis the effects of prevailing policies in achieving stated national objectives, countries (stakeholders) can assess their efficacy and efficiency and, if needed, adjust them. Greater analysis of the effects of discrimination in trade—both unilateral preferences and PTAs—should be part of this agenda. Regular monitoring and assessments of the implementation and economic effects of PTAs would help identify detrimental effects on non-members and possible issues for negotiation in WTO rounds. Such analysis could be taken up in organisations such as the WTO, as well as research organisations and networks of think tanks and researchers (e.g., the Global Development Network). Beyond access: trade capacity and technical assistance A major constraint limiting export growth in many LDCs and other small and lowincome countries is a lack of supply capacity and a high-cost business environment. Firms in these countries may also find it difficult to deal with regulatory requirements that apply in export markets. In the literature a useful distinction is made between market access (trade policy) and market entry. The latter pertains to the ability of firms to make effective use of (benefit from) market access opportunities. Health and safety standards, for example, are frequent regulatory barriers to entry, as standards can be excessively strict and compliance costly, weighing disproportionately on producers in low-income countries. Development assistance can play an important role in helping to build the institutional and trade capacity needed to benefit from increased trade and better access to markets. This assistance must go beyond the implementation of narrowly defined trade agreements and focus on supply capacity more broadly, as well as addressing adjustment costs associated with reforms. Although greater attention has recently been given to expanding programs that provide aid for trade, a precondition for effective claims for greater assistance is that trade issues are integrated into a nation’s overall development priorities. While priorities will differ, in many cases assistance will be needed to address traderelated policy and public investment priorities, as well as to help adapt to a reduction in trade preferences and deal with the potential detrimental effects of a significant increase in world food prices should these materialise following further non-discriminatory trade liberalisation. The development community made commitments to this effect at the International Conference on Financing for Development in Monterrey in March 2002— what is needed is an equally clear articulation of trade-related requests by developing countries.22

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CONCLUSION The international order comprises many forms of international cooperation on traderelated policies. At times the existing institutions are complementary, but they are also often competing. In itself this is not necessarily bad, as it allows a process of discovery in terms of which arrangements are most effective. The relative comparative advantages of different types of institutions for international cooperation do differ, however, and a case can be made that greater coherence between the alternatives would be beneficial to developing countries. For example, it is noteworthy that the strong resistance of many low-income countries to the inclusion of the Singapore issues in the WTO is accompanied by sometimes substantially stronger disciplines on similar issues being included in North-South PTAs. It is not clear that these disciplines are seen as beneficial by developing country signatories as opposed to being regarded as the price that needs to be paid to guarantee access to US or EU markets. Four ‘rules of thumb’ are suggested by the foregoing analysis: • First, the WTO has a strong comparative advantage in dealing with the market access agenda and trade-distorting policies such as agricultural subsidies and antidumping. The experience to date suggests that PTAs will not deliver much in these areas to developing country signatories. Moreover, to the extent that they do (and it is certainly the case that at the margin signatories generally obtain some preferential treatment in these areas), they may reduce the pressure for more general, non-discriminatory market access. Thus, the WTO is critical. There is still huge scope for developing countries to trade concessions on tariffs—both applied rates and tariff bindings—and access to services markets. A focused effort centred on market access, complemented by a strengthening of mechanisms aimed at enhancing transparency and predictability of policies, could help realise the development promise of the Doha Round. Whether this will be feasible depends importantly on political economy forces, in particular whether services and manufacturing industries in both OECD and developing countries perceive it to be in their interest to devote the required political lobbying resources to support a meaningful market access agenda. A precondition for this to occur is a change in the perception that much of what is desirable can be obtained through regional agreements. Recent developments (e.g., the resistance on the part of large Latin American countries to negotiate on services in the FTAA context without meaningful negotiations on agriculture) suggest there may be a rising awareness of the limitations of what can be achieved on market access in regional forums. • Second, the acid test for the inclusion of binding disciplines on regulatory issues in trade agreements—WTO or PTAs—is whether benefits outweigh costs. International mechanisms to exchange information on good practices and develop rules of thumb for behind the border, trade-related policies could be very beneficial for developing countries. Greater reliance on a ‘soft law’ approach that establishes broad guidelines and relies on transparency and accountability through regular (multilateral) monitoring of performance may be more effective to increase cooperation by enhancing the feeling of ownership of specific norms. As emphasised by Helleiner (2000), Finger (2002), Rodrik (2002) and Sabel and Reddy (2002), among others, countries need the freedom to experiment with domestic regulatory policies. While detailed international harmonisation through trade agreements is likely to be inappropriate in many

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instances, multilateral norms and disciplines, especially monitoring and information exchange, can help prevent capture and provide information on the effectiveness and impacts of policies. • Third, there are potential positive payoffs associated with embedding deeper integration disciplines (harmonisation, minimum standards) into formal trade agreements (WTO or PTA), especially if this helps to overcome political economy problems that impede the adoption of welfare-improving policies. The same is true of specific policies by foreign countries that impose significant negative externalities. It is not possible to generalise here, except to note that the existence of such rationales needs to be carefully analysed, calling for country-specific assessments. • Finally, insofar as deeper integration is pursued in PTAs, the WTO has a major role to play in defending the MFN principle. Most important is full information, implying a need for more analysis of the effects of PTA-based policy harmonisation on nonmembers, and in particular, the identification and quantification of the incidence of discriminatory implementation of deeper integration. This in turn will help determine where WTO negotiations on rules make sense in reducing externalities caused by PTA-based integration.

NOTES The author thanks Christopher Findlay, Philippa Dee, Wisarn Pupphavesa, Gary Hufbauer and participants in the Twenty-Ninth PAFTAD conference for helpful comments and suggestions. The views expressed are personal and should not be attributed to the World Bank. 1 The study focuses on regulation of new entry (number of procedures, time and cost involved) and labour market restrictions on hiring and layoffs. 2 Maintaining protection may also be an appropriate second-best response to the price-lowering and/or volatility-increasing effects of OECD policies for countries that do not have access to more efficient instruments. 3 The European Union has no tariffs over 15 per cent for textiles and clothing. In the United States and Canada, most tariff peaks affect industrial products (over 85 per cent), whereas in the European Union and Japan most peaks affect agricultural products (91 per cent and 77 per cent, respectively)—Hoekman et al. (2002). 4 Bown et al. (2003) note that the number of cases against developing countries is much higher than their share in US imports. The average duty on developed countries (except Japan) was 31 per cent, compared to 53 per cent for developing countries. Similar conclusions hold for other major users of antidumping. In the case of the United States for 1979–98, the likelihood of an early termination of investigations is much lower for developing countries, especially East Asian economies, 31 per cent for the investigations initiated against developed countries (excluding Japan), as compared to 10 per cent and 7 per cent for lowerincome developing countries and China, respectively. The probability of developed countries being named (26 per cent) is much lower than for China (66 per cent). Antidumping investigations against China (and Japan) are rarely terminated at an intermediate stage. 5 Stern (2002) surveys the literature. 6 Walmsley and Winters (2003) estimate the global gains from allowing temporary entry of both skilled and unskilled labour services equivalent to 3 per cent of the current workforce in OECD countries (16 million people) would be some 1½ times greater than the gains from complete merchandise trade liberalisation.

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7 The available evidence on whether PTAs lead the WTO or vice versa is ambivalent (Hoekman and Kostecki 2001; Schiff and Winters 2003). 8 Deep integration involves measures that increase the competitiveness of member economies with respect to suppliers from the other members. This includes harmonisation or mutual recognition of standards and regulations. 9 Regional cooperation may also be driven by a desire to internalise regional externalities (e.g., management of a shared resource such as water) or to attain economies of scale in regulation or infrastructure. An example would be the creation of common regulatory bodies for network industries such as transport or telecommunications. 10 This is less the case for the US. NAFTA extends to agriculture, as do the agreements with Central America and Chile, albeit with a few exceptions for agricultural commodities that are very ‘sensitive’—sugar in the case of the United States. 11 The same is true of ‘other’ duties and taxes on imports, which are frequently used in developing countries. Indeed, some developing countries have replaced high tariffs by ‘other’ duties and taxes, in the process reversing liberalisation, maintaining high barriers to trade and introducing non-transparency into the trade regime. A ban on the use of additional ‘other’ duties and taxes would also help increase transparency. 12 Thus, although such data have been compiled in electronically readable databases, the relevant organisations involved in this effort (UNCTAD, ITC, WTO) are not permitted to post this data on the Internet. Instead they are restricted to releasing tariff-binding data at the six-digit level of the Harmonised System—not very relevant to the private sector, where the interest is in their specific products, not in an aggregate that covers a number of different products. 13 A simple rule that would move in this direction would be not to allow any WTO member to impose tariffs at the tariff-line level that are larger than three times its average tariff. Predictability would also be enhanced through full binding by all WTO members of their tariff lines. For example, of the forty-one African WTO members, only nine have bound all their manufacturing tariff lines. Fifteen have bound less than 10 per cent of their tariffs. 14 Such approaches have of course been adopted in past negotiations, the Agreement on Textiles and Clothing being an example: all quotas to be eliminated by the end of 2004. 15 For a more extensive discussion, see Hoekman, Michalopoulos and Winters (2004). 16 A major feature of the 1979 enabling clause is that it calls on industrialised countries not to seek reciprocal concessions from developing countries that are ‘inconsistent with their individual development, financial and trade needs’. Overuse of the non-reciprocity clause has, in the past, excluded developing countries from the major source of gains from trade liberalisation—namely the reform of their own policies. Non-reciprocity is also a major reason why tariff peaks today are largely on goods produced in developing countries. 17 The same is true for certain trade policies (e.g., the permissive approach that has historically been taken toward the use of import quotas on textile products—in principle prohibited by GATT rules). 18 There has been a substantial amount of research on the economics of the Singapore issues. This concludes generally that they are all important from a development perspective—all relate to the investment climate—but that doubts can be expressed regarding the appropriateness of dealing with the issues in the WTO (see, e.g., Hoekman and Kostecki 2001; World Bank 2003; and Evenett 2003). 19 Some WTO disciplines may not be appropriate for very small countries if the institutions that are required are unduly costly—that is, countries may lack the scale needed for benefits to exceed implementation costs. 20 These options are discussed further in Stevens (2002); Prowse (2002); Wang and Winters (2000); and Hoekman, Michalopoulos and Winters (2004). 21 Hoekman, Maskus and Saggi (2004) provide an elaboration of these ideas in the case of technology transfer.

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22 In order to maximise financing for trade-related assistance and to ensure that assistance addresses priority areas for intervention, the trade-related technical assistance and capacitybuilding agenda must be embedded in a country’s national development plan or strategy. In the case of low-income countries the primary example of such an instrument is the Poverty Reduction Strategy Paper (PRSP)—implying that governments and stakeholders must take action to embed trade in PRSPs in those instances where trade is seen as a priority.

REFERENCES Anderson, Kym (2003) ‘How can agricultural trade reform reduce poverty?’, background paper prepared for the UN Millennium Project Task Force on Trade, mimeo. Baffes, J. (2003) ‘Cotton market policies: issues and facts’, Policy Research Working Paper 3218, New York: World Bank. Bhagwati, J. (1988) Protectionism, Cambridge: MIT Press. Bolaky, B. and Caroline Freund (2004) ‘Trade, regulations and growth’, Policy Research Working Paper 3255, New York: World Bank. Bown, Chad, B.Hoekman and C.Ozden (2003) ‘Developing countries and U.S. antidumping: the path from initial filing to WTO dispute settlement’, World Trade Review 2:349–71. Brenton, Paul (2003) ‘Integrating the least developed countries into the world trading system: the current impact of EU preferences under Everything But Arms’, Journal of World Trade 37(3):623–46. Chang, Won and L.Alan Winters (2002) ‘How regional blocs affect excluded countries: the price effects of MERCOSUR’, American Economic Review 92:889–904. Dee, P. and J.Gali (forthcoming) ‘The trade and investment effects of preferential trading arrangements’, in NBER East Asian Seminar in Economics 14 Proceedings, Chicago: University of Chicago Press. Evenett, S.J. (2003) The Singapore Issues and The World Trading System: The Road to Cancun and Beyond, Berne, Switzerland: World Trade Institute. Finger, J.M (2002) ‘The Doha agenda and development: a view from the Uruguay Round’, Manila: Asian Development Bank. Francois, J.F. (1997) ‘External bindings and the credibility of reform’, in A.Galal and B.Hoekman (eds) Regional Partners in Global Markets: Limits and Possibilities of the Euro-Med Agreements, London: Centre for Economic Policy Research. Helleiner, G. (2000) ‘Markets, politics and globalization: can the global economy be civilized?’, Tenth UNCTAD Prebisch lecture, Bangkok, 12 February, at . Hoekman, B. and M.Kostecki (2001) The Political Economy of the World Trading System: The WTO and Beyond, Second Edition, Oxford: Oxford University Press. Hoekman, B., K.Maskus and K.Saggi (2004) ‘Transfer of technology to developing countries: unilateral and multilateral policy options’, mimeo, Washington: World Bank Policy Research Paper No. 3332. Hoekman, B., C.Michalopoulos and L.Alan Winters (2004) ‘Special and differential treatment in the WTO after Cancún’, The World Economy 27:481–506. Hoekman, B., F.Ng and M.Olarreaga (2002) ‘Eliminating excessive tariffs on exports of least developed countries’, World Bank Economic Review 16(1):1–22. ——(2004) ‘Agricultural tariffs or subsidies: which are important for developing countries?’, World Bank Economic Review 18(2):175. Hoekman, B. and M.Olarreaga (2003) ‘Economic development and the WTO after Cancún: back to basics?’, Intereconomics: Review of European Economic Policy 38(5):232–5. Inama, Stefano (2002) ‘Market access for LDCs—issues to be addressed’, Journal of World Trade 36:85–116.

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Irwin, Douglas (2001) Free Trade Under Fire, Princeton: Princeton University Press. Liu, X. and H.VandenBussche (2003) ‘European Union antidumping policy against China: an overview and future prospects in view of China’s WTO membership’, Journal of World Trade 36(6):1125–44. Mattoo, Aaditya (2002) ‘Services in a development round’, mimeo, New York: World Bank. Messerlin, P (2002) ‘Agriculture in the Doha agenda’, Policy Research Working Paper 3009, New York: World Bank. Mitchell, Don (2003) ‘Sugar policies: opportunity for change’, Policy Research Working Paper 3222, New York: World Bank. Olarreaga, M. and C.Ozden (2005) ‘AGOA and apparel: who captures the tariff rent in the presence of preferential market access?’, World Economy, 28(1):63–77. Ozden, Cagler and Eric Reinhardt (2003) ‘The perversity of preferences: the Generalised System of Preferences and developing country trade policies, 1976–2000’, World Bank Policy Working Paper 2955. Prowse, Susan (2002) ‘The role of international and national agencies in trade-related capacity building’, World Economy 25(9):1235–61. Roberts, Mark and James Tybout (eds) (1997) Industrial Evolution in Developing Countries: Micro Patterns of Turnover, Productivity, and Market Structure, Oxford: Oxford University Press. Rodrik, Dani (2002) ‘What is wrong with the (augmented) Washington consensus?’, mimeo, at <www.sopde.org/discussion.htm>. Sabel, Charles and Sanjay Reddy (2002) ‘Learning to learn: undoing the Gordian knot of development today’, Columbia University, mimeo, at . Schiff, M. and L.A.Winters (2003) Regionalism and Development, Oxford: Oxford University Press and World Bank. Schiff, Maurice, Yanling Wang and Marcelo Olarreaga (2002) ‘North-South and South-South trade-related technology diffusion: an industry-level analysis’, mimeo, Washington DC: World Bank. Stern, R (2002) ‘Quantifying barriers to trade in services’, in B.Hoekman, P.English and A.Mattoo (eds) Development, Trade and the WTO: A Handbook, Washington DC: World Bank. Stevens, Christopher (2002) ‘The future of SDT for developing countries in the WTO’, mimeo, Sussex: Institute for Development Studies (May). Walmsley, T. and L.A.Winters (2003) ‘Relaxing restrictions on temporary movement of natural persons: a simulation analysis’, CEPR Discussion Paper 3719, London: Centre for Economic Policy Research. Wang, Z.K. and L.A.Winters (2000) ‘Putting “Humpty” together again: including developing countries in a consensus for the WTO’, CEPR Policy Paper No. 4, London: Centre for Economic Policy Research. Winters, L.A (2000) ‘Regionalism versus multilateralism’, in Robert Baldwin, Daniel Cohen, André Sapir and Anthony J.Venables (eds) Market Integration, Regionalism and the Global Economy, London: Centre for Economic Policy Research. World Bank (2000) Trade Blocs, Washington DC: World Bank. ——(2003) Global Economic Prospects and the Developing Countries: Realizing the Development Promise of the Doha Agenda, Washington DC: World Bank.

4 Truncated globalisation: the fate of the Asia Pacific economies? Ross Garnaut and Ligang Song

INTRODUCTION The Asia Pacific region has returned to strong growth in the early twenty-first century, leaving the financial crisis and the US ‘tech wreck’ and recession behind it. East Asia is again the main locus of growth in output and trade in the world economy, as it was in the decade before the financial crisis. Intra-regional trade within East Asia continues to grow much faster than total East Asian, Asia Pacific or world trade. Trade in components is expanding more rapidly than in final goods, as firms, many of them formed through foreign direct investment in or from East Asia, relentlessly search for and find more costeffective ways of supplying goods and services. Some things are different in this new era of internationalisation and economic growth in the Asia Pacific economies. While the first East Asian global boom had Japan at its centre (Drysdale 2003), this era is centred on economic growth, internationalisation and structural change in China. This time Southeast Asia is more ambivalent about the processes of internationalisation, and is experiencing strong but less spectacular growth than in the earlier period. The main Southeast Asian states are less prominent in leadership of the conceptual and political currents of Asia Pacific affairs. The caution comes to some extent from the hard lessons from the earlier period of optimistic expansion that came to a painful and unexpected halt. It is affected by the scale and pace of change in China, which offers immense opportunity, the realisation of which requires continuous change in specialisation in production and trade to stay out of the way of emerging Chinese comparative advantage. Most importantly of all, this time there is no ground for confidence that the continued strengthening of an open multilateral trading system will provide continually expanding access on a non-discriminatory basis for exports from each Asia Pacific economy’s most productive industries as they evolve over time. The old western Pacific doctrine of open regionalism, and a conceptual framework within which unilateral trade liberalisation, regional cooperation within ASEAN and APEC and multilateral liberalisation under the aegis of the WTO complement each other, have gone. No conceptual or institutional alternative has emerged to provide confidence that the international environment will support continued rapid, internationally oriented growth. The consequence is a feeling of vulnerability and a rush into defensive discriminatory trading arrangements, the overall effect of which will, at best, be extremely disappointing for those who hold most hope in them. At worst, the contemporary disintegration in commitment to open multilateral trade

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threatens to truncate the beneficent process of globalisation in the western Pacific and Asia Pacific economies, with its promise of rising and eventually high living standards throughout the region. This chapter describes and analyses the internationalisation of the western Pacific economies over the past several decades, the policy and institutional environment in which it has evolved, the effects on the western Pacific and Asia Pacific economies, and the effects on the global economy. It then focuses on the sea change in trade policy orientation in recent times and its consequences, including weakened support for domestic reforms, implications for the international trading system, higher transaction costs in trade and the loss of potential gains from trade. There are suggestions for reducing the prospects of the worst outcomes. Few governments in the Asia Pacific have comprehended the costs and risks of favouring discriminatory over multilateral trade. The new trend toward preferential trade may prove unable to support continued strong trade liberalisation, trade expansion and economic growth in the region. The hope for sustaining reform, productive internationally oriented structural change and economic growth lies with early recognition that our region has driven into a dead end, leading to a rapid return to multilateral trade expansion. Only multilateral trade can provide the context for the globalisation of production according to comparative advantage in finely differentiated parts of the supply process. Only multilateral trade can accommodate the immense structural strains associated with rapid growth and structural change in China.

OPEN REGIONALISM AND THE OLD FRAMEWORK OF EAST ASIAN TRADE EXPANSION The rapid, internationally oriented growth of East Asia required a supportive international framework of international economic relations. This was provided initially by the postwar system of multilateral trade managed through the General Agreement on Tariffs and Trade (GATT). Only developed countries were active and influential members of the GATT before the 1980s. In the western Pacific, the GATT framework was underpinned by the strong participation of an economically prosperous and increasingly open United States, which was until the 1970s overwhelmingly the most important market for East Asian exports. The GATT provided for East Asia access to rapidly expanding North American and international markets on a most-favoured-nation basis. This was appreciated most poignantly by Japan, whose exclusion from the preferential trading blocs that emerged from the stress of the Great Depression had curtailed economic opportunity in the 1930s and helped tip the balance of internal Japanese politics disastrously toward war. All members of the GATT enjoyed the protection of Article 1, the most-favoured-nation clause. Almost all other substantial trading economies received most-favoured-nation treatment in practice. The significant exceptions in the Asia Pacific region all had their origins in Cold War strategic relationships. There were restrictions on China-US trade prior to the establishment of diplomatic relations in 1979; trade between the Republic of Korea and the People’s Republic of China until the thaw in political relations following political change in the former Soviet Union in the late 1980s; China-Taiwan, involving a

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ban on trade until Taiwan liberalised contacts with the mainland in 1987 and still inhibiting much trade today; and US trade with Vietnam until the restoration of normal relations in the late 1990s. The most-favoured-nation clause was the first article of the GATT. The Roosevelt and Truman administrations were determined that there would be no return to the fractured trading system that had exacerbated and slowed recovery from depression in the 1930s. There was one exception under the rules: Article 24 allowed trade discrimination in a free trade area or customs union that removed barriers to substantially all trade among members. This exception allowed the emergence of the new economic relationships among European states that became the European Union, favoured by the United States as a matter of security policy in the early postwar period. The Article 24 exception was expected to be applied rarely. The founders of the GATT never envisaged that it would cover more than an occasional special case, and undoubtedly would have put more effort into its design if they had foreseen that its use would one day be common. Rapid expansion in labour-intensive exports from Japan in the 1960s created conditions for one important new exception to the most-favoured-nation clause. To secure Congressional support for the Kennedy Round of multilateral negotiations, the Kennedy administration forced Japan to agree on a five-year voluntary export restriction on cotton textile exports, the demonstration effects of which generated the Multifibre Arrangement (MFA). The MFA was to control comprehensively imports of textiles and clothing into Western Europe and North America. As it turned out, the main effect of the MFA was to inhibit export expansion from the newly competitive East Asian economies, at first the NIEs and later China, as by the mid-1960s Japan’s comparative advantage was evolving rapidly into more capital-intensive and technologically sophisticated products. Agriculture was the other major exception to the postwar rules securing liberal trade in goods. It suited the developed countries that managed the system to exclude agriculture from the disciplines of the GATT. The United States wanted the freedom to continue the New Deal agricultural policies. In the absence of any countervailing international forces, protection for agriculture rose to previously unimaginable heights in Europe, then in Japan, and, in retaliation against European export subsidies, in the United States in the 1980s. The textiles exception to non-discriminatory trade and the agriculture exception to liberal trade were especially damaging in the western Pacific. Textiles had been the leading manufactured export product of every East Asian economy embarking on a strategy of internationally oriented growth: Japan, Hong Kong and Taiwan in the 1950s; Korea and Singapore in the 1960s; Malaysia and Thailand in the 1970s; China and Indonesia in the 1980s; Vietnam in the 1990s; and the Philippines from time to time but decisively under the Ramos administration in the 1990s. Australia and New Zealand and each of the more populous of the original ASEAN economies (Indonesia, Thailand, the Philippines and Malaysia) retained a strong comparative advantage in agriculture into the twenty-first century. The extension of the GATT disciplines to textiles and agriculture was therefore the basis of western Pacific cooperation from 1983 to launch a new round of multilateral negotiations with a wide agenda, and through to the successful conclusion of the Uruguay Round. The success in textiles was qualified by the back-ended nature of developed country commitments, so that there is still anxiety about whether the United States will

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phase out the MFA by 2005. In agriculture, while a start was made with the introduction of normal international disciplines, major steps were left to a ‘built-in agenda’ for a subsequent round of negotiations, therefore requiring a successful outcome to the current Doha Round. The US commitment to non-discrimination in trade remained until the 1980s. When early Japanese and Australian exploration of ideas for Asia Pacific economic cooperation drifted into consideration of a free trade agreement (FTA), the idea was combated vigorously from Washington DC and the Boston academies. The interests of all western Pacific economies and the realities of emerging patterns of trade spoke as eloquently as the Americans for non-discrimination. Liberal trade on a most-favoured-nation basis supported rapid change in patterns of trade as comparative advantage changed quickly in response to rapid economic growth in one after another East Asian economy. It allowed the region to strengthen its position in global markets for final products through the fragmentation of production and supply across the western Pacific according to competitiveness in parts of the supply process. It secured all economies’ interests in the extension of internationally oriented growth to newcomers, through its avoidance of discrimination against economies that were not yet part of the regional and international division of labour. This consonance of interests shaped the discussion of institutions for strengthening Asia Pacific economic cooperation. The first Pacific Economic Cooperation (later PECC) meeting, at the Australian National University in Canberra in 1980, concluded that the model for Asia Pacific cooperation would not be a European Union-style customs union or FTA (Crawford and Seow 1981; Drysdale 1988). Subsequent exchanges in this and other regional forums defined interest in deeper integration without discrimination against outsiders. Trade and investment facilitation would reduce costs of international transactions across the Asia Pacific. Unilateral liberalisation in each economy would strengthen the liberalising economy and also expand the gains from liberalisation in other Asia Pacific economies. Concerted unilateral liberalisation would increase the feasible extent of liberalisation in each economy. And the Asia Pacific region would cooperate to support the multilateral trading institutions—the GATT and, after the Uruguay Round, the WTO, and any trade liberalising negotiations under their auspices (Soesastro 1994). This unique western Pacific approach to regional cooperation came to be known as open regionalism (Elek 1992; Garnaut 1996). Open regionalism was adopted explicitly as the approach to regional cooperation by the Asia Pacific Economic Cooperation (APEC) forum at its first meeting in Canberra in 1989. Open regionalism was always the only feasible guiding principle for APEC. The practical barriers to a European-type preferential area across the Asia Pacific included political barriers to free agricultural trade in Japan and Korea, strategic barriers to free trade between China and the United States, and the high costs of excluding such potential participants as India and Russia in internationally oriented growth from Asia Pacific markets (Drysdale and Garnaut 1993). But it was never accepted with commitment by eastern Pacific participants in Asia Pacific cooperation, some of whom came to hanker after old-style discriminatory regionalism in the region as inhibitions against preferential trade diminished in the United States throughout the 1990s. The Eminent Persons Group established by APEC leaders in Seattle in 1993 became a locus of contest between open regionalism and traditional trade discrimination as an

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organising principle. The differences were never resolved, and the two reports of the Eminent Persons Group were flawed by internal contradictions on this critical conceptual matter. The western and eastern Pacific entered a commitment to free and open trade and investment without sharing an understanding of whether it would be achieved through an old-style FTA or through the new open regionalism. The Chinese classics would describe it as a case of ‘same bed, different dreams’. But that is a later story. The early to mid-1990s were the high tide of open regionalism. Every one of the western Pacific economies embarked on far-reaching unilateral liberalisation of trade and, in many economies, investment. Trade and investment facilitation to reduce transaction costs was given substantive form in APEC. The Bogor Declaration in 1994 established a commitment to free and open trade in the Asia Pacific region by 2010 for developed economies and 2020 for developing economies. The Osaka (1995) and Manila (1996) APEC leaders’ meetings established ‘concerted unilateralism’ as the approach toward the Bogor goals, disciplined by detailed exposure of progress within a framework established in Osaka. Western Pacific and APEC support was important to maintaining progress and to eventual success in the Uruguay Round, and in establishing a core of support for the entry of China and Taiwan into the WTO. The Soeharto government in Indonesia, Ramos in the Philippines and Jiang Zemin and Zhu Rongji in China used the Bogor Declaration skilfully to accelerate domestic trade liberalisation. The Australian and New Zealand governments found the Bogor Declaration useful against pressures to compromise earlier commitments on trade liberalisation. By 1997 liberalisation in every western Pacific developing member of APEC had proceeded more rapidly than the linear rate required to achieve the Bogor goals. Two subregional trade agreements in the Asia Pacific from the 1980s were potentially discriminatory against outsiders, but in practice only marginally so at this time. In practice, the AFTA was implemented by each Southeast Asian country reducing barriers to trade on a most-favoured-nation basis. The 1983 Closer Economic Relations agreement between Australia and New Zealand was preferential, but its implementation was accompanied by radical reductions to external trade barriers on a most-favourednation basis by both countries. At the new WTO’s first ministerial meeting in Singapore in 1996, the first Director General of the WTO, Renato Ruggeiro, saw the Asia Pacific concept of open regionalism as providing the instrument for productive deflection of a new and dangerous tide of preferential trade in the global economy: I see the ensuring that national barriers are not just replaced by regional ones, but that, on the contrary, regionalism and multilateralism converge at the end of the road as the main challenge facing the multilateral system at present, one which will shape its future and help shape the world of the 21st century. The trading system is now moving forward on two tracks—regional and multilateral… Some of the newer regional groups (such as APEC and MERCOSUR) contain a commitment which is very important for the future of the multilateral system: this is open regionalism.

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Of course, we need to be clear about what open regionalism means. Among the different possibilities, I see two basic alternatives. The first is based on the assumption that any preferential area under consideration will be consistent with the legal requirements of the multilateral system. This would mean that such areas could at the same time be legally compatible with the WTO’s rules and preferential in their nature, which means they would be an exception to the m.f.n. clause which is the basic principle of the multilateral system. The possibility of making such a legal exception to the m.f.n. principle within the rules was conceived in a completely different time and situation. Today, with the proliferation of regional groupings, the exception could become the rule, and this would risk changing completely the nature of the system. The second interpretation of open regionalism is the one I hear from a number of governments who are members of APEC. In this scenario, the gradual elimination of internal barriers to trade within a regional grouping will be implemented at more or less the same rate and on the same timetable as the lowering of barriers toward non-members. This would mean that regional liberalisation would be generally consistent not only with the rules of the WTO but also—and this is very important—with the m.f.n. principle. The choice between these alternatives is a critical one; they point to very different outcomes. In the first case, the point at which we would arrive in no more than 20 to 25 years would be a division of the trading world into two or three intercontinental preferential areas, each with its own rules and with free trade inside the area, but with external barriers still existing among the blocs. Is this the sort of world any of us would want? I leave you to imagine the consequences of this vision in terms of economic and political equilibrium; the problem of those who did not fit into any of the blocs would be a serious one—and where would China and Russia be in such a world? The second alternative, on the other hand, points towards the gradual convergence on the basis of shared rules and principles of all the major regional groups. (Ruggeiro 1996, cited in Garnaut 1996:2–4)

INTERNATIONALLY ORIENTED DEVELOPMENT STRATEGIES AND EAST ASIAN GROWTH Over the past half century, one after another of the East Asian economies has undergone domestic economic reform to facilitate deeper integration into the international economy. This has everywhere been associated with a lift in average growth rates, and movements toward the productivity and income levels of the advanced economies. Sustained rapid growth has been associated with rising trade shares in output and expenditure, absorption of productive technology and Western approaches to business and government, and rising and eventually high rates of savings and investment including investment in human

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capital. It has required acceptance of rapid change in industrial structure as the process of economic growth at home and in neighbouring East Asian economies has generated change in comparative advantage (Drysdale 1988; Garnaut 1989; World Bank 1993). In the popular comprehension of the East Asian growth story in North America and to some extent Australia, and even in some East Asian countries, the Asian financial crisis of 1997–98 marks a dislocation in growth performance, with the subsequent growth trajectory being much lower than before the crisis. It is difficult to find support for this perspective in the data. Figure 4.1 shows continued growth in total output after 1998 at rates well above those in the rest of the world, with the margin of superiority not markedly different from before the crisis. In Figure 4.1, the financial crisis appears as a modest and temporary dip in the East Asian growth trend. While the East Asian growth pattern was everywhere characterised by increasing openness to the international economy, the character of the openness varied greatly. Hong Kong and Singapore have been very open to trade from the beginning, while other economies have been increasingly open over time, with the exception of agriculture in Northeast Asia. A high tide in liberalisation throughout the region as a whole was experienced in the dozen years preceding the financial crisis, but continued and rapid trade and investment liberalisation has caused the opening of the region as a whole to expand at a considerable rate since 1997. Different approaches have been adopted to foreign direct investment (FDI), with Hong Kong, Singapore and China at the open end of the spectrum and Japan at the restrictive end. Much of Southeast Asia is at or toward the China end of the spectrum, and Korea is near the Japanese end. Whereas trade liberalisation slowed after the financial crisis in the economies most deeply affected by it,

Figure 4.1 GDP-PPP growth, 1985– 2001 (1985 prices)

Notes: PPP stands for purchasing power parity; world excludes East Asia. Sources: International Financial Statistics, International Monetary Fund, various issues; World Development Indicators, the World Bank.

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the liberalisation of FDI accelerated after 1998 in Korea and much of Southeast Asia. As with foreign direct investment, there are varied approaches to portfolio capital flows, with Vietnam, China and Malaysia the most cautious, and more so after the financial crisis. FDI is an important and efficient source of advanced technology and management approaches from the advanced economies. It has been supplemented by the purchase (and illicit adaptation) of technology and by educational exchanges and domestic commitments to applied technological development. The distinctive feature of the East Asian growth path is the speed with which relatively backward countries approached the developed country frontiers of productivity and incomes, rather than a capacity to grow exceptionally once the frontiers were near. Those East Asian economies that have attained incomes in the range of developed countries—so far, Japan, Singapore, Hong Kong and Taiwan—have grown unexceptionally since catching up with the rich countries. The especially low rates of growth in Japan over the past decade are significantly the result of demographic structures that are unfavourable to economic growth. The trade shares of East Asian output were initially low, but have increased rapidly throughout the period of rapid growth. For the region as a whole, the ratio of exports to GDP is now close to the European Union and several times higher than North America. Each of the East Asian economies began its internationally oriented growth relying strongly on exports of labour-intensive products. This reflected the relative abundance of labour at the beginning of the growth process. The accumulation of capital in the process of growth saw comparative advantage shift swiftly to increasingly capital-intensive products (Song 1996). Figure 4.2 demonstrates the large shifts in individual East Asian economies’ shares of world exports of labour-intensive manufactures over the past several decades.1 It is interesting that the share for East Asia as a whole has been fairly stable. After Japan established a prominent position in global markets for labour-intensive manufactures in the 1960s, the rapid rise in the NIEs’ shares in the 1970s was mainly accommodated by their taking over the Japanese position. Continued growth in NIE exports through the 1980s was mainly accommodated by further falls in the Japanese share, although the total East Asian share of global imports rose by about 5 percentage points in the first half of the 1980s. The huge expansion in Chinese exports of labour-intensive products from the second half of the 1980s onward was achieved entirely through contraction of the position of the more advanced East Asian economies. Figure 4.3 illustrates the decline in the relative position of labour-intensive products in individual economies’ exports in the process of rapid growth.

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Figure 4.2 Changing share of some East Asian economies in world total labour-intensive manufactured exports, 1970–2000 (per cent)

Source: Calculated using UN COMTRADE data, International Economic Databank, the Australian National University.

Figure 4.3 Share of labour-intensive products in total exports, 1970–2000 (per cent)

Source: Calculated using UN COMTRADE data, International Economic Databank, the Australian National University. The share of labour-intensive exports in the NIEs peaked in the early 1970s and in China in the early 1990s. Australia is as deeply integrated into western Pacific trade patterns as the East Asian economies themselves (Tables 4.1–4.3), and this integration has been increasing over time.

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The large increase in the trade shares of East Asian production and consumption over the past several decades has had a large intra-East Asian component, but has been more broadly based geographically than the trade expansion of any other region. Over time, the increase in scale of East Asian trade made intra-regional markets more important in providing markets for regional export expansion. Between 1985 and 2002, 4.9 percentage points of the 5.6 percentage point lift in the export share of East Asian GDP comprised sales to East Asian markets (Table 4.3). The ratio of intra-East Asian exports to regional GDP increased strongly from 1975 through to the present (Table 4.3). But the ratio of East Asian exports to each of Europe, North America, Australia and New Zealand and the rest of the world rose even more rapidly from a lower base (Table 4.2). This contrasts with the experience of North America and Europe, each of which experienced an increase in the ratio of intra-regional trade to GDP, and also of trade with East Asia to GDP, but after 1985, not in the ratio of trade with each other or with the rest of the world to GDP. Table 4.4 illustrates the process of changing comparative advantage by reference to individual commodities. Japan’s export specialisation in the labour-intensive products of travel goods, clothing and footwear was still above the global mean in 1970, but fell well below unity and then to zero by 1995. There was a corresponding rise over the period in export specialisation in such capital-intensive products as machinery and electrical machinery. The NIEs’ export specialisation in labour-intensive products reached a peak between 1975 and the early 1980s, and then fell away rapidly to well below unity for most products by the end of the century. The NIEs’ export specialisation in machinery rose rapidly from low levels in 1970 to above unity at the end of the century. Export specialisation in electrical machinery was more stable, reflecting a wider range of factor requirements in the production of these goods. Exports of labour-intensive products tended to rise in proportion to ASEAN countries’ total exports until the mid-1980s. That their peaks were much lower than in Northeast Asian economies is a reflection of the ASEAN economies’ larger per capita endowments of natural resources. ASEAN export specialisation in electrical machinery exceeded unity by the 1980s and stabilised at around two late in the 1990s. Export specialisation in machinery exceeded unity in the mid-1990s and continues to rise. China’s export specialisation in labour-intensive products peaked at very high levels between the mid-1980s (travel goods and clothing) and the mid-

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Table 4.1 Exports of East Asia, North America and the European Union, 1985–2002 (US$ billion, current prices) Importer/ Exporter

East Asia 1985

Australia 10.2 New Zealand 1.4 East Asia 115.4 Japan 37.7 Korea 7.6 China 16.0 ASEAN6 34.3 EU15 29.4 North America 51.7 United States 43.3 Canada 6.5 Mexico 1.9 Rest of world 50.5 World 258.6 Importer/ Exporter European Union 1985 Australia 3.2 New Zealand 1.2 East Asia 44.4 Japan 23.3 Korea 3.6 China 2.5 ASEAN6 8.1 EU15 422.4 North America 61.3 United States 51.9 Canada 5.4 Mexico 4.1 Rest of world 170.6 World 703.1 Importer/ Exporter North America 1985 Australia 2.7 New Zealand 1.0 East Asia 127.1 Japan 72.2 Korea 12.0 China 2.6

1992 20.3 3.2 336.6 112.4 31.2 56.6 89.5 92.8 123.8 110.9 11.7 1.2 82.4 659.1 1992 5.4 1.4 134.2 67.1 9.8 8.0 30.2 1,043.6 113.8 100.5 9.9 3.4 242.7 1,541.0 1992 4.2 1.4 210.9 107.4 20.7 9.4

1995 29.4 4.7 591.3 158.5 54.7 80.9 156.1 146.3 172.8 155.2 15.8 1.8 118.4 1,062.8 1995 5.9 1.9 191.9 70.4 16.3 19.3 45.3 1,259.7 138.3 123.6 11.3 3.4 308.0 1,905.7 1995 4.3 1.7 317.4 131.4 27.1 26.5

2002 33.4 4.7 659.8 163.8 68.7 138.1 207.3 158.5 182.3 167.1 11.9 3.3 158.6 1,197.2 2002 7.3 2.4 227.7 58.4 19.2 46.5 51.2 1,405.6 164.9 148.2 11.2 5.5 409.3 2,217.2 2002 7.5 3.0 383.0 126.3 37.4 91.9

Reshaping the Asia pacific economic order

ASEAN6 EU15 North America United States Canada Mexico Rest of world World Importer/ Exporter

14.4

38.7

62.7

52

75.8

81.3 121.5 154.5 245.0 143.2 263.8 394.5 598.7 60.9 122.1 172.3 245.5 68.6 103.5 153.7 215.6 13.7 38.3 68.5 128.7 58.7 84.6 103.3 182.4 414.0 686.4 975.6 1,419.6 Rest of world 1985 1992 1995 2002 Australia 7.1 8.2 11.0 12.5 New Zealand 2.4 3.3 5.0 4.0 East Asia 80.1 114.5 178.9 173.0 Japan 44.6 52.5 54.0 18.1 Korea 8.2 14.7 29.3 21.6 China 6.2 10.9 19.3 33.6 ASEAN6 12.7 25.3 45.5 29.8 EU15 198.2 320.1 444.8 442.4 North America 74.3 97.6 127.2 111.0 United States 57.7 87.3 113.2 96.8 Canada 13.9 7.0 8.2 6.2 Mexico 2.7 3.3 5.8 8.0 Rest of world 162.5 162.1 276.0 348.9 World 524.6 705.7 1,042.9 1,091.9 Importer/ Exporter World 1985 1992 1995 2002 Australia 23.1 38.1 50.6 60.6 New Zealand 5.9 9.3 13.3 14.1 East Asia 367.0 796.2 1,279.5 1,443.5 Japan 177.9 339.5 414.3 366.7 Korea 31.4 76.4 127.5 146.9 China 27.3 84.9 145.9 310.1 ASEAN6 69.5 183.6 309.6 364.1 EU15 731.3 1,577.9 2,005.3 2,251.5 North America 330.6 599.0 832.7 1,056.9 United States 213.7 420.8 564.3 666.6 Canada 94.4 132.1 189.0 244.9 Mexico 22.5 46.2 79.5 145.5 Rest of world 442.3 571.7 805.6 1,099.2 World 1,900.3 3,592.3 4,987.0 5,925.9 Source: Direction of Trade, International Monetary Fund; International Economic Databank, the Australian National University.

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Table 4.2 Exporting regions’ shares of import markets, 1965–2002 (per cent) Importer/ Exporter

Australia and New Zealand 1965 1975 1985 1995

Australia and New Zealand 5.7 7.0 6.0 8.7 East Asia 14.3 27.5 37.7 36.6 European Union 37.8 29.4 23.7 21.5 Eastern Europe & FSU 0.7 0.4 0.3 0.2 North America 24.3 21.3 23.6 21.3 Rest of world 17.2 14.4 8.8 11.7 World 100 100 100 100 Importer/ Exporter East Asia 1965 1975 1985 1995 Australia and New Zealand 6.0 6.1 4.6 2.8 East Asia 31.8 33.5 46.9 53.4 European Union 13.5 10.1 11.0 12.8 Eastern Europe & FSU 2.4 1.9 1.0 1.6 North America 24.1 21.8 22.0 17.2 Rest of world 22.2 26.7 14.5 12.2 World 100 100 100 100 Importer/ Exporter European Union 1965 1975 1985 1995 Australia and New Zealand 2.5 0.9 0.6 0.4 East Asia 3.3 4.4 6.6 9.9 European Union 46.9 53.7 54.6 56.9 Eastern Europe & FSU 3.8 3.8 4.2 3.4 North America 13.3 9.7 8.5 7.4 Rest of world 30.3 27.5 25.4 22.1 World 100 100 100 100 Importer/ Exporter North America 1965 1975 1985 1995 Australia and New Zealand 1.7 1.4 0.7 0.5 East Asia 13.5 17.6 31.2 30.8 European Union 21.4 16.3 17.7 14.3 Eastern Europe & FSU 0.6 0.7 0.6 0.7 North America 39.4 38.6 34.7 40.9 Rest of world 23.4 25.5 15.1 12.8 World 100 100 100 100

2002 9.0 41.7 19.7 0.3 20.3 9.1 100 2002 3.1 61.0 11.0 1.2 14.4 9.2 100 2002 0.5 10.5 54.4 5.3 7.4 21.9 100 2002 0.7 24.9 16.3 0.9 42.8 14.4 100

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Importer/ Exporter

54

World 1965 2.3

1975 1985 1995 2002 Australia and New 1.7 1.5 1.3 1.3 Zealand East Asia 9.1 11.8 19.4 24.6 24.7 European Union 37.4 36.2 34.4 35.9 34.2 Eastern Europe & 4.7 5.6 4.9 2.6 3.8 FSU North America 20.8 17.0 17.5 17.0 17.6 Rest of world 25.6 27.8 22.3 18.5 18.4 World 100 100 100 100 100 Notes: Exports in this and other tables are merchandise exports; East Asia includes Japan, Korea, China, Taiwan, Hong Kong, Thailand, Malaysia, the Philippines, Indonesia, Singapore and Vietnam; North America includes the United States, Canada and Mexico; FSU is the former Soviet Union; the European Union is the EU15. Source: UN Trade Data, International Economic Databank, the Australian National University.

1990s (footwear). It has tended to remain high: China’s internal economic differentiation means that the country as a whole can retain its comparative advantage in labourintensive products for longer, as lower-cost labour from the inland replaces the labour from coastal China as the coastal provinces absorb more valuable skills and their labour costs rise. China’s export specialisation in machinery rose rapidly from the mid-1980s and was around unity and rising at the end of the century. By contrast, the US export specialisation in the products for which data are recorded in Table 4.4 remained fairly stable throughout the last several decades. It was consistently low for labour-intensive goods and high for machinery. An outstanding feature of the changing pattern of East Asian comparative advantage and trade specialisation is the huge expansion of trade in components. There is no longer a Japanese car or Chinese television set. Components are sourced from many countries to minimise total supply costs. This is a feature of the contemporary global economy, but it has been taken further in East Asia than in other major economic region. Greater openness leads to the internationalisation of a manufacturing process in which many countries participate in different stages of the manufacture of a product. There is increasing trade in intermediate goods such as machinery parts and components. The process allows stages of production to be located where they can be undertaken most efficiently and at the lowest cost. As a result, countries are becoming more interdependent (Yeats 1998) and global value chains offer significant opportunities to many Asian firms to take advantage of the potential benefits of globalisation (ADB 2003).

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Table 4.3 Export/GDP ratio for regional economies by destination, 1965–2002 (per cent) Importer/ Exporter

Australia and New Zealand 1965 1975 1985

Australia and 0.7 0.7 New Zealand East Asia 0.3 0.4 European 0.7 0.3 Union Eastern Europe 0.0 0.0 and FSU North America 0.1 0.1 Rest of world 0.2 0.1 World 0.2 0.2 Importer/ East Asia Exporter 1965 1975 Australia and 3.0 4.8 New Zealand East Asia 2.6 4.0 European 0.9 0.8 Union Eastern Europe 0.1 0.3 and FSU North America 0.5 1.1 Rest of world 0.8 1.6 World 0.9 1.7 Importer/ European Union Exporter 1965 1975 Australia and 5.2 2.1 New Zealand East Asia 1.2 1.6 European 13.3 13.0 Union Eastern Europe 0.4 1.8 and FSU North America 1.1 1.5 Rest of world 4.7 5.2 World 3.9 5.2 Importer/ North America Exporter 1965 1975 Australia and 1.7 1.5 New Zealand East Asia 2.2 2.9 European 2.8 1.8 Union

1995

2002

0.8

1.2

1.6

0.5 0.3

0.3 0.2

0.5 0.2

0.0

0.0

0.0

0.1 0.1 0.2

0.2 0.1 0.2

0.1 0.1 0.2

1985 5.7

1995 2002 6.7 7.9

5.5 1.4

7.5 2.3

10.4 1.7

0.4

2.8

1.9

1.1 1.3 2.1

2.2 2.0 3.6

1.4 2.1 3.6

1985 1.9

1995 2002 1.4 1.9

1.9 16.7

2.1 15.3

3.1 14.4

4.3

9.0

13.8

1.1 5.5 5.1

1.4 5.4 5.4

1.2 8.7 6.1

1985 1.5 6.1 3.7

1995 2002 1.0 2.2 3.8 2.3

5.3 3.2

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Eastern Europe 0.0 0.2 0.4 1.2 1.6 and FSU North America 1.5 2.7 3.0 4.6 5.2 Rest of world 1.7 2.2 2.2 1.8 4.2 World 1.8 2.4 3.4 3.2 4.5 Importer/ World Exporter 1965 1975 1985 1995 2002 Australia and 12.7 11.8 14.0 13.8 16.7 New Zealand East Asia 8.4 12.4 16.8 15.6 22.4 European 28.1 25.5 31.5 29.3 28.2 Union Eastern Europe 1.4 7.8 14.9 21.1 30.4 and FSU North America 4.6 7.5 6.7 9.9 9.1 Rest of world 10.5 15.2 14.4 13.7 22.9 World 10.4 15.2 15.3 16.4 19.0 Note: See Table 4.2 for the definitions of country groupings. Source: UN trade data, International Economic Databank, the Australian National University.

Table 4.4 International comparison of shifting patterns of export specialisation in selected industrial sectors, 1970–2000 (index of revealed comparative advantage: RCA) Machinery (SITC 71) 1970 1975 1980 1985 1990 1995

2000

China 0.1 0.1 0.1 0.1 0.3 0.4 0.7 Japan 0.9 1.0 1.4 1.4 1.6 1.7 1.5 NIEs 0.1 0.2 0.4 0.5 0.8 1.0 1.4 ASEAN 0.1 0.2 0.2 0.4 0.8 1.2 1.4 United States 1.6 1.7 1.9 1.7 1.3 1.4 1.4 Electrical machinery 1970 1975 1980 1985 1990 1995 2000 (SITC 72) China 0.2 0.2 0.2 0.3 0.7 0.9 1.1 Japan 2.1 1.9 2.5 2.2 2.1 1.9 1.6 NIEs 1.8 2.0 2.3 1.8 2.0 2.0 1.8 ASEAN 0.2 0.6 1.2 1.3 1.8 2.0 2.1 United States 1.2 1.3 1.5 1.4 1.3 1.2 1.2 Travel goods (SITC 83) 1970 1975 1980 1985 1990 1995 2000 China 2.8 3.2 3.4 8.2 3.1 8.6 7.9 Japan 2.0 0.5 0.3 0.2 0.1 0.0 0.0 NIEs 8.9 14.9 16.2 9.7 6.5 2.1 0.8 ASEAN 0.4 0.7 0.4 0.3 1.2 1.1 1.2 United States 0.2 0.3 0.3 0.1 0.2 0.2 0.3 Clothing (SITC 84) 1970 1975 1980 1985 1990 1995 2000

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China 2.0 2.4 4.7 5.2 4.9 5.1 4.6 Japan 1.2 0.3 0.2 0.2 0.1 0.0 0.0 NIEs 13.3 14.2 10.1 6.8 4.2 2.1 1.7 ASEAN 0.3 0.6 0.9 1.1 1.8 1.4 1.2 United States 0.3 0.2 0.3 0.1 0.2 0.4 0.4 Footwear (SITC 85) 1970 1975 1980 1985 1990 1995 2000 China 1.3 1.6 1.8 1.6 3.8 6.1 6.4 Japan 1.1 0.1 0.1 0.0 0.0 0.0 0.0 NIEs 3.6 6.2 7.8 6.5 5.1 1.1 0.3 ASEAN 0.2 0.2 0.4 0.3 1.3 2.1 1.1 United States 0.0 0.1 0.1 0.1 0.1 0.1 0.1 Note: ASEAN includes Singapore; NIEs excludes Singapore. Source: Calculated using UN COMTRADE data, International Economic Databank, the Australian National University.

Closer regional economic integration emerges through market processes. A central feature of deeper East Asian economic integration has been the remarkable growth of trade in intermediate goods and components. China is now a major element in this process. Much of the recent increase in intra-regional trade in the western Pacific can be explained by the rapid expansion in cross-border fragmentation trade. Athukorala (2003) shows that in 2000, over 60 per cent of ‘final exports’ from developing Asia went to countries outside the East Asian region, especially North America and Europe, up from 55 per cent in 1992. Table 4.5 shows that East Asia has been more deeply involved in fragmentation trade than other regions. Fragmentation trade is damaged more than conventional trade by transaction costs. For this and other reasons, it is damaged more than traditional trade by FTAs with their rules of origin. While trade in components is mainly within East Asia, most of the markets for final products are still extra-regional. The fragmentation of the supply chain accelerates the growth of trade in components and makes the region more heavily dependent on extra-regional trade for ‘growth dynamism’ than is suggested by data that do not separate out the trade in components (Findlay 2003). The large increases in fragmentation trade have been associated with rising intraindustry trade. The previously low intra-industry trade indexes

Table 4.5 Contribution of parts and components to export growth, 1992–2000 (per cent) ASEAN East Asia EU12 NAFTA China Korea Japan Taiwan Hong Kong ASEAN East Asia EU12

32.9 58.9 66.9 67.6 29.2 67.6 64.2 48.8

31.1 51.2 52.7 50.8 21.6 60.0 52.6 31.1

12.6 35.4 86.2 37.5 34.9 53.1 40.9 20.0

10.3 40.6 34.1 54.9 8.8 52.1 35.0 18.1

World 17.9 41.0 50.1 47.4 16.3 54.7 42.8 22.0

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NAFTA 74.4 55.8 34.2 23.3 United States 73.9 55.9 34.8 30.7 World 63.0 49.6 21.1 25.1 Source: Compiled from Athukorala (2003): Table A–3(B).

29.9 38.1 27.0

were once seen in the United States as evidence of the closed nature of the East Asian and especially the Japanese economies (Lawrence 1991). Table 4.6 shows that by 2000, a few East Asian economies (Singapore, Korea, Taiwan, Thailand) had similar indexes of intra-industry trade with the world as a whole as the North American economies.2 Most global indexes for the East Asians were moderately lower. Hong Kong was very low, reflecting characteristics of trade and industry structure rather than any failure of openness. Japan’s global index had more than doubled between 1985 and 2000, but remained fairly low. When the focus shifts from global to regional intra-industry trade indexes, it is apparent that the high scores for Europe and North America are mostly associated with trade within their own regions. East Asian intra-industry trade is more widely spread geographically. Japan in 2000 had similar indexes in trade with East Asia as with North America, Europe and the world as a whole. Intra-industry trade within East Asia is different in character from that in East Asian long-distance trade. The former is mainly in components, and the latter in differentiations of finished products.

Table 4.6 Intra-industry trade indexes by destination, 1985 and 2000 East Asia

North World America 1985 2000 1985 2000 1985 2000 1985 2000 Australia New Zealand Japan Korea China Hong Kong Taiwan Singapore Indonesia Malaysia Thailand Philippines Vietnam EU12 United Kingdom

EU12

11.9 25.7 10.5 23.4 12.2 27.9 22.4 36.6 8.8 12.0 6.5 16.7 12.9 23.3 20.7 30.3 17.7 48.5 23.2 24.8

42.5 68.7 49.9 11.5

32.9 44.2 10.0 30.7

43.1 21.2 42.1 19.8 41.6 40.5 25.1 48.9 40.7 55.9 42.7 7.6 32.6 21.3 47.5 20.1 20.8 18.2 45.7 19.6

48.9 44.9 10.1 25.6 21.3 32.3 2.2 43.5 39.4

76.5 82.3 32.8 65.8 61.7 56.4 19.0 50.9 41.7

28.9 41.9 3.9 20.1 13.6 25.5 3.2 97.6 62.7

43.4 45.9 20.1 48.7 43.3 29.2 8.1 92.9 74.1

17.9 51.1 1.9 50.9 24.0 45.1 0.3 53.3 50.8

37.9 56.2 14.8 43.2 35.1 45.1 7.7 67.2 65.2

35.0 58.5 15.1 37.2 23.1 36.1 7.1 78.9 72.2

60.8 78.9 34.0 60.4 57.3 49.8 17.6 86.6 79.9

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Germany 36.3 47.9 49.6 70.5 21.3 59.7 51.9 72.9 United 27.5 44.1 47.5 62.2 61.6 64.2 52.1 62.9 States Canada 13.3 17.2 25.7 39.5 61.3 63.4 63.1 66.0 Mexico 6.1 12.2 8.7 30.7 33.8 59.1 31.9 60.5 Source: UN trade data, International Economic Databank, the Australian National University.

EFFECTS ON THE INTERNATIONAL ECONOMY Examination of import shares suggests that East Asia’s international trade is more strongly concentrated in its own region than that of either of the other two regional concentrations of production and trade—North America and the European Union (Table 4.2). East Asia drew over 60 per cent of its imports from its own region in 2002, double the proportion of the mid-1960s and continuing to rise rapidly. The corresponding ratio for Western Europe is a bit over 50 per cent, having hardly changed over a quarter century. The ratio for North America is just above 40 per cent, having lifted since the mid-1980s after a long period of decline. A somewhat different picture emerges from examination of export data. (The difference arises to a considerable extent from the North American trade deficits and the East Asian surpluses.) Table 4.3, using export shares of GDP, shows that the intraregional share of export trade is greatest in North America, followed by the European Union and then East Asia. Europe remains the most strongly oriented toward foreign trade of the three regions, but East Asia has been catching up rapidly. North America is a long way behind both and its orientation to foreign trade has not been increasing over the past decade (Table 4.2). By 2002 intra-regional exports represented 42.8 per cent of the total in North America, 54.4 per cent in Western Europe and 61 per cent in East Asia. East Asia has been a participant in most of the world’s intercontinental trade expansion since the mid-1980s. By 2002 the dollar value of East Asia’s exports beyond its own region greatly exceeded that of North America, but was substantially lower than that of the European Union (Table 4.1). The share of intercontinental exports in North American GDP was only 3.9 per cent in 2002, compared with 12 per cent for East Asia and 13.8 per cent for Western Europe (derived from data presented in Table 4.3). The inter-continental export share of GDP rose in East Asia but not in the other regions from the mid-1980s to 2002. Table 4.7 sheds light on the extent to which the expansion of East Asian intercontinental and intra-regional trade has simply reflected the increase in scale of East Asia’s trade with the rest of the world, and the extent to which it has involved changes in trade intensity with its trading partners. It does this through the presentation of intensity indexes as originally developed by Kojima (1964). It also breaks down the intensity index into complementarity and geographic bias indexes, following Drysdale (1969) (see also the synthesis in Drysdale and Garnaut 1982). This step allows assessment of the extent to which any change in intensity of trade reflects a closer match of the commodity composition of the two partners’ trade (relative to their trade with the rest of the world)

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and the extent to which it resulted from changes in intensity of trade commodity by commodity. Between 1985 and 2000, the intensity of intra-regional trade fell in East Asia,3 but rose in North America and Western Europe. Relative to the respective

Table 4.7 Bias, complementarity and intensity indexes for major country groups, 1985 and 2000 Partner

Reporter Type

Australia East Asia ASEAN6 EU12 North Rest of and New America world Zealand 1985 2000 1985 2000 1985 2000 1985 2000 1985 2000 1985 2000

Australia Bias 8.3 9.0 1.8 1.7 2.6 2.3 0.4 0.3 0.9 0.6 1.1 1.1 and New Zealand Complementarity 0.5 0.7 1.4 1.2 0.7 0.8 1.0 1.0 0.5 0.7 1.0 1.2 Intensity 3.9 6.3 2.5 2.0 1.8 1.9 0.4 0.3 0.5 0.4 1.1 1.3 East Asia Bias 1.4 1.2 1.6 1.2 2.0 1.4 0.3 0.4 1.1 0.7 0.6 0.5 Complementarity 1.1 1.0 1.1 1.3 1.1 1.5 0.9 1.0 1.1 1.1 1.0 0.9 Intensity 1.6 1.2 1.7 1.6 2.2 2.0 0.3 0.4 1.3 0.8 0.6 0.4 ASEAN6 Bias 2.0 2.2 2.5 1.6 4.1 2.5 0.4 0.5 1.0 0.7 0.5 0.6 Complementarity 0.8 0.9 1.2 1.3 1.3 1.5 0.9 0.9 0.9 1.0 0.9 0.9 Intensity 1.6 2.0 3.1 2.2 5.2 3.8 0.3 0.4 0.9 0.7 0.5 0.5 EU12 Bias 0.4 0.4 0.2 0.2 0.2 0.2 1.0 1.1 0.3 0.3 0.8 1.0 Complementarity 1.1 1.1 0.9 0.9 1.0 0.9 1.1 1.1 1.0 1.0 1.1 1.1 Intensity 0.5 0.4 0.2 0.2 0.2 0.2 1.1 1.2 0.3 0.3 0.8 1.1 North Bias 0.9 0.7 0.9 0.6 0.7 0.6 0.4 0.3 1.1 1.4 0.6 0.4 America Complementarity 1.2 1.1 1.0 0.9 0.9 1.0 1.0 1.0 1.3 1.1 1.0 1.0 Intensity 1.0 0.7 0.8 0.6 0.6 0.5 0.4 0.3 1.4 1.6 0.6 0.4 Rest of Bias 0.3 0.3 0.3 0.4 0.3 0.4 0.8 0.9 0.5 0.5 1.2 1.4 world Complementarity 0.8 1.0 1.2 1.0 1.1 0.9 1.0 1.0 0.9 1.0 1.1 1.1 Intensity 0.3 0.3 0.4 0.4 0.3 0.4 0.8 0.9 0.4 0.5 1.2 1.5 Source: Calculated using UN COMTRADE data, International Economic Databank, the Australian National University.

regions’ shares in world trade, East Asia has come to trade relatively less within its own region, and the other two regions relatively more. Complementarity in intra-regional trade rose in East Asia, remained steady in Europe and fell in North America. How has East Asia’s rapid growth in output and trade, and tendency to trade intercontinentally more intensively than North America and Europe, affected the rest of the world economy? The main effect is to expand the potential gains from trade in the rest of the world. This follows simply from the expanded scope for other economies to specialise in the supply of goods and services in which their comparative advantage is strong.

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The utilisation of these opportunities has required acceptance of structural change. The relatively steady East Asian share of global markets for the products in which the region’s export specialisation has been strongest, labour-intensive manufactures, suggests that the costs of structural change for the world outside East Asia have not been high since the early 1980s; that is, since the early entry of East Asia into the international economy. The pressures for continuing structural change of a radical kind have been greatest within East Asia itself. The skewed nature of East Asia’s resource endowment relative to the rest of the world, with extreme scarcity of land and other natural resources, has made East Asia disproportionately and increasingly an importer of resource-based products. This has reduced the pressures on these old industries to decline in the industrial economies of the North Atlantic (although increased agricultural protection with the decline in comparative advantage in Japan, Korea and Taiwan has lessened this moderating effect). Much has been made from time to time about the large surpluses in East Asia’s current payments, and the corresponding deficit in the United States. This is the other side of the coin to the large capital flows from East Asia to the United States, which have sustained American expenditure at levels that could not otherwise have been attained. It could be said that by creating the opportunity for the United States to expand public expenditure at the same time as cutting taxation, East Asian surpluses are supporting a pattern of public finance that is damaging to the long-term interests of the citizens of the United States. But surpluses are making possible a choice that for the moment seems to be favoured by a democratic majority in the United States.

INTERNATIONAL AND REGIONAL ADJUSTMENT TO A RISING CHINA The internationalisation of the Chinese economy has extended the longevity and importance of the East Asian growth process. If China had remained a centrally planned, inward-looking economy in the pre-1978 mould, the period of superlative East Asian growth would now be moving toward a close. Japan, Taiwan, Singapore and Hong Kong have completed the process of moving rapidly to the world’s frontiers of productivity and incomes. Korea is nearing these frontiers. Malaysia and Thailand are moving closer, having been interrupted for a few years by financial crisis. The Philippines, Indonesia and Vietnam have further to go, but in each case with structural impediments to sustained rapid growth that suggest more moderate speed limits than in the most successful East Asian economies. China can be expected to grow strongly through the first half of the twenty-first century. Of course there is much that could disrupt the process for a while. There is one development—the failure of the political system to adapt to the rapidly changing political forces of an increasingly wealthy, well-educated and internationally connected society— that might threaten its continuation altogether. But the most likely course now is for the dynamism of coastal China in the era of reform to spread inland. This would cause sustained rapid growth in East Asia to reach its apogee with the industrialisation of the Chinese hinterland in the second quarter of the twenty-first century. By then, China alone would be a larger economy than Western Europe or North America.

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On the patterns of East Asian and Chinese growth so far, this prosperous China would be deeply integrated into the East Asian and global economies, providing a large proportion of the potential gains from international trade for people everywhere. This is a natural development. It should take no one by surprise, although it does involve radical rearrangement of power relationships in the global economy and eventually in the world’s political system. But that is running ahead of the story. What we know without speculation is that China’s foreign trade and investment have been growing much more rapidly than its strongly expanding output. Its emerging patterns of international trade follow closely the comparative advantage determined by its resource endowments. The resource endowments argued at first for exceptionally strong export specialisation in labourintensive exports. But high rates of investment and factor immobility in China’s vast economy have moved comparative advantage into more capital-intensive and technologically sophisticated goods and services in parts of coastal China when much of the interior still has a relative abundance of low-skilled labour. So China’s impact on global markets from here on will be over a wide range of products, and not only in the labour-intensive goods that dominate export specialisation in the early stages of East Asian-style development. The most concentrated impact of Chinese growth on markets is likely to be on the import side. China’s low ratios of natural resources (including agricultural land) relative to population and increasingly to capital give it a pronounced and increasing comparative disadvantage in resource-based products. In an open global economy, Chinese growth will move terms of trade in favour of producers of these products, and against other economies with a comparative disadvantage in them. Beyond the resource-based industries, Chinese growth will generate opportunities for export expansion and heightened competition in domestic and international markets of a highly diverse kind. The opportunities and competition will be felt by all economies, and most powerfully among China’s western Pacific neighbours. China is already a major trading partner of all western Pacific economies, and the largest export market for the rest of Northeast Asia (Table 4.8). Its trade has grown rapidly with partners all over the world (Table 4.9). China has been by far the main source of growth in international trade since 2000. It accounted for the whole of the growth in world exports and nearly a quarter of world import growth in 2001–02 (Table 4.10). There is also evidence that the rapid integration of China into the regional value chains in electronics and motor vehicle industries has set the stage for growing complementarity in multinational enterprises’ activities in China and other East Asian countries. The speed and scale of Chinese trade and investment expansion have generated anxious reactions in other economies, especially over the past several years. This has been most important politically in Southeast Asia, where the adjustment pressures are genuinely large (Table 4.4; Xu and Song

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Table 4.8 China plus Hong Kong’s share of exports of major countries and regions, 1996–2002 (per cent) 1996

2000

2002

Exports Japan 12.2 13.0 16.4 Korea 16.8 17.8 19.9 Taiwan 23.7 24.4 32.3 ASEAN6 9.4 9.7 11.6 East Asia 10.8 10.9 12.8 Australia 9.3 9.3 10.3 United States 4.3 4.1 5.1 Canada 1.5 1.2 1.3 World 4.5 4.6 4.7 Imports Japan 12.3 15.0 19.7 Korea 6.4 8.8 11.2 Taiwan 4.7 6.1 8.9 ASEAN6 5.3 7.3 10.3 East Asia 6.3 7.7 11.9 Australia 6.4 8.8 11.2 United States 7.9 9.6 12.3 Canada 2.6 3.6 4.9 World 4.3 5.6 7.0 Source: Direction of Trade, International Monetary Fund; International Economic Databank, the Australian National University.

Table 4.9 China’s major trading partners, ranking, total trade, growth rate and trade shares (US$ billion, per cent), January–September 2003 Ranking Amount Growth Share in total (US$ rate (year(per cent) billion) on-year) Total Japan United States European Union Hong Kong ASEAN Korea

1 2

606 96 91

36.2 31.7 29.9

100 15.8 15.0

3

89

41.5

14.7

4

61

22.5

10.1

5 6

56 44

44.3 43.1

9.2 7.3

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Taiwan 7 41 29.1 Russia 8 11 26.6 Australia 9 10 26.7 Canada 10 7 23.4 Source: Trade statistics, China International Electronic Commerce Network, Ministry of Commerce, China (http://www.ec.com.cn/).

6.8 1.9 1.6 1.2

Table 4.10 China’s share of world export and import growth, 1996–2002 (per cent) 1996– 1999– 2001– 1996–2002 97 2000 02 Export growth World export 4.1 12.2 1.9 2.5 growth rate China’s export 21.0 27.8 44.7 9.9 growth rate China’s share of 14.5 7.8 103.2 24.4 world export growth (%) Import growth World import 6.3 13.6 2.4 2.8 growth rate China’s import 2.5 37.1 16.2 10.2 growth rate China’s share of 0.9 7.0 23.7 11.9 world import growth (%) Source: Direction of Trade, International Monetary Fund; International Economic Databank, the Australian National University.

2000). There has also been strong political reaction in the North Atlantic, especially the United States, although the reasons for the reaction are not obvious in the trade and investment data. Some diversion of FDI from Southeast Asian countries to China is evident from Table 4.11. There is a declining trend of FDI flowing into most Southeast Asian countries and the NIEs, alongside a continuing rise to China during 1996–2002. China absorbed 66 per cent of the total FDI flowing into East

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Table 4.11 FDI inflows in East Asia (US$ billion, 1995 prices) 1996 1997 1998 1999

2000 2001 2002 1996– 2002

China 40.9 43.5 43.2 37.8 37.4 42 46.8 41.7 Singapore 8.4 10.3 6.1 11.1 5 7.7 5.8 7.8 Thailand 2.3 3.7 7 5.7 3.1 3.4 0.9 3.7 Indonesia 6.1 4.5 0.3 2.6 4.2 2.9 2 3.2 Malaysia 5 4.9 2.1 3.6 3.5 0.5 1.6 3 Vietnam 2.3 2.1 1.6 1.3 1.2 1.2 1.3 1.6 Philippines 1.5 1.2 2.2 0.5 1.1 0.9 1 1.2 Japan 0.2 3.1 3.1 11.5 7.6 5.5 8.1 5.6 Korea 2.3 2.7 5.1 8.7 8.5 3.2 1.7 4.6 Taiwan 1.8 2.2 0.2 2.7 4.5 3.7 1.3 2.3 Hong 10.3 10.9 14 23 56.8 21.3 12.2 21.2 Kong East Asia 81.1 89.3 84.9 108.7 132.8 92.4 82.4 96 total World 378.8 460 660.1 1,019.70 1,369.20 659.1 n.a. 757.8 total China’s 57.7% 55.6% 61.0% 44.1% 49.2% 59.2% 66.5% 55.8% share of East Asia total China’s 10.8% 9.5% 6.5% 3.7% 2.7% 6.4% n.a. 5.5% share of world total Note: n.a. means not available. Source: International Financial Statistics, International Monetary Fund; World Investment Report, UNCTAD (http://stats.unctad.org/fdi/).

Asia in 2002.4 The trend continues, as investors respond to expectations of a more open business environment in China resulting from its accession to the WTO in 2001. China will maintain its comparative advantage in labour-intensive industries for a long time to come. At the same time, the matching of increased technological capability with low-cost labour will support the expansion of a wide variety of more sophisticated exports. This will force the NIEs to move more quickly in upgrading their industrial structures. China’s imports of a wide range of manufactured goods and services, as well as natural-resource-based products, will increase rapidly. The utilisation of the opportunities that derive from China’s internationalisation requires the transfer of resources from activities that compete directly with emerging comparative strengths of China, into others in which its trading partners have stronger comparative advantage as a result of China’s growth and increased participation in international exchange. There are short-term adjustment costs, and negative domestic political reactions (Garnaut 2003).

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More recently, there has been wider international concern about the shift of global manufacturing capacity to China. Recent political discussion in the United States has identified growing imports from China as a significant factor in the decline in manufacturing employment, and the undervaluation of the yuan as a contributing cause. While the arithmetic of increased imports from China and declining manufacturing employment in large industrial countries does not suggest strong causation, there is no doubt that the issue has political traction. China does not have a huge current account surplus. But a bilateral surplus generates tensions with the United States. This is a problem without an economic solution, as it does not have an economic cause. There can be some easing of pressure, however, if China uses the scope provided by external payments surpluses to liberalise trade more rapidly than is required by the commitments that it has provided to the WTO. China’s growth and integration into the international economy could go badly wrong if reactions to the costs of adjustment to rapid structural change become influential in political processes at home or abroad. The nature of international institutions through which political reactions to structural change are mediated can therefore have an important influence on the sustainability of growth. The WTO is the most important of the international institutions in mediating pressure for restrictive reactions to adjustment pressures arising from the rapid growth of Chinese foreign trade. China’s (and Taiwan’s) membership has reduced the risk that reactions to domestic political pressures in China or in its trading partners would block expansion of profitable trade relations between China and the rest of the world. Constraints on protectionist uses of antidumping arrangements are an important Chinese interest in the Doha Round of multilateral trade negotiations (Garnaut 2003).

THE SEA CHANGE IN TRADE POLICY ORIENTATION Open regionalism in the western Pacific, unilateral liberalisation everywhere except in China, and the liberalising role of the WTO except in China were all under strain by early 2000. Trade discrimination within NAFTA had seemed in practice to have been damaging to East Asian interests, and this perception generated some hankering after preferential treatment in East Asia. The failure of the WTO meeting in Seattle in 1999 to launch a new round of multilateral negotiations encouraged disillusionment with the multilateral processes, so important in East Asian views of the trading system. The financial crisis had weakened commitment to deep integration into the international economy in Indonesia and Malaysia. As the most important legacy of the financial crisis, the authoritarian Soeharto government in Indonesia had been replaced by a democratically elected government that attached low priority to regional leadership on trade issues. The latter development on top of the financial crisis left ASEAN, previously a leader in Asia Pacific institution building and trade policy, incoherent and ineffective. Despite the strain, it could still be said in early 2001 that Japan, Korea, China, Hong Kong and Taiwan were the only major economies to conduct their foreign trade entirely on a most-favoured-nation basis. Trade discrimination within ASEAN and Australia-New Zealand Closer Economic Relations remained minor exceptions to the western Pacific economies’ commitment to Article 1 of the GATT. The political foundations of open

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regionalism had been weakened, but the structure was still standing. And with the admission of China and Taiwan into the WTO, with far-reaching commitments to nondiscriminatory liberalisation, and the launch of multilateral negotiations with a strong agenda and broad support, at the WTO ministerial meeting in Doha in November 2001, it was possible to believe that it may be gathering strength again. The structure has crumbled since late 2001. The Doha Round was treated lightly in the major economies, including those of the Asia Pacific. The new Bush administration gave explicit priority to bilateral and subregional FTAs which, while involving minor trading partners of the United States and making slow progress in negotiations, lifted the credibility of small-group FTAs throughout the Asia Pacific. A Japan-Singapore FTA was concluded in early 2002. This was followed by Singapore-New Zealand, Singapore-Australia, Hong Kong-China and Singapore-US. Australia-Thailand was signed by the two prime ministers at the time of the 2003 APEC leaders’ meeting in Bangkok. China-ASEAN is under negotiation, although trade discrimination associated with it began with duty-free access to China for Thai fruit and vegetables from 1 October 2003, and extended to ASEAN exports of 200 agricultural products on 1 January 2004. Negotiations are at various stages for FTAs involving JapanThailand, Japan-Malaysia and Japan-Philippines, with these three expected to coalesce eventually into Japan-ASEAN; ASEAN-Korea; ASEAN-India; Korea-Japan; KoreaChina; Japan-Mexico (in trouble over pork); US-Australia (in trouble over agriculture and services); US-Thailand; and Korea-Chile. Australia has persuaded China to enter two years of discussions on whether the two countries should commence negotiations on an FTA, and Japan not to exclude the possibility of negotiations in the future despite the agricultural problem. There is an expectation that some of these discussions will lead to consideration of China-Korea-Japan and ASEAN-China-Korea-Japan. Meanwhile the collapse of the WTO ministerial meeting in Cancun, which was meant to settle some key Doha Round issues, was greeted by leaders of three APEC members (Australia, the United States and Thailand) as a cause for elevation of bilateral FTAs over multilateral negotiations. The defeat of open regionalism in the Asia Pacific seems comprehensive.

TRUNCATED GLOBALISATION? The proliferation of bilateral and small-group FTAs in the Asia Pacific is threatening the East Asian development pattern in fundamental ways. It is likely to inhibit the continued development of fragmentation trade. It will create problems for East Asian adjustment to the rise of China. And it will separate other parts of the world economy from the gains from trade with a dynamic East Asian region. In the worst of circumstances, it could truncate the globalisation of production and expenditure that has been a central feature of sustained strong growth in East Asia. Defenders of the sea change in East Asian and Asia Pacific trade policy argue that the new FTAs are or can be consistent with the WTO rules, that they are stepping stones to an East Asia-wide or Asia Pacific-wide FTA (on the presumption that this would be desirable), and that they improve the prospects for multilateral liberalisation (the concept of ‘competitive liberalisation’ promoted by US Trade Representative Robert Zoellick). It

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is difficult to reconcile these perspectives with the contemporary world of Asia Pacific trade policy. In truth, the new FTAs involving western Pacific economies have breached WTO rules in relation to commodity coverage and length of transition periods. But it would be little comfort if they had conformed fully: for the reasons set out by former WTO Director General Ruggiero in the passage cited above, the proliferation of FTAs that are fully consistent with Article 24 of the GATT can greatly weaken the multilateral system. There are several reasons why the drift into FTAs will diminish the prospects of maintaining and extending the system of liberal, multilateral trade in the Asia Pacific. First, bilateral FTAs by their nature contain welfare-destroying trade diversion as well as welfare-enhancing trade creation, and the political economy of the policymaking process tends to emphasise the trade diversion. Countries avoid partners which would be associated with high levels of trade creation (for example, Japan-US because of the difficulty of agriculture), or seek to make exceptions for sectors which would involve high levels of trade creation (for example, agricultural protectionism in the United States leads to an unwillingness to reduce agricultural subsidies in FTA negotiations with countries such as Australia and the Americas, especially Brazil). Also some marketopening decisions are harder to take in a bilateral than in a multilateral context—witness the difficulties over access to American agricultural markets in US-Australia negotiations. Second, the rules of origin that are required to protect the preferential privileges of an FTA are themselves a source of distortion and economic loss. For this reason, even a complete matrix of bilateral FTAs, joining every country with every potential trading partner, would not produce welfare effects that were in any way comparable to multilateral free trade. Transaction costs in international trade and investment would be very much higher, and trade in final goods and intermediate goods would be encouraged into suboptimal patterns by arbitrary incentives created by these rules of origin. Third, the creation of small-group FTAs adversely affects the political economy for subsequent multilateral liberalisation. Some countries which benefit from increased exports within the preferential area resist the erosion of their regional preferences which would happen in a multilateral WTO liberalisation. It has been suggested that Mexico may have been influenced by such considerations in Cancun, and those developing countries with preferences have always sought to resist the multilateral liberalisation of European agricultural trade. Fiji and other South Pacific countries have asked for compensation for the effects of unilateral liberalisation on their margins of preference in the Australian market. Industries supported by rules of origin add to such pressure against further liberalisation. Fourth, it appears that some in the United States today view access to the US market as a benefit which should be granted only to supporters of US foreign policy on whatever are the big issues of the times. Such an approach politicises moves toward further trade liberalisation, and introduces a risk that political and cultural divisions will be exacerbated and entrenched. Most importantly, when some countries join small-group FTAs, others are led to seek similar arrangements for defensive reasons (Garnaut and Vines 2003). The new pattern of bilateral and subregional preferences would truncate the process of increasingly fine specialisation in the supply of inputs into final products assembled in

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one or other of the Asia Pacific economies, because of the rules of origin. No car or television set or computer or shirt produced in Australia, Thailand or Taiwan, or any but the largest and most diverse Asia Pacific economies, and possibly not even China or Japan, would have sufficient domestic-plus-partner value-added to meet NAFTA-style rules of origin in any bilateral FTA. So, on these rules, the products of the new global industries in the Asia Pacific would be denied free access to FTA partners, and would be disadvantaged in competition with products of the old, nationally integrated patterns of production. The nationally integrated patterns would in any case be feasible only in the largest economies: there would be tendencies for production to gravitate toward economies in which it was less uneconomic to draw all inputs from domestic or single FTA partner sources. The competitive position of the United States and China would be enhanced. Other economies would find that their opportunities to participate in the regional and global division of labour by specialising in parts of the supply process were greatly diminished. The contemporary regionalisation and globalisation of production would also be damaged by the transaction costs associated with monitoring and enforcing rules of origin, even in cases in which the domestic-plus-partner value-added were able to meet the tests. For example, Singapore producers seeking to supply US customers under the FTA would need to monitor production processes to ensure that there was not too much Indonesian or Malaysian or other western Pacific value-added in components. They would need to maintain records in forms suitable for inspection by US authorities seeking to enforce rules of origin. As demonstrated by Athukorala (2003), fragmentation trade is more sensitive than conventional trade to international transaction costs. The proliferation of FTAs is a problem for adjustment to the rise of China because it concentrates adjustment excessively in countries which have FTAs with China and also in those which do not have FTAs with third countries. It denies the great advantage of multilateral trade on a global basis, in that it diffuses pressures for adjustment throughout the global economy. The tendency for an FTA with China to magnify pressures for adjustment to Chinese growth and structural change in partner countries increases the chances of domestic political resistance to adjustment, and is likely to increase bilateral political tensions. Pressures for a neighbouring country to adjust to Chinese growth and structural change are also magnified by other trading partners entering FTAs with each other, even if neither China nor its neighbour is directly involved. The point emerges from general equilibrium theory, but can be illustrated by the Canadian experience after the formation of NAFTA. Canadian and US businesses traded more with each other after the formation of NAFTA. This diminished Canada’s trade with non-NAFTA partners through three processes. One was conventional trade diversion, where the protection differentials directly raised the profitability of NAFTA relative to external transactions. The second was the general equilibrium effects of trade diversion in raising costs: at the margin, Canadian suppliers became less competitive in third markets. The third, and probably the most important, is that in a world in which business leaders have limited resources to search the global environment for trade opportunities, an FTA with an important economy, especially a neighbour and ‘natural trading partner’, diminishes the effort that is put into developing opportunities with third countries. For these and other reasons, there was a radical reduction in Canada’s share of markets in East Asia, Europe and the

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rest of the world over the years in which the NAFTA preferential arrangements were implemented (compare Canadian and Australian growth in exports to Europe and East Asia in Table 4.1). Reduced engagement of Canada with the ASEAN and Chinese economies means relatively greater engagement of China and ASEAN with each other, and greater adjustment pressure to the rise of China being focused on ASEAN. Diminished gains from trade accompany diminished adjustment pressure. The separation of third countries from East Asian dynamism by FTAs, whether in East Asia or joining third countries, reduces their exposure to opportunities for raising living standards. This is likely to be most damaging to potential suppliers of the naturalresource-based products in which China’s comparative disadvantage is most pronounced, and especially of the agricultural industries in which trade distortion is endemic. The danger is greatest for Australia and New Zealand, for which East Asia is a natural trading partner. The trade-off between costs of adjustment and gains from trade through the rise of China is affected by the presence of FTAs. For the world as a whole, the trade-off between adjustment costs and gains from trade is more favourable if the movement is toward specialisation according to global comparative advantage, as it is modified by growth and structural change in individual economies. Are these problems of central or peripheral importance to East Asian development and its contribution to Asia Pacific and global income growth? The effects on transaction costs and fine specialisation in parts of the supply process could turn out to be very important indeed. The impact on China is likely to be less than for its western Pacific partners, because of China’s prospects of internal specialisation as internationally oriented growth spreads to the inland regions. But even in China, inhibitions against cost-minimising purchases of inputs could significantly weaken competitiveness in the more sophisticated products toward which Chinese comparative advantage is evolving. China would need to allocate more high-level political energy to managing tensions in the East Asian partners experiencing adjustment costs, and in the best of circumstances would experience slower trade growth and smaller gains from trade than would otherwise be available. Even for the huge US economy with its many options for continued growth, greater separation from the dynamism of East Asia would make it harder to retain global leadership in many areas of business. US FTAs with the main East Asian economies, first of all China, would be debarred for the foreseeable future by the political and political economy constraints. The US would be bound by trade discrimination to intense political relations with relatively unimportant members of the international economy. Further, the US economic and trading interest in global agricultural trade liberalisation would be damaged, as these interests can be pursued effectively only in an international context. US agriculture is already facing discrimination against it in the Chinese market from the ‘early harvest’ of the China-ASEAN FTA. The costs of exclusion would multiply as competitors in broad-acre temperate agricultural production, including Australia, entered discriminatory arrangements in East Asia. There would be some compensating benefits for the United States in a retreat into preferential trade, from the tendency for more manufacturing activities to agglomerate in large and diverse economies—first of all in the United States. But the United States would share with others the increase in costs of international transactions, at a time when

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these are being inflated in any case by terrorism and the response to it. It would share with others the loss of opportunity in a world in which the truncation of globalisation led to slower global economic growth. The Asia Pacific region had found a successful formula for sustained rapid growth, based on continually reducing costs of international transactions, leading to deepening integration into the international economy and to increasingly fine specialisation in parts of the supply process. This pattern of growth had considerable momentum with the integration of China into the world economy. The new world of proliferating Asia Pacific FTAs would need a new pattern of growth. There is a risk that the successor to the established growth model will not work well.

CHINESE LEADERSHIP AND A WAY FORWARD There is huge momentum behind the breakdown of multilateral trade. The Asia Pacific countries that had been most sceptical about preferential trade, Malaysia and China, joined the momentum in 2003. There is a strong sense in every country in the region that it must move quickly to secure as many preferential deals as possible, lest it be the object of damaging discrimination. This is a time when the political commitments to the sea change are fresh, and before the costs of the change are known from experience. It is a difficult time to change policy again, and yet it is important for the sustainability of internationally oriented growth that a way forward be found from the present difficulties. An essential element of any way forward is widespread recognition of the risks and costs of the proliferation of preferential trading areas. This for a time will be the lonely work of independent analysts, including those associated with the PAFTAD conference series. There has been some discussion of the need to strengthen Article 24 of the GATT— the rules for formation of FTAs—and their enforcement. One suggestion is simply to enforce the existing requirements that an FTA should cover substantially all trade and should be built on a plan and a schedule to achieve this result within ten years. Another is to provide for uniform and liberal rules of origin. A third suggests the provision for rights of accession to any third party that is prepared to accept the rules upon which the FTA was established. There is likely to be little value or hope in enforcing the existing rules. Little value because, as Renato Ruggiero explained in 1996, the problem lies in the rules rather than in their breach. Little hope because the breaches are nowhere more egregious than in the FTAs negotiated by the WTO’s most influential member. The illiberality of rules of origin and their inconsistency across products and agreements, and the effective exclusion of newcomers, are the products of the political economy that generated the FTAs. They would be as difficult to put aside as the FTAs themselves. There would be no harm in APEC developing model rules of origin and for open accession, but there would be little expectation that they would be influential. The most valuable element of a model FTA would be a commitment for members to make the terms of market access for members available to all trading partners. If one or more APEC members were to act on such a rule—and it would be in the economic interests of every one of them to do so—it would provide a starting point for the

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restoration of the interest in unilateral liberalisation that was at the heart of internationally oriented development in the western Pacific for the decade from the mid-1980s. Nothing would be as helpful as timely success in the Doha Round of multilateral negotiations. The enthusiasm for FTAs has denied high-level political focus to the Doha Round. Japan and Korea have shown signs of relief that the shift to preferential trade, in which they can choose their partners, may allow them to avoid pressure for liberalisation of agriculture. The announcement of the Australia-US FTA, with its effective exclusion of the most heavily protected agricultural industries in the US, was especially welcome to Seoul and Tokyo. Japan, once a global champion of multilateral trade, now does not see multilateral negotiations as the main priority (Ito 2003). There is no contemporary analogue to the intense and productive discussions among western Pacific members of the GATT, and later in APEC, at a corresponding stage of the Uruguay Round. Instead, when the heads of government of Thailand, Japan, Korea, Singapore, Australia, the United States and others meet and get around to trade policy, they talk FTAs. But the gains from FTAs are so dubious and the difficulties that arise in their negotiation so large that progress has been slow. There has been some recognition since the breakdown of the Cancun meeting of the costs of eventual failure in the Doha Round. This is the background to the APEC leaders’ Bangkok Declaration, calling for a return to Doha Round negotiations on the basis of the Chairman’s text at Cancun—a course of action rejected firmly by several influential APEC members only a few weeks before. The APEC leaders’ support for the Doha Round after Cancun has been noted favourably in Europe (Lamy 2004). But to be influential it needs a champion or champion among APEC members. China is the most likely and effective champion of the Bangkok Declaration on the Doha Round. It is the most likely because it has more at stake than any other WTO member: the preservation of the open global trading environment in which it can emerge as the world’s largest trading economy over the next one or two decades. China was late and reluctant to join the enthusiasm for FTAs, in recognition of its interests in global trade. It entered the discussions on an FTA with ASEAN to assuage pressures resulting from the Southeast Asian structural change that has accompanied internationally oriented growth in China. The solution does not suit the problem. Preferential trade will exacerbate structural pressures on the ASEAN economies. And ASEAN economies seeking special access to the growing Chinese market will find that the breakdown of the region into preferential trade agreements will diminish opportunities for specialisation in exports of parts of the supply process, which has been so valuable to them and promises much more. Moreover, China has big reasons outside the negotiations to accelerate its own liberalisation in ways that would reinforce its leadership role in the multilateral negotiations. Its external payments surpluses have attracted pressure from abroad for premature liberalisation of foreign exchange markets. Accelerated trade liberalisation would achieve similar macroeconomic and external political objectives, without the systemic risk. The value of the multilateral negotiations is so large that the prospects have remained alive despite the neglect of the parties that could have been expected to be their

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protectors. The opportunity for moving forward on the basis of the Bangkok Declaration and a positive lead from China would be enhanced if a clear signal were given that major East Asian states were putting the negotiation of new FTAs on hold for the duration of the Doha Round. This would realise the hopes of those supporters of FTAs in the Asia Pacific region, who have argued that they can be stepping stones toward multilateral liberalisation.

NOTES We are grateful to Peter Petri and Prema-Chandra Athukorala for their constructive comments on an earlier version of this chapter, and to Marpudin Azis for organising the data. 1 The definition of labour-intensive manufactures used here is the sum of the standard labourintensive products belonging mainly to SITC 8. 2 For most countries, the level and rate of growth of intra-industry trade could be much lower than reported here since the estimates did not exclude component trade. 3 The intensity could fall more if ‘fragmentation trade’ was appropriately excluded from total trade as cross-border trade in parts and components accounts for an increasing share of intraregional trade in the region. 4 This may overestimate the real figure as it did not consider the ‘round-tripping’ of capital from mainland China to Hong Kong as investment to take advantage of tax, tariff and other benefits accorded to foreign-invested firms (Wei 2000). Also, the figure did not consider the disruption of FDI inflows into most East Asian countries during the East Asian financial crisis.

REFERENCES Asian Development Bank (ADB) (2003) Asian Development Outlook, Manila: ADB. Athukorala, Prema-Chandra (2003) ‘Product fragmentation and trade patterns in East Asia’, Working Paper 2003/21, Research School of Pacific and Asian Studies, the Australian National University. Crawford, Sir John and Greg Seow (eds) (1981) Pacific Economic Cooperation: Suggestions for Action, Petaling Jaba, Selangor, Malaysia: Heinemann Asia, for the Pacific Community Seminar. Drysdale, Peter (1969) ‘Japan-Australia: the prospects for closer economic integration’, Economic Papers 30:12–28. ——(1988) International Economic Pluralism: Economic Policy in East Asia and the Pacific, Sydney: Allen and Unwin. ——(2003) ‘Regional cooperation in East Asia and FTA strategies’, presentation to IIPS conference on Building a Regime of Regional Cooperation in East Asia and the Role which Japan Can Play, Tokyo, 2–3 December. Drysdale, Peter and Ross Garnaut (1982) ‘Trade intensities and the analysis of bilateral trade flows in a many-country world’, Hitotsubashi Journal of Economics 22(2): 62–84, February. ——(1993) ‘The Pacific: an application of a general theory of economic integration’, in Fred Bergsten and Marcus Noland (eds) Pacific Dynamism and the International Economic System, Washington DC: Institute for International Economics.

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Elek, Andrew (1992) ‘Trade policy options for the Asia Pacific region in the 1990s: the potential of open regionalism’, American Economic Review, Papers and Proceedings 82(2):74–8. Findlay, Christopher (2003) ‘China in the world economy: the FTA strategy’, in Ross Garnaut and Ligang Song (eds) China: New Engine of World Growth, Canberra: Asia Pacific Press. Garnaut, Ross (1989) Australia and the Northeast Asia Ascendancy, Canberra: Australian Government Publishing Service. ——(1994) ‘Trade liberalization and the Washington consensus in Australia’, in J. Willliamson (ed.), The Political Economy of Policy Reform, pp. 51–72, Institute of International Economics, Washington. ——(1996) Open Regionalism and Trade Liberalisation: An Asia-Pacific Contribution to the World Trading System, Singapore and Sydney: Institute of Southeast Asian Studies and Allen and Unwin. ——(2003) ‘China: new engine of world growth’, in Ross Garnaut and Ligang Song (eds) China: New Engine of World Growth, Canberra: Asia Pacific Press. Garnaut, Ross and David Vines (2003) ‘Putting Doha back on track: aligning the interests of Europe and the Asia Pacific’, Royal Institute of International Affairs, Chatham House, London, 15 December. Ito, Takatoshi (2003) ‘Japan’s approach to bilateral FTAs’, mimeo, Tokyo University. Kojima, Kiyoshi (1964) ‘The pattern of international trade among advanced countries’, Hitotsubashi Journal of Economics 5(1):16–36, June. Lamy, Pascal (2004) ‘Europe and the future of economic governance’, Journal of Common Market Studies 42(1):5–22, March. Lawrence, Robert (1991) ‘How open is Japan?’, in Paul Krugman (ed.) Trade with Japan: Has the Door Opened Wider?, Chicago: The University of Chicago Press. Soesastro, Hadi (1994) ‘Pacific economic cooperation: the history of an idea’, in Ross Garnaut and Peter Drysdale (eds) Asia Pacific Regionalism: Readings in International Economic Relations, Pymble, NSW: HarperEducational. Song, Ligang (1996) Changing Global Comparative Advantage: Evidence from Asia and the Pacific, Melbourne: Addison-Wesley. Wei, Shang-Jin (2000) ‘Why does China attract so little foreign direct investment?’, in Takatoshi Ito and Anne O.Krueger (eds) The Role of Foreign Direct Investment in East Asian Economic Development, Chicago: University of Chicago Press. World Bank (1993) The East Asian Miracle: Economic Growth and Public Policy, World Bank Policy Research Report, New York: Oxford University Press. Xu, Xinpeng and Ligang Song (2000) ‘Export similarity and the pattern of East Asia development’, in Peter Lloyd and Xiao-guang Zhang (eds) China in the Global Economy, Cheltenham: Edward Elgar. Yeats, Alexander (1998) ‘Just how big is global production sharing?’, Policy Research Working Paper 1871, New York: The World Bank.

5 Asia Pacific economies and the Doha Development Agenda Bijit Bora and Muhammad Chatib Basri

INTRODUCTION The economic success of the Asia Pacific region over the past two decades has been built on openness to international trade and foreign investment. Debates continue about the role of government policy in steering this success, but the fact that tariffs on imports were reduced and restrictions on foreign investment relaxed cannot be contested. The manner in which these policies were implemented offers important lessons for developing countries still searching for a path to integrate into the world trading system. Instead of pursuing regional or preferential schemes, the Asia Pacific economies, using the Asia Pacific Economic Cooperation (APEC) forum as a framework, adopted a policy of unilateral or most-favoured-nation (MFN) liberalisation. The launch of the Doha Round of World Trade Organisation (WTO) negotiations in 2001 presented an opportunity for the Asia Pacific economies to further their process of reform and take advantage of new areas of market access. The setback at the mid-term review in Cancun dampened expectations about what the negotiations could achieve. The Cancun Ministerial broke down in acrimony between developed and developing countries. There were differing views about the criteria required to define it as the ‘development round’: some developing countries would only commit to a minimum set of obligations, while others stated that only developed countries needed to make concessions. The negotiations have missed the agreed deadlines: an agreement on basic modalities was only reached in July 2004. Nevertheless, one important lesson has been learned—developing countries have a great deal to lose if the round is unsuccessful. Hence, there is a strong incentive to work toward reigniting the negotiations. This chapter examines the issues of concern to Asia Pacific economies in the Doha Round and the issues raised by the move toward preferential trading arrangements (PTAs). East Asian economies are particularly important to a successful conclusion to the round, as the region accounts for two-thirds of world trade.

THE STRUCTURE OF EAST ASIAN TRADE Major changes have taken place in global trade and, correspondingly, in East Asian trade during the last decade. The principal change has been the reduction in the importance of agriculture trade in world trade. The average annual growth rate in manufacturing trade has exceeded that of agricultural trade by about 2 per cent over the past twenty years

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(Figure 5.1). In absolute terms the average annual growth rate was about 5 per cent. Much of this change was driven by developing countries, whose growth rate of manufacturing exports was roughly double that of the world rate in the 1990s. This fact is also reflected in the difference in the growth rates of their manufactured exports to industrialised countries, which have averaged approximately 8 per cent over the past two decades. Developing countries in East Asia have been the principal drivers of this change. Economies such as Hong Kong, China, Korea, Taiwan and Singapore have experienced strong manufacturing growth rates in the late 1980s, although these stabilised in the 1990s. Tables 5.1 and 5.2 provide an overview of the broad interests of the developing countries in the East Asia region. Table 5.1 shows that, aside

Figure 5.1 Annual real export growth rate (per cent)

Source: Comtrade, UN.

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Table 5.1 Exports of manufactures of selected economies, 1990–2003 Value (US$ billion)

1990

1995

2001

2002

Share in economy’s total merchandise exports 2003 1995 2003a

World 2,391.00 3,719.00 4,517.00 4,749.00 5,437.00 44.31 124.84 235.82 292.57 397.00 Chinab Hong Kong 75.64 160.77 181.97 191.55 215.49 domestic 27.41 28.02 18.79 15.82 14.59 exports re-exports 48.23 132.75 163.18 175.74 200.90 Indonesia 9.04 22.96 31.52 30.91 31.62 South Koreac 60.60 114.40 135.46 147.29 177.10 15.82 55.09 70.42 74.01 77.28 Malaysiab Philippinesb,c 5.59 13.78 29.24 32.31 35.54 Singapore 37.55 99.04 102.59 105.64 120.93 domestic 23.26 57.87 52.00 52.92 65.68 exports re-exports 14.28 41.17 50.59 52.72 55.25 Taiwan 62.05 104.88 119.40 123.00 141.12 Thailandc 14.58 41.22 48.26 51.98 60.08 Notes a Or nearest year. b Includes significant exports from processing zones. c Includes WTO Secretariat estimates. Source: International Trade Statistics 2004, WTO.

74.1 83.9 92.5 93.6

74.5 90.7 94.2 74.5

92.2 50.5 91.5 74.5 78.8 83.7 83.2

96.1 51.9 91.4 77.8 88.5 83.9 82.4

84.5 92.8 73.0

85.8 93.7 74.6

from Indonesia, in 2003 each economy’s share of manufacturing exports in total exports was above the world average. Table 5.1 also shows that this share has either been stable or has increased between 1995 and 2003. This means that merchandise exports are the primary offensive interests of developing countries in the negotiations. Indonesia, for which manufactures account for only 50 per cent of exports, has offensive interests in both agriculture and manufactures. Table 5.2 provides similar data on imports of manufactures. Indonesia stands out again. Manufactures accounted for 72.8 per cent of imports in 1995, but 56.5 per cent in 2003. In general, however, the table illustrates that these economies are primarily manufacturing exporters in return for agricultural products. There is no doubt that the interests of each economy will differ slightly, given the broad range of manufacturing products. Some of these interests are reflected in Table 5.3, which presents the export growth rates of a number of different products. These differential growth rates and the corresponding shares of these product groups in the export basket of countries are important determinants of strategic trading interests. While

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Table 5.2 Imports of manufactures of selected economies, 1990–2003 Value (US$ billion)

1990 1995

Share in economy’s total merchandise imports 2001 2002 2003 1995 2003a

Chinac 42.39 103.41 189.92 236.81 328.57 Hong Kong 70.53 170.56 182.53 188.25 212.17 retained 22.30 37.81 19.35 12.51 11.27 imports Indonesia 16.64 29.57 18.91 18.41 18.39 South Koreac 44.10 89.85 84.64 94.22 111.92 22.87 64.42 59.95 65.53 67.98 Malaysiab Philippinesb,c 8.96 21.83 23.76 28.41 32.38 Singapore 44.42 103.32 93.14 92.96 102.02 retained 30.13 62.15 42.55 40.24 46.77 imports Taiwan 36.77 76.85 81.53 86.16 95.73 24.83 56.70 46.58 48.32 56.99 Thailandc Notes a Or nearest year. b Includes significant imports into processing zones. c Includes WTO Secretariat estimates. Source: International Trade Statistics 2004, WTO.

78.3 87.0 72.5

79.5 91.0 46.7

72.8 66.5 82.9 77.0 83.0 82.0

56.5 62.6 83.0 81.9 79.7 73.6

74.2 80.1

75.2 75.2

some of the more developed economies in the region have shifted their export basket toward more skill-intensive products, others are still continuing the transition from lowerskill to higher-skill products. Export composition is not the sole determinant of negotiating interests. One of the key features of the trade performance of East Asia has been the propensity to trade with each other. Intra-regional trade is an important component of economic restructuring.

THE DEVELOPMENT AGENDA AND CHALLENGES TO ASIA PACIFIC’S TRADE POLICY A number of trade policy developments in 2003 and 2004 had an impact on the parameters of the World Trade Organisation negotiations. Among these, the failure to reach an agreement at the fifth WTO ministerial was an important one. The dramatic failure of that conference may have catalysed another development—the increased trend toward preferential trading agreements that appears to be concentrated in East Asia.

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Market access Although the Uruguay Round was important in bringing agriculture within the multilateral trading system, agricultural exporters still face high levels of protection. The Doha Declaration set the aims of improving market access,

Table 5.3 Growth rates of exports by product category, 1985, 1995 and 2001 Exporter Year Feeds Tobacco Agric. Ores Fuels Animal Che Other Mach Misc Raw and & Veg. micals Manuf. inery & Manuf. Mate Metals Oils Transp. rials China

1985 1995 2001 Hong 1985 Kong 1995 2001 Indonesia 1985 1995 2001 South 1985 Korea 1995 2001 Malaysia 1985 1995 2001 Philip 1985 pines 1995 2001 Singa 1985 pore 1995 2001

1.13 0.63 0.91 1.09 0.70 0.85 1.12 0.74 0.82 0.49 0.38 0.36 1.34 1.87 1.96 0.51 0.71 0.60 0.74 0.71 0.65

3.86 8.61 5.41 16.24 3.65 2.57 0.10 0.38 1.35 0.76 1.15 0.60 3.65 17.04 13.55 0.47 2.65 0.76 4.56 7.52 7.06

0.66 0.98 0.77 5.40 2.94 5.61 2.08 1.11 2.53 3.83 2.49 1.98 0.84 1.03 1.01 0.64 1.29 0.44 0.42 0.41 0.71

0.60 1.87 1.90 3.22 2.13 7.66 0.69 1.13 1.11 1.53 1.70 2.33 0.29 2.41 2.15 1.01 2.51 2.35 1.86 3.55 2.03

0.77 0.86 2.37 88.25 20.71 18.54 0.70 1.31 1.50 1.15 1.59 1.64 1.64 1.29 1.23 22.12 6.63 3.54 1.94 5.89 5.03

0.36 0.68 8.98 0.92 4.82 0.97 6.55 4.84 5.68 4.63 1.83 7.86 0.43 12.66 0.37 4.43 0.75 3.56 2.83 5.51 1.29 3.33 2.03 3.49 0.76 1.08 0.62 1.83 0.69 2.09 0.19 3.76 0.43 3.42 0.38 3.16 0.40 2.35 1.04 2.11 0.47 1.38

1.20 0.96 1.03 0.31 0.60 0.54 3.02 1.07 0.64 0.81 1.40 1.13 0.89 1.05 0.84 0.31 0.22 0.18 0.57 1.14 1.09

3.12 1.22 1.15 1.41 2.00 1.68 2.03 0.66 0.84 1.17 0.69 0.72 0.75 0.95 0.97 2.29 1.41 1.23 0.59 0.70 0.84

1.19 0.86 0.73 0.40 0.56 0.53 1.14 0.20 0.15 0.33 0.38 0.64 0.83 0.90 0.73 0.23 0.27 0.28 0.54 0.81 0.78

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Taiwan

1985 0.85 1995 0.23 2001 0.52 Thailand 1985 1.20 1995 0.85 2001 0.67 Vietnam 1985 1.83 1995 1.38 2001 0.87 All above 1985 1.14 countries 1995 0.61 2001 0.70 Memo items: net changes Indonesia 1985– −0.30 01 All above 1985– −0.44 countries 01 Source: Comtrade, UN.

2.82 3.22 4.43 6.58 0.30 1.83 2.51 2.75 3.26 2.67 1.75 2.21 4.75 5.02 1.76 0.67 0.89 0.96 0.45 2.11 1.25 0.95 2.24 12.38 1.95 0.93 1.88 2.63 8.84 5.84 0.00 2.82 0.68 0.03 4.52 2.98 5.40 10.56 0.89 96.55 0.98 2.88 3.58 2.54 5.52 1.87 1.34 0.99 1.21 1.01 4.00 1.11 1.89 1.58 0.68 2.89 1.45 2.28 1.96 0.83

3.60 5.17 4.96 2.91 3.88 4.42 0.48 4.76 3.63 2.34 2.55 2.54

80

1.24 1.50 1.09 0.53 0.64 0.49 0.06 0.47 0.50 0.79 0.99 0.83

0.92 0.77 0.83 1.81 1.46 1.22 0.04 7.82 2.64 0.94 0.96 1.04

0.34 0.39 0.43 0.45 0.30 0.22 0.01 0.27 0.17 0.45 0.68 0.56

1.25 0.45 0.42 0.80 0.32 −9.10 −2.39 −1.19 −0.99 1.03 0.11 1.30 0.74 −0.19 0.20 0.05 0.10

0.11

Table 5.4 MFN statutory applied tariff for agricultural products Import markets

Year Total Simple Coeffi Max Duty- Dutiable (per Inter National number average cient imum free Total cent) national peaks of tariff variation of (per dutiable Non ad peaks (per lines cent) valorem (per cent) cent)

Canada 2001 European 2002 Union Japan 2001 United 2001 States Developing 2001 countriesa East Asian 2001 economiesa,b Brunei 2001 China 2002 Hong Kong 2002 Indonesia 2002 South Korea 2001 Malaysia 2001 Philippines 2002 Singapore 2001 Taiwan 2001

1,425 2,151

3.0 5.9

2.1 238.0 49–8 1.3 74.9 25.8

50.2 74.2

19–9 39.9

1.2 8.2

7.8 4.1

1,793 1,740

7.1 4.7

1.2 50.0 29.2 2.0 350.0 28.5

70.8 71.5

23.2 1.8

16.1 7.2

8.6 8.1

1,153

16.3

1.0 97.9 16.3

81.8

5.4

35.5

5.9

1,029

13.0

1.0 136.0 37.0

63.0

7.0

23.0

5.0

930 1,047 907 1,085 1,653 1,164 788 844 1,216

0.0 19.2 0.0 8.2 45.5 2.1 9.2 0.0 17.3

0.0 0.7 0.0 2.8 2.4 2.1 1.3 0.0 0.9

5.3 97.5 0.0 89.6 98.1 34.0 100.0 0.3 83.9

4.7 0.6 0.0 0.7 3.1 4.9 0.0 0.3 4.6

0.0 55.7 0.0 3.9 48.6 2.5 10.2 0.0 45.6

0.6 2.6 0.0 2.9 7.1 8.9 9.3 0.0 0.0

30.0 71.0 0.0 170.0 917.0 30.0 65.0 0.0 50.0

94.7 2.5 100.0 10.4 1.9 66.0 0.0 99.7 16.1

Asia Pacific economies and the doha development agenda

Thailand 1999 1,001 30.8 0.7 65.0 2.8 97.2 Vietnama 2001 832 24.0 0.9 100.0 12.9 87.1 Average 1,029 13.2 1.1 136.2 37.0 63.0 East Asian economies Notes a Simple, b East Asian economies is defined as APEC members from East Asia. Source: Compiled from WTO (2003).

53.3 0.0 6.6

81

31.5 55.8 23.1

0.0 19–0 4.6

reducing and eventually eliminating export subsidies, and substantively reducing domestic support. In the July 2004 package, WTO members agreed on basic modalities to reduce tariffs and domestic support and eliminate export subsidies. There was some discussion of formulas for reducing tariffs and a timeframe for trade liberalisation, but no consensus was reached. Although average tariffs on agricultural products are higher in developing countries, tariffs in developed countries have a greater dispersion. For example, in 2001 the maximum Canadian tariff on agricultural products was 238 per cent and the maximum US tariff was 350 per cent (Table 5.4). It is misleading to use simple averages as an indicator of the extent of protection—tariff peaks and high tariffs on processed products are significant barriers for developing countries. Processed agricultural products entering the European Union, the United States and Japan attract high tariffs. Although unroasted coffee beans enter the European Union duty free, a duty of 12.1 per cent is placed on processed coffee. Negotiations therefore need to address high average duties in developing countries, while reducing tariff peaks and tariff escalation for agricultural exports in developed markets. Many developed countries also impose non-ad valorem duties on agricultural products. For instance, duties are imposed on around 40 per cent of EU tariff lines. These duties are not transparent and can vary with exchange rate and price movements. They discriminate against low-value suppliers. The average non-ad valorem duty imposed by the United States on imports from developing countries is three times higher than on imports from developed countries. This suggests that such duties should be phased out, or at least reduced substantially. Such duties are rarely used by developing countries: less than 6 per cent of exports to other developing countries face duties. As for manufacturing products, market access to OECD countries is characterised by relatively low average duties, around 4.2 per cent in the European Union and 3.8 per cent in the United States, but substantial dispersion and hence tariff peaks around that average (particularly in the United States) (Table 5.5). As a result, the issue of tariff peaks and escalation dominates market access to these countries. For example the maximum tariff for the United States is still 109 per cent, while for other developed countries it is still above 25 per cent. The non-ad valorem duties on industrial products are not very significant, except for the case of Japan. The tariff dispersion is also relatively higher than for developing countries. Bachetta and Bora (2001) point out that developed countries’ tariffs continue to show relatively large dispersions in rates and significant peaks on products such as textiles, clothing and leather products. These duties can be

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very high, at about 9 per cent in the United States, 8 per cent in the European Union and 7 per cent in Japan. Most of Indonesia’s manufacturing exports to the European Union and the United States attract above-average duties, so that the trade-weighted average

Table 5.5 MFN statutory applied tariff for nonagricultural products Import markets

Year Total Simple Coefficient Max Duty- Dutiable (per Inte National number average of imum free Total cent) rnational peaks of tariff variation (per dutiable Non ad peaks (per lines cent) valorem (percent) cent)

Canada 2001 8,163 4.3 1.3 25.0 37.1 62.9 European 2002 8,305 4.2 0.9 26.0 17.1 82.9 Union Japan 2001 7,243 2.7 1.4 33.8 47.7 52.3 United 2001 8,447 3.8 1.2 109.7 31.1 68.9 States 9.8 1.0 67.4 18.8 79.5 Developing 2001 6,096 countriesa 6.0 1.0 92.0 37.0 63.0 East Asian 2001 6,491 economiesa,b Brunei 2001 5,551 3.0 2.4 200.0 74.4 25.6 China 2002 6,276 11.3 0.6 51.0 3.3 96.7 Hong Kong 2002 5,645 0.0 0.0 0.0 100.0 0.0 Indonesia 2002 6,450 6.7 0.9 170.0 20.6 79.4 South Korea 2001 9,767 7.5 0.4 30.0 5.4 94.6 Malaysia 2001 9,215 8.1 1.3 300.0 51.4 48.6 Philippines 2002 4,852 5.2 0.9 30.0 2.4 97.6 Singapore 2001 5,133 0.0 0.0 0.0 100.0 0.0 Taiwan 2001 7,183 6.3 0.9 50.0 13.9 86.1 Thailand 1999 5,866 15.5 0.9 80.0 1.2 98.8 Vietnama 2001 5,466 15.3 1.2 100.0 35.6 64.4 Average 6,491 6.4 0.8 91.9 37.1 62.9 East Asian economies Notes a Simple, b East Asian economies is defined as APEC members from East Asia. Source: Compiled from WTO (2003).

0.3 0.7

93 0.9

10.6 1.5

3.9 0.0

0.7 4.1

9.9 7.9

2.9

23.4

3.1

2.0

12.0

4.0

0.1 0.5 0.0 0.0 0.1 0.2 0.0 0.0 1.1 18.0 0.0 1.8

8.2 26.4 0.0 2.6 1.6 23.3 0.4 0.0 4.3 31.2 36.8 12.3

15.7 1.0 0.0 0.6 0.0 10.8 0.4 0.0 2.9 4.0 8.8 4.0

of duties applied to its exports is more than the unweighted average. The main products exported to the United States (wood products, clothing and footwear) attract the full MFN duty, which can be as high as 16 per cent for footwear and 27.5 per cent for certain clothing products (WTO 2003). A key issue in market access negotiations is whether bound or applied duties should form the basis for reductions. On this, there is some common interest between East Asian

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economies and other APEC members, including the United States, Japan, Australia and Latin American countries. The modality for tariff reductions is being considered in the light of proposals for tariff reductions from the agricultural negotiating group. Of course, another important issue is non-tariff barriers. Although applied tariffs for some products remain high in developed countries, the averages in developing countries are considerably higher; for example, over 11 per cent in China and 30.5 per cent in India. Average bound tariffs are even higher. As such, market access to developing countries is another important issue for discussion. The majority of APEC developing country economies that are also WTO members have bound most of their manufacturing tariffs. Thus, they cannot increase manufacturing tariffs. It is worth noting, however, that the average level of bound tariffs is often higher than the average level of applied rates. Thus, for East Asian countries, as for other developing countries, the key issue is whether cuts should be made to bound or to applied rates. Cuts to bound rates would probably leave the bound average substantially above the average of applied rates, but there would be large reductions in some of the very high tariffs currently applied. Creeping protectionism The Cancun Ministerial was supposed to introduce momentum into the Doha Round but instead ended in deadlock and resulted in a return to protectionism (Krueger 2003; Alan Greenspan, Washington Post, 20 November 2003). Although trade policy can be politically controversial, Krueger argues that governments need to resist the lobbying of interest groups in the wider public interest. Indonesia is one example where creeping protectionism has become evident. Trade reforms in Indonesia over the past decade have created many proponents for liberalisation, including exporters, academics, the media and government officials. Nevertheless, there are others that blame liberalisation for Indonesia’s economic problems. Antidumping duties, increases in tariffs, and new import regulations are instruments of the new protectionism, and protectionist groups hold some key positions in the government and the business sector. The tug of war between groups opposing and supporting trade reform involves complex bargaining. Regional trade arrangements and free trade areas The 2003 World Trade Report argues that the bleak prospect for progress in multilateral negotiations, particularly after Cancun, is one reason for the sharp increase in preferential arrangements over the past decade. As at December 2004, the only WTO member not party to a PTA was Mongolia. PTAs are now more activity negotiated in the Asia Pacific than in Europe. They are being pursued in an uncoordinated fashion, increasing trade fragmentation, absorbing resources, and threatening the WTO negotiations and the Doha Development Agenda. Another concern is that countries will believe that market access gains can only materialise in PTAs. Unlike WTO negotiations, which cut bound tariff rates, not applied tariff rates, East Asian talks have focused on cutting the gap between bound and applied rates, as opposed to cutting applied rates. It is ironic that countries are signing agreements

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that incorporate issues such as investment and competition policy, but are resisting the inclusion of these issues in the multilateral agenda.

THE ASIA PACIFIC REGION AND THE DOHA DEVELOPMENT AGENDA In the early 1990s the Asia Pacific region was riding a wave of unprecedented economic growth. Although there was debate about the catalysts driving this ‘miracle’, openness to trade and foreign investment was recognised as a common element. One defining feature of the period was the conscious effort to build and develop institutions. APEC was established in 1989 with a broad goal of community building. By 1994 trade policy had become the central platform and APEC had become one of the strongest supporters of the WTO. Although the region has not lost its economic credentials following the failures at Seattle and Cancun and the financial crisis of 1997–98, its ability and willingness to assert them within the multilateral negotiating process is at question. This has implications for the region and the trading system. Asia Pacific interest in the Doha Development Agenda The Doha Development Agenda is broad. The market access agenda includes addressing tariffs and non-tariff barriers for merchandise trade but also services, domestic support and export subsidies. Other issues on the table are issues of rule making—the so-called Singapore issues of competition policy, investment, trade facilitation and transparency in government procurement. Although some of these issues are partly covered by existing GATT rules, the agenda envisages further disciplines. Strengthening existing rules is also part of the agenda. This includes not only the special and differential agenda, but also the implementation agenda from the Uruguay Round and the dispute settlement mechanism. It is not an easy task to map the interests of the Asia Pacific economies in the agenda. Differing interests mean differing priorities. For instance, Indonesia, the Philippines and Thailand have traditional interests in agriculture. Hong Kong and Singapore have interests in services and high-technology products. China has broad interests and holds a strong negotiating position as it is still implementing its accession commitments. Japan and Korea have interests in rule making but will resist agricultural liberalisation. In the context of these diverse interests, as countries learned in Cancun, one feature of the WTO process is very important for East Asia’s negotiating strategy—nothing is agreed until everything is agreed. Staying the course There are three concrete examples of areas where Asia Pacific countries have failed to stay the course. These are the relinquishing of the role as defender of the MFN principle, withering commitment to free trade and inconsistencies in rule making.

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The MFN principle The United States was a traditional defender of the world trading system and the MFN principle up until the 1980s, when it started to rely on aggressive unilateralism to defend its trade. The signing of the Canada-US Free Trade Agreement and then the North American Free Trade Agreement showed that America had stepped down from this role. In its place stood the Asia Pacific region, including Australia and New Zealand. At that time the major trading nations in the region, Hong Kong, China, Japan and Korea, were not members of any PTA. Others were members of the ASEAN Free Trade Area. Australia and New Zealand had their Closer Economic Relations Agreement. In addition, Hong Kong, China and Singapore were shining examples of open traders with applied tariffs set to zero across the entire range of products. The fear that a wave of PTAs would exclude the Asia Pacific region and the prospect of failed Uruguay Round negotiations were behind the conception of APEC and its objective of free and open trade and investment through MFN liberalisation. This support appears to have unravelled since 1997. Japan and Korea are negotiating a trade agreement. Australia, arguably the most vocal supporter of open regionalism, has negotiated a broad-ranging PTA with the United States, as well as agreements with Singapore and Thailand, and is actively courting other partners in Southeast Asia. The signing of PTAs indicates a lack of support for the MFN principle. The Asia Pacific region, once a strong defender of the principle, now looks to be the most active violator. Tariff elimination In 1994 APEC member economies set an objective of free and open trade and investment by 2010 for developed countries and 2020 for developing countries. The following year in Osaka leaders reaffirmed this objective and began developing the framework to achieve it. The Manila Plan of Action was developed in 1996 to formalise the process. APEC members were showing that they were serious about free trade. This discussion indicates that the 2020 target might be ambitious, at least for Southeast Asia. It is also doubtful that developed countries, with the exception of Australia and New Zealand, will achieve the 2010 objective. Zero tariffs might be achievable for industrial products, but near impossible for agriculture, especially if the Bogor definition is interpreted to include domestic support and subsidies. Japan and Korea have pursued claims in the WTO for policies based on objectives that are broader than economic efficiency. The US Farm Bill will be in place until 2007 and Canada continues to support its dairy, meat and poultry industries. At this stage it is difficult to envisage developed economies in APEC announcing that they have achieved the stated objective. Furthermore, APEC’s principle of special and differential treatment through allowing differing timeframes for implementation gives developing countries less incentive to achieve the objectives. Taken together it is becoming less likely that APEC members can point to the Bogor objective as evidence of their commitment to an open multilateral trading system.

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Rule making Once the Uruguay Round concluded it was countries in the Asia Pacific region that pushed for ‘new’ issues to be part of the built-in agenda. This was done with good reason. Open trade and investment were at the heart of the region’s economic success, hence any policy that deepened integration was welcomed. This was manifested in the 1994 Bogor Declaration. However, what is often forgotten is that Asia Pacific economies had argued for and developed a respectable work program on competition policy and investment within the APEC framework. Investment was put on the agenda in 1994 after the first APEC leaders meeting in the United States. In Bogor trade ministers endorsed the non-binding investment principles, in recognition of the contribution investment had made to the success of the region and the role that clearer rules could play. Despite being non-binding, this was a significant step in rule making. However, it occurred prior to the OECD Multilateral Agreement on Investment and prior to the commencement of the WTO Working Group on the Relationship between Trade and Investment. The only initiatives before then had been the investment provisions in the Canada-US Free Trade Agreement, which became Chapter 11 provisions in NAFTA. That ministers from such a diverse set of countries could agree on some core investment principles was an achievement. Another positive step was the decision to establish the ASEAN Investment Area. Unfortunately the architecture of a negative list for reducing exemptions has proven unachievable in the current climate. Similarly APEC’s competition policy agenda is considerably further advanced than the WTO’s program. Trade ministers endorsed a set of competition principles in 1999 at the APEC meeting in Auckland. Given the progress in these new areas it is surprising that Asia Pacific countries have not shown any leadership in this regard. Perhaps this is because APEC is non-binding, and therefore an easier forum to make commitments. Leaders have been reluctant to make binding commitments at the multilateral level. At Cancun Malaysia said no to all four Singapore issues. Trade facilitation has since gained the support of members, but there are questions about whether the remaining three issues should remain in the WTO. Moving forward In July 2004 WTO members agreed on a framework to put the Doha Round back on track. Although the extent the package will contribute to the negotiations is debatable, at least members are back at the table with clearer guidelines on moving forward. One important decision was to commence negotiations on only one of the four Singapore issues—trade facilitation. This decision was complemented with a commitment to eliminate export subsidies. There is much work to be done before a final agreement materialises. For example, the date for eliminating export subsidies needs to be determined and the text on non-agricultural market access has not evolved since Cancun. Several Asia Pacific countries are important players in the world trading system. Indeed, Japan and Korea were at the centre of the controversy that led to the collapse of the Cancun Ministerial, when they refused to budge from their original negotiating positions. Asian countries are members of the G20 group of developing countries that

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countered the EU and US proposals on agriculture. And although Malaysia now holds the chair of the new Negotiating Group on Trade Facilitation it maintained a rigid position on the Singapore issues. As a group ASEAN does caucus on issues and makes statements in various forums, but there is no obvious leader or spokesperson. This may be because Singapore has a very different trade policy from other ASEAN members and because some members do not belong to the WTO. However, these should not be impediments to forming negotiating positions. China has made some impact on multinational forums, particularly the G20. For example, the formula put forward by the chair of the Negotiating Group on Market Access was based on a Chinese proposal. Market access on agriculture and non-agricultural products that face high protection is a key theme. WTO negotiations can address these issues, but so can existing commitments made under APEC. A similar statement could be made about rule making.

CONCLUSION The trade interests of the Asia Pacific region, mapped back into the Doha Development Agenda, show that the region has much to gain from fully and effectively participating in multilateral negotiations. Although a successful result in the Doha Round relies on all WTO members, Asia Pacific countries should recognise that they can play an influential role in the process. The region has a very credible record in the area of trade and investment liberalisation and APEC has also done much to advance the thinking on rule making. Asia Pacific economies can do more to translate this work into the WTO framework to achieve a better result for all members.

REFERENCES Bachetta, M and B.Bora (2001) ‘Industrial tariffs and the Doha Development Agenda’, WTO Discussion Paper No. 1, Geneva: World Trade Organisation. Krueger, A. (2003) ‘Moving on from Cancun: agricultural trade and the poor’, speech given to the Agricultural Trade Policy Workshop, 3 November, Washington Terrace Hotel, Washington DC. World Trade Organisation (WTO) (2003) World Trade Report: 2003, Geneva: World Trade Organisation.

6 APEC in the emerging international economic order: lame duck or catalyst? Andrew Elek

INTRODUCTION Many formal border barriers to trade in the Asia Pacific have already been reduced to negligible levels. Political pressures sustain high protection of a few sensitive sectors, especially parts of agriculture, but there is no intention to revert to a development strategy based on protectionism. On the contrary, there is a growing desire for closer economic cooperation with distant as well as neighbouring economies. Governments of the Asia Pacific Economic Cooperation (APEC) economies continue to reaffirm their support for a rules-based global economic order, built around the norms of the World Trade Organisation (WTO), as well as for the goal of achieving free and open trade and investment by the 2010/2020 Bogor deadlines agreed in 1994. At the same time, as described by Chia and Pangestu in Chapter 7, there is widespread disappointment with the capacity of either the WTO or APEC to meet the desire for closer cooperation, either in terms of trade liberalisation or by addressing other emerging opportunities to reduce impediments to international commerce. This has led to a rush toward regional trading arrangements (RTAs). New partnerships are being set up, almost each month. These emerging partnerships have a wide scope, covering trade liberalisation, investment, non-border issues such as competition policy, and cooperative arrangements to improve communications and reduce needless divergences in economic regulations, including standards and administrative procedures.1 There is a general expectation that new partnerships among often overlapping pairs or groups of economies will lead to closer cooperation among wider groups, such as the member economies of APEC. Unfortunately, these new economic partnerships are nearly always built around a preferential trading arrangement (PTA) to deal with border barriers. These discriminatory arrangements are inconsistent with the basic non-discriminatory principle at the heart of the GATT/WTO economic order. They follow the path of the zollvereinschafts, or customs unions, created in the very different international trading environment of past centuries. But, unlike customs unions, PTAs allow economies to continue to shelter sensitive sectors where producer interests still outweigh economy-wide interests. As discussed in this chapter, PTAs are not the most effective means of seizing any of the opportunities for promoting economic integration or development cooperation. All of them can be pursued more efficiently by other means, ranging from unilateral decision making, multilateral institutions, such as the WTO, and plurilateral forums like APEC.

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Even where it is efficient for small groups to move ahead of others, this can be done by cooperative arrangements other than PTAs. Since PTAs are not efficient instruments for integration, they will not meet all the expectations of those who enter into them. For example, it will prove very difficult to link partnerships based on discriminatory PTAs, which are tailored to the specific sensitivities of particular small groups, to form wider zones of genuine free trade and investment. Their inherent reliance on discriminatory rules of origin will, instead, divert trade away from partners in already existing agreements and lead former partners to race each other for scarce access to the sensitive sectors of the largest economies. Asia Pacific governments need to move away from over-reliance on PTAs. As in all other areas of policymaking, it would be preferable to select and use the instruments that are most effective in tackling particular objectives and do least harm in terms of progress toward the others. APEC is one of the instruments already available. The process was designed at the outset to help address all of these issues, working alongside existing international institutions as well as opening up new options for cooperative action. To enhance APEC’s potential to promote aspects of economic cooperation, the first step in this chapter is to assess its track record. This is followed by analyses of objectives and instruments to identify effective ways for APEC, a voluntary process of cooperation, to encourage Asia Pacific governments to act in their own, as well as shared, economic interests. There are many opportunities to do so unilaterally, in small groups, or in multilateral forums. As the disadvantages of proliferating PTAs become more evident, APEC may also help governments to make preferential agreements more compatible with wider cooperation, and proposals for that purpose complete the chapter. APEC’s objectives and achievements The main propositions underlying the APEC process were set out in Drysdale (1988). Prominent among these is the need for mutual trust and confidence, underpinned by frequent consultations to identify and act on shared interests, including overriding interest in a rules-based multilateral trading system. Moreover, sustained peace based on growing prosperity in the Asia Pacific needs an equally sustained commitment to remain open to the rest of the world, including to trade, investment and ideas. Some of the benefits of opening to the outside world can be obtained unilaterally, and the bulk of the benefits of these reforms accrue to those who implement them. At the same time, the benefits can be magnified if significant trading partners are also opening their economies, so there is scope for collective action. APEC was designed to promote policy-oriented consultations among regional economies to encourage such concerted moves to further economic openness. APEC was intended to complement, rather than replace, existing institutions and instruments for promoting economic integration. This approach recognised that reaping the benefits of openness and, hence, the willingness to sustain openness requires confidence in the international economic system (Drysdale 1988; Chapter 13 by MacIntyre and Soesastro). The most useful way to underpin this confidence was

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collective efforts to sustain and strengthen the rules-based global economic order, based on the GATT/WTO. Lasting adherence to a rules-based order needs, in turn, a perception that the benefits are shared reasonably evenly among participating economies. In the context of a diverse group like APEC, that requires a willingness to help the less developed economies build up the physical, social and institutional capacity to take advantage of opportunities from opening to the outside world. In other words, trade and investment liberalisation and facilitation (TILF) is a necessary, but not sufficient, condition for realising the potential for sustainable economic growth. The interdependence of economic development, openness, peace and stability was reflected in the objectives adopted by APEC Ministers in the 1991 Seoul APEC Declaration. The basic developmental aim: to sustain the growth and development of the region for the common good of its peoples and, in this way, to contribute to the growth and development of the world economy. (Seoul APEC Declaration, Clause 1(a)) was to be complemented by promoting shared trade policy objectives, namely: to enhance the positive gains, both for the region and the world economy, resulting from increasing economic interdependence, including by encouraging the flow of goods, services, capital and technology; to develop and strengthen an open multilateral trading system in the interest of Asia Pacific and all other economies; to reduce barriers to trade in goods and services among participants in a manner consistent with GATT principles, where applicable, and without detriment to other economies. (Seoul APEC Declaration, Clause 1(b,c,d)) As suggested by this emphasis on trade policy, the aim was to reduce impediments to international economic transactions, including border barriers and costs imposed by different approaches to economic regulation. Consistent with the wish to strengthen, not undermine, the GATT/WTO-based order, APEC was intended to reduce these impediments among participants without seeking to disadvantage other economies.2 This approach, termed open regionalism, can be sustained only if the governments involved believe that moves to open their economies benefit themselves and are not seen as ‘concessions’ granted to others who reciprocate by opening their markets. Sustaining a perception of self-interest in greater openness means that most producers and consumers must believe they will benefit. Maintaining that perception requires more than compensating short-term losers from structural change. It is also essential to help economies seize opportunities to exploit their comparative advantage. Accordingly, APEC’s work program went beyond trade to technology and human resource development as well as sectoral issues, including energy, transport and tourism (the Osaka Action Agenda).3

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Mixed achievements APEC’s progress has been uneven. Owing to the early emphasis on trade issues, most observers have assessed progress in terms of trade liberalisation, especially after APEC leaders adopted the goal of free and open trade and investment by 2010 for developed countries and 2020 for developing countries. Trade liberalisation APEC economies have sustained the trend toward lower border barriers—a trend that started, in most cases, well before 1989. Average tariffs as well as trade-weighted measures (tariff equivalents) have fallen steadily. Progress was not undone even by the severe financial crisis that hit many East Asian economies in the late 1980s. Simple extrapolations of the trend in average tariffs indicate that zero, or at least negligible, border protection remains in reach by 2010/2020 (ABAC 2003). By 1997 APEC was also able to show collective leadership to forge a WTO agreement to prevent trade in information technology (IT) products from being disrupted by protectionists. However, by that time, most easy steps toward trade liberalisation had been taken. Border barriers were either already low, or well entrenched. The early voluntary sectoral liberalisation (EVSL) initiative sought to build on the IT precedent by dismantling all border barriers to trade in fifteen other sectors, but it proved impossible to agree on further significant areas where all APEC governments perceived the economywide gains to outweigh short-term political costs of liberalisation. Self-contradictory attempts to negotiate a ‘voluntary’ ‘package deal’ for liberalisation failed (Macduff and Woo 2003:56). APEC’s critics point out, correctly, that there has been very limited progress in dismantling protection of the most politically sensitive sectors, such as agriculture and some labour-intensive parts of manufacturing. Moreover, the progress made in other areas is often little more, it is argued, than governments agreed to undertake in WTO negotiations and in structural adjustment programs agreed with international financial institutions.4 The second criticism can be easily dismissed. APEC is a voluntary process of cooperation, not a decision-making institution. The role of APEC consultations is to encourage member governments to use whatever means are available to liberalise trade in order to approach the agreed targets. Therefore, it is not meaningful to try to isolate the effects of APEC decisions’.5 The first criticism, however, is quite valid. APEC economies have ceased to be champions for genuinely free trade. Even the most vocal and enthusiastic supporters of the Bogor goals, such as the United States and Australia, have made domestic policy decisions and adopted negotiating positions in the WTO and in recent PTAs that make it clear they do not intend to meet the deadline for several sensitive sectors.6 In 1994 APEC governments adopted a non-binding investment code, indicating their intent to adopt liberal policies on inward and outward foreign direct investment. Some have questioned the value of a non-binding code. However, Davidson (2003) notes that domestic legislation has increasingly been brought in line with these principles. This experience indicates that in policy areas where greater openness is seen to be in the self-

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interest of Asia Pacific governments, an informal consensus can encourage governments to commit themselves voluntarily, yet formally, to more liberal provisions.7 Facilitating trade and investment Most of the 1995 Osaka Action Agenda, adopted to implement the Bogor commitment, deals with issues other than border barriers to trade and investment, addressing other means of facilitating trade and investment, such as the harmonisation of administrative procedures and mutual recognition of standards. These arrangements are being implemented by a growing number of cooperative arrangements among APEC economies. These are set out in collective action plans that are reviewed and strengthened each year. Some significant gains have been made, notably in the streamlining and harmonisation of customs clearance procedures (APEC 1997). APEC has also created mutual recognition agreements in significant sectors, such as telecommunications, and has facilitated more efficient access to, and exchange of, information about the policies and regulations of APEC economies. Following heightened concerns about international terrorism, APEC provided an effective forum for coordinated action to reduce the risks of terrorism, while adding as little as possible to the transaction costs of moving products, capital and people around the region. APEC has also seized new opportunities created by rapid advances in information and communications technology (ICT). The e-APEC program includes region-wide training in ICT skills, promoting paperless trading and widening access to the internet. All of these are important complements to liberalising trade and investment. The Osaka Action Agenda is updated regularly to reflect new issues and opportunities, particularly due to technological change. APEC’s comparative advantage in facilitation and the importance of facilitation are beginning to be realised. In 2001 APEC leaders adopted a target of reducing transaction costs by 5 per cent over five years.8 Although a step in the right direction, the objective is hard to measure, has little political resonance and fails to set priorities. Above all, it is nowhere near ambitious enough. Compared to what was achieved by the European Union’s Single Market Agenda in the 1990s, Asia Pacific economies are barely scratching the surface of the many opportunities to facilitate trade and investment. That does not mean that APEC should imitate the European Union. APEC needs to find less bureaucratic and more imaginative approaches. But Asia Pacific economies will have to address the same wide range of issues to achieve anything like free and open trade and investment. Most APEC governments perceive their self-interest in a very wide range of options to facilitate trade and investment, but these options are often hard to implement. A massive capacity-building effort will be needed to enable many economies to acquire the capacity to take advantage of many opportunities for facilitation. APEC’s capacity-building efforts are, therefore, a vital complement to TILF. Development cooperation APEC has been slow to seize opportunities to enhance the capacity of all its members for sustainable growth. In the early years, leaders were anxious to avoid North-South

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divisions and did not want APEC to be seen as yet another window for disbursing foreign aid. They were also anxious to avoid a diversion of attention from the TILF agenda. APEC working groups quickly identified many opportunities for mutually beneficial sharing of information, experience and expertise in the region. This led to hundreds of small cooperative actions, such as data collection and dissemination, seminars, workshops and training courses, which became known as APEC’s economic and technical cooperation (ECOTECH) program. Almost all of these were small in scale and often funded by one APEC economy. While most have proved useful, APEC’s consensus-based decision-making process made it hard to set priorities. So none of them could be scaled up to make a significant contribution to the region’s vast need for additional human resources, institutional capacity or economic infrastructure. The East Asian financial crisis in the late 1990s showed up these shortcomings, demonstrating the need to go beyond TILF and attend to the many other foundations of sustainable growth. The need for better institutional capacity was particularly evident in the financial sector, but it was also recognised that improved financial sector management could only be sustained in a sound legal environment and a framework for ensuring adequate competition in domestic and international markets. At the same time, efforts to implement opportunities for facilitation indicated other substantial capacity constraints, so capacity building became seen to be a crucial part of the APEC agenda. Gradually, the ECOTECH agenda has come to be seen less as a diversion from TILF to one that is needed to achieve all of APEC’s objectives (Elek and Soesastro 2000). Since the financial crisis, ECOTECH priorities have been sharpened to some extent, leading to some significant programs to enhance capacity for financial sector management, information and communications technology, and for implementing facilitation initiatives such as mutual recognition and conformance to standards and harmonisation of customs procedures. Nevertheless, the total resources devoted to capacity building are tiny, compared to the overall potential to boost capacity for development that would benefit all APEC economies, not just the currently less developed. It has been agreed that APEC should not seek to duplicate the work of others or to finance or implement large-scale capacity-building efforts. APEC’s comparative advantage is to identify opportunities to capture economies of scale and scope from collective activities, rather than economy-by-economy efforts, to enhance capacity. The challenge is to catalyse partnerships with the private sector and existing development agencies to finance and implement some of these ideas on a scale large enough to make a difference. Multilateral development agencies, such as the World Bank, are willing to work with APEC.9 But much more remains to be done to set clearer priorities. APEC needs to move away from making annual declarations about the need to enhance almost every aspect of capacity building to setting just a small number of realistic medium-term targets and establishing a mechanism for managing and monitoring progress toward creating the partnerships needed to meet these targets.

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Lessons from experience APEC’s mixed record is not surprising, given its multiple tasks and the diversity of its participants.10 Such diversity meant that a voluntary process of cooperation was the only option available—in the early years of APEC, there was no intention of ceding significant sovereignty to a new supranational institution in the Asia Pacific. The recent proliferation of RTAs suggests that there is a greater willingness to pool some economic sovereignty, but there is still no prospect of all members accepting any formal, overarching authority. The voluntary nature of the process does limit what APEC can expect to achieve. Within those limits, APEC has performed reasonably well. Much of the current disappointment with the APEC process can be explained by a reluctance to accept its voluntary nature. Cooperative arrangements to promote economic integration seldom benefit every agent in participating economies. Even if the economic gains are well above the economic losses, compensating the losers may be seen to be too hard to arrange. These realities, which lead to the persistent protection of sensitive sectors, certainly apply to APEC (Ravenhill 2001). They must be acknowledged when setting priorities for any process of voluntary cooperation, including APEC. If the potential costs of options for cooperation are perceived to exceed the benefits, then voluntary cooperation will not work. Negotiations are needed and it is helpful to involve a large number of issues and participants, in order to structure a package deal where all participants perceive potential net benefits from the package as a whole.11 The track record of Asia Pacific governments up to the establishment of APEC, including their negotiating positions in the Uruguay Round, indicated that most of them protected some sensitive products and were not prepared to end such protection without some direct compensation by others. Therefore, it was highly optimistic for APEC leaders to commit to free and open trade and investment in 1994. Moreover, it was unhelpful to raise expectations that this could be achieved within the APEC process itself. APEC had not only set itself an objective it could not deliver by itself, but had made the Bogor goals its main priority. That has seriously damaged the credibility of the process. Fortunately, economic cooperation in the Asia Pacific is not limited to situations involving adversarial relations. There are very many opportunities for collective action where there are substantial potential economy-wide mutual benefits and weak causes for resistance. Each of these opportunities to create mutual benefits can be seized on its own merits. In these cases, negotiations are not only unnecessary, but can be counterproductive. Opportunities for immediate mutual benefit can be foregone if they are linked to a package deal that includes other arrangements not perceived to be of mutual benefit. The gains from cooperative arrangements to facilitate trade or investment can be magnified by capturing network effects. It is not essential to involve a large number of players from the outset. A small number of participants can initiate such arrangements, as long as these arrangements are open to wider participation once others also perceive their potential benefits. APEC leaders are encouraging some economies to set examples for others and tangible progress is being made.12

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Unfortunately, most observers tend to measure APEC’s effectiveness in terms of liberalising all trade. Therefore, APEC successes in facilitating trade and investment have been undervalued (Dymond 1999). For these reasons, and some others cited by Chia and Pangestu (Chapter 7), there has been a sense of disillusionment with APEC since 1998. APEC has continued to provide an efficient opportunity for APEC leaders to meet annually to discuss issues, including foreign policy and security issues, which they considered urgent. However, APEC is considered to be somewhat of a lame duck in terms of promoting regional economic integration. Following these disappointments with APEC, and with the WTO, East Asian leaders have turned their attention to other ways to pursue economic cooperation. Like the rest of the world, East Asia has moved to rely on PTAs as the primary means to promote cooperation and integration. Several agreements have been concluded and many more are under consideration or active negotiation. So far, none of them has made worthwhile progress on any sensitive issues of trade liberalisation, nor has much attention been given to whether they are best ways of tackling the many other opportunities for mutual beneficial economic cooperation. An important lesson from APEC’s experience is the need for a conceptual framework for assigning bilateral, regional and multilateral policy instruments for pursuing various aspects of economic cooperation. The fundamental aim of such cooperation is to enhance the capacity of each participating economy to achieve its potential for sustainable growth.

OBJECTIVES AND INSTRUMENTS OF ECONOMIC COOPERATION13 A central objective of international economic cooperation is to promote closer and mutually beneficial economic integration. This requires, above all, a rules-based system of disciplines on international commerce. In addition to this systemic objective, there are many opportunities to reduce, or eliminate, impediments that add to the costs and risks of international commerce among any group of economies, such as East Asia. These impediments can be grouped into: • border barriers to trade in products and factors of production; • divergences in standards or administrative procedures; • physical impediments (for example, communications networks); and • uncertainty (for example, contingent protection, such as antidumping measures). Dealing with the first of these sets of impediments is usually termed liberalisation, while arrangements to deal with the second and third sets are termed facilitation. The final group applies to both liberalisation and facilitation, since uncertainties can prevent specialisation in line with international comparative advantage, even in the absence of other impediments. This TILF agenda is important, but not sufficient. There is extensive scope for development cooperation.14 Such cooperation is not simply a matter of transferring financial resources, but the pooling and dissemination of the rich resources of

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information, experience, expertise and technology available in a diverse region like the Asia Pacific. Options for promoting all of these objectives of international economic cooperation include: • unilateral policy decisions by individual governments; • concerted unilateral decision making encouraged by voluntary cooperation among groups of economies; • formal agreements or treaties among groups of economies, which may involve PTAs; and • multilateral agreements on disciplines to limit policies that create impediments to international commerce, for example through the WTO. Groups of economies involved in either voluntary or formal economic cooperation can range from bilateral partnerships among pairs of economies to cooperation in large groups, such as APEC and the WTO. In general, negotiating formal treaties is necessary only if political leaders do not perceive mutual benefit from making such decisions in isolation. In the many cases where potential mutual benefit is perceived by both sides, it is more efficient to make the appropriate unilateral decisions. Such unilateral decisions can, in turn, be encouraged by consultations and coordination, since concerted decision making can often magnify the benefits to all who participate. There are many cases where concerted decision making is more efficient than uncoordinated unilateral action. On the other hand, the advantage of conceited action by a large number of governments can be outweighed by the time and transaction costs of achieving the necessary degree of voluntary coordination or formal agreement. The following paragraphs examine the potential of various forms of voluntary, or formal, cooperation to deal with both TILF and ECOTECH objectives. In each case, it is possible to identify the most efficient way of pursuing that objective as well as an effective complementary role for APEC. Border barriers Some products and factors of production remain heavily protected. However, the great majority of goods and services, especially those that have been recently invented, are subject to very light, or no, border barriers. Technology is rapidly making controls on capital movements obsolete and there are fewer and fewer restrictions on the short-term movement of people across borders to provide or receive services. Zero or negligible border barriers Many governments, including in East Asia, have demonstrated that they are willing to act individually to reduce many border barriers. Most recent liberalisation has been implemented unilaterally, rather than during GATT/ WTO negotiations, as governments have recognised their self-interest in closer integration with the global economy. In some cases, the potential for rent-seeking may have been weakened by structural and technological changes or, in the case of new products or factors of production, vested

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interests against international competition may not have had time to become effective. International negotiations are no longer, or not yet, needed to remove such negligible border barriers. Unilateral reforms are possible and desirable, since the benefits of reform accrue largely to the economies undertaking the reform. There is some resistance to voluntary reform by those who believe that such reforms can prove more useful in the context of bilateral or multilateral negotiations. However, negligible reductions of already low barriers do not provide negotiating leverage on other, more difficult, issues when negotiating PTAs, while the WTO provides means for obtaining credit from past reforms. Therefore, there is no need to wait for either bilateral or multilateral negotiations before getting rid of border barriers that are already low. Moreover, the gains are greatest if the liberalisation applies to all trading partners. The benefits of liberalisation can be magnified if trading partners are undertaking similar reforms. Therefore, conceited action encouraged by voluntary international economic cooperation (for example, through APEC) can help accelerate the process. As already noted, the desire to show leadership in APEC and the peer reviews of individual action plans (IAPs) have hastened the reduction of many border barriers. Some may regard these gains as merely symbolic. However, if Asia Pacific economies agree to bind these changes in the WTO, that will help to avoid the emergence of new sensitive sectors in the future.15 APEC has already proved helpful in ‘immunising’ information technology products from becoming sensitive sectors in the future, before any of them became commodities produced in locations that had lost comparative advantage in these products. It may be possible to build on these experiences by establishing a general agreement that products of the future, where initial comparative advantage is due to the location of intellectual property, rather than factor costs, should also be immunised against rent-seeking through trade restrictions. High border barriers The IAPs of APEC economies indicate that voluntary liberalisation is making reasonably consistent progress. At the same time, it is becoming increasingly evident that voluntary cooperation will not be able to deal with the most sensitive sectors in the near future. Progress on such hard issues is most likely to be made in forums like the WTO that are designed to negotiate simultaneous action by the many economies involved. Lowering border barriers can also be negotiated as part of PTAs between pairs or among small groups of economies. However, for reasons set out in Findlay et al. (2003), it is harder to deal with sensitive sectors in small groups. Compared to multilateral negotiations, it is more difficult to overcome vested interests against reform. In a growing number of examples, PTAs deal with relatively easy aspects of trade liberalisation, while dodging the hardest ones. Recent agreements, including those between Japan and Singapore, Korea and Chile, and the United States and Australia, demonstrate that PTAs tend to exempt the products deemed to be the most sensitive. In practice, if governments are not willing to agree to end their protection of some products in the course of WTO negotiations, they are even less likely to do so for selected

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competitors.16 If sensitive issues like rice, pork or goldfish cannot be tackled in the WTO, they will not be dealt with in PTAs. This suggests that an economy that is not ready to open some sectors to significant international competition can form PTAs only with economies that do not offer serious competition in these sectors or with economies that are willing to exclude these sectors from the agreement. Since the WTO does allow some exemptions, it would be possible to envisage a WTO-consistent agreement between economies that wish to protect the same set of products. For example, Japan and Korea could create a PTA that excluded rice. However, PTAs that exclude sensitive sectors or serious competitors will not be stepping stones to region-wide or multilateral zones of free trade.17 Using APEC and the WTO As explained above, it is not necessary to negotiate formal PTAs to get rid of border barriers that are already low. Moreover, PTAs are not making much headway on liberalising sensitive sectors. As indicated in Table 6.1, a combination of concerted unilateral liberalisation and WTO negotiations is the more efficient way to promote trade liberalisation. Despite their relative inefficiency, the current enthusiasm for PTAs will take time to dissipate. But, once their shortcomings become increasingly evident, APEC can provide a forum for identifying options that can deliver meaningful region-wide trade liberalisation. APEC leaders should be able to agree to continue to promote concerted unilateral liberalisation wherever possible and to acknowledge that negotiations will be needed to deal with the hardest issues. APEC leaders will also need to acknowledge, in due course, that a large number of overlapping PTAs, which do not deal with the various sensitive sectors of a diverse group of economies, cannot be linked to form an APEC-wide zone of free and open trade and investment. It may then be possible to achieve consensus that the WTO is the appropriate forum for such negotiations. APEC’s most significant, albeit indirect, contribution to trade liberalisation would be collective leadership in the WTO. One aspect of this would be to accept that the Doha Development Round will not succeed without significant liberalisation of sensitive sectors. Nor will it be possible to reach the Bogor goals of free and open trade and investment. APEC leaders could help focus the WTO’s attention on sensitive sectors by agreeing to defer some less urgent matters currently on the agenda, as

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Table 6.1 Options for trade and investment liberalisation and facilitation Policy options

Most efficient Supporting role for Remarks instrument APEC

Liberalisation concerted zero or negligible unilateral border protection liberalisation

consultations and agreed IAPs within APEC can accelerate the process with benefit to all participants

WTO high border barriers to trade in negotiations sensitive sectors

encourage governments to make offers consistent with achieving free and open trade and investment by 2010/2020

Facilitation

cooperative arrangements among groups of economies

provides a framework to encourage some economies to set examples that others are encouraged to follow

Confidence building

predictable and equal treatment of all trading partners

provides a forum for assessing the costs as well as potential benefits of PTAs

negotiations are not needed; eliminating low barriers does not provide negotiating leverage on other, more difficult, issues; can obtain credit for unilateral liberalisation in subsequent WTO rounds APEC governments are not ready to end the protection of sensitive sectors, either in the WTO or PTAs; APEC can promote policy development to compensate short-term losers and enhance the capacity to seize opportunities from trade liberalisation APEC working groups can identify new opportunities for collective action; APEC can also encourage wider participation in PTA arrangements to facilitate trade or investment once the costs of proliferating PTAs become more evident, APEC can help adapt PTAs to become more consistent with region-wide free and open trade and investment

discussed by Hoekman in Chapter 3. A more important move would be to make a joint offer to meet the 2010/2020 deadlines, provided the European Union is willing to match their offer. The 2005 mid-term review of progress toward the Bogor goals could provide an opportunity to agree on such collective leadership. A further credible contribution by APEC to trade liberalisation between now and 2020 may be a sustained capacity-building effort to shore up the political will for further liberalisation (Macduff and Woo 2003:60).

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Beyond border barriers In addition to trade liberalisation, there are many opportunities to promote mutually beneficial economic integration by adopting more compatible regulatory systems, including standards, intellectual property rights and competition policy. Practical options to reduce transaction costs, such as more efficient customs procedures, can be undertaken by individual governments or by cooperative arrangements among governments. Such arrangements can be voluntary or binding agreements, possibly in the context of the WTO, or closer economic partnerships. Promoting facilitation through APEC The argument for a cooperative approach to facilitation has already been presented. APEC is well placed to identify opportunities for facilitation and encourage governments to implement cooperative arrangements among as many economies as possible. The time has come to build on APEC’s ongoing work to facilitate trade and investment. As outlined in Elek (2004), as part of recommendations to the APEC Business Advisory Council (ABAC), Asia Pacific governments now need to implement a massive program of facilitation and to address some liberalisation issues, such as investment and transport, which are not yet on the WTO agenda.18 That effort will need to be comparable to the European Union’s Single Market Agenda, but implemented in a way suitable to a much more diverse group of economies. The Australian members of ABAC accepted these ideas and have, in turn, recommended that APEC’s existing trade facilitation initiatives should be brought together under a single banner, setting new and more ambitious goals, so as to create greater momentum for reform (ABAC Australia 2004). In order to begin to approach the degree of economic integration achieved in the European Union, they recommended that, by 2020 at the latest, APEC economies should implement: • an intensified program of mutual recognition of product standards and professional qualifications, comparable in scope to that achieved by the European Union; • full compatibility and fully electronic data interchange of customs procedures; • transparency and harmonisation of a wide range of administrative procedures, including agreed minimum standards for auditing and disclosure; • harmonised fiscal incentives for international investment and an APEC code for the taxation of international income; and • region-wide minimum standards for competition policy that are sufficiently rigorous to avoid the need for antidumping actions among APEC economies. Or, even more ambitiously: • full rights of establishment and the national treatment of all firms, in all significant sectors; • open seas and open skies in the Asia Pacific, subject to an agreed set of traffic control and other safety and security procedures for ports and airports; and • an end to all restrictions on short-term business-related travel (ABAC Australia 2004).

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ABAC agreed these recommendations, termed the Trans-Pacific Business Agenda, in August 2004 and has urged APEC leaders to implement such measures from 2005. This is a very broad agenda, but it should be possible to make some progress, starting with those governments that perceive at least some of these aspects of cooperation to be positive-sum games. Once arrangements are perceived as positive-sum games, it will be efficient to proceed with individual arrangements on their own merits. Economies of scope might be gained by acting on a range of related issues, but there is no need to delay seizing opportunities to reduce transaction costs by making them conditional on implementing other, unrelated, arrangements for facilitation, or on sensitive aspects of trade liberalisation. In practice, APEC-wide targets will be reached by some ahead of others. If some governments do not perceive the immediate advantages of participating in such new arrangements, then they will stand aside and wait until others have demonstrated the benefits of cooperative action. In most cases, the capacity to participate in specific cooperative arrangements will not be a lack of will, but a lack of capacity. Therefore, cooperative arrangements pioneered by some will need to be genuinely open to others. Pathfinders who implement initiatives ahead of others will need to share the information, experience, expertise and technology needed for others to join as soon as they perceive the benefits of doing so. Facilitation and the WTO The WTO is designed to define binding disciplines on cooperative arrangements for facilitating trade or investment in order to ensure that they do not become new ways of distorting international commerce. For example, the WTO can require that mutual recognition arrangements among any group of economies are transparent and open to accession by others who are willing to implement the policy norms of these arrangements. However, the WTO is not well placed to implement arrangements for mutual recognition of particular standards. Not only is it inefficient, but also unnecessary, for all members to act simultaneously, as long as such arrangements are open to accession. There is no need to clutter the WTO’s already heavy agenda with unnecessary negotiations about the many arrangements for facilitation that are already perceived to be positive-sum games by most governments. Constraints on the capacity to implement such arrangements cannot be negotiated away, and WTO should not be expected to become a capacity-building institution. There are some cases where the constraint on participation in arrangements for facilitation is in the vested interest of some producers. For example, lawyers may oppose any international arrangements for mutual recognition of legal qualifications. If their arguments outweigh the economy-wide interest for greater competition in providing legal services, then negotiations will be needed. In these cases, some progress can be expected in either the WTO or in PTAs where negotiations can be used to outflank vested interests by playing them off against each other. It may be possible to have a division of effort between the WTO and PTAs. Since the issues involved in arrangements for facilitation are often quite complex, it may not always be efficient to conduct negotiations among large numbers of economies in the

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WTO itself. It may be more useful to look for WTO disciplines on the nature of arrangements which can be negotiated among smaller group of economies, for example to ensure these are not needlessly discriminatory and are genuinely open to accession. The prospects for multilateral agreement on such broad WTO principles for facilitation depend on the design of PTAs. Facilitation in closer economic partnerships The partnerships that have been agreed recently, as well as those under consideration among East Asian economies, deal with many issues simultaneously. With many more PTAs in prospect, it is quite likely that several will pioneer innovative arrangements to deal with new aspects of facilitation. But it may prove difficult to use these new arrangements as precedents for region-wide facilitation, especially if they are part of many-faceted agreements, including a PTA for trade liberalisation. Figure 6.1 illustrates a situation where two economies (A and B) have agreed a PTA together with numerous arrangements for facilitation. Other economies (C and D) may wish to join one of these arrangements and be able to demonstrate that they can implement the policies and make the institutional changes necessary to join. If this PTA is to be a building block for wider cooperation, then it would seem desirable to admit them. But several problems may arise, even if the arrangement is stated to be open to wider accession. One problem, which is certainly relevant to Asia Pacific economies, is that many economies find it difficult to implement a large number of arrangements for facilitation simultaneously. The European Union has adopted such an all-or-nothing approach. There is an acquis communitaire of several

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Figure 6.1 The effects of different facilitation arrangements

hundred arrangements that potential participants are required to adopt at the same time. This has made the European Union very difficult to join. Such an approach would be highly undesirable for the Asia Pacific, which is seeking to promote the integration of a diverse group of economies. Economies like Japan and Singapore have the capacity to implement many cooperative arrangements to facilitate trade and investment. However, others, like Brunei, Papua New Guinea or Vietnam, might find it impossible to join all the arrangements that have been agreed by Japan and Singapore. A second problem can be caused by linking some options for cooperation that are perceived to be of mutual benefit with other options that are not. For example, Australia and Japan may want to agree on mutual recognition standards for auditing and disclosure for firms that are listed on their stock exchanges, with shares traded electronically on either exchange. That option would be ruled out if it could only be considered alongside a PTA. In that case, Australia and Japan would need to forgo the mutual benefits of this option for wider facilitation, since they cannot expect to enter into a WTO-consistent PTA owing to their various sectoral sensitivities. However, the two governments should be able to proceed with such a practical option, even if a PTA is not feasible or desirable. Moreover, they may recognise that they can proceed with any other beneficial cooperative arrangement whenever they are ready. They could adopt a framework agreement, such as the Transatlantic Economic Partnership set up to facilitate trade and investment between the United States and the European Union.19 Now consider the potential to link another economy, say Singapore, to a practical arrangement for trade or investment facilitation between Australia and Japan. A problem may arise, since Australia and Japan have already concluded wide-ranging FTAs with

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Singapore and either or both of these may have already included a similar option for facilitation. It might seem natural to create a triangular arrangement covering all three (and potentially more) economies. The scope to do so will depend on the nature of any provisions for accession to all or part of the already-signed agreements. If each arrangement to facilitate trade or investment in PTAs among APEC economies is seen as a pathfinder in the context of APEC, then it should be possible for others to join that arrangement. But that may be ruled out by the nature of the partnership. If the PTA required the negotiation of some liberalisation which was seen as a concession, then there will be a tendency to regard it as a ‘single undertaking’. Insistence on a package deal could not only make it impossible to capture potential network effects, but would also rule out using practical options for facilitation, pioneered among PTA partners, as building blocks for region-wide arrangements for facilitation (Figure 6.1). In view of these considerations, arrangements that are perceived as positive-sum games should not be bundled with other arrangements that require negotiation. Where possible, opportunities for mutual benefit should be pursued in their own right, making provision for others to join these arrangements as soon as they are willing and able to do so. In practice, many innovative arrangements are already being bundled with PTAs, which will prove difficult to link. APEC can help members to find ways to link various cooperative arrangements for facilitation. It may be possible for APEC governments to agree that all of their cooperative arrangements for facilitation be treated as pathfinder initiatives in the context of the APEC process.20 If APEC governments agreed to adopt such a principle for facilitation, it may be possible, subsequently, to have such a principle adopted as a WTO discipline on facilitating trade and investment. On the other hand, if APEC governments were not willing to promote wider accession to individual facilitation arrangements within PTAs, then these partnership would be even less likely to be building blocks for region-wide free and open trade and investment. Confidence building A vital aim of economic cooperation, reflected in the objectives of both the WTO and APEC, is to reinforce mutual trust among groups of economies. The current rush into PTAs threatens to undermine such confidence. Discriminatory PTAs will not create regional zones of confident trading arrangements. They are much more likely to create a pattern of hub-and-spoke arrangements with a few very large economies as hubs. The largest economies will be able to dictate the nature of economic engagement with others, continuing to shelter their sensitive sectors and disrupting confident trading arrangements among smaller partners.21 A number of factors may contribute to this undesirable outcome. Economic cooperation based on PTAs is not consistent with fundamental GATT/WTO principles. Trading arrangements that discriminate against outsiders need to be shored up by rules of origin, which impose needless costs on all economies (including participants) and destroy opportunities for fine specialisation.

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As emphasised by WTO Director General Supachai (2004), each new PTA encourages others, partly to gain comparable preferential treatment but, just as importantly, to reduce the costs and risks imposed by being outsiders.22 The proliferation of discriminatory trading arrangements is also likely to create new opportunities for selective contingent protection. Just as the WTO is preparing to abolish the Multifibre Arrangement, other new and confidence-destroying contingent protection could still lead to selective discrimination. The most effective defence against contingent protection appears to be to seek PTAs with all significant trading partners. Not surprisingly, a large number of economies are now seeking PTAs with the currently most important economies, especially the United States, the European Union and China, the next economic giant. Such agreements, negotiated by economies of negligible leverage over these giants, usually fail to achieve any change in the determination of the United States and the European Union to protect their most sensitive sectors. However, economies still perceive the need to enter such agreements: otherwise they will be increasingly exposed to arbitrary restrictions to very important markets. Such defensive and reactive discriminatory arrangements also undermine earlier efforts to create closer partnerships. Any marginal gains in access to sensitive sectors of large economies, such as the United States, may come at the expense of others. For example, the minuscule new access to sugar offered to Central American economies meant no new access for Australia. The Australia-US FTA, in turn, offered minuscule new access to some other agricultural products. Such access will come, at least in part, at the cost of other exporters, including New Zealand, with whom Australia has had a PTA for many years. Free trade between Australia and New Zealand will also be disrupted by the many pages of preferential rules of origin for products deemed sensitive by the United States, damaging the prospects for Australia and New Zealand becoming a fully integrated market. Another example of disruption to existing partnerships is emerging in Southeast Asia. ASEAN economies are considering the possibility of a single ASEAN market, but at the same time racing each other to secure PTAs with the United States and Japan. ASEAN governments seem to be driven by the defensive need to secure some secure preferential access to sensitive sectors of key trading partners, at the risk of eroding mutual trust among themselves and undermining the possibility of a genuine single market. Once again, discriminatory rules of origin will make it impossible to take full advantage of the potential for intra-industry specialisation within ASEAN.23 The APEC process will not be able to reduce the current momentum toward PTAs in the near future, despite these emerging risks. But it should be possible to make some modest contribution. APEC leaders have agreed that they should begin to assess, collectively, the effects of new PTAs. As the costs of these discriminatory arrangements begin to mount, especially for non-participants, and it proves difficult to extend PTAs to broader trading arrangements, there should be some interest in adapting them to be more consistent with the spirit as well as the letter of the WTO. That will take some time; in the interim APEC can pursue other options that can lead to tangible mutual benefits and foster some sense of mutual confidence and trust, through facilitation and development cooperation.

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Development cooperation Trade policy is likely to prove a divisive issue within APEC in the next few years as it becomes clear that the 2010 Bogor target is out of reach and PTAs increasingly disrupt market-driven integration. Concern about terrorism has provided a new dimension of cooperation as governments have been able to use the APEC network to devise and implement some practical arrangements to reduce the risks of disruption to trade and investment. However, everyone hopes that terrorism will not be a major preoccupation for long. APEC needs to find additional means of promoting a sense of community. There are many ways to do so, by strengthening the capacity to realise opportunities for sustainable development, including the opportunities being created by facilitating and liberalising trade and investment. Once again, APEC’s role will be as a facilitator. As discussed above, APEC should not become a development agency that finances and implements a large ECOTECH program. The challenge is to help Asia Pacific governments to implement progressively more efficient policies, both individually and collectively, to boost their capacity for development. There are many options for exchanging information, experience, expertise and technology and promoting public-private partnerships that can mobilise resources for development from international capital markets.24 For example, cooperative policy development can help APEC economies to design ways to strengthen financial sector management. Interaction within APEC can continue to help gather and disseminate information on best practices for policies to facilitate large-scale private investment in economic infrastructure. A long-term commitment to human resource development is also needed to help APEC governments to design and implement policies that are closer in line with their commitment to enhance competition. Substantial financial resources will be needed to support programs for human resource development and institution building. Such policy development resembles the work of the Organisation for Economic Cooperation and Development (OECD), among a more homogenous group of economies (Macduff and Woo 2003). There have been calls to expand the APEC Secretariat to manage this work (Soesastro 2003). A modest expansion may be helpful; however, the Secretariat should not be expected to do much of the policy research. That should continue to be managed by officials in each economy, drawing on business and academic expertise in the region.

CONCLUSION Despite a deepening sense of scepticism, APEC will not disappear. However, most participants are currently cooperating with others in ways that are quite contrary to APEC’s original ideal of open regionalism. To regain its relevance, APEC needs to deliver tangible economic benefits in ways that are consistent with the nature of the process. Both voluntary and binding cooperation have their advantages. APEC could seek to promote both, but there is no realistic prospect of such a diverse group of governments

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accepting a powerful supra-national authority. Rather than attempting to create one, it is far more efficient for APEC to focus on the considerable potential for voluntary cooperation. APEC leaders need to accept that cooperation is voluntary and look for the comparative advantage of such a process. Experience has shown that APEC is not a useful forum for negotiations. Rather than attempting to duplicate the WTO, it is more efficient to work like the OECD, while accepting the challenge of encouraging cooperation among a more diverse group of economies. APEC should also accept that it is a facilitator of change which needs to act through others. APEC does not make decisions; its role is to encourage decisions that will help economies realise their full potential for sustainable growth. Some of these decisions will be unilateral ones: for example, the adoption of regulations that are more in line with international best practice. Some will be taken in concert with others: for example, a group of economies could decide to adopt more compatible standards for some products, or to co-finance better transport links. There are many opportunities for cooperative action on matters where Asia Pacific governments perceive the potential for mutual benefit. In these cases, it is efficient to seize each of these opportunities on their own merits. It is also efficient for some to move ahead of others, provided that they act in ways which not only permit, but encourage, others to join later. In the many cases where governments perceive the benefit of options for collective, or concerted, action, there is no need for international negotiations and sanctions to adopt and adhere to the policies needed to implement these opportunities. Individual governments enacting appropriate legislation and regulations can create adequate confidence in future adherence to these policies. In some cases, such legislation will provide for acceptance of obligations in already existing international institutions with binding powers. In cases where actions are not seen to be of mutual benefit in their own right, negotiations will be needed to devise a package deal in which the perceived gains outweigh the perceived costs. A voluntary process is not an efficient venue for such negotiations, but APEC consultations can help promote a concerted effort to make effective use of other forums for negotiation, especially the WTO. Perhaps even more importantly, the exchange of information and experience can enlarge, over time, the range of opportunities for cooperative action that are perceived to be of mutual benefit. These considerations imply that the APEC process can promote various aspects of TILF and capacity building by encouraging appropriate policy decisions by Asia Pacific governments, acting individually or collectively, including in other institutions and forums for cooperation. In particular, they lead to the following specific recommendations. The protection of some sensitive products will need to be negotiated in the WTO. In order to achieve free and open trade and investment by 2010/ 2020, APEC governments need to offer to dismantle border barriers to trade and investment in all products in the WTO, by those deadlines, as long as other significant economies are prepared to do the same. The 2005 review of progress toward APEC’s Bogor goals is a useful opportunity to make such an offer.

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At the same time, APEC economies can continue the concerted unilateral liberalisation of trade and investment in many other products where rates of protection are already low. APEC governments will be able to make use of these reforms in WTO negotiations by offering to bind them at reduced rates. APEC can look for ways of promoting WTO-wide agreements to avoid the emergence of future sensitive sectors. It may be possible to follow the precedent set in IT, by similar agreements on other recently invented products, or even for products yet to be invented. Free and open trade and investment requires much more than eliminating border barriers. While waiting for the political will to liberalise trade in the remaining sensitive products, APEC leaders should embark on a much more ambitious and unified program of facilitation, as recommended by ABAC. The diversity of the region means that the targets for ABAC’S Trans-Pacific Business Agenda will be reached by some ahead of others. It is therefore important that practical cooperative arrangements for facilitation are genuinely open to others. Pathfinders who implement initiatives will need to share the information, experience, expertise and technology needed for others to join as soon as they perceive the benefits of doing so. A massive enhancement of human, technological and institutional capacity will be needed to implement this agenda. APEC’s current capacity-building program will need to grow rapidly, giving priority to capacity needed for region-wide economic integration. Such an effort will not be financed by aid programs, but will need creative ways to forge public-private partnerships.

NOTES 1 Other chapters in this volume, including Chapter 7 by Chia and Pangestu, list the many new partnerships that have been set up or are under consideration. 2 This approach, described in detail in Drysdale et al. (1998), was to be in contrast to the discriminatory approach adopted elsewhere. 3 Since its establishment in 1980, the Pacific Economic Cooperation Council (PECC) has identified many opportunities for mutually beneficial cooperation in a wide range of sectors. 4 Garnaut (1998:289) lists some major market-opening measures by China, Indonesia and the Philippines that were taken unilaterally, but explicitly, in the context of meeting their commitment to APEC’s objective of free and open trade and investment. Other observers, including Ravenhill (2001), make no mention of this contribution by APEC. 5 The APEC International Assessment Network (APIAN) has evaluated many aspects of APEC’s performance and structure in recent years (Feinberg 2003). 6 For example, the US offer on non-agricultural tariffs in the WTO is to eliminate them by 2015, but only subject to the response of others. Australia has decided to retain border protection of motor vehicles, textiles, clothing and footwear beyond 2010. The Australia-US FTA excludes some agricultural products (notably sugar) and has phase-in periods for free trade in some other products that extend beyond 2020. 7 A similar approach is expected in terms of competition policy. APEC working groups have agreed on strategies to adopt the APEC Competition Principles, agreed in 1999. Although the principles are non-binding, APEC governments are expected to commit to reforms in their individual action plans and collective action plans. 8 A recent study (cited in ABAC 2003) estimates that achieving this goal would lead to a 1 per cent increase in the GDP of APEC economies, a gain of over US$150 billion. 9 Carol Brookins, the US Executive Director to the World Bank, has stated that the World Bank is ready to work with APEC and noted the cooperation that is already taking place to

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enhance the capacity of APEC economies for trade and investment facilitation (Brookins 2002). 10 At the formative stage, it was evident that the twelve original members (Australia, Brunei, Canada, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, Thailand and the United States) together with the three Chinese economies were a highly interdependent group of economies, which made a high degree of diversity unavoidable. 11 This perception is the basis of the GATT/WTO sequence of comprehensive negotiating rounds, designed to help outflank the varied set of vested interests in different economies. 12 The 1994 Bogor Declaration explicitly encouraged some APEC economies to set positive examples for others. More recently, this has been reaffirmed in the 2001 Shanghai Accord of APEC leaders. A practical precedent has been set by the APEC Business Travel Card. Six economies volunteered to launch this scheme to facilitate business mobility in 1996; many others have joined subsequently. 13 This section draws on Elek (2003). 14 In APEC jargon, development cooperation is described as economic and technical cooperation (ECOTECH). 15 In many cases, the prevailing low border barriers are far below the ceilings notified to (or ‘bound’ in) the WTO. Economies that have implemented significant trade policy reforms in recent years can use the WTO not just for further reductions, but to undertake to bind border barriers at their already low rates. Such WTO ‘bindings’ can generate negotiating leverage from past reforms, since they reduce the uncertainty faced by trading partners. 16 The United States made this quite explicit during the negotiations for the Free Trade Area of the Americas and the free trade agreement with Australia. 17 In early 2004 some Canadian business people proposed a Free Trade Area of the Asia Pacific. However, it was soon realised that such an arrangement would only be politically feasible if it exempted the sensitive sectors of all APEC economies. Such an arrangement would not satisfy the WTO requirement for complete liberalisation of substantially all trade. 18 That paper, prepared on behalf of the Australian PECC network, made several other recommendations to ABAC, including this proposal for implementing a Single Market Agenda for the Asia Pacific (SMAAP). 19 See Elek (1998) for discussion of the Transatlantic Economic Partnership and its implications for APEC 20 APEC’s current principles for facilitation do not offer guidance on accession to cooperative arrangements which involve some, but not all, APEC economies. It is certainly not clear if the facilitation principles apply at all to arrangements contained in RTAs. PECC’s proposals for a common understanding do not yet address this issue explicitly.

As explained in Elek (2003) a synthesis between APEC’s principles for facilitation and its pathfinder principle could be achieved by adopting additional principles along the following lines: Cooperative arrangements to facilitate trade and investment may be pioneered among pairs or groups of economies, including in the context of closer economic partnerships (or regional trading arrangements) involving APEC economies. In line with the principles of the 1995 Osaka Action Agenda and the concept of pathfinder initiatives endorsed in the 2001 Shanghai Accord, APEC economies should be encouraged to pioneer new arrangements for facilitation. In the interest of promoting wider free and open trade and investment, any economy whose government adopts policies compatible with any

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existing or proposed cooperative arrangement involving APEC economies should be able to, and be encouraged to, become party to any of those arrangements. 21 If a few giant economies can force most others to accept arrangements suitable to them, multilateral disciplines and confidence in a predictable international economic system will be eroded along with prospects for significant liberalisation of markets for agricultural and labour-intensive products, which are needed for the continued stability and prosperity of the Asia Pacific region. 22 For example, when the United States imposed restrictions on steel imports in 2002, imports from PTA partners were exempted. These restrictions were rescinded in 2003, since they were deemed to be in breach of WTO disciplines. However, the breaches cited by the WTO did not include the different treatment of trading partners. 23 The terms of the US-Singapore FTA allow some products from Batam to be treated as originating in Singapore. However, this imposes limits on the content from the rest of Indonesia, effectively impeding Indonesia’s internal trade. 24 Foundation for Development Cooperation (2000), one of a series of publications on capacity building and ECOTECH in APEC, provides a number of examples of these forms of cooperation.

REFERENCES APEC Business Advisory Council (ABAC) (2003) ‘The first decade since Bogor: a business appraisal’, Trade and Investment Working Group, ABAC. ——Australia (2004) ‘A “single market” agenda for Asia Pacific’, Canberra, August. Asia Pacific Economic Cooperation (APEC) (1997) ‘Blueprint for APEC customs modernisation: working with business for a faster, better border’, APEC Secretariat, quoted in ABAC (2003). Brookins, C. (2002) ‘Opening address to the workshop on ECOTECH and capacity building: assisting integration into the global economy’, Acapulco de Juarez, Mexico, August, Ministry of the Economy, Mexico City. Davidson, P.J. (2003) ‘Is APEC relevant? APEC’s non-binding investment principles and their effect on the regional trading arrangements which are being formed in the region’, Document II.C.26, in Release 2003–4 (August), P.J.Davidson (ed.) Trading Arrangements in the Pacific Rim, New York-London-Rome: Oceana Publications, available at http://www.apecthai.org/admin/uploadfile/file_art/%2010.PaulDavidson.pdf. Drysdale, P. (1988) International Economic Pluralism: Economic Policy in East Asia and the Pacific, Sydney: Allen and Unwin, in association with the Australia-Japan Research Centre. Drysdale, P., A.Elek and H.Soesastro (1998) ‘Open regionalism: the nature of Asia Pacific integration’, in Peter Drysdale and David Vines (eds) Europe, East Asia and APEC: A Shared Global Agenda?, Cambridge: Cambridge University Press. Dymond, W. (1999) ‘The MAI: a sad and melancholy tale’, in F.E.Hampson, M. Rudner and M.Hart (eds) Canada among Nations: A Big League Player, Toronto: Oxford University Press, quoted in D.Macduff and Y.P.Woo (2003). Elek, A. (1998) ‘Open regionalism going global: APEC and the new transatlantic economic partnership’, Pacific Economic Papers 286, Canberra: Australia-Japan Research Centre, December. ——(2003) ‘Beyond free trade agreements: 21st century choices for East Asian economic cooperation’, Pacific Economic Papers 336, Canberra: Australia-Japan Research Centre, February. ——(2004) ‘Accelerating economic integration in the Asia Pacific: recommendations to the APEC Business Advisory Council’, mimeo, prepared for the Australian PECC network, Canberra.

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Elek, A. and H.Soesastro (2000) ‘ECOTECH at the heart of APEC: capacity-building in the Asia Pacific’, in I.Yamazawa (ed.) Asia Pacific Economic Cooperation (APEC): Challenges and Tasks for the Twenty-first Century, London: Routledge. Feinberg, R. (ed.) (2003) APEC as an Institution: Multilateral Governance in the Asia-Pacific, Singapore: Institute of Southeast Asian Studies. Findlay, C., Mohd. H.Piei and M.Pangestu (2003) ‘Trading with favourites: free trade arrangements in the Asia Pacific’, Pacific Economic Papers 335, Canberra: Australia-Japan Research Centre, January. Foundation for Development Cooperation (2000) ‘Capacity-building in the Asia Pacific: a way forward for ECOTECH’, issues paper prepared for APEC, PECC and APEC Studies Centre Consortium, Brunei Darussalam, May, the Foundation for Development Cooperation, Brisbane, available at http://www.fdc.org.au/. Garnaut, R. (1998) ‘Europe and Asia Pacific economic cooperation’, in Peter Drysdale and David Vines (eds) Europe, East Asia and APEC: A Shared Global Agenda?, Cambridge: Cambridge University Press. Macduff, D. and Y.P.Woo (2003) ‘APEC as a Pacific OECD revisited’, in R.Feinberg (ed.) APEC as an Institution: Multilateral Governance in the Asia-Pacific, Singapore: Institute of Southeast Asian Studies. Ravenhill, J. (2001) APEC and the Construction of Pacific Rim Regionalism, Cambridge: Cambridge University Press. Soesastro, H. (2003) ‘APEC’s overall goals and objectives, evolution and current status’, in R.Feinberg (ed.) APEC as an Institution: Multilateral Governance in the Asia-Pacific, Singapore: Institute of Southeast Asian Studies. Supachai, P. (2004) ‘American leadership and the World Trade Organization: what is the alternative?’, speech to National Press Club, Washington DC, 26 February, available at http://www.wto.org/english/news_e/spsp_e/spsp22_e.htm.

7 Rise of East Asian regionalism Chia Slow Yue and Mari Pangestu

INTRODUCTION Rapid growth rates, strong economic fundamentals, and stable political and social conditions had marked East Asia as an ‘economic miracle’ up until the financial crisis in July 1997. The term ‘miracle’ is a misnomer—the region’s success over several decades could be explained by a combination of good initial conditions and the right economic policies, including strong savings and investment and openness to trade and foreign investment. The exposure to products and investment from overseas drove domestic deregulation and liberalisation policies that encouraged competitiveness and dynamic comparative advantage. East Asian economies have favoured multilateralism over preferential trading arrangements (PTAs), be it free trade areas, customs unions or common markets, because their export-led growth models required openness to global markets and foreign investment. Economies have been competing rather than cooperating for markets and investment, and have seen multilateral commitments as helping to set the framework for domestic policies. Institutional forms of East Asian regionalism were also opposed by the United States, which rejected Malaysian Prime Minister Mahathir’s proposal for an East Asian Economic Group (EAEG) in 1990. Until recent years the only PTA was the ASEAN Free Trade Area (AFTA), established in 1992. The recent shift in East Asia from market-driven regionalisation to regionalism is partly a search for an East Asian identity and new forms of regional cooperation after the financial crisis, and partly an attempt to catch up with the rest of the world. PTAs have been proliferating since 1999, and most WTO members are party to one or more arrangement. PTAs are often a response to pressures that multilateralism has failed to resolve. In major countries such as Japan, South Korea and China there has been a shift of attitudes toward institutionalised and policy-driven regionalism, for instance monetary and financial cooperation under the ASEAN-plus-three framework. This chapter analyses frameworks and structures that might emerge in East Asia, and asks whether East Asian economies can still continue to pursue a policy approach of ‘open regionalism’. The chapter examines the history behind market-driven integration in East Asia by looking at changes in trade and investment patterns and the emergence of a regional production network. The motivations for preferential agreements are analysed. The chapter suggests a framework for a more strategic East Asia regionalism where a web of preferential agreements can still provide clarity between means and ends, and where PTAs can be building blocks for an open trading system.

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THE SETTING: MARKET-DRIVEN INTEGRATION Shifts in comparative advantage in East Asia have created a regional production network, or natural economic bloc. As manufacturing developed, and as producers sought economies of scope and scale, production shifted to cheaper locations and intra-regional trade and investment flows changed.1 In East Asia specialised activities are conducted in different locations as part of a vertically integrated production chain. This is largely driven by multinational corporations (MNCs) establishing regional production networks that source parts from the cheapest producer. The machinery and electronics industry led the process (Anderson and Hu 2003). The share of machinery and transport equipment in intra-East Asian trade increased from 18 per cent in 1985 to 48 per cent in 2001 (Ng and Yeats 2003, Table 11.2). Rising indices for intra-industry trade in East Asia reflect this trend (Ng and Yeats 2003, Table 15.1). Japan has traditionally dominated East Asian trade and investment flows. Currency realignments and the search for lower production costs drove the move of foreign direct investment (FDI) from Japan to the NIEs in the 1970s and subsequently from Japan and the NIEs to Southeast Asia in the mid-1980s. Since the late 1980s FDI has moved to China in response to high economic growth. Substantial Hong Kong and Taiwan investment in China reflect economic complementarity and the closeness of geography, history and culture. FDI from East Asia to other East Asian destinations increased in the 1990s, except between China and ASEAN (Urata 2003). The trade complementarity index reveals the similarity between the types of goods East Asian economies export and import. The index for East Asia increased from 51.2 per cent in 1985 to 67.3 per cent in 2001, which was higher than the index of 64 per cent for NAFTA and 53 per cent for the EU6 (Ng and Yeats 2003, Table 8.1). The importance of East Asian countries in world and regional trade is illustrated in Table 7.1. It shows the growth in East Asia’s share of world exports, and also the rise in the significance of intraregional export flows. Intra-ASEAN trade is more important for imports than exports (Ng and Yeats 2003, Table 5.1). In contrast intra-NAFTA trade is more important for exports than for imports. Regional input-output tables show an increase of procurement of inputs from East Asia between 1985 and 1995 (Urata 2003).2 Revealed comparative advantage calculations by Ng and Yeats (2003) on sixty component product groups illustrate that lower-wage countries have a

Table 7.1 Importance of East Asia in world trade Total exports Share world trade (%) (US$billion) 1985 1995 2001 1985 1995 2001 Australia/New Zealand East Asia (excl. Japan) Japan ASEAN EU15 NAFTA

32.6

70.1

84.6

1.4

1.3

9.4 16.3

18.7

190.3 476.1 448.6 9.6 9.3 72.0 307.8 403.8 3.6 6.0 711.6 1,893.4 2,194.8 36.0 36.0 351.9 922.4 1,214.7 17.8 18.0

7.0 6.3 34.3 19.0

186.2 839.0 1,194.4

1.6

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Latin America 115.8 245.3 382.1 5.9 4.8 6.0 South Asia 16.5 52.0 70.3 0.8 1.0 1.1 Other 371.0 639.0 813.6 18.8 12.4 12.7 World 1,975.9 5,137.3 6,403.1 100.0 100.0 100.0 Intra-East Asian 44.1 314.5 418 2.2 6.1 6.5 trade East Asia-Japan 35.3 118.7 144.9 1.8 2.3 2.3 trade East Asia-China 5.9 43.5 83.5 0.3 0.8 1.3 trade East Asia-ROW 142.1 524.5 776.4 7.2 10.2 12.1 Intra-NAFTA 159.5 396 646.5 8.1 7.7 10.1 trade Intra-EU trade 416.9 1168.5 1296.6 21.1 22.7 20.2 Intra-Mercosur 2.0 14.5 16.6 0.1 0.3 0.3 trade Intra-ASEAN 11.3 64.6 74.2 0.6 1.3 1.2 trade Notes: East Asia is Brunei, Cambodia, China, Korea, Hong Kong, Indonesia, Malaysia, Mongolia, Philippines, Singapore, Taiwan, Thailand and Vietnam; ROW means rest of the world. Source: Direction of Trade, IMF, adapted from Ng and Yeats (2003).

comparative advantage in assembly operations while higher-wage countries such as Japan and NIEs are losing this advantage. Japan is still the hub for sourcing components: Indonesia sources 70 per cent, South Korea, Philippines and Taiwan more than 50 per cent, and China and Thailand just under 50 per cent of components from Japan. However, South Korea, Taiwan and China are emerging as important sources of components. It is likely that higher-end components are sourced from Japan and lower-end components from China. Exports to China and Hong Kong from the ASEAN6 (Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam), South Korea and Taiwan increased rapidly to reach 16 per cent of total exports compared to 8 per cent in 1990. Exports to China have exceeded exports to Japan and are nearing the size of exports to the United States (Anderson and Hu 2003). China has overtaken Japan as the most important source of export growth for East Asia. The exports of the ASEAN6, South Korea and Taiwan to China grew by 35 per cent and contributed to 37 per cent of total export growth in 2002 (Anderson and Hu 2003). East Asia provided important markets for China, but the United States remained its most dynamic market. The emerging pattern is one of exports from East Asia to China of components and parts, raw materials and food to service China’s huge domestic demand and provide inputs for its exports to US and other developed country markets. Japan is no longer the trade and production hub for East Asia. Economic modelling shows that domestic demand and export markets are equally important in determining China’s import demand from East Asia (World Bank 2003). In other words, its huge domestic demand acts as a buffer for any volatility in exports to the United States caused by trade friction or a US recession.

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The increase in intra-regional trade and investment and the emergence of a regional production centre occurred in the absence of any institutionalised trading arrangement. These trends were driven by market forces, including FDI flows and reductions in protection (and, where significant protection remained, trade policies that allowed for duty-free imports to be incorporated into export production). The question arises as to whether market-driven integration is a sufficient path forward, or whether formal regional arrangements would facilitate the market-driven processes. And did the financial crisis provide a rationale for a more formalised East Asian regionalism?

FROM REGIONALISATION TO REGIONALISM: A SHIFTING ‘ORDER’? The WTO, APEC and ASEAN East Asia generally favoured multilateralism and eschewed PTAs prior to the financial crisis. Most economies belong to the WTO: China joined in December 2001, Taiwan in January 2002, Cambodia ratified its membership agreement in 2004, and Vietnam and Laos are negotiating over accession. Some of the Uruguay Round commitments to reduce tariffs and non-tariff barriers, bind tariffs (admittedly at high levels in a number of countries), eliminate local content requirements, adhere to various rules (e.g., on intellectual property rights) and facilitation measures (e.g., harmonised customs procedures) will be a challenge for some countries. However, the WTO has had a strong influence on domestic policies, particularly for the countries seeking accession. Efforts to launch a new WTO round have faced setbacks, leading to growing uncertainty about the fate of the multilateral system. The Ministerial Meeting in Seattle in September 1999 to launch the new trade round ended in debacle. Agreement was finally reached in December 2001 to launch the Doha Development Round, only to be met by failure to move forward at the September 2003 Cancun meeting. East Asian economies hold differing positions on the key issues and debates in the WTO. For instance, China and Thailand are members of the Group of Twenty (G20), which has an agenda of agricultural liberalisation, but Japan and South Korea maintain a protectionist stance over agriculture. A number of Southeast Asian countries are opposed to the new ‘Singapore issues’ of investment, competition policy, government procurement and trade facilitation, while Japan favours including investment. Japan, South Korea and the ASEAN6 were founding members of the Asia Pacific Economic Cooperation (APEC) forum, and China, Hong Kong and Taiwan joined in November 1991. It has been argued that APEC resolve in 1993 broke the deadlock on agriculture between the United States and the European Union, paving the way for the completion of the Uruguay Round negotiations. At the 1993 Leaders Meeting in Seattle, APEC agreed on a vision of free trade and investment in the region. In Bogor in 1994, it was agreed to reach this goal by 2010 for developed countries and 2020 for developing countries. The 1995 Osaka Action Agenda laid out the basic principles of APEC, followed by the 1996 Manila Plan of Action (MAPA). APEC members have used the forum to push through domestic reforms. When hosting the 1994 meeting, Indonesian

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President Soeharto used APEC to push for the removal of foreign ownership restrictions in Indonesia and a more transparent tariff reduction schedule. One of APEC’s aims was to prevent the emergence of separate economic blocs on both sides of the Pacific. APEC provided the rationale for the rejection of Mahathir’s EAEG proposal, but failed to forestall the North American Free Trade Agreement (NAFTA) or the emerging Free Trade Area of the Americas (FTAA). APEC relies on peer pressure to achieve open regionalism and unilateral trade and investment liberalisation. Agreements among members are non-binding and there is a commitment to liberalisation on a most-favoured-nation (MFN) basis. Open trade and investment depends on the two pillars of trade and investment liberalisation and facilitation (TILF) and economic and technical cooperation (ECOTECH) for capacity building among less developed members. APEC scored a tangible success when its support in 1996 helped pave the way for the subsequent successful WTO negotiations on the Information Technology Agreement. However, a subsequent proposal for tariff negotiations in a number of sectors as a way to accelerate APEC-wide liberalisation under the Early Voluntary Sectoral Liberalisation (EVSL) scheme failed. The failure of EVSL, combined with the 1997 Asian financial crisis, led to increased doubts and uncertainty regarding APEC’s effectiveness to achieve the Bogor goals. The ASEAN Free Trade Area (AFTA), established in 1992, now covers all ten Southeast Asian countries. Until recently none of the Northeast Asian economies of China, Hong Kong, Japan, South Korea and Taiwan belonged to a PTA. China spent fourteen years negotiating for WTO accession and in the process began opening up its domestic market and reforming its policies and institutions (Garnaut and Song 2002). The push to form AFTA came from ASEAN’s concerns about the rise of regionalism in North America and Western Europe and the emergence of central and eastern European countries and China as competitors for FDI. AFTA achieved its objective of trade liberalisation to the 0–5 per cent level by 2002 among the ASEAN6, which was well ahead of the initial target of 2008, and set a new target of zero tariffs for the ASEAN10 by 2015. However, intra-ASEAN trade has not grown much faster than extra-ASEAN trade. Moreover, it is reported that only a small percentage of intra-ASEAN trade utilises the AFTA trade preferences. ASEAN is still far from being an integrated market for goods—tariffs have yet to be brought down to zero for the whole of ASEAN, and there are many non-tariff barriers that are more serious impediments to trade, including cumbersome customs procedures and transportation and logistics bottlenecks. ASEAN has also been slow in implementing agreements to liberalise services trade and investment. The 1995 ASEAN Framework Agreement on Services (AFAS) aimed at services liberalisation beyond GATS, but there has been a reluctance to liberalise services under mode 3 (commercial presence) and mode 4 (movement of natural persons). This has led to two modifications. First, a new approach where liberalisation involves the removal of all limitations for mode 1 (cross-border supply) and mode 2 (consumption abroad), and progressive liberalisation for modes 3 and 4. Second, an ‘ASEAN minus x’ formula was adopted, enabling two or more members to negotiate liberalisation of specific sectors and subsectors, with other countries joining in when they are ready. The 1996 Agreement on the ASEAN Investment Area (AIA) aims to liberalise restrictions and establish national treatment among ASEAN investors, and then among non-ASEAN investors. Liberalisation was initially slow but quickened as FDI inflows in ASEAN

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failed to rise above pre-crisis levels and FDI seemed to be moving to Mexico, central and eastern Europe and China. However, the uncertain political and social environment in ASEAN and the lack of full market integration have continued to deter foreign investors. Faced with growing external challenges, particularly the rise of China and India, and the need to cooperate more effectively to improve competitiveness and attract investment, ASEAN leaders agreed in November 2002 to explore prospects for an ASEAN economic community (AEC). An Institute of Southeast Asian Studies proposal envisaged this as a FTA-plus arrangement, with zero tariffs under AFTA, elimination of non-tariff barriers, harmonised standards and customs procedures, an institutional and legal infrastructure to facilitate economic integration, and inclusion of some elements of a common market such as the free movement of labour and capital (ISEAS 2003). Another proposal in April 2003 envisaged a common market-minus arrangement, with free flows of trade in a customs union (with common external tariffs), free mobility of labour and capital, and strengthening of the ASEAN Secretariat and the dispute settlement mechanism (ASEANISIS 2003; Hew and Soesastro 2003). The October 2003 ASEAN Summit adopted a framework to achieve a single market with the free flow of goods, services, investment, capital and skilled labour by 2020. The agreed road map has four components. First, to eliminate non-tariff trade barriers by 2005, including harmonisation of product standards and technical regulations, and mutual recognition agreements for five priority sectors. Second, eleven priority sectors have been identified for fast-track vertical integration. Third, institutions will be strengthened and the decision-making process streamlined to ensure effective implementation, and a dispute-settlement mechanism will be established to provide greater predictability to the ASEAN business environment. Fourth, the original ASEAN members will continue to help the newer members with capacity building and narrow the development gap. In view of past failures to meet liberalisation and facilitation deadlines, it remains to be seen whether ASEAN has the political will and discipline to deliver on its new commitments. Rising regionalism and bilateralism in East Asia The economic literature has demonstrated that trade liberalisation under a multilateral framework is the first-best solution and that PTAs are second best, whether they be customs unions or free trade areas, plurilateral or bilateral agreements. PTAs are discriminatory and will adversely affect non-members if they divert trade from a lowercost non-member supplier to a higher-cost member supplier. When economic theory is so supportive of multilateralism, why are so many countries, developed and developing, large and small, pursuing a second-best option? It could be that the first-best option is not attainable, that the second-best option is preferred because there are other objectives that could not be achieved under the first option, that policymakers are misguided or that there are vested interests involved. Critics of PTAs contend that not only is it an inferior strategy, but that it has been ineffective in liberalising and promoting trade. The first efforts at economic integration in East Asia date back to the late 1980s when the ASEAN-US Initiative was mooted (Naya et al. 1989). There were also discussions of bilateral FTAs between the United States and Japan, and South Korea and Taiwan, as well as the EAEG. None of these ideas took off, and efforts focused on the creation of

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APEC and its principles of voluntarism and open regionalism. Then in 1992 ASEAN established AFTA. Various political, strategic and economic forces built up momentum for East Asian regionalism in the late 1990s. The financial crisis served as the catalyst, demonstrating the extent of economic and financial interdependence among East Asian economies. The crisis-afflicted economies of Indonesia, Malaysia, Philippines, Thailand and South Korea were dissatisfied with the level of assistance from the United States and the European Union and the conditionality of IMF financial assistance, which led to resentment of the ‘Washington consensus’. After the crisis leaders and officials set up the ASEAN-plusthree grouping as a forum to discuss regional financial cooperation. And, in the postcrisis period, PTAs have seemed an increasingly attractive option for sustainable economic recovery, providing more secure market access and encouraging inflows of investment. Concerns about slow economic recovery and flagging competitiveness following the financial crisis triggered a defensive reaction to regionalism elsewhere, particularly the European Union, NAFTA and the emerging Free Trade Area of the Americas (FTAA). East Asia’s producers and exporters have suffered the discriminatory practices of PTAs (e.g., Japanese products in the Mexican market) and have watched foreign investment flock to locations with preferential access to NAFTA or the European Union, for instance Mexico and central and eastern Europe. They have pressured governments to improve market access and market security. Improved political relations at the end of the Cold War and other developments in the 1990s provided additional impetus to East Asian regionalism. The rise in intra-regional trade and investment and China’s growing economic power increased the prospect of a large and dynamic bloc that could compete more effectively with the European Union and NAFTA. China, Japan and the Asian NIEs also have considerable foreign reserves that could be deployed to meet the financial and capital needs of the region. Several East Asian economies have been disappointed with APEC and the WTO. For members seeking trade and investment liberalisation, APEC has not moved fast enough as there is no mandatory progression toward the Bogor goals. Developing economies seeking development assistance and capacity building for trade and investment liberalisation also feel APEC is not delivering. Furthermore, APEC failed to check the momentum of regionalism in North America and Latin America, or contain US trade sanctions. WTO negotiations among over 140 countries have been typically slow: the Uruguay Round took seven years to conclude, and efforts to launch a new round since 1999 have faced difficulties. Neither GATT nor the WTO has been able to stem the proliferation of PTAs. Multilateralism in practice is far from the theoretical ideal: there is neither free trade nor fair trade. Developing countries complain that the playing field is not level, that they lack negotiating power, and that developed countries control WTO agreements, disciplines and rules. Effects and features of the new PTAs Gravity models have highlighted the importance of geographic proximity and cultural and language affinities in promoting trade (Sohn 2001). However, geographical proximity is no longer the main factor in the choice of PTA partners. As Table 7.2 shows,

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there are agreements (or proposed agreements) between Southeast and Northeast Asian countries, as well as beyond East Asia, stretching to North America, Latin America, Europe, India, Australia and New Zealand. Developments in transportation and communications have reduced geographical barriers and transaction costs, but common political and security interests, cultures and values do still remain important. Economic complementarity has been another motivation behind PTAs, but agreements are being considered between economies that are at different

Table 7.2 Regional, trilateral and bilateral trading arrangements in East Asia Membership

Status

Regional: AFTA ASEAN 10 Implemented. ASEAN-China ASEAN10, Framework Agreement signed Comprehensive China November 2002; official Economic negotiations underway; early Cooperation harvest implemented. (with FTA) ASEAN-Japan ASEAN10, Japan Framework Agreement signed Comprehensive October 2003; bilateral FTAs Economic under study and negotiation, Partnership except for Japan-Singapore, (with bilateral which was implemented January FTAs) 2003. ASEAN-South ASEAN10, South Discussions and joint study. Korea Korea Comprehensive Economic Partnership (with FTA) ASEAN-India ASEAN10, India Framework Agreement signed Comprehensive October 2003; negotiations begin Economic January 2004. Cooperation (with FTA) ASEAN-US Select ASEAN US-Singapore FTA implemented Enterprise for countries, United January 2004; other bilaterals ASEAN States under discussion and negotiation. Initiative (with FTA) East Asia FTA ASEAN10, East Asia Vision Group Report (ASEAN+3) China, Japan, completed; official discussions South Korea ongoing. Trilateral and bilateral: China-Japan- China, Japan, Under discussion. Korea FTA South Korea Bilateral with Hong Kong China With Hong

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bilaterals Hong Kong bilaterals

Kong, South Korea With China, New Zealand

120

implemented; bilateral with South Korea under discussion. Bilateral with China implemented; bilateral with New Zealand under discussion. Bilateral with Singapore implemented January 2003; bilaterals with Mexico, South Korea, Malaysia, Philippines, Thailand under negotiation; bilaterals with Indonesia, Taiwan, Canada under discussion. Under negotiation.

Japan bilaterals With Canada, Mexico, South Korea, Taiwan, Indonesia, Malaysia, Philippines, Singapore, Thailand Malaysia With Japan, bilaterals United States Philippines With United Under negotiation. bilaterals States Singapore With Australia, Bilaterals with Australia, EFTA, bilaterals Canada, EFTA, Japan and New Zealand India, Japan, implemented; others under Jordan, Mexico, negotiation. New Zealand, Sri Lanka, South Korea, United States Source: Drawn from Chia (2004).

levels of development and between complementary as well as competitive economies. In East Asia, Japan has strong complementarity with China and ASEAN, as there is limited competition between what Japan exports and what China and ASEAN (excluding Singapore) export. The NIEs (including Singapore) are competitive with one another and with Japan in high-end goods, and with ASEAN and China in low-end goods. China has strong complementarity with the NIEs and a competitive relationship with ASEAN. Economic complementarity fosters inter-industry trade and requires less domestic structural adjustment and hence can be more politically acceptable to domestic constituencies. Preferential access to a sizeable market is important to the choice of an FTA partner, as FTAs with large markets provide greater scope for economies of scale and agglomeration, and have a bigger clout internationally. As Table 7.3 shows, AFTA is not large enough to be a significant global player. AFTA has a population of 526 million, but a market size of only US$580 billion (about 7 per cent of the European Union, 5 per cent of NAFTA, 13 per cent of Japan and 51 per cent of China). FTAs with the United States, Japan, China and the ASEAN 10 are attractive propositions. A US-ASEAN FTA would create a market size of US$10.4 trillion, almost the same size as NAFTA. However, the United States is adopting a bilateral approach toward ASEAN under the Enterprise for ASEAN Initiative (EAI), having signed an FTA with Singapore and now exploring FTAs with several other ASEAN countries, giving

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rise to concerns of an emerging hub-and-spoke pattern. An FTA among China, Japan and South Korea would create a market worth US$6.2 trillion, eleven times that of AFTA, and satisfy the criteria of geographical proximity and economic complementarity, but is unlikely to materialise because of political and historical barriers. Such problems also hinder a China-Japan FTA: Japan is reluctant to open its agricultural sector, while China is wary of competition in high-tech industries. Japan’s priority has been South Korea. Negotiations for the Japan-South Korea FTA began in 2003 and are planned to conclude in 2005. The FTA is taking longer to conclude than the Japan-Singapore FTA because of Korea’s concerns about falling industrial competitiveness and its trade deficit with Japan. The political history between the two countries has not seemed to have inhibited the negotiations (Munakata 2003). An ASEAN-Japan FTA would have a market size of US$5.2 trillion, while an ASEAN-China FTA would be much smaller at US$1.7 trillion (although it would be the world’s most populous FTA). ASEAN-Japan would be a partnership of complementary economies, with Japan having a comparative advantage in high-tech and skills-intensive industries and services, and ASEAN (excluding Singapore) having a comparative advantage in natural-resource-based and labour-intensive industries. Japan has opted for a two-track

Table 7.3 Comparative sizes of emerging FTAs in East Asia, 2001 Population Nominal External trade US$ million GNP billion US$ billion Northeast Asia: China Japan South Korea Hong Kong Taiwan Southeast Asia: Brunei Indonesia Malaysia Philippines Singapore Thailand ASEAN6 Cambodia Laos Myanmar Vietnam Cambodia,

1,271.9 127.1 47.6 6.9 22.4

1,131 4,574 448 176 287

510 755 292 393 230

0.3 213.6 23.8 77.0 4.1 61.2 380.0 12.3 5.4 48.3 79.5 145.5

5 145 87 81 99 121 538 3 2 5 33 43

5 88 163 65 238 124 683 3 1 4 31 39

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Laos, Myanmar and Vietnam ASEAN10 525.5 580 722 Other FTA partners: US 285.0 9,781 1,911 Mexico 99.0 550 335 Chile 15.0 71 35 India 1,032.0 477 93 Australia 19.0 386 127 New Zealand 4.0 51 27 China-Japan1,446.6 6,153 1,556 South Korea China-Japan 1,399.0 5,705 1,265 China-South 1,319.5 1,579 802 Korea Japan-South 174.7 5,022 1,047 Korea ASEAN+3 1,972.1 6,733 2,278 ASEAN-China 1,797.4 1,711 1,231 ASEAN-Japan 652.6 5,154 1,476 ASEAN-South 573.1 1,028 1,013 Korea ASEAN-India 1,557.5 1,057 815 ASEAN-CER 548.5 1,017 876 (Australia, NZ) ASEAN-US 810.5 10,361 2,633 NAFTA 415.0 11,013 2,727 EU15 377.9 8,171 4,625 Sources: Adapted from Tables 7.1 and 7.2; World Development Indicators 2003, World Bank; International Trade Statistics 2002, IMF.

approach, negotiating FTAs with selected ASEAN countries ahead of the Framework Agreement with the ASEAN10. The Framework Agreement will cover liberalisation, facilitation and cooperation activities, special and differential treatment for less developed member states, and flexibility to address sensitive sectors. As a number of ASEAN countries have competitive agricultural sectors and Japan remains protectionist on agriculture, bilateral negotiations could prove difficult. Japan is a developed country, so the FTA would have to conform to the GATT/WTO Article XXIV requiring trade liberalisation in ‘substantially all sectors’. The ASEAN-China Framework Agreement, signed in November 2002, commits to an FTA covering trade and investment liberalisation and facilitation, and other areas of economic cooperation. Tariff reductions will begin in July 2005 and be completed by 2010 for the ASEAN6 and China, and by 2015 for the less developed members. In the meantime, an initial ‘early harvest’ program was implemented in 2003, covering tariff reductions in some agricultural goods.

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Finally, an East Asia FTA formed by the ASEAN-plus-three grouping would result in an economic bloc of two billion people (the largest in the world), a market size of US$6.7 trillion (82 per cent of the EU15 and 61 per cent of NAFTA) and total trade of US$2.3 trillion (49 per cent of the EU15 and 84 per cent of NAFTA). The PTAs being negotiated exceed the provisions of a traditional free trade area and the scope of the WTO because they: • extend beyond the liberalisation of trade in goods to encompass services and investment, facilitation of trade and investment, and development cooperation and capacity building in areas such as agriculture, industry, human resource development, small and medium-sized enterprises, and resources; • contain, for example in the negotiations ASEAN is having with Japan and China, provisions for special and differential treatment for the less developed economies (Cambodia, Laos, Myanmar and Vietnam), either a longer period for liberalisation or development and technical assistance for capacity building. A number of advantages are claimed for PTAs: that like-minded partners can achieve speedier trade and investment liberalisation; that market access for exporters is more certain; that an integrated market encourages economies of scale, specialisation according to comparative advantage, and competitive pressure to improve efficiency; and that inflows of FDI are larger. One theory is that multiple PTAs will lead to ‘competitive liberalisation’, serving as the vanguard for trade and investment liberalisation at the global level. And, as noted earlier, many PTAs exceed the scope of WTO negotiations by including facilitation measures as well as development and technical assistance. There are usually political and strategic motivations beyond economic considerations. These are important factors in negotiations between big powers and smaller states, and the big powers may not exercise their full bargaining leverage and may offer economic and technical assistance as sweeteners to achieve political objectives. This has been the case in negotiations with ASEAN. China has sought to assuage the region’s fears over Chinese economic ascendancy, while diminishing the influence of Japan and the United States over ASEAN. Japan proposed a PTA with ASEAN soon after China, so as not to be upstaged in its traditional sphere of influence. The United States proposed the EAI to support its fight against international terrorism and build allies among moderate Muslim states. Singapore’s very open economy and position as a strategic ally of Japan and the United States meant it could conclude comprehensive FTAs in rapid time. Previously the only global power not to have participated in a PTA, Japan in recent years has pursued initiatives with South Korea, Singapore, ASEAN and across the Pacific. The policy shift has been motivated by economic and geopolitical factors. PTAs offer a way to strengthen partnerships in areas not covered by the WTO and achieve liberalisation beyond levels attainable under the WTO, enabling Japan to develop its economic relationships with other countries, expand markets, improve efficiency and competitiveness, reduce the likelihood of economic frictions and expand and harmonise trade-related regulations and systems. PTAs also offer political and diplomatic advantages, such as increasing Japan’s bargaining power in the WTO, engendering political trust among partners, and expanding diplomatic influence. PTAs with East Asia are seen as producing the greatest economic benefits, as this is where Japanese products face the highest tariff barriers.

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Japan’s first effort to forge a PTA was with South Korea, a close partner with similar geopolitical and economic interests. Japan has concluded a PTA with Mexico, a NAFTA member that can provide ‘backdoor’ preferential entry into the US market, after having made some compromises over agriculture. The PTA with Singapore, which has no major agricultural exports, was concluded in record time and has been promoted as the model for PTAs with ASEAN countries. This may not go down well with ASEAN countries that are hesitant to liberalise their services sectors and are seeking a more open Japanese agricultural market. The rise of China has also played a role in changing Japan’s attitude toward PTAs. Since the late 1990s Singapore has pursued a multi-track strategy of multilateralism, regionalism and bilateralism, as it has been disappointed with the pace and scope of liberalisation under the WTO, APEC and ASEAN. Singapore has been a model WTO member and is active in the Doha Round, but wants to move faster and deeper than the WTO. It measures up well against the APEC goals, having brought tariffs on goods to zero, opened up trade in services, and achieved an open investment regime. Tariffs were at zero far before the AFTA deadline and Singapore opened up services and investment way ahead of AFAS and the AIA. It is pushing for faster and deeper ASEAN integration under the ASEAN economic community. The Singapore-New Zealand PTA was first mooted during the APEC Summit in New Zealand in September 1999 and was promoted as a partnership between like-minded countries and as a catalyst for APEC trade liberalisation. As at December 2003, Singapore had signed bilateral FTAs with New Zealand, Australia, the European Free Trade Association (EFTA), Japan and the United States, and was engaged in discussions or negotiations with Canada, India, Jordan, Mexico, South Korea and Sri Lanka. Singaporean negotiators believe that WTO-plus PTAs will reinforce multilateral trade policy and ratchet up the pace of global trade liberalisation. Singapore is increasingly concerned about the discrimination its exports face in European and North American markets. There have been a number of criticisms of PTAs. One is that the cost of trade diversion is higher in a bilateral than a plurilateral PTA, unless it is an agreement between two low-cost producers or unless secure market access encourages a high-cost supplier to innovate and achieve scale economies, becoming a low-cost supplier. Findlay et al. (2004) note that the cost of trade diversion can be larger for services than for goods because the first-mover advantage can lock in second-best suppliers. A good PTA should minimise discrimination by allowing other members to join and committing to lower trade and investment barriers to all countries. The FTAs that Japan and the United States have with Singapore have led to similar agreements with other ASEAN countries. A second criticism of PTAs is that they are ‘stumbling blocks’ in the multilateral trading system. Large economies such as the European Union, the United States and Japan may lose commitment to the WTO process when they are at the hub of preferential deals. And for developing economies with limited financial and human resources, negotiating PTAs could divert resources that would otherwise be devoted to the Doha Round. An alternative perspective is that PTAs offer negotiating experience that can be applied to WTO negotiations. Another criticism is that bilateral FTAs negotiated by Singapore and Thailand undermine ASEAN cohesiveness and bargaining leverage and have a ‘domino effect’, pressuring other members into FTAs. An alternative argument is

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that this leads to ‘competitive liberalisation’ that will hasten and deepen economic integration and strengthen ASEAN as an economic region. A third criticism is that PTAs infringe the Article XXIV principle by excluding sensitive sectors such as agriculture, textiles and services. Agriculture is a thorny issue in Japan’s negotiations with Singapore, Chile, Mexico and South Korea, and will pose similar problems in negotiations with ASEAN agricultural exporters. Fourth, multiple and overlapping PTAs give rise to differing tariff reduction schedules, varying product standards and conformance requirements and a complex matrix of rules of origin, creating a ‘spaghetti bowl’ effect and raising transaction costs (Brenton 2003). Rules of origin and standards can affect decisions to locate production in the most efficient location and decisions to source inputs from the cheapest source, and can also affect economies of scale, as production is subject to different content requirements and production processes. The burden is greatest on small and mediumsized companies and less developed countries. Finally, critics point to the undesirable hub-and-spoke effect of multiple and overlapping PTAs. Hubs reap more benefits than spokes, since a hub has market access to all the spokes while each spoke only has access to the hub. The asymmetrical benefits are more severe with a developed country hub and developing country spokes. The United States is a hub not only in NAFTA but also in various bilateral FTAs. However, its NAFTA partners, Canada and Mexico, are signing onto other regional and bilateral FTAs, also becoming hubs and diminishing this advantage. In East Asia, Japan, Singapore and ASEAN have become hubs but will have their positions eroded when their FTA partners sign on to multiple FTAs. Also, whether ASEAN can exploit its hub position depends on whether negotiations are as a group or as individual countries. A good PTA design should result in faster and deeper trade and investment liberalisation and facilitation, and minimise trade and investment diversion by observing certain principles. These principles include that a large PTA is preferable to a small one; that it should be WTO-consistent in covering substantially all trade (Article XXIV rather than the enabling clause), result in the eventual lowering of MFN tariffs, and be open to accession by other countries; and that it should be WTO-plus in liberalisation and facilitation beyond the WTO agenda, promote economic cooperation and provide special and differential treatment as well as development and technical assistance for capacity building in less developed members. The PTAs within East Asia and with other countries should be designed to support the WTO process and the APEC goals of free and open trade and investment. The feasibility of these conditions being met is examined below.

AN EAST ASIA FREE TRADE AREA AND NEW ORDER? An optimistic scenario for East Asia is that the proliferation of plurilateral and bilateral PTAs will eventually consolidate and coalesce into a single PTA covering the whole region. A pessimistic scenario is that varying rules of origin and hub-and-spoke effects will undermine the exploitation of economies of scale and agglomeration, and economic efficiency. It may well be that the inadequacy of the multilateral process and growing regionalism in the Americas and Europe will pressure East Asian economies into consolidation and establishment of a region-wide PTA.

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The East Asia Vision Group envisaged an FTA among ASEAN, China, Japan and Korea ‘moving from a region of nations to a bona fide regional community where collective efforts are made for peace, prosperity and progress’ (East Asia Vision Group 2001). The report, submitted to the ASEAN-plus-three summit in November 2001, recommended the establishment of an East Asian FTA (EAFTA) and trade liberalisation well ahead of the Bogor goals; expansion of the AIA framework to all of East Asia; greater development and technological cooperation, especially with less developed countries; and the realisation of a knowledge-based economy. The East Asia Study Group, a committee of government officials, recommended moving from ASEAN-plusthree to an East Asia summit and then to EAFTA, while addressing concerns that ASEAN may be marginalised if the pace is too fast, and nurturing a sense of ownership among Northeast Asian countries (East Asia Study Group 2002). The November 2002 ASEAN-plus-three summit accepted the recommendation and tasked economic ministers to formulate options on the gradual formation of an EAFTA. East Asia has already embarked on the path of regionalism, so a single, large PTA embracing as many economies as feasible is preferable to the current proliferation. A large bloc would enable exploitation of comparative advantage, and economies of scale and agglomeration, leading to enhanced efficiency and growth. Region-wide production networks in a free trade and investment environment would lead to vertical and horizontal division of labour along a value chain that embraces all member states. An EAFTA would be able to compete more effectively with the European Union and NAFTA. As the European experience has shown, the formation of a large economic bloc can bring stability and peace to a region. Greater interdependence increases mutual understanding and provides a sense of a shared future that deters intra-regional conflict. And if there are serious disputes, there are regional institutions, mechanisms and processes to handle them. There are political and economic challenges to the realisation of EAFTA. East Asia comprises economies of varying population, income, development, economic systems and institutions, and competitiveness. This makes it difficult to achieve consensus on the depth and speed of trade and investment liberalisation and the harmonisation (or mutual recognition) of standards and customs procedures. Extensive trade liberalisation may impose unacceptable adjustment costs on the less developed economies and they will need development assistance and a longer period to liberalise. There must be perceptions that a region-wide PTA will be a ‘win-win’ formula for all members. However, the formation of an FTA always encounters strong opposition from non-competitive sectors. Although the shortage of farm labour is making it increasingly difficult to maintain rice self-sufficiency, Japan and South Korea are unwilling to end protectionism and import from more efficient producers in Southeast Asia. ASEAN states may find it difficult to open up to cheap manufactures from China that could threaten their nascent industries. Although wages in China will converge to the levels of the less developed ASEAN economies, these economies will still need to improve competitiveness, introduce structural adjustments, and provide an adequate mechanism for compensating losers. Mutual distrust and security concerns need to be overcome. It has taken decades for ASEAN states to bury their historical, territorial and ideological conflicts. Such issues

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still divide China, Japan and South Korea, and economic rivalry between China and Japan is rapidly growing. The continuing reliance of Japan and South Korea on the United States for security may be a further obstacle to an East Asian FTA. Politics may again be a problem when discussing the membership of Taiwan, North Korea, Australia and New Zealand. The European experience shows the crucial role of strong political leadership. In NAFTA the United States took the hegemonic role. However, there is no common vision or clear leader in East Asia—leadership will have to be shared between China and Japan. How to get to an East Asian FTA? The pragmatic approach is to build on the current FTAs and wider framework of ASEAN cooperation, for instance by consolidating ASEAN-China, ASEAN-Japan and ASEAN-South Korea. An alternative is the establishment of a China-Japan-South Korea FTA followed by a consolidation with Southeast Asia. A third approach is the consolidation of Japan-South Korea, China-Japan and China-South Korea with ASEAN. Consolidating the complex matrix of rules of origin and product and technical standards, and minimising the impact on sensitive sectors, will be difficult. East Asia is unlikely to replicate NAFTA’s experience, where the United States is the hegemon, as both China and Japan are major regional powers. Perhaps East Asia can follow ASEAN’s example, where there are no hegemons and decisions are based on consensus, despite the fact that members vary in economic size and strength. There will be much to learn from the ongoing FTAA negotiations about accommodating various subregional and bilateral FTAs.

CONCLUSION East Asia is the only major region in the world not to have formed an economic bloc. The East Asian miracle was founded on individual economies adopting an open economy model and integrating with the global economy through trade and investment. Economies have become increasingly integrated, particularly through the nexus between trade and investment. The Asian financial crisis eroded confidence in meeting the challenges of globalisation. Economies have struggled to put in place the structural and corporate reforms needed to re-establish macroeconomic and financial stability and regain dynamism. At the same time, the world trading system has changed. The European Union has expanded, the FTAA and other trans-Atlantic alliances are emerging, and trade and investment liberalisation under the WTO and APEC has made limited progress. East Asia finds it increasingly difficult to remain the main defender of multilateralism under the WTO against the proliferation of regional, cross-regional, plurilateral and bilateral PTAs. The effects have included trade diversion, pressure on countries to join the bandwagon, the degradation of the Article XXIV principle, and multiple and overlapping PTAs. To ensure that PTAs maximise benefits and minimise costs, their design requires stronger governance by the WTO and stricter enforcement of Article XXIV. It is highly desirable that the multitude of PTAs in East Asia be consolidated under a region-wide FTA to eliminate hub-and-spoke effects, reduce transaction costs, improve efficiency through specialisation and scale economies and provide impetus for innovation and research. It would also have a political dividend, helping to secure regional peace and stability and

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bring about a new economic and political order in East Asia, as the European experience has shown. The road to an East Asian community or an East Asian FTA is long and requires a common political and economic vision, political leadership, a clear road map, and the building of regional institutions and processes. An FTA should not be an end goal but a stepping stone toward achieving global free trade under the WTO. While in pursuit of an FTA, East Asia should continue to support the Doha Development Round and the Bogor goals. Some have suggested East Asia could play a leadership role in global negotiations. An open, rules-based global trading system is in the interest of East Asian economies, who rely on exports for growth and development, and a prospering and peaceful East Asia is in the interests of the rest of the world. Allowing convergence of the different regional agreements in East Asia will be important because it is critical to them becoming a building block for the creation of at least the sense of an ‘East Asian community’. This may or may not result in a full and formal regional trade agreement, but could manifest in aspects of regional cooperation such as an agreement on trade facilitation, while most liberalisation is undertaken under the multilateral framework.

NOTES 1 In Chapter 4 Garnaut and Song give a more detailed analysis of economic integration in East Asia. 2 Regional input-output tables, constructed by linking the tables of individual economies, show whether output is sold domestically or exported, and whether inputs are procured domestically or imported. The procurement of inputs by East Asian countries from East Asia out of total inputs increased from 0.042 to −0.058 over the 1985–95 period. Intra-regional dependence increased for all economies except Korea and Japan.

REFERENCES Anderson, Jonathan and Fred Hu (2003) ‘The five great myths about China and the world’, Hong Kong: Goldman Sachs. ASEAN-ISIS (2003) ‘Towards an ASEAN economic community—a track two report to ASEAN policymakers’, Jakarta, April. Brenton, Paul (2003) ‘Notes on rules of origin, with implications for regional integration in South East Asia’, Washington: World Bank, July. Chia, Siow Yue (2004) ‘The rise of China and emergent East Asian regionalism’, in Kokubun Ryosei and Wang Jisi (eds) The Rise of China and a Changing East Asian Order, Tokyo: Japan Centre for International Exchange. East Asia Study Group (2002) ‘Final report of the East Asia study group’, Jakarta: ASEAN Secretariat, November. East Asia Vision Group (2001) ‘Towards an East Asian community: region of peace, prosperity and progress’, Jakarta: ASEAN Secretariat, October. Findlay, Christopher, Mohd. Haflah Piei and Mari Pangestu (2004) ‘Trading with favourites: free trade agreements in the Asia-Pacific’, in Riyana Miranti and Denis Hew (eds) APEC in the 21st Century, Singapore: ISEAS Publications. Garnaut, Ross and Ligang Song (2002) China 2002: WTO Entry and World Recession, Canberra: Asia Pacific Press.

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Hew, Denis and Hadi Soesastro (2003) ‘Realizing the ASEAN Economic Community by 2020: ISEAS and ASEAN-ISIS approaches’, ASEAN Economic Bulletin 20(3): 292–6, December. Institute of Southeast Asian Studies (ISEAS) (2003) ‘Concept paper on the ASEAN economic community’, Singapore, February. Munakata, Naoko (2003) US Should Bless the Japan-ROK Free Trade Pact, Honolulu: Pacific Forum CSIS, Pacnet 24, 9 June. Naya, Seiji, Kernial S Sandhu, Michael Plummer and Narongchai Akrasanee (1989) ASEAN-US Initiative: Assessment and Recommendations for Improved Economic Relations, Honolulu and Singapore: East-West Centre and Institute of Southeast Asian Studies. Ng, Francis and Alexander Yeats (2003) ‘Major trade trends in East Asia: what are their implications for regional cooperation and growth?’, World Bank Policy Research Working Paper 3084, June, Washington: World Bank, available from http://econ.worldbank.org/files/27878_wps3084.pdf. Sohn, Chan-Hyun (2001) ‘Korea’s FTA developments, experiences and perspectives with Chile, Japan and the US’, paper presented at the PECC Trade Forum, Bangkok, June. Urata, Shujiro (2003) ‘FDI flows, their determinants and economic impacts on East Asia’, paper prepared for World Bank workshop on Foreign Direct Investment and Economic Development: Lessons from East Asian Experience, Bali, Indonesia, 30 November–1 December. World Bank (2003) World Development Report 2003, Washington DC: World Bank.

8 The Free Trade Area of the Americas: how deep an integration in the Western Hemisphere? Gary Clyde Hufbauer and Sherry Stephenson

INTRODUCTION Economic integration in the Western Hemisphere grows out of distinct historical visions in North and South America. The concept of a North American economic market dates from the nineteenth century. In its early manifestations, economic union was closely—in fact too closely—associated with political union. Thanks in part to loose rhetoric, particularly the colourful remarks of House Speaker Joseph Cannon, Canadians came to see economic union as a device for turning Canadian provinces into American states. Thus, on four occasions between the mid-nineteenth century and the end of the Second World War, Canada rejected overtures for something like a free trade area. Meanwhile, resentful of American territorial acquisitions and military intervention, Mexico did its utmost to limit commerce with the United States. The story in Latin America ran a different course with the same result. The charismatic Simon Bolivar (1783–1830) deployed his considerable military skills to liberate the Andean countries and create a single state north of Brazil. Bolivar’s autocratic ways, however, sparked local revolts, followed by periodic border disputes over the next century. These were accompanied by episodic battles both within the South American Southern Cone and within Central America. Partly owing to decades of strife, at the end of the Second World War, Latin American countries conducted the great bulk of their trade and finance with the United States and the United Kingdom, and very little commerce with one another. The subsequent era of import substitution (roughly 1950 to 1970) reinforced the commercial isolation of Latin American states from one another. The Latin American ‘common markets’ of the 1960s and 1970s were essentially paper agreements, with little economic content. From import substitution to economic integration Thinking changed in the late 1980s and 1990s. A decade of sub-par performance, with high inflation and financial crises, propelled Latin American political and business leaders to search for new models. They embraced three pillars of what was later dubbed the ‘Washington consensus’: fiscal rectitude, sound money and freer trade. Political leaders were not suddenly convinced by the logic of Paul Samuelson, Milton Friedman or

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David Ricardo, but they were persuaded by the sparkling performance of East Asia. Canada and Mexico experienced parallel, if less dramatic, conversions. Political strategy played a role. Leaders in Ottawa and Mexico City found that declarations of economic independence from the United States had less popular payoffs. Leaders in Santiago, Buenos Aires, Brasilia and other capitals found that nationalistic agendas—rectifying old wrongs, redrawing old borders—were no longer central to popular concerns. But the driving force behind the new agenda was the hope of economic prosperity, not the hope of averting military hostility. In this critical respect, free trade agreements in the Western Hemisphere flowed from a different logic than free trade agreements on the European continent and in Southeast Asia. Intellectual firepower Three sets of empirical findings, distilled from the research of economists, underpinned the hemispheric free trade agenda. The first was the connection, stressed by Balassa (1965), between rising intensity of trade (exports plus imports as a per cent of GDP) and rising levels of per capita income. Interpreting the connection as a causation—a matter of continuing debate—the GDP gains resulting from trade liberalisation far exceed the gains that might be calculated from textbook static equilibrium analysis. This was a dramatic finding. It spawned a literature of dynamic trade models which eventually persuaded policy officials that trade expansion causes per capita income to rise, and is not merely a consequence of higher GDP. The second set of findings underpinning the liberalisation agenda, and indeed transforming it into a free trade and investment agenda, originated with the research of Vernon (1966) and Dunning (1966). They discovered a strong connection between foreign direct investment (FDI) sponsored by multinational enterprises (MNEs), and dense international networks of trade in goods and services. ‘Slicing the value-added chain’ and ‘outsourcing’ later became sound-bite descriptions. The concept of autonomous enterprises dealing at arm’s length with one another is the traditional view of world trade. But commerce between related MNE entities accounts for an enormous volume of trade in manufactured goods and business services. Countries that provide hospitable conditions for MNEs find it that much easier to break into export markets. As a happy coincidence, free trade and investment complement one another: liberal trade policies turn out to lure more MNEs than protected home markets, especially for small and medium-sized countries. Ireland and Singapore are two nations that have applied the teachings of Vernon and Dunning with great success. The third set of findings underpinning the free trade and investment agenda was the economic convergence literature, pioneered by Barro and Sala-I-Martin (1992). These and other scholars detected a catch-up by poorer states in the United States and poorer regions in post-war Europe, closing the initial gap as fast as 2 per cent per year over long periods. Internal free trade and investment are hallmarks of an economic union. As McCallum (1995) and Helliwell (1998) discovered, trade intensities within Canada and the United States are many times denser (by factors between five and twenty) than trade intensities across borders, after allowing for distance, province/ state economic size and other control variables. The obvious inference, it seemed, was that freer trade and

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investment policies within the hemisphere would not only stimulate commerce, they would also enable poorer countries to catch up with their richer partners. These three sets of empirical findings furnished the intellectual firepower for a new wave of trade agreements. Without the new findings, it would have been harder for liberal-minded leaders to overcome vested interests. As it happened, by the early 1990s, free trade and investment policies came to be widely recognised as desirable reforms from the laboratory of economic growth. Disappointing decade Now, after a decade of reform policies and trade agreements, disappointment is setting in. Table 8.1 gives the performance numbers. The United States can be left out of the story, since freer trade and investment only played a supporting role in the boom of the 1990s. Elsewhere in the hemisphere, Chile, Costa Rica, El Salvador, the Dominican Republic and six small Caribbean countries enjoyed per capita GDP growth of more than 25 per cent over the decade. Argentina did well through until 2001, and then disaster struck and Argentina experienced two straight years of negative growth. Most of the hemisphere had a mediocre decade, not as bad as the 1980s, but less than the promise of the early 1990s. Venezuela and four smaller countries suffered negative per capita income growth for the decade as a whole. Examined through the lens of economic convergence (see Table 8.1), eleven Latin American countries (including Argentina as of 2000) with a combined population of 74 million converged toward the US per capita GDP during the course of the 1990s (the population figure drops to 37 million if Argentina is excluded). By contrast thirteen countries with a combined population of 313 million diverged from the US per capita GDP. Eight countries, with combined population of 153 million, neither converged nor diverged. This is the context of the Free Trade Area of the Americas (FTAA) negotiations that were formally launched at the Miami Summit of the Americas in 1994: great expectations, disappointing performance, but still hope.

TRADE AGREEMENTS IN THE WESTERN HEMISPHERE In the mid-1990s, bilateral and regional free trade agreements (FTAs) surpassed the multilateral GATT/WTO system as the lead engine of trade policy. Bhagwati and Panagariya (1996) bemoan the encroachment of FTAs; Bergsten (1996) celebrates their contribution to ‘competitive liberalisation’.1 Whatever

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Table 8.1 Western Hemisphere income per capita Country GDP per Ratio Population GDP per Ratio to capita to (000) 2000 capita US (constant US (constant 2000–01 1995 1990 1995 US$) US$) 1990 2000–01 Antigua and Barbuda Argentina Bahamas Barbados Belize Bolivia Brazil Chile Colombia Costa Rica Dominica Dominican Republic Ecuador El Salvador Grenada Guatemala Guyana Haiti Honduras Jamaica Mexico Nicaraguaa Panama Paraguay Peru St Kitts and Nevis St Lucia St Vincent and the Grenadines Trinidad and Tobago

6,980 0.27

GDP per capita increase 1990– 2000

68

9,062

0.29

30

0.22 0.53 0.28 0.10 0.03 0.16 0.13 0.08 0.11 0.11 0.05

37,488 310 268 247 8,515 172,386 15,402 43,035 3,873 72 8,505

7,913 13,836 8,522 3,125 954 4,626 5,304 2,285 3,928 3,432 2,054

0.25 0.44 0.27 0.10 0.03 0.15 0.17 0.07 0.12 0.11 0.07

37 0 16 23 14 13 62 8 33 20 49

1,475 0.06 1,376 0.05

12,879 6,400

1,425 1,759

0.05 0.06

−3 28

2,822 1,358 604 482 683 2,235 3,187 446 2,523 1,822 1,905 4,555

0.11 0.05 0.02 0.02 0.03 0.09 0.12 0.02 0.10 0.07 0.07 0.17

100 11,683 766 8,132 6,585 2,590 99,420 5,205 2,897 5,390 26,347 45

3,809 1,562 934 368 711 2,149 3,806 437 3,243 1,703 2,311 6,535

0.12 0.05 0.03 0.01 0.02 0.07 0.12 0.01 0.10 0.05 0.07 0.21

35 15 55 −24 4 −4 19 −2 29 −7 21 43

3,542 0.14 2,168 0.08

157 116

3,771 2,737

0.12 0.09

6 26

4,094 0.16

1,310

5,553

0.18

36

5,776 13,836 7,330 2,543 836 4,079 3,283 2,119 2,945 2,871 1,377

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Uruguay Venezuela Canada United States Notes

4,870 3,350 19,229 26,141

0.19 0.13 0.74 1.00

3,361 24,632 31,082 285,318

a 1998 data. Source: World Bank, World Number of countries Development Indicators (2003). Population (millions)

5,870 3,326 22,981 31,592

134

0.19 0.11 0.73 1.00

21 −1 20 21

Converging Diverging

Neither converging countries countries nor diverging 11 13 8

74

313

153

the relative merits of bilateral and regional agreements, they are a fact of commercial life: Schott (2003) has counted a grand total of 283 FTAs, including those notified to the WTO (153), those concluded but not notified (83) and those under negotiation (45). The Western Hemisphere is a leader in the worldwide rush to preferential trade arrangements: sixty full and partial trade agreements now exist between Western Hemisphere nations.2 The Canada-US Free Trade Agreement (CUSFTA), ratified in 1989, provided the template for the North American Free Trade Agreement (NAFTA), which came into force in January 1994. NAFTA in the north, together with MERCOSUR in the south (ratified in 1991), provided inspiration for launching the hemisphere-wide Free Trade Area of the Americas (FTAA) in December 1994. Numerous other regional agreements have either been negotiated or re-invigorated over the past decade. No fewer than fifteen of the full FTAs have been signed (and most of them ratified and in force) as of the end of 2003. Following the NAFTA precedent toward more farreaching rules and greater market access, most of these agreements cover a wide and ambitious number of trade issues, as shown in Table 8.2, ranging from tariffs and nontariff barriers, to standards and technical regulations, investment, services, government procurement and competition policy. The services area, in particular, is treated in considerable depth in many of these FTAs through the inclusion of separate chapters with specific disciplines on cross-border trade in services, financial services, air transportation, telecommunications and the temporary entry of business persons (although not all agreements include chapters on all of these sectors/modes of supply). The two most recent FTAs (Chile-United States and CAFTA, which links Central America with the United States) also innovate through the inclusion of new chapters with disciplines on electronic commerce and transparency, as well as chapters on trade-related labour and environmental issues that fall within the body of the agreement. All fifteen FTAs bar one include a binding state-to-state dispute settlement mechanism. Additionally, several of the NAFTA-inspired agreements provide for an investor-state dispute settlement mechanism in the event differences arise under the investment chapter. Of the four regional agreements in the Western Hemisphere that are customs unions (Andean Community, Central American Common Market, CARICOM and MERCOSUR, shown in Table 8.3), the first three predate NAFTA by several decades. They have, however, been reinvigorated by their members in the mid-1990s and

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revamped to become modern, comprehensive trade agreements, adding protocols or decisions covering many new areas embraced in the Uruguay Round and NAFTA (such as services, investment, competition policy and intellectual property). However, many of the protocols negotiated by MERCOSUR are yet to be implemented, while the process of implementing the various decisions and resolutions adopted by the Central American and the Andean Community countries is moving very slowly, since these commitments are ambitious. All of the customs unions have also added on a binding dispute settlement mechanism. Thus experimentation with regionalism in the Western Hemisphere has been highly dynamic. All thirty-four countries of the hemisphere participate in one or more of the nineteen current reciprocal regional agreements, and a few countries—especially Mexico and Chile—are members of several. The agreements negotiated range from moderately to very ambitious and have pushed the envelope of regionalism forward in the Americas more than in other continents outside Europe.

THE FTAA ASPIRATION While the NAFTA agreement covers the majority of trade that takes place within the Western Hemisphere, the Free Trade Area of the Americas (FTAA) has larger economic dimensions than either existing subregional agreements or individual bilateral FTAs now under consideration in Washington.3 It is also placed in the context of a broad social and political agenda that is absent in the case of other free trade agreements. President George H.W.Bush launched the concept of hemispheric free trade in 1990, under the label Enterprise for the Americas Initiative (EAI). This concept was not new in the Americas, having been first proposed by Simon Bolivar, the liberator of the countries of the Andean region, more than 200 years earlier. The EAI was sidetracked during the NAFTA ratification battle, but was revived and rechristened as the FTAA by President Bill Clinton at the first Summit of the Americas, when thirty-four democratically elected governments in the Western Hemisphere met in Miami in December 1994.4 Thus the FTAA process began as an integral component of the Summit of the Americas, endorsed by heads of state and government. The FTAA component of the ‘Partnership for the Development and Prosperity of the Americas’ of the Summit of the Americas process is nestled in a commitment to four major objectives and twenty-three very wide-ranging economic, political and social initiatives. The four major objectives are to preserve and strengthen democracy, to promote prosperity through economic integration, to eradicate poverty and discrimination, and to guarantee sustainable development. Although the summit initiatives range from the promotion of democracy and human rights to sustainable development, improved infrastructure and labour conditions, educational opportunities, control of narco-trafficking, among others, the FTAA is generally viewed as the centrepiece of the summit process, through its potential contribution to increased economic prosperity in the region.

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Unique characteristics of the FTAA The FTAA process has been ongoing now for nine years, a long time even compared to the pace of multilateral trade negotiations. However, considerable preparatory work was figured into the timeframe, partly in order to train

Table 8.2 Free trade agreements CAFTA- Chile- Central Canada- Mexico- Central CARICOM- ChileUnited United America- Costa Northern America- Dominican Mexico States States Panama Rica Triangle Chile Republic Member countries

Date of signature

Entry into force

Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, United States For El 6–Jun– Salvador, 03 Guatemala, Honduras and Nicaragua, 17–Dec– 03 For Costa Rica, 25– Jan–04 1–Jan– 04

X Objectives, general definitionsc National treatment and X market access for goods Agricultured Rules of X X origin

Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Panama

Mexico, El Costa For Salvador, Rica, El CARICOM Guatemala, Salvador, see footnotea Honduras Chile

6–Feb–02 23–Apr– 29–Jun–00 18–Oct– 22–Aug–98 1–Oct– 01 99 98

El 1–Nov– El Salvador 02 Salvador 3–Oct–03 15–Mar– Panama 01 Feb–03 Guatemala 15–Mar– 01 Honduras 1–Jun–01 Mexico 14–Mar– 01 X X X

Costa Dec–01b Rica 15– Feb–02 El Salvador 3–Jun–02

1–Aug– 99

X

X

X

X

X

X

X

X

X

X

X

X X

X

X

X

The free trade area of the Americas

Procedures related to the rules of origin Customs administration Sanitary and phytosanitary measures Technical barriers to trade Safeguards Antidumping and countervailing dutiesg Government procurementk Investment Services Cross-border trade in services Temporary entry for business persons Professional servicesr Financial servicess Air transportationu Telecommunicationsw Electronic commercex Competition policy Intellectual property Labour Environment Transparency Administration of the agreementdd Dispute settlement Exceptions Final provisions

137

X

X

X

X

X

X

X

X

X Xe

X Xe

X X

X X Xe X

X X

X X

X X

X X Xh

X X Xh

X X X

Xf X X X Xh X

X X Xh

X X Xh

X X X

X X X X

X X X X

X X X X

X Xn X Xp X X

X Xo X X

Xm X X X

X X X

X

X

Xq X

X

X

X

X X

X X

X X

X

X

X Xt

X

X X X X Xcc X X

X X X X X X X X

X X X Xz

X X X

X X X

X X

X

X X X X

X X

X Xbb Xbb X X X

X X

X X X

X X X

X X X

X X

X X X

X X X Xaa

X X X X X

X X X X

X X X

Central Mexico- Canada- Bolivia- Group of Costa NAFTA America- Nicaragua Chile Mexico Three RicaDominican Mexico Republic Member countries

Date of signature Entry into force

Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Dominican Republic 16–Apr–98 18–Dec–97 5–Dec– 96 Costa Rica 1–Jul–98 5–Jul–97 7–Mar–02

Columbia, Mexico, Venezuela

10–Sep– 13–Jun– 94 94 1–Jan– 1–Jan–95 95

Canada, Mexico, United States

5–Apr– 94 1–Jan– 95

17– Dec–92 1–Jan– 94

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El Salvador 1–Oct–01 Guatemala 6–Oct–01 Honduras 19–Dec–01 Nicaragua 3–Sep–03 X X

Objectives, general definitionsc National X X treatment and market access for goods X Agricultured Rules of X X origin Procedures X X related to the rules of origin Customs administration Sanitary and phytosanitary measures Technical barriers to trade Safeguards Antidumping and countervailing dutiesg Government procurementk Investment Services Cross-border trade in services Temporary entry for business persons Professional servicesr Financial servicess Air transportationu Telecommunicationsw Electronic commercex Competition policy Intellectual property Labour Environment Transparency Administration of the agreementdd Dispute settlement

138

X

X

X

X

X

X

X

X

X

X

X

X X

X X

X X

X X

X

X

X

X

X

X X

X

X X Xh

X X X

X X X X X

X X X X X

X Xt X X X Xz

X X X

X

X

X

X

X Xi

X X X

X X X

X X X

X X Xi

X X X X

X X X X X

X X X X X

X X X X X

X X X X X

X X

X

X

X X

X X

X X X

X X X

X X X Xv X X X Xy X X

X X X

X X X

X

X X X

Xbb Xbb X X X

X

X X X X Xbb Xbb X X X

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Exceptions X X X X X X X Final provisions X X X X X X X Notes a Barbados, Guyana, Jamaica, Suriname, Trinidad and Tobago, Antigua and Barbuda, Belize, Dominica, Grenada, Montserrat, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Dominican Republic, b Came into effect in December 2001 in Barbados, Jamaica, Trinidad and Tobago, and the Dominican Republic. Under this agreement, the Dominican Republic, Barbados, Guyana, Jamaica, Suriname, and Trinidad and Tobago committed to gradually eliminate duties by 2004. The smaller countries of the eastern Caribbean and Belize obtained access to a tariff-exemption system, c Most agreements also include a preamble. d It applies to measures adopted or maintained by a party relating to agricultural trade, and also covers agricultural market access. In most agreements, market access in agriculture is covered under the chapter ‘National treatment and market access for goods’. e Parties affirm their rights and obligations with respect to the WTO Agreement on the Application of Sanitary and Phytosanitary Measures, and agree to create a committee on sanitary and phytosanitary measures to provide a forum for consultations and technical cooperation. f Parties affirm their rights and obligations under the WTO Agreement on Technical Barriers to Trade (TBT Agreement). g Chile and Mexico agree to start negotiations to exempt each other from the application of antidumping duties one year after the entry into force. h Parties confirm their obligations under WTO agreements on antidumping and countervailing duties. i Parties exempt each other from the application of antidumping duties. j Review and Dispute Settlement in Antidumping and Countervailing Duty Matters. Each party retains the right to apply its antidumping law and countervailing duty law. k Eighteen months after the entry into force of the Mexico-Northern Triangle Free Trade Agreement, parties must start negotiating an agreement on government procurement. In the case of Chile-Mexico, parties must do so one year after the entry into force. l Parties agree to cooperate with the aim of achieving further liberalisation of public procurement markets and greater transparency in public procurement. m Best-endeavour language to encourage and facilitate greater participation by their economic entities in business opportunities arising from government procurement activities. n Parties agree that within three years of the date of entry into force, they will review developments related to investment, and consider the need for further disciplines. Parties note the existence of the Agreement between the Government of Canada and the Government of Costa Rica for the Promotion and Protection of Investments, signed in San José, Costa Rica, on 18 March 1998. o The investment rules are those of the bilateral investment treaties signed by each Central American country with Chile. Parties may decide within two years of the date of entry into force to broaden the coverage of those rules. p Parties agree that within three years of the date of entry into force, they will review developments related to trade in services, and consider the need for further disciplines. Parties recognise their rights and obligations under the WTO General Agreement on

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Trade in Services (GATS). q Best-endeavour language to facilitate the temporary entry of intra-company transferees, business visitors, after-sales service suppliers and certain family members. r All agreements cover professional services under the general provision on services or cross-border services. s Chile and Mexico agree to start negotiations on financial services no later than 30 June 1999. Central America and Chile, and Canada and Chile agree to develop provisions related to investment in financial services in the future. t The agreement does not contain a separate chapter on financial services. These are covered under the general disciplines on services. u Except the agreements marked, all remaining agreements exclude air transport services, save for a very limited list of support services. v As opposed to the Central America-Chile and Chile-Mexico agreements, which contain separate articles on air transport services, the Group of Three agreement covers these services under the general chapter on services. w All agreements contain a separate provision on telecommunications services, except the CARICOM-Dominican Republic, Central America-Dominican Republic and Costa Rica-Mexico agreements. x Electronic commerce is covered under the general disciplines on services, except in the CAFTA-US and Chile-US agreements, both of which contain a separate chapter dealing with this issue. y Limited provisions. Policy guidelines on state enterprises only. z Parties confirm their rights and obligations under the WTO’s Agreement on TradeRelated Aspects of Intellectual Property Rights (TRIPS). A committee on intellectual property is established. aa Parties agree to develop and adopt an agreement on intellectual property rights, bb Separate cooperation agreement. cc There is also a separate environmental cooperation agreement that has not been signed as of 27 January 2004. dd The issue of the administration of the agreement is addressed in the section of dispute settlement in NAFTA and the Canada-Chile Free Trade Agreement. Source: Data from the OAS Trade Unit, Washington DC.

negotiators from countries of widely diverging levels of capacity and negotiating readiness, a strategy that has proven successful. During the first three preparatory years, background documents and initial discussions were undertaken in various working groups. The FTAA negotiations were formally launched at the Trade Ministerial Meeting in Costa Rica in March 1998 and endorsed by the heads of state and government at the second Summit of the Americas in Santiago de Chile in April 1998. Since that time there have been four meetings of trade ministers (in Toronto, Buenos Aires, Quito and Miami) and seventeen meetings of vice-ministers of trade. The end date for the negotiations was fixed at the outset as January 2005, making the FTAA a decade-long project. The FTAA negotiations are notable for several reasons. 1) Size of the potential free trade area to be created. The countries negotiating the FTAA stretch from the Alaskan Yukon in North America to Tierra del Fuego in South America. The future FTAA will be larger than any other regional trading agreement in the world except for the European Union (a customs union and not a free trade area).

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The thirty-four countries involved represent a combined population of over 800 million people, a GDP of US$13 trillion and trade flows of US$3.4 trillion, thus constituting approximately one-fourth of the world’s output and one-fifth of the world’s trade. 2) Ambition of the negotiating mandate. The scope of the negotiations is very broad, encompassing subjects that are not yet on the negotiating table at the WTO but that have been discussed in the FTAA since the beginning of the process. The nine negotiating areas include not only the traditional market access areas of tariffs and non-tariff barriers for goods (including, of course, agriculture), but also services, investment, government procurement, as well as intellectual property rights, antidumping, subsidies and countervailing duties, competition policy, and dispute settlement where rules are being developed for the hemisphere.

Table 8.3 Customs unions MERCOSUR Caricom

Member countries

Argentina, Brazil, Paraguay, Uruguay

Andean Central Community American Common Market

Antigua and Bolivia, Barbuda, the Colombia Equador, Bahamas, Peru, Barbados, Venezuela Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St Lucia, St Kitts and Nevis, St Vincent & the Grenadines, Suriname, Trinidad and Tobagoa Date of Treaty of Treaty of Cartagena signature of Asuncion 26– Chaguaramas Accord original Mar–91 4–Jul–7326– agreement May–69 Tegucigalpa Date of Protocol I Trujillo reinvigoration Protocol 4– 30–Oct–96 Sucre of the Jul–1997 Protocol agreement Revised 25–Jun–97 Treaty of Chaguaramasb Protocol 5–Jul–01 Xe Xf (1993) Free trade Xd (1994)

Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua

General Treaty 13– Dec–60 Protocol 22–Jul–92 Guatemala 29–Oct–93

Xg (1993)

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areac Xi (1995) Customs Xj (1992) Xk (1995) Xl (2000) h union X Xn (1991) Xo (1998) Rules of Xm (1994) origin Procedures X X X (1991) X related to the rules of origin X Xq (2002) Xr (1999) Sanitary and Xp (1993) phyto-sanitary measures X Xt (1997) Xu (1999) Technical Xs (1992) barriers to trade Safeguards X Xv (1996) w X Xx (1999) Xy (1995) Antidumping X (1995) and countervailing duties Xaa Xbb 1991) Xcc (2000) Investment Xz (1993) dd aa Services X (1997) X Xee (1998) Xcc (2000) ff X Xgg (1991) Competition X (1996) policy Intelluctual Xhh (1991) property Xjj Xkk(1982) Xll (2003) Dispute Xii (1993) settlement Notes a The Bahamas is not a party to the market arrangements. b Preparations for the establishment of the Caricom Single Market and Economy (CSME) included the negotiation of nine protocols meant to amend the Treaty of Chaguaramas. The nine protocols have been consolidated and integrated into the Revised Treaty of Chaguaramas. As of February 2004, the Revised Treaty of Chaguaramas has been signed by thirteen member states. It has to be given provisional application by twelve member states, ratified by eight and enacted into domestic law by two member states. c Refers to the full liberalisation of trade in goods within the subregion. d Most tariffs on goods were eliminated between 1991 and 1994. e Free trade for goods is almost complete. f Trade among Bolivia, Colombia, Ecuador and Venezuela is fully liberalised. In 1997 an agreement was reached for Peru’s gradual incorporation into the Andean Free Trade Zone (Decision 414). g Annex A of the General Treaty contains a small list of exceptions such as sugar and coffee. h Refers to the adoption of a common external tariff. i MERCOSUR’s common external tariff will be fully implemented

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in 2006. j A common external tariff regime has been in place involving all member states since 1992. There has been agreement to a revision of the common external tariff and three member states are still to complete that process of revision. k The Andean Customs Union has been in operation since 1995 (Decision 370), when the common external tariff (CET) approved by Colombia, Ecuador and Venezuela came into effect. Bolivia enjoys preferential treatment and only applies levels of 5 and 10 per cent, while Peru did not sign that agreement. Decision 535 (2002) determined the new common external tariff that harmonises only 62 per cent of the tariff universe. The new tariff will enter into effect in March 2004. l In 1996 Guatemala and El Salvador initiated the process of creating a customs union. In 2000 Honduras and Nicaragua initiated the process to join. In 2002 Costa Rica decided to join. As of January 2004, the common external tariff had harmonised 92 per cent of the tariff universe. m Common Market Council (CMC) Decision 23/94 and Decision 6/94 later modified by Decision 3/00. n The rules of origin for the Andean Community were approved in December 1987 through Decision 231. Subsequently, in March 1991, amendments were introduced through Decision 293. The formation of a customs union generated the need for an update that was accomplished in 1997 by means of Decision 416. o Central American Regime on the Origin of Goods. p CMC Decision 6/96 adopts the WTO Agreement on the Application of Sanitary and Phytosanitary Measures as the regulatory framework for the applications of sanitary and phytosanitary measures in MERCOSUR. It revokes Decision 6/93 that established the MERCOSUR sanitary and phytosanitary agreement. q Decision 515 regulates agricultural health by establishing the Andean legal framework for adoption of sanitary and phytosanitary measures to be applied within the sub-region and with third countries. r Central American Regime on Sanitary and Phytosanitary Measures and Procedures. s MERCOSUR Working Subgroup 3 is responsible for technical regulations. Related directives are issued by resolutions of the Common Market Group, including Common Market Group (CMG) Resolution 56/02 (Guidelines for the Elaboration and Revision of MERCOSUR Technical Regulations and MERCOSUR Conformity Assessment Procedures). t Decision 419 (Andean System of Standardisation, Accreditation, Testing, Certification, Technical Regulations and Metrology), further modified by the Decision 506 (Recognition and Acceptance of Certificates of Products Marketed in the Andean Community). u Central American Regime on Standard-Related Measures, Metrology and Authorisation Procedures.

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v Decision 389. w CMC Decision 64/00. It revokes CMC Directive 5/95. x Decision 456 (Antidumping)—Decision 457 (Countervailing Duties). y Central American Regime on unfair trade practices. z Protocol of Colonia on the Promotion and Reciprocal Protection of Investments within MERCOSUR, and Buenos Aires Protocol on International Jurisdiction in Contractual Matters. aa Protocol II, entered into force provisionally in 1998, provides for the free movement of capital and selected categories of skilled persons in addition to measures for liberalisation of trade in services. A program that requires each member state to eliminate all existing discriminatory measures by 31 December 2005 was approved in February 2002. bb Decision 291 (Regime for the Common Treatment of Foreign Capital and Trademarks, Patents, Licensing Agreements and Royalties). cc The Investment and Trade in Services Treaty was signed in March 2000. As of October 2003 it has only been ratified in Honduras. dd Protocol of Montevideo on Trade in Services in the Southern Common Market. The protocol establishes that MERCOSUR countries will advance in the creation of a common market in services to be achieved within a ten-year period. CMG Resolution 52/03 convokes the V Round of Negotiations on specific commitments in services. ee Decision 439 (1998) establishes the general framework of principles and provisions for liberalising trade in services. Decision 510 (2001) adopts the Inventory of Measures that Restrict Trade in Services. ff The MERCOSUR Protocol for the Defense of Competition (Fortaleza Protocol). In December 2002, MERCOSUR countries signed the ‘Acuerdo sobre el Reglamento del Protocolo de la Defensa de la Competencia del MERCOSUR’, which envisages the enforcement of such protocol. gg Decision 285. hh The Andean Community has many provisions on intellectual property, including the following: The Common Industrial Property System—Decision 486 (2000); The Common Regime on Copyright and Related Rights—Decision 351 (1993); The Regime for Protection of the Rights of Obtentors of new Plant Varieties—Decision 345 (1993); Common Regime on Access to Genetic Resources—Decision 391 (1996). ii MERCOSUR/CMC/DEC. 1/91—Protocol of Brasilia for the Solution of Controversies. In 2002 MERCOSUR countries signed the Protocol of the Olivos that modifies the dispute settlement mechanism in MERCOSUR. MERCOSUR/CMC/DEC. 37/03 of the Common Market Council approves the rules and regulations of the Protocol of the Olivos. jj Protocol IX and the Agreement Establishing the Caribbean Court of

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Justice. As of February 2004, the agreement to establish the court had been signed by twelve member states and ratified by eleven. kk Andean Court of Justice. ll Resolution 106–2003 (COMIECO-XXVI), Central America Dispute Settlement Mechanism. Source: OAS Trade Unit, Washington DC.

To round out the FTAA process, three non-negotiating groups deal with institutional issues, civil society and the unique situation of smaller economies. Some 900 negotiators from around the hemisphere have been meeting on a bimonthly cycle for more than five years to discuss these issues. 3) Incorporation of countries of very differing sizes and levels of economic development and thus a particular attention to the needs of smaller economies and to building capacity as part of the FTAA process. The FTAA negotiations are unique in having established for the first time a Consultative Group on Smaller Economies, which was subsequently reproduced at the WTO level in the Doha Declaration. FTAA ministers have also agreed to establish a Hemispheric Cooperation Program to attend to the technical assistance and capacity needs of smaller countries, both during the negotiations and after they are completed. 4) Transparency of the FTAA negotiating process. The FTAA has been unique in creating a Committee on Civil Society from the outset of the negotiations. Public submissions are welcomed on an ongoing basis and open meetings are held periodically on the various negotiating issues. Recently in Miami a Sustainable Development Forum took place to debate broader civil society concerns and to transmit these to ministers. Additionally and very significantly, the draft text of the FTAA agreement has been made public on three different occasions. This represents a unique step in the history of trade negotiations and the first time that governments involved in a negotiating process have published the draft negotiating text. The draft text of the FTAA agreement in its entirety, as it has been negotiated to date (at the end of 2003), can be found on the official FTAA website at http://www.ftaa-alca.org/. These four characteristics that distinguish the FTAA process—size, ambition, diversity, transparency—set it apart from other regional negotiating efforts and agreements. However, these unique characteristics have also created major challenges to the FTAA. Six years into the negotiating process, doubts have been raised from several quarters as to the feasibility of the original FTAA vision. At the meeting of trade ministers held in Miami on 20 November 2003, several questions were being raised by participating governments, including: 1) Scope: is the scope of the FTAA still suitable for all participants? 2) Ambition: does the ambition of the proposed agreement go too far? 3) End date: is the 2005 end date set for the FTAA a realistic one? 4) Redefinition: in light of various political constraints, how can the negotiations be redefined to make them acceptable to all and meet the stated deadline? These questions are taken up later in the chapter.

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What kind of benefits? The FTAA project has burned brightly up to now in the minds of negotiators because of the potential benefits the future agreement will bring to promote the economic development objectives of Latin American and Caribbean countries. As with NAFTA in the late 1980s and early 1990s, much of the enthusiasm for the FTAA project derives from the economic literature. Since that time models of multilateral liberalisation and free trade agreements have advanced considerably. The models can be grouped into three categories: 1) computable general equilibrium (CGE) models based on the GTAP framework (Global Trade Analysis Project), which uses comparative statics; 2) CGE models with dynamic features, such as induced competition, greater efficiency, scale economies and more investment; and 3) gravity models that use regression techniques to search thousands of cross-country merchandise trade flows for empirical regularities. Dynamic CGE models tend to generate much larger estimates of trade creation than do static CGE models. There is less agreement within the modelling community, however, about the specification and ingredients of dynamic models. Gravity models—essentially single-equation regression models that explain bilateral trade volumes in terms of distance, GDP and numerous other variables—often generate surprisingly large parameters for the trade-enhancing effect of common membership in a free trade agreement. Analysis done by DeRosa and Gilbert (2003) for a conference sponsored by the Institute for International Economics used both the static GTAP framework and the gravity model to size up the potential trade effects of various free trade arrangements. For reasons of data availability, they focused on merchandise trade. The FTAA itself was not analysed, but DeRosa and Gilbert did analyse FTAs between the United States, Brazil, Chile, Central America and several other countries, taken individually and in combination. The static GTAP framework suggests that an FTA between the United States and Brazil would increase US merchandise exports to Brazil by 78 per cent, and US merchandise imports from Brazil by 37 per cent. From the US standpoint, these magnitudes are a little less than 1 per cent of total US merchandise trade. From the Brazilian standpoint, the trade gains are between 8 per cent and 9 per cent of total Brazilian merchandise trade. Using a similar framework, Diao et al. (2002) calculated that an FTAA would increase US exports by 1.2 per cent, Brazilian exports by 7.3 per cent and total FTAA trade by 1.9 per cent. In dollar terms, total FTAA trade for all members (merchandise exports plus imports) would increase by US$59 billion. To summarise, different research groups working from the same GTAP model obtain similar results: big percentage increases in bilateral trade flows, but modest or small percentage increases in overall trade flows. The gravity model suggests a far more robust expansion of trade. The core parameter is that an FTA increases bilateral trade between the partners by 118 per cent—a much bigger figure than static GTAP estimates. Based on this parameter, a Brazil-US FTA alone would expand Brazilian exports by 28 per cent of Brazil’s exports to the world. An FTA between the United States, Brazil, Chile and Central America would expand exports

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from the Latin American partners by 41 per cent of their world exports. Applying this figure to the whole region suggests total Latin American export gains of US$143 billion. In other words, depending on the model, the potential trade expansion for Latin America from an FTAA is somewhere between modest and stunning. The FDI estimates for an FTAA, again based on a gravity model, are equally striking for several Latin American countries (Yeyati et al. 2002). FDI stock from Canada and the United States into MERCOSUR countries (mainly Brazil and Argentina) might increase by nearly 60 per cent, and FDI from the rest of the world might increase by 26 per cent. For Colombia and Venezuela, the respective gains are calculated at 80 per cent and 44 per cent. For two small countries, Costa Rica and Panama, the FDI stock gains are 130 per cent and 80 per cent, respectively. The highest trade and investment calculations cited here probably exaggerate what a future FTAA could deliver. Nevertheless, these figures help explain the enduring enthusiasm for the FTAA, in the wake of a disappointing economic decade for Latin America. FTAA negotiating objectives The general objective for the FTAA negotiations as set out in the San Jose Ministerial Declaration (March 1998) is an ambitious one, describing the outcome of the negotiations in the following manner: ‘To establish a Free Trade Area, in which barriers to trade in goods and services and investment will be progressively eliminated, concluding negotiations no later than 2005’. Additionally, the San Jose Ministerial Declaration sets out the basic principles for the negotiations that have been retained to the present. These are: the FTAA agreement will be balanced, comprehensive, WTO-consistent, and will constitute a single undertaking. It will take into account the needs, economic conditions and opportunities of the smaller economies. The negotiations will be transparent and built on consensus decision making. The FTAA can co-exist with bilateral and sub-regional agreements, to the extent that the rights and obligations under these agreements are not covered or go beyond the rights and obligations of the FTAA. The FTAA ministerial declarations since that time (Toronto, November 1999; Buenos Aires, April 2001; Quito, November 2002; and Miami, November 2003) have reemphasised the concepts of balance, comprehensiveness, WTO consistency and a single undertaking, although with the important addition of the concept of ‘flexibility’ in the Miami Ministerial Declaration that was not present in any of the previous ones.5 The FTAA negotiations have moved forward through negotiating proposals offered by the participants. Many of these mirror the text and existing disciplines of existing subregional agreements in the hemisphere (NAFTA and others), while others incorporate elements of newer agreements such as the ones between Chile and Central America (2002), Panama and Central America (2003), Chile and the United States (2004), and Central America and the United States (signed at the end of 2003, not yet ratified).

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The benchmark for the FTAA negotiations are the WTO disciplines; however, all parties recognise that it is necessary to go further in order to reach a WTO-plus agreement. The difficulty lies in wide-ranging judgements of what should be the acceptable level of WTO-plus disciplines. This is complicated by the fact that the WTO itself (or rather its members) has been unable to set out clear benchmarks for evaluating the compliance of regional trading agreements with WTO requirements—Article XXIV of the GATT in the case of goods and Article V of the GATS in the case of services. This lack of clarity has meant that FTAA members have considerable latitude to argue which disciplines and market access conditions qualify for ‘WTO-plus’ status (Stephenson 2000). Partly for this reason the regional agreements vary in their coverage and disciplines, as well as in their degree of market opening in goods and services. Such variety, together with the lack of clarity of WTO requirements, means that no single template exists for a hemispheric agreement. As previously stated, the text of the third draft version of the entire FTAA agreement can be found on the official FTAA website, and various negotiating proposals can therefore be publicly verified. Some of the most important negotiating areas and the difficulties that each one presents in the FTAA are reviewed below.6 Market access. The elimination of tariff and non-tariff barriers to trade in goods (including agricultural products which are dealt with separately below) is the heart of any free trade area negotiation. One of the main objectives of the FTAA, as set out in the San Jose Ministerial Declaration of March 1998 that officially launched the negotiations, is to achieve this liberalisation, namely: a) To progressively eliminate, tariffs, and non tariff barriers, as well as other measures with equivalent effects, which restrict trade between participating countries. b) All tariffs will be subject to negotiation. c) Different trade liberalization timetables may be negotiated. Although the stated goal of the FTAA is to eliminate all barriers affecting trade in goods to reach a zero tariff across the board, in reality many of the existing FTAs have not been able to eliminate all tariffs and notable barriers have been retained for agricultural products. Sensitivity over agriculture is most marked in Canada and the United States, while Latin American countries want to take advantage of their status as lower-cost agricultural exporters for numerous products that now face high barriers (tariffs, tariffrate quotas, sanitary and phytosanitary requirements, etc.) in northern markets. Whether or not the FTAA will result in tariff elimination and/or significant tariff reduction for all products or only for ‘substantially all trade’ (as required by GATT Article XXIV for goods) is a question that negotiators must define. The outcome will most likely depend upon the balance of commitments and access that is undertaken across the board. Additionally, the negotiating group on market access in the FTAA covers four other important areas as well, including rules of origin, safeguards, customs procedures and technical barriers to trade. Agriculture. In the FTAA, Latin American nations want to go further than the concept of ‘free trade’ under NAFTA and to discipline export subsidies and domestic subsidies, as well as eliminate market access barriers.7 They argue, correctly enough, that US and Canadian subsidy policies severely distort the market and limit their export opportunities

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(Nogues 2003). In the San Jose Ministerial Declaration several objectives are set out for agriculture, including: a) To progressively eliminate tariffs, and non-tariff barriers, as well as other measures with equivalent effects, which restrict trade between participating countries. b) To eliminate agricultural export subsidies affecting trade in the Hemisphere. c) To identify other trade-distorting practices for agricultural products, including those that have an effect equivalent to agriculture export subsidies, and bring them under greater discipline. This ambitious agenda has proved to be the Achilles heel of the FTAA and has made the agricultural negotiations extremely difficult. In turn, that has slowed the progress in other negotiating areas. From the start, the United States and Canada have insisted that domestic agricultural subsidies can only be negotiated at the multilateral level, in the WTO Doha Round. Neither country wishes to curtail its subsidy programs unless the European Union accepts similar disciplines. Even if Europe did an unlikely about-face on subsidy policy, important US agricultural interests will still try to retain their government payments after the Farm Act of 2002 expires in 2007. Moreover, several US agricultural lobbies have insisted that trade barriers (tariffs and tariff quotas) on sensitive US crops— some of great interest to Latin America—must be phased out very slowly. While all FTAA participants have agreed on several occasions (including at the ministerial level), that one FTAA goal is to eliminate export subsidies on agricultural products traded within the hemisphere, the United States and others are worried about the ability of subsidised products from third countries outside the hemisphere (particularly the European Union and Japan) to undercut this discipline. They want to see a mechanism created both to deter and counteract imports of subsidised agricultural products from non-FTAA countries. Meanwhile Latin Americans are worried about the effects of continued domestic support if this is not going to be discussed within the FTAA, and would like a mechanism to neutralise the effects of such distorting measures and practices. For their part, the Caribbean countries wish to continue to enjoy the historical preferences they have with the European Union, as ACP (Africa, Caribbean and Pacific) former colonies. Priorities in agriculture thus remain far apart and controversial, although a meeting of the minds will be essential for the FTAA negotiations to move forward. Services. Contrary to the area of trade in goods, the objectives for services in the FTAA negotiations do not envisage complete liberalisation. Rather, the San Jose Ministerial Declaration reads as follows for services: Establish disciplines to progressively liberalise trade in services, so as to permit the achievement of a hemispheric free trade area under conditions of certainty and transparency. Although business services and certain network services such as finance and telecommunications have been largely liberalised within North America and some Latin American countries, significant barriers to service suppliers still remain in some markets, whether this be in the form of restrictions on crossborder trade or on commercial

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presence (investment). However, even within North America there are still important sectors that continue to be reserved by each NAFTA party.8 The services area, along with investment (a mode of services supply enumerated in the WTO General Agreement on Services framework), has proven to be politically sensitive. Many Latin American nations fear that they will give up their right to regulate in a discriminatory fashion if they enter into services disciplines that comprehensively affect all sectors (particularly under the ‘negative list’ approach). From the outset, Brazil and its MERCOSUR colleagues have linked progress in the services negotiations to progress in agriculture, and thus services talks have moved very slowly. The services area is also beset with a major difference in vision as to how a trade agreement should be constructed. A large subset of countries (the ‘like-minded’ NAFTA countries that have either negotiated with the United States or are in the process of doing so) wish to proceed along the lines of a negative-list approach: comprehensive sector coverage and binding of all outstanding non-conforming measures at the level of current regulatory practice. However, other countries wish to proceed along the lines of the WTO GATS ‘positive list’ approach, with sectors included at choice, and no or weak disciplines on the level of binding commitments. The services area has been made hostage to the divisions and disappointments elsewhere in the FTAA negotiations. It is unclear what degree of liberalisation Latin America (particularly MERCOSUR) would be willing to concede, were there significant market access breakthrough in agriculture and antidumping rules. From an economic point of view, services are at the heart of the economic equation, to a much greater degree than agriculture or antidumping, but negotiators are understandably compelled to concentrate on old barriers rather than new opportunities. Even if the modality for services liberalisation is agreed (negative list or positive list), there will still be one area in which concessions will be extremely difficult for the United States. This is the question of the movement of natural persons seeking work abroad on a temporary basis (GATS mode 4), especially persons seeking work in the United States. Latin American and Caribbean countries want FTAA visas, akin to H1B visas, not only for skilled workers and corporate employees, but also for an additional category of technical workers. For the United States it will be difficult to agree to numerical temporary work permits, given Congressional objections to mode 4 negotiations and heightened security worries. Investment. The San Jose negotiating objective states investment goals, rather blandly: To establish a fair and transparent legal framework to promote investment through the creation of a stable and predictable environment that protects the investor, his investment and related flows, without creating obstacles to investments from outside the hemisphere. When this language was included in the negotiating agenda of the FTAA, investment was much less controversial than it has since become. One problem is the thorny question of where to place mode 3, or investment to supply services, and this decision is intimately linked to the type and extent of disciplines that will ultimately be agreed in the investment chapter. Another problem is how to define ‘investment’ itself—in a broad, allencompassing manner (including non-tangible assets such as stocks and bonds) or in a

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narrow sense, limited to foreign direct investment only. The most difficult problem, however, is the question of whether investor-state disputes will be subject to arbitration, akin to the controversial NAFTA Chapter 11 provisions that have been carried (with slight modifications) into the US-Chile and US-Singapore FTAs (but excluded from the US-Australia FTA). Government procurement. Government procurement is a big market, a protected market, and a market close to the political bone. In principle, the United States wants liberalisation in the FTAA, but this was not an issue on which progress was made in NAFTA. The objectives of the FTAA procurement negotiations (again from the San Jose Ministerial Declaration) are the following: i) To achieve a normative framework that ensures openness and transparency of government procurement processes, without necessarily implying the establishment of identical government procurement systems in all countries; ii) To ensure non-discrimination in government procurement within a scope to be negotiated; iii) To ensure impartial and fair review for the resolution of procurement complaints and appeals by suppliers and the effective implementation of such resolutions. From the US standpoint, there are two difficulties. The federal government, as a political matter (not a constitutional matter), cannot bind the states to open their procurement. Moreover, certain kinds of federal purchases might cause a public backlash if opened to foreign suppliers, historically defence procurement, but now outsourcing as well. Some Latin American countries face the same federal-state problems as the United States, but the greater difficulty is the iron triangle between procurement, corruption and political power. While many Latin American countries are on board for the procurement discussion in the FTAA, others (and all of the Caribbean) wish to limit this negotiating area to that of procedural transparency only, and not to make any commitments on actual government bids. Trade remedies. In the FTAA, the attempt to discipline trade remedies has been highly contentious. US negotiating latitude was circumscribed by Congress in the Trade Promotion Authority Act of 2002, and the United States has been unwilling or unable, or both, to budge an inch in its recently concluded free trade agreements (or in the current FTAA talks). The NAFTA precedent offers little hope in this regard. During those negotiations the United States likened its countervailing and antidumping duty laws to sacred texts, but agreed as a compromise to a tri-national dispute settlement system to review countervailing and antidumping determinations made in accordance with national law (Hufbauer et al. 2003). While NAFTA dispute settlement has worked well in most of the eighty-five countervailing and antidumping cases reviewed (Hufbauer et al. 2003), Latin American nations want tighter disciplines. The stated objective of the hemispheric agreement set out in the FTAA San Jose Ministerial Declaration is: To achieve a common understanding with a view to improving, where possible, the rules and procedures regarding the operation and application of trade remedy laws in order to not create unjustified barriers to trade in the Hemisphere.

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This objective clearly allows for the possible revision and rewriting of the rules and procedures governing trade remedy actions in the hemisphere. Like Canada and Mexico, most Latin American nations want to rewrite, and limit, trade remedies, especially antidumping actions. They anticipate that their steel, agriculture and apparel exports will be especially vulnerable, once US and Canadian tariffs and quotas are dismantled. However, in spite of agreed objectives, the United States has consistently stated, as with domestic agricultural subsidies, that this topic can be negotiated only in the WTO, and that domestic law should not be touched. Intellectual property rights. The United States would like the FTAA to pioneer the next advance in intellectual property rights. It would like its FTAA partners to agree to the same forward steps that Mexico did during the NAFTA negotiations, when Mexico amended its patent and copyright laws to the satisfaction of the United States and these reforms were subsequently advertised as a model for the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) negotiated in the Uruguay Round (Maskus 2000). The ways in which the United States (and at times other countries) would like for the FTAA to innovate in this area are: (1) to extend protection in those areas already included in the WTO TRIPS Agreement (i.e., the areas of patents, trademarks, copyrights) by signing additional intellectual property right treaties; (2) to agree to enhanced enforcement; and (3) to take into account the implications the internet raises for copyright protection and related rights. The stated objective of the FTAA in this area is to: reduce distortions in trade in the Hemisphere and promote and ensure adequate and effective protection to intellectual property rights. Changes in technology must be considered. Most controversially, the United States wants its FTAA partners to accept very strict requirements for the use of compulsory licensing of patented Pharmaceuticals provided in the Doha Declaration on TRIPS and Public Health. According to the US Trade Representative, compulsory licensing should be permitted only in the narrowest circumstances. Moreover, FTAA partners should extend the life of pharmaceutical patents to cover ‘unreasonable delays’ in getting marketing approval. Attitudes have changed since NAFTA and the Uruguay Round with respect to the benefits for developing countries from adhering to tough intellectual property disciplines, and US objectives are difficult for Latin America to accept. Brazil and Argentina, along with most other South American countries (Chile excepted), argue that TRIPS conceded far too much to intellectual property owners, mostly multinational enterprises based in developed countries. Argentina and Brazil still have not complied with the TRIPS accord to the satisfaction of the United States. An FTAA chapter on intellectual property rights promises to be extremely difficult, though there are aspects of the equation that could be taken on board to somewhat rebalance the unbalanced present situation, including stricter rules on transfer of technology, the protection of folklore and indigenous plant species and varieties along with natural medicines, and long phase-in periods for new enforcement commitments. Labour and the environment. Countries in the Western Hemisphere that have negotiated or are in the process of negotiating FTAs with the United States understand

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the political necessity of including labour and environmental provisions in the FTAA. However, others still do not, and there is considerable opposition by participants who argue that neither FTAA ministers nor heads of state and government have given a mandate to negotiate on these subjects, despite (or perhaps because of) the objectives set out in the San Jose Ministerial Declaration: a) To strive to make our trade liberalization and environmental policies mutually supportive, taking into account work undertaken by the WTO and other international organisations. b) To further secure, in accordance with our respective laws and regulations, the observance and promotion of worker rights, renewing our commitment to the observance of internationally recognised core labour standards and acknowledging that the International Labor Organization is the competent body to set and deal with those core labour standards. The ultimate battle may not be so much between Latin America and the United States as between the Congress and the president (so long as a Republican occupies the White House). The United States has gone beyond the formula developed in NAFTA in its more recent FTAs with Jordan, Chile, Singapore and Australia. In those FTAs, provisions on labour and the environment form an integral part of the basic treaty and are therefore subject to its dispute settlement proceedings. Each country commits to enforce its own laws, with the possibility of monetary fines or trade sanctions in the event a country engages in a persistent pattern of non-enforcement. However, Congressional Democrats wish to go even further. They want FTAA members to adopt core labour standards (and perhaps core environmental standards), and they want meaningful sanctions to be a realistic outcome. This will be an area of great scrutiny and discussion once the agreement is finalised and comes before Congress for approval, but it is difficult to imagine that such an important political initiative as the FTAA would be denied on the grounds of too lax labour and environment provisions. It is notable that the FTAA negotiations have no formal working group on these issues. Rather, proposals on the environment and labour have been presented by the United States, and they currently appear in the form of draft chapters of the agreement (Chapters VI and VII, respectively, both still in brackets). These are being discussed in the Committee on Institutional Issues, which is charged with developing the institutional structure of the FTAA agreement and dealing with all issues of horizontal application. The US draft chapters on labour and the environment are very similar to what was agreed in the US-Chile and US-Singapore FTAs. They contain provisions on the application and enforcement of national environmental and labour laws, provisions for environmental and labour cooperation, consultation mechanisms and disciplines for procedural matters. They allow the right to bring cases before FTAA panels, along with the possibility of trade sanctions if a party does not comply with an adverse panel decision on the enforcement of national laws. Monetary cooperation. A subject not on the FTAA agenda is monetary cooperation— despite the dismal Latin American record of financial crises and exchange rate instability. The orthodox establishment view—spelled out, for example, by Eichengreen and Taylor (2003)—is sceptical of currency unions, holding that they are driven more by politics than economics. The right policy framework for the FTAA members, according to this

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view, entails independent central banks, inflation targeting and floating rates. Indeed, this has been the path within NAFTA since the peso crisis, followed with considerable success. The problem with the orthodox prescription is that it offers no institutional support (within the FTAA context) for moderating financial crises, and it ignores the desperate need for ex ante financial surveillance (banks, insurance companies, stock exchanges).9 In other words, programs akin to the famous Mexican bail-out of 1995 will continue to depend on the pleasure of the United States—pleasure withheld from Argentina in 2001 and grudgingly bestowed on Brazil in 2002. The FTAA can certainly be launched without a monetary chapter, but it is unlikely to thrive for twenty-five years without action on financial surveillance and commitments to emergency cooperation.

THE FTAA ONE DECADE LATER—NEW CONTEXT Despite promises held out by econometric models, the FTAA project has undergone second thoughts during what should be its penultimate year, even as the economic and political context in which it was conceived has evolved over the past decade since the Miami summit in 1994. Second thoughts on the FTAA vision and objective can be traced to several reasons, which are reviewed below. Disappointing reforms At the Miami summit in 1994, prospects seemed bright for Latin America: ‘Washington consensus’ was the buzzword, reform was in the air, economies were growing, property values and stock markets were rising. All that changed when the Mexican peso crisis erupted shortly after, in late November 1994. Throughout Latin America (with the conspicuous exception of Chile), the second half of the 1990s was marked by financial crisis and slow growth. Taken as a whole, the decade of the 1990s was disappointing. To quote Williamson (Kuczynski and Williamson 2003:1): These may not be the worst of times, but few view them as among the best of times in Latin America. The region has lived through another decade of slow growth. Crises seem to have become ever more frequent, with the consequences of the Argentine crisis particularly painful. Poverty fell in the first half of the 1990s but has been increasing again since 1997. Growth in employment in the formal sector has been agonisingly slow. The world economy is in recession, the prices of many primary products were recently at record low levels, and emerging markets are out of favour with investors. Slow growth in the 1990s was additionally disappointing because, in many dimensions, Latin American policies had been reformed. Yet little of the reform effort had translated into better growth or lesser poverty. In their detailed review of commercial policies, Bouzas and Keifman (2003) found widespread trade liberalisation throughout Latin America during the 1990s, much of it unilateral. Policy progress likewise shows up in the

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‘readiness indicators’ calculated by Schott (2001) for 1994 and 2001.10 The readiness indicators are composites of five macroeconomic indicators (price stability, budget discipline, national savings, external debt, currency stability) and two market indicators (market-oriented policies, reliance on trade taxes). With the conspicuous exception of Brazil, all large countries improved their readiness indicators, and only a few small countries slipped back. Despite disappointing growth, the conventional advice to policymakers—voiced not only by Washington officials but also by academic commentators—is: ‘carry on’ (see, e.g., Kuczynski and Williamson 2003). Trade liberalisation still features prominently on the Latin American agenda, notwithstanding the election of populist leaders in Venezuela (Chavez), Peru (Toledo), Brazil (Lula da Silva) and Argentina (Kirchner). Continued support for the FTAA can be attributed to the perceived payoff from increased trade and investment, conspicuously evident in Asia, but also in Chile and more recently in Mexico and Costa Rica. Sombre economic numbers have, however, translated into harder negotiating stances. Disillusionment with globalisation Policy reform and trade liberalisation have become less popular in Latin America. A decade ago most Latin American countries had enthusiastically put in place economic reforms flavoured by the Washington consensus, designed to open markets through trade liberalisation and privatisation. Along with reforms, long-standing prejudices against economic cooperation with the United States went by the wayside. Currently a widespread disillusionment exists about the wisdom of this course of action, since it is widely felt that the reforms did not live up to expected results (Salazar 2003). Important sectors of society in Latin America and the Caribbean are questioning and resisting further reforms and liberalisation and pointing to what they perceive as the failure of the orthodox approach to deliver higher growth, more employment and better standards of living. Even among those that are convinced about the need to maintain the course, there are doubts about the appropriate speed and depth of this process. The scepticism over further trade liberalisation and reform is compounded by the significant deterioration in the economic situation in many countries of the hemisphere during 2001 and 2002. This exacerbates fiscal, social and political constraints, and makes the task more difficult, even for those reformist governments committed to freer trade. It also makes the ‘selling’ of further trade liberalisation and economic reform much more difficult in Latin America. And yet, as a recent Council of the Americas report argues, the FTAA will only become a reality if each government in Latin America and the Caribbean can make a credible case that the FTAA is good for that country, that the FTAA is a key ingredient to restore economic growth, increase employment, reduce poverty—in short, that the FTAA is an important element of a broader national strategy to reduce the economic and social distress that has been on the rise in recent years (Council of the Americas 2001). Fortunately there is a silver lining in the cloud of doubt: a long-awaited turnaround in the form of higher export prices, better economic performance and strong stock markets throughout most of Latin America in 2003 and 2004.

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Doubts about US negotiating ability Latin America and the Caribbean FTAA participants have grown increasingly sceptical as to the real intentions of the United States in the area of trade liberalisation. Signs from Washington on the trade policy front have not been positive over the past two years. The Farm Act passed in 2002 appears to mock stated US intentions to roll back agricultural subsidies. Instead, it guarantees up to US$20 billion annually in various payments to agricultural producers (the amount of subsidies actually disbursed will vary inversely with the level of farm prices). The Farm Act was carefully drafted not to violate US obligations under the WTO Agreement on Agriculture. Nonetheless it sent an adverse signal to Washington’s FTAA partners, most of whom are strong agricultural exporters. The signal was amplified when sugar liberalisation was all but excluded from the CAFTA agreement with Central America, and entirely excluded from the US-Australia FTA. The steel safeguard tariffs imposed by the Bush Administration in March 2002 (initially around 24 per cent on average) were declared illegal by the WTO Appellate Body in November 2003, and then removed. However, during the twenty-one months that the steel tariffs were in place, they reinforced the impression of a US retreat from open markets. In Latin America, Brazil is an important exporter of steel and felt very adversely affected by this unilateral trade action. Third, the position taken by US negotiators to remove sensitive topics from the FTAA negotiations, notably agricultural production subsidies and antidumping rules, declaring them to be ‘off limits’, has given several Latin American countries—again primarily Brazil and its MERCOSUR partners—good reason to drag their feet on other negotiating areas. The four-tiered structure of the market access offer for goods presented by the United States in the FTAA negotiations has put the MERCOSUR members in the unpleasant position of feeling that they are objects of discrimination, as the tariff reduction schedule and included products are less favourable for them than for other FTAA members. These various factors, taken together, have generated a successful push by Brazil to reorient the entire FTAA negotiations. Fourth, while the passage of trade promotion authority in the United States in August 2002 was a cause for satisfaction in several quarters, as it allowed the United States to engage seriously in trade initiatives, it also crystallised the constraints on US trade policy. These include, among others, stipulations that any new trade agreement must be comprehensive and ambitious (and meet the objectives set out in section 2102 of the Trade Promotion Authority Act); that changes to contingent protection (US antidumping and countervailing duty laws) can only be undertaken if the president reports to Congress at least 180 days before signing any trade agreement proposals, to which Congress may disapprove; that any negotiated agreement must contain provisions on labour and the environment, which have to figure as an integral part of the agreement and not annexes; and, lastly, that the negotiation of tariff reduction on a number of specified importsensitive agricultural products (around 130 identified by the US Trade Representative) needs to be notified in advance for consultations with Congress.11 Lastly, there has been a movement underfoot among several members of Congress to forestall the ability of US negotiators to include any type of commitment on labour

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mobility in the form of mode 4 (entitled ‘movement of business persons’ under NAFTA and ‘temporary movement of natural persons’ under the GATS). Key House members wrote a letter to Ambassador Robert Zoellick to this effect in November 2003 and threatened legislation. The sentiment in Congress is so strong that US negotiators were not able to include a chapter on mode 4 in the most recent FTAs with CAFTA and with Australia (completed in December 2003 and February 2004, respectively). All these episodes underline the constraints faced by US negotiators in offering meaningful concessions to Latin America in areas of strong interest. They also put Latin America on guard against significant commitments in areas of interest to the United States, such as services, investment, government procurement and intellectual property rights. Conflicting motivations in Brazil The other major player in the Western Hemisphere besides the United States is Brazil. Though clearly not representing the same degree of overwhelming economic strength, nonetheless Brazil sees itself as the reckoning force in South America. The government of Ignacio Lula da Silva, through its negotiating arm of Itamarati, the foreign ministry, has apparently decided to use trade policy as its political tool for taking an ideological hard line against what many Brazilians perceive to be the northern imperialist design of economic domination through the FTAA (Hakim 2004). Meanwhile, Brazil’s policies have remained highly orthodox in the monetary and financial arenas, reflecting the constraints of outstanding debt and the strictures of IMF programs. So it has fallen to trade policy to become the area where Brazil’s president could take a nationalistic stance, ignoring voices even within his own government that have favoured a more accommodating approach. Open dissension with the president’s line was expressed prior to the meeting of trade ministers in Miami by no less than three Brazilian ministers— those for finance, industry and agriculture—but to little avail (Jornal do Commercio, 11 November 2003). On the contrary, Brazil has forged ahead to use its considerable political and negotiating force to redefine and shape the entire FTAA negotiations, for better or for worse. At the same time Brazil still has the ambition of expanding its influence in South America.

CHANGING PERCEPTIONS OF THE FTAA During 2003 it became evident that the political panorama in the Western Hemisphere had changed, along with the perceptions about the FTAA, and that there was a wide gulf of ambition between several of the participants. Under new governments, Brazil and Argentina, along with their MERCOSUR partners, shifted rhetoric and tactics to propose a ‘three-track’ approach to the FTAA. According to this proposal, made at the meeting of trade vice-ministers in El Salvador in June 2003, certain issues would be dealt with at the multilateral level (domestic support for agriculture, trade remedy disciplines, but also other issues that MERCOSUR was not eager to negotiate such as investment, aspects of services, intellectual property rights, competition policy and government procurement), the remaining issues at the FTAA level, and the market access negotiations on tariffs, agriculture and services would be addressed through a bilateral track.

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This proposal stimulated considerable dismay among all the other FTAA participants and threw a roadblock into the negotiations. While most of the other countries were willing to maintain the originally agreed high level of ambition for the FTAA agreement no matter the consequences, the United States, for political and economic reasons, was unwilling to go forward on the FTAA project without Brazil on board. Serving as cochairs of the FTAA process, the two large countries worked out a compromise arrangement for the FTAA that was grudgingly endorsed at the meeting of trade ministers in Miami on 20 November 2003. Ironically Miami was the location of the original conception of the FTAA in December 1994, and nine years later Miami marked a distinct turning point in the FTAA vision. The original vision of an ambitious single undertaking with substantial disciplines gave way to a two-tiered, more complex agreement. In the process, hemispheric foot-draggers obtained a perceived, but most likely Pyrrhic victory. The ‘new’ Miami vision What resulted from the Miami meeting is no longer a one-track, unified agreement but a two-track, double FTAA vision with differing levels of ambition depending upon the track chosen. Gone—at least in the short-to-medium term—is the notion of a single agreement with uniform disciplines for all the thirty-four negotiating governments. The decision by trade ministers to bifurcate the FTAA process into two negotiating tracks is found in paragraphs five to ten of the Miami Ministerial Declaration entitled ‘The Vision of the FTAA’. The major innovation in these paragraphs is the introduction of the term ‘flexibility’ in order to accompany the renewed commitment to a ‘comprehensive and balanced FTAA’. The Miami Ministerial Declaration recognises—for the first time in the nine-year process—that ‘countries may assume different levels of commitments’ and that plurilateral negotiations may be conducted among those countries wishing to take on higher levels of commitments, or those willing to ‘agree to additional obligations and benefits’ (paragraph 7). The declaration insists that the FTAA will still be comprehensive in that it will ‘include measures in each negotiating discipline, and horizontal measures, as appropriate’ (paragraph 9). The vice-ministers are to develop a ‘common and balanced set of rights and obligations applicable to all countries’, while interested parties may choose ‘to develop additional liberalization and disciplines on a plurilateral basis’ (paragraph 10). Countries may choose to be a part of the higher-level negotiations at any time they wish by notifying this intention; if they do not wish to take part in the negotiations, they may still attend as observers and become participants at any time thereafter. Importantly, the ‘results of the negotiations [presumably both of them but this is not specified] must be WTO compliant’ (paragraph 10). The vision paragraphs are intriguing and manage to patch over significant differences in the short run, but they leave open several critical questions. These include: • What will constitute the FTAA agreement? • What will be the legal and institutional linkage between the results of the two sets of negotiations, both of them within the FTAA? • Will the dispute settlement understanding cover both sets of obligations?

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• How will the objectives of ‘comprehensiveness’, ‘balanced’ and ‘flexible’ be reconciled with one another? • Operationally, how will two sets of negotiations (one with all thirty-four participants and one on a plurilateral, voluntary basis) be conducted simultaneously, as the declaration implies? • How will the WTO evaluate two sets of FTAA agreements in terms of its requirements for ‘WTO-plus’ in the area of goods and services? • In what way can a country choose to move from one level of disciplines to the other, and will this be possible on an issue-by-issue basis, or will the entire set of higher obligations need to be accepted as a whole? The declaration is unclear with respect to the link between the level of obligations a country would undertake and the market access it would receive, and instead includes ambiguous language setting out the expectation that the agreement ‘will result in an appropriate balance of rights and obligations where countries reap the benefits of their respective commitments’ (paragraph 8). Additionally, what is not specified in this vision is whether the countries taking on the higher level of obligations within the FTAA would extend these to all of the other participants or only to those having signed on to the higher effort. If the most-favoured-nation principle is not practised within the hemisphere for the two tiers of the FTAA, then the agreement will result in a system of preferences within a preferential arrangement, possibly not only for market access commitments, but also for rules. If countries are additionally allowed to take on different levels of obligations in different negotiating areas according to their desire, this will result in extremely complicated arrangements, hardly conducive to greater intra-regional trade and investment flows. In summary, the major outcomes of the Miami meeting of end 2003 were to: • Allow the FTAA process to move forward with all 34 participants still on board. • Introduce a principle of ‘flexibility’ into the negotiations that had not previously been there. • Endorse a minimum level of common disciplines for the agreement so as to accommodate all governments, but allow countries to subscribe to additional liberalisation and deeper disciplines on a plurilateral basis. • Put the FTAA negotiations effectively on a two-track basis with the need to define the procedures for moving forward on this basis. US and Brazilian officials defend their decision to cast aside the single undertaking, claiming that the two-tiered approach affords FTAA governments the requisite flexibility to decide their level of commitment in light of their needs, objectives and capacities. This change is highlighted as necessary to accommodate the changed circumstances and political constraints in the South American Southern Cone in particular. Ambassador Zoellick has defended the revised vision of the FTAA as giving the MERCOSUR members and the Caribbean countries opportunities to move forward with trade liberalisation that suits their circumstances and, importantly, to use aid to support trade liberalisation (Financial Times, 9 December 2003). The actual negotiations, however, are effectively stalled until the vice-ministers, under instruction (paragraph 10), are able to unravel the mystery behind the vision statement in the Miami Ministerial Declaration and decide upon the level of baseline obligation that

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will be acceptable to all participants in each of the nine negotiating groups (and fifteen negotiating subjects—tariffs, non-tariff measures, safeguards, rules of origin, customs procedures, standards and technical barriers to trade, agriculture, services, investment, government procurement, competition policy, intellectual property rights, antidumping, countervailing duty measures and dispute settlement). This is a formidable task, given the inability of the same vice-ministers to reach agreement on several outstanding issues in the past concerning these negotiating areas. A meeting of trade vice-ministers held in Puebla, Mexico, in February 2003 took a first stab at this task but adjourned without resolving these thorny questions. A resumed session of the vice-ministerial meeting in March 2004 will attempt to put more flesh on the skeleton of the new vision. Vice-ministers must take decisions both on the content of the agreed rules and disciplines for all FTAA participants for the first tier of the agreement, and on the procedures for conducting negotiations at the level of the second (plurilateral) tier of the agreement. Difficult questions must be resolved. What role will observers play in the second-tier negotiations, and what rights will new participants have if they join at some point before the agreement is finalised? Are new participants entitled to reopen all issues, and thus effectively block the second tier, or must they accept the ‘negotiated acquis’? Moreover, a delicate balance will have to be reached in terms of the depth of disciplines that suit all participants for all areas at the first-tier level (Inside US Trade, 9 February 2004). Can the first-tier outcome both satisfy all FTAA members and meet the requirements of the WTO (by covering substantially all trade) and the US Congress (by covering labour and environment)? There is a final challenge: how can an ambitious second-tier outcome be designed so that all FTAA members will have an incentive to sign on at some future date? Only with a proper design will the FTAA evolve into a truly hemispheric pact, and not a fragmented agreement with adverse commercial and political consequences. Options for the future FTAA The fact that the FTAA process has hit a snag is not necessarily fatal, given that there have been delays and bumps along the way in the completion of several of the multilateral trading rounds as well as of regional trading agreements (for example, the Uruguay Round had to be extended by two years, the Chile-Korea FTA was put on hold for over a year, and the EU-MERCOSUR negotiations are proceeding so slowly that few deadlines are even set any more). A longer time frame might even be beneficial to the FTAA, as it would stretch the negotiations beyond the US presidential campaign of 2004 and make it easier for the United States to make the kind of concessions that other countries would find essential in order to achieve a balanced agreement. However, the modifications agreed at Miami change the nature of the future FTAA: both the way in which the agreement will be negotiated (along a two-tiered track) as well as the depth of disciplines that it will embrace (some deep, some shallow). These represent significant departures from the original vision. Only time will tell whether the changes prove wise. What are the options for the FTAA governments in 2004, supposedly the final year of the negotiations? Four options have been set out as possible courses of action (Bernal 2003):

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• Retain both the scope of ambition and the original schedule of January 2005 (while several countries still adhere to this option—the NAFTA members and the NAFTA sympathisers—it is seen as too ambitious by the other half). • Reduce the scope of ambition and maintain the schedule of January 2005 (the option apparently favoured by MERCOSUR members). • Reduce the scope of ambition and extend the original schedule (the option apparently favoured by no one around the table at this point). • Retain the scope of ambition and extend the original schedule (the option apparently favoured by CARICOM members, who feel that it is more important to get a good agreement than to stay on schedule). At this point it is difficult to say which of the above four options will ultimately triumph during 2004. Much will depend upon how quickly the vice-ministers of the thirty-four FTAA countries are able to define the baseline disciplines for the agreement that are acceptable to all participants, and in turn when the negotiating groups can begin their work once again. The alternative bilateral track Bilateral tendencies, evident for more than a decade both in the global trading system and in the Western Hemisphere, came to the forefront at the Miami Ministerial in November 2003. Even as the Doha Development Agenda was foundering and missing deadline after deadline in 2003, to ultimately land in Cancun without any clear outcome and considerable rancour, participants in the FTAA process were undergoing their own soulsearching. Several countries continued to link their negotiating stance on certain issues to movement in the Doha Round. As both of these negotiations faltered and looked problematic, the bilateral track gleamed brighter. Indeed, the temptation to bypass the difficulties inherent in multilateral and regional negotiations, and open a direct path to the giant US market, led many countries to knock on the door of the United States. And they have found it open. On the fringe of the meeting of trade ministers in Miami, the United States announced that it would be opening bilateral negotiations with four members of the Andean Community next year—Colombia and Peru at once, while Ecuador and Bolivia would initially be observers but then join as full participants. The United States also announced that the Dominican Republic would be added onto the negotiating outcome of the FTA with CAFTA, and that negotiations would begin with Panama for an FTA in 2004. In some ways the bilateral announcements could be considered as important an outcome in Miami as the changed vision of the FTAA. Through existing bilateral agreements or ongoing negotiations, the United States has now effectively ‘captured’ all of the countries in Latin America except for the MERCOSUR members. The CARICOM countries already have special access to the US market for most products, under the Caribbean Basin Initiative Act of 2002 (due to expire, however, in 2007). This growing web of bilateral FTAs in the Western Hemisphere negotiated by the United States is leading rapidly to the development of a hub-and-spoke arrangement, in which the largest market—the US market—will serve as the hub with the other countries being the spokes. The problem is that MERCOSUR is not part of this wagon at all.

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In this way the Miami outcome may prove to be a Pyrrhic victory for Brazil, as it may allow for the consolidation of US influence in the Western Hemisphere in a way that Brazil has long tried to counter. This is the view of Peter Hakim of the Inter-American Dialogue, who has written that the Brazilians may in the end turn out to be the losers if the United States completes all the bilateral agreements it has pledged to pursue, leaving only Brazil and its MERCOSUR partners on the sidelines (along with Venezuela, Cuba and Haiti), while other Latin American nations secure preferential access to the US market (Hakim 2003). Hakim writes that even if MERCOSUR decided belatedly to negotiate its own deal with Washington, it would still leave the United States at the centre of all trade and investment flows in the hemisphere.

CONCLUSION The long journey of the FTAA seems set to arrive, in 2005 or possibly later, at a different station than the one envisaged by the Miami summit leaders in 1994. The original vision contemplated a grand hemispheric free trade area. The FTAA was not envisaged as the exclusive free trade arrangement in the Western Hemisphere, but the vision called for the FTAA to be the senior arrangement. Recent political and economic forces have created a double path. The FTAA will now be two agreements within one, so to speak, with all participants travelling down a wider road and some participants (self-selected) taking a more ambitious and narrower path. What is clear is that the ambition for the common level has been considerably lowered following the meeting of trade ministers in Miami in 2003, with some commentators now referring to a ‘mini-FTAA’. However, even a modest agreement could still represent a landmark achievement if it is able to bring about free hemispheric trade in manufactured goods within ten to fifteen years. Measured against the accomplishments of the GATT system, this is noteworthy. It has taken more than fifty years of GATT bargaining for trade in manufactures between industrial countries to approach (on average) mostfavoured-nation tariffs of around 3 per cent. A mini-FTAA that slashed tariffs on trade in manufactured goods to zero in ten to fifteen years and significantly increased market access in agriculture would compare very well. Agriculture, services, intellectual property, procurement and investor rights are all important. But export growth in the hemisphere, as in Asia, will surely be centred on manufactured goods. Paring of the original grand FTAA has to be regretted, but an FTAA for manufactured goods would be a worthy achievement. The areas that receive scant treatment on the first-tier level of the FTAA will be addressed in depth in the second tier, among like-minded participants. Certainly this will be true of services, intellectual property, investment and procurement, where the more ambitious tier of the FTAA will most likely result in disciplines and access conditions similar to those contained in the recent FTAs negotiated by the United States with Chile, Singapore, CAFTA and Australia. An ambitious tier composed of countries representing nearly 90 per cent of the trade in the Western Hemisphere (excluding some MERCOSUR and CARICOM members and a few others in the first instance) would certainly create a major vehicle for trade liberalisation in the region and could lead, under the right conditions, to the accession of these countries to the more ambitious tier within another five or ten years.

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Taken together, both levels of the FTAA, along with the bilateral agreements that continue to profligate, will substantially advance hemispheric free trade and investment, although the outcome will not be tidy. The hope is that the disciplines in a large number of these agreements will allow them to converge over time toward each other. This will certainly be the case of the ‘NAFTA-like countries’ under the plurilateral FTAA approach, and may in the future be the case with those remaining outside.

NOTES The views expressed are the opinions of the authors, and do not necessarily reflect the views of the Institute for International Economics, the Organisation of American States (OAS), or the officers, staff members or directors of those institutions. This chapter draws on Hufbauer (2003). 1 As Hufbauer put the matter in 1989, before the term ‘competitive liberalisation’ was coined: ‘In fact, even the remote possibility of trade diversion is part of the magnetic allure of a vital free trade area. The prospect of trade diversion prompts other countries to seek affiliation with the group, and the end result is to enlarge the zone of liberalization’ (Hufbauer 1989:136). 2 Data for FTAs in the Western Hemisphere come from the OAS. In addition, some nations have multiple agreements with partners outside the hemisphere. After the European Union and the European Free Trade Association (which together have seventy-one FTAs in all stages), Mexico leads the world with fifteen FTAs, and Chile comes third with thirteen. 3 In 2003 the United States concluded FTAs with Singapore and Chile. These agreements have slightly more economic importance than the previous FTAs with Israel and Jordan. The United States concluded an FTA with Australia early in 2004, but Australia only constitutes 1.1 per cent of US trade and 2.5 per cent of the US FDI stock. Leaving aside Canada and Mexico, only 6 per cent of US trade with the world in 2002 involved other potential FTAA partners. The United States has more investment in the rest of Latin America than in Mexico, but less than in Canada. 4 For background, see Hufbauer and Schott (1994) and Schott (2001). 5 A number of ministerial declarations can be found on the official FTAA website at http://www.ftaa-alca.org/. Toronto Ministerial Declaration (November 1999): We reaffirm the principles and objectives that have guided our work since Miami, including inter alia that the agreement will be balanced, comprehensive, WTO-consistent, and will constitute a single undertaking.’ Buenos Aires Ministerial Declaration (April 2001): ‘achievement of a balanced, comprehensive agreement that is consistent with the rules and disciplines of the World Trade Organisation. We reaffirm that the result of the FTAA negotiations shall constitute a comprehensive single undertaking.’ Quito Ministerial Declaration (November 2002): ‘We reaffirm the basic principle of consensus in decision making within the FTAA process and the achievement of a balanced and comprehensive agreement that is also consistent with the rules and disciplines of the World Trade Organisation (WTO). We reaffirm that the result of the FTAA negotiations shall constitute a comprehensive single undertaking that incorporates the rights and obligations that are mutually agreed for all member countries.’ Miami Ministerial Declaration (November 2003): ‘Ministers reaffirm their commitment to a comprehensive and balanced FTAA’ and ‘Ministers also recognise the need for flexibility to take into account the needs and sensitivities of all FTAA partners.’ 6 The OAS Trade Unit and the Inter-American Development Bank (IDE), as two of the three members of the Tripartite Committee (the third being the UN Commission for Latin America and the Caribbean, or ECLAC), maintain and update the official website for the FTAA

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process, located at http://www.ftaa-alca.org/. Additionally, the OAS maintains a very comprehensive set of official documents and trade agreements, together with useful summaries and analysis, on its website at http://www.sice.oas.org/. In the academic literature, valuable papers have been authored by Nogues (2003) and Rivas-Campo et al. (2003), among others. 7 In NAFTA agriculture is treated differently from other goods, and is governed by bilateral agreements between the three parties rather than by a common agreement. As between Mexico and the United States, NAFTA promises ‘free’ agricultural trade, defined as the absence of tariffs or quotas, after long delays and phase-ins for ‘sensitive’ products like sugar, corn, beans and several minor crops. There is no mention of export subsidies or domestic subsidies, nor are they disciplined. 8 For example, the United States has refused to move on maritime transport, Canada still protects its cultural industries, and Mexico maintains its nationalised energy sector, including electricity and drilling services. All three cases are outside of the disciplines of the agreement. And all three countries continue to limit foreign ownership of television and radio. Indeed, most of the liberalisation in the services area that has taken place in North America has occurred independently of NAFTA, through voluntary liberalisation rather than through negotiated market opening (the telecommunications sector is an excellent example). The main exception to this rule is the financial services sector in Mexico. 9 On the unmet need for better financial surveillance, see Dobson and Hufbauer (2001). 10 For a detailed explanation of the ‘readiness indicators’, see Hufbauer and Schott (1994) and Schott (2001). 11 See Title XXI—Trade Promotion Authority—Public Law 107–210, 6 August 2002.

REFERENCES Balassa, Bela (1965) ‘Trade liberalization and “revealed” comparative advantage’, Manchester School 33:99–123. Barro, Robert J. and Xavier Sala-I-Martin (1992) ‘Convergence’, Journal of Political Economy 100(2):223–51. Bergsten, C.Fred (1996) ‘Competitive liberalization and global free trade: a vision for the early 21st century’, APEC Working Papers 96–15, Washington DC: Institute for International Economics. Bernal, Richard (2003) Chief Negotiator for CARICOM, comments in a panel discussion on the FTAA negotiations, jointly organised by the OAS and George Washington University’s Centre for Latin American Studies, 25 November. Bhagwati, Jagdish and Arvind Panagariya (1996) ‘Preferential trading areas and multilateralism— strangers, friends, or foes?’, in Jagdish Bhagwati and Arvind Panagariya (eds) The Economics of Preferential Trade Agreements, Washington DC: The AEI Press. Bouzas, R. and S.Keifman (2003) ‘Making trade liberalisation work’, in: Pedro-Pablo Kuczynski and John Williamson (eds) After the Washington Consensus: Restarting Growth and Reform in Latin America, Washington DC: Institute for International Economics, pp. 157–79. Council of the Americas (2001) ‘FTAA: Blueprint for Prosperity: Building on NAFTA’s Success, Washington DC: Council of the Americas. DeRosa, Dean A. and John Gilbert (2003) ‘Technical appendix: quantitative estimates of the economic impacts of US bilateral free trade agreements’, prepared for the conference on Free Trade Agreements and US Trade Policy, Institute for International Economics, Washington DC, 7–8 May. Diao, Xinshen, Eugenio Diaz-Bonilla and Sherman Robinson (2002) ‘Scenarios for trade integration in the Americas’, TMD Discussion Paper 90, Washington DC: Trade and Macroeconomics Division, International Food Policy Research Institute, February.

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Dobson, Wendy and Gary Hufbauer (2001) World Capital Markets: Challenge to the G-10, Washington DC: Institute for International Economics. Dunning, John H. (1966) American Investment in British Manufacturing Industry, London: Allen and Unwin. Eichengreen, Barry and Alan M.Taylor (2003) ‘The monetary consequences of a Free Trade Area of the Americas’, Discussion Paper 3909, London: Centre for Economic Policy Research, May. Hakim, Peter (2003) ‘America and Brazil both lost out in Miami’, Financial Times, 25 November. ——(2004) ‘Summit goal: get FTAA back on track’, The Miami Herald, 11 January. Helliwell, John F. (1998) How Much Do National Borders Matter?, Washington DC: Brookings Institution. Hufbauer, Gary Clyde (1989) ‘Background paper’, in The Free Trade Debate: Reports of the Twentieth Century Fund Task Force on the Future of American Trade Policy, New York: Priority Press. ——(2003) ‘From NAFTA to FTAA’, paper delivered to the KIEP/NEAEF Conference, Honolulu, Hawaii, August. Hufbauer, Gary Clyde and Jeffrey J.Schott (1994) Western Hemisphere Economic Integration, Washington DC: Institute for International Economics. Hufbauer, Gary Clyde, Jeffrey J.Schott and Yee Wong (2003) ‘NAFTA dispute settlement systems’, Washington DC: Institute for International Economics, http://www.iie.com/. Kuczynski, Pedro-Pablo and John Williamson (2003) After the Washington Consensus: Restarting Growth and Reform in Latin America, Washington DC: Institute for International Economics. McCallum, John (1995) ‘National borders matter: Canada-U.S. regional trade patterns’, American Economic Review 85(3), June. Maskus, Keith E. (2000) Intellectual Property Rights in the Global Economy, Washington DC: Institute for International Economics. Nogues, Julio J. (2003) ‘Reciprocity in the FTAA: the roles of market access, institutions and negotiating capacity’, Working Paper SITI-02, Washington DC: Inter-American Development Bank, July. Rivas-Campo, Jose Antonio and Rafael Tiago Juk Benke (2003) ‘FTAA negotiations: short overview’, Journal of International Economic Law 6(3): 661–94, September. Salazar, Jose Manuel (2003) ‘The politics and future of hemispheric trade’, paper given at the Yale Conference on Hemispheric Trade, 4 April. Schott, Jeffrey J. (2001) Prospects for Free Trade in the Americas, Washington DC: Institute for International Economics. ——(2003) ‘Free trade agreements: boon or bane for the world trading system?’, paper given at the conference on Free Trade Agreements and US Trade Policy, Washington, DC: Institute for International Economics, 7–8 May. Stephenson, Sherry (2000) ‘GATS and regional integration’, in Pierre Sauvé and Robert Stern (eds) GATS 2000: New Directions in Services Trade Liberalization, Washington DC: Brookings Institution Press. Vernon, Raymond (1966) ‘International investment and international trade in the product cycle’, Quarterly Journal of Economics 80, May. Yeyati, Eduardo Levy, Ernesto Stein and Christian Daude (2002) ‘The FTAA and the location of FDI’, paper given at the IDB-Harvard Conference on the FTAA, Punta del Este, Uruguay, 7 December.

9 East Asian regionalism—undermining or underpinning Asia Pacific integration? Robert Scollay

INTRODUCTION The title of this chapter suggests opposition, or at least tension, between processes of economic integration based on two different concepts of region, one of an East Asian region and the other of an Asia Pacific region embracing both sides of the Pacific Ocean. In fact matters are far more complicated. Within East Asia a number of different approaches to economic integration are being pursued, with considerable uncertainty over whether these represent separate competing processes or multiple strands of a single process. Other economies in the wider Asia Pacific region are also taking multi-faceted approaches to economic integration. This chapter endeavours to summarise these trends. It goes on to examine the effects of East Asian integration on the Asia Pacific, looking at economic effects by means of computable general equilibrium (CGE) analysis and then addressing broader strategic issues. The chapter concludes with a discussion of the relationship between economic integration in East Asia and liberalisation at the APEC and multilateral levels.

ECONOMIC INTEGRATION IN EAST ASIA AND THE ASIA PACIFIC REGION The vehicle for the vision of economic integration of the Asia Pacific region is of course APEC, whose membership includes most of the economies, in particular all the larger economies, of the Pacific Rim. In the Bogor Declaration of 1994 APEC members committed themselves to achieving integration through a process of non-discriminatory trade and investment liberalisation, supported by trade and investment facilitation and economic and technical cooperation. A rival proposal for an East Asian Economic Group (EAEG) failed at that time to gain sufficient traction. In 2002 APEC members accounted for 61 per cent of world GNP measured at official exchange rates or 55 per cent of world GNP at purchasing power parity exchange rates (Table 9.1), and slightly less than 50 per cent of world trade. They display enormous diversity in resource endowments and levels of development. World Bank Development Indicators for 2002 show a ratio

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Table 9.1 Shares of world GNP, 2002 Official exchange rates (per cent)

PPP (per cent)

APEC 61.1 Japan 13.5 China 3.8 Korea 1.5 Northeast Asia 20.3 ASEAN 1.9 ASEAN-plus-three 20.8 East Asia 22.2 (Northeast Asia plus ASEAN) Australasia 1.4 US 32.1 NAFTA 36.2 FTAA 39.6 EU15 25.6 EU25 27.4 Source: World Development Indicators, World Bank.

55.5 7.1 12.0 1.7 22.0 4.2 24.9 26.2

1.3 21.5 25.2 30.7 20.3 23.4

of 81:1 between the highest and lowest GNP per capita among APEC economies.1 The rationale for Asia Pacific economic integration was based on the very substantial prospective gains from exploiting the complementarities between a large group of economies that have different resource endowments and levels of development, and that already trade intensively with each other, as is shown in Table 9.2. The potential of the trans-Pacific dimension of APEC is attested by the importance to APEC members of trans-Pacific trade, as Table 9.2 indicates. Particular noteworthy is the fact that the share of US trade conducted with the western Pacific is equal to the share conducted with its NAFTA partners (32 per cent), and much higher than the share of its trade conducted with South America (4 per cent). Northeast and Southeast Asian economies respectively conduct 23 per cent and 18 per cent of their trade with the Americas. North America and Northeast Asia are clearly the economic powerhouses of the APEC region, together accounting for 56.5 per cent of 2002 world GNP2 (36.2 per cent for North America and 20.3 per cent for Northeast Asia). The importance of APEC in the world economy is thus primarily due to the participation of the economies of these two sub-regions. North America and Northeast Asia also dominate the trade of the APEC region. Figure 9.1 shows that the trade of the economies of these two regions with other APEC economies greatly exceeds that of any other regions within APEC.

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Table 9.2 Trade among APEC economies, 2000–02 Region

Percentage of trade conducted with: East Western Pacific US Asia

NAFTA APEC

South America

Northeast 49 52 20 22 74 Asia among 41 44 25 27 73 which Japan Southeast 55 58 16 17 73 Asia Australasia 45 52 15 16 70 NAFTA 24 25 46 72 among 31 32 32 65 which US Chile and 23 24 20 26 49 Peru Notes: Northeast Asia: China, Hong Kong, Japan, Korea, Taiwan; Southeast Asia: Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam; Australasia: Australia, New Zealand; western Pacific: Northeast Asia, Southeast Asia, Australasia; NAFTA: Canada, Mexico, United States. Source: Direction of Trade Statistics, IMF.

1 2

1 1 4 4 23

A large part of the trade flows of NAFTA and Northeast Asia depicted in Figure 9.1 are of course intra-NAFTA and intra-Northeast Asia flows, respectively. An alternative decomposition of the export flows of APEC regions, in Figure 9.2, shows that in fact intra-NAFTA and intra-Northeast Asia exports are much larger than any other interregional or intra-regional export flows of APEC economies within the wider Asia Pacific region.3 The trans-Pacific exports of the Northeast Asian and North American economies (Northeast Asia to NAFTA and NAFTA to Northeast Asia) rank next, however, ahead of all other intra-regional and inter-regional export flows shown in Figure 9.2. The intensity of trade between North America and Northeast Asia thus remains a key feature of the trade pattern of the APEC region, despite some recent decline in its relative importance to the economies concerned.4 Regional trading initiatives in the APEC region and East Asia APEC is unique among regional trading initiatives in embracing a non-preferential approach to regional trade liberalisation, embodied in the adoption of the modality known as ‘concerted unilateralism’. The rationale for concerted unilateralism and the difficulties encountered in implementing this modality have been widely discussed elsewhere and will not be elaborated here.5 The membership of APEC embraces three preferential trading arrangements (PTAs) whose formation pre-dates the Bogor Declaration: the North American Free Trade Agreement (NAFTA), the ASEAN Free Trade Agreement (AFTA)

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Figure 9.1 Average annual trade flows of major Asia Pacific regions with APEC economies, 2000–02

Source: Direction of Trade Statistics, IMF.

Figure 9.2 APEC economies: main intra-regional and inter-regional export flows in the Asia Pacific region, 2000– 02 (annual averages)

Source: Direction of Trade Statistics, IMF.

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and the Closer Economic Relations Agreement (CER) between Australia and New Zealand. These were augmented in 1997 and 1998 respectively by free trade agreements between Canada and Chile and between Mexico and Chile. NAFTA is a major trade bloc in its own right, accounting for 36.2 per cent of world GNP in 2002, primarily of course because of the membership of the United States, which accounts for 32 per cent of the world figure as noted earlier. By contrast the AFTA and CER economies account respectively for 1.8 per cent and 1.4 per cent of world GNP. The failure of the EAEG to gain traction in the early 1990s was due primarily to the lack of support from Northeast Asia. Japan and Korea had a firm policy against involvement in PTAs, while China was preoccupied with its transition to a market economy and its application for WTO membership. An East Asian trade bloc was out of the question as long as Northeast Asia remained an ‘empty box’ in the global map of preferential arrangements. The situation began changing dramatically in 1998, as Japan and Korea announced that they would explore the possibility of a free trade area between themselves, and then proceeded to pursue preferential agreements with other APEC members, and subsequently to conclude agreements with Singapore in the case of Japan and with Chile in the case of Korea. Both economies are now engaged in the negotiation of further PTAs. A natural vehicle for a possible East Asian trade bloc emerged in 1998 with the formation in response to the East Asian economic crisis of the ASEAN-plus-three group, comprising China, Japan and Korea along with the ten ASEAN economies. An initial focus on monetary cooperation and coordination was quickly broadened to include study of the possibility of an ASEAN-plus-three free trade agreement, which would in effect constitute an East Asian trade bloc. On the opposite side of the Pacific a proposal to create a Free Trade Area of the Americas (FTAA) has been underway since 1994. The FTAA would potentially amalgamate NAFTA and the multiplicity of PTAs existing in the rest of the Americas into a single hemisphere-wide PTA, whose members would account for almost 40 per cent of world GNP. The possibility that these two developments could proceed in parallel in East Asia and the Americas highlights the potential for a bipolar Pacific architecture based on separate trade blocs on either side of the Pacific to emerge as an alternative to the APEC vision of integrating the economies on both sides of the ocean. Placed alongside an enlarging European Union this would in turn formalise a ‘tripolar’ architecture of preferential trade blocs dominating the world economy, with the prospective members of the three blocs accounting for just under 90 per cent of world GNP. In addition to exploring the possibility of an East Asian trade bloc, a number of East Asian economies have also been active participants in the rapid proliferation of bilateral trade initiatives that has been another prominent feature of the trade landscape in the Asia Pacific region since 1998. In addition to Japan and Korea, Singapore and more recently Thailand have been especially active in the pursuit of bilateral agreements, and other East Asian economies now appear to be following suit. In the wider APEC region Chile, Australia and New Zealand as well as the United States have also been prominent participants in bilateral trade agreements. Of greater potential significance in the long term for the future of economic integration in the region has been the more recent overshadowing of the proposal for an

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East Asian trade bloc based on the ASEAN-plus-three group by separate proposals for PTAs between China and ASEAN and then Japan and ASEAN. These proposals were followed by the US ‘Enterprise for ASEAN’ initiative, and by a proposal for an ASEAN preferential agreement with India.6 These so-called ASEAN-plus-one initiatives have opened up two further alternative paths toward East Asian economic integration. On the one hand, they raise the prospect of a more central role for ASEAN as a possible ‘hub’ in the developing preferential architecture of the region. This would represent an unorthodox variation on the usual ‘hub-and-spoke’ architecture, which traditionally involves a major economy as a hub with an array of smaller economies as the spokes. ASEAN’s prospects of successfully establishing itself as an alternative hub depend crucially on its ability to maintain a united front in negotiating on a common basis with its larger prospective partners. Recognising this, ASEAN has moved to increase its economic cohesion with proposals for the establishment of an ASEAN common market. On the other hand ASEAN’s ambitions to serve as the regional hub are challenged by the evident intention of at least Japan and the United States, and possibly also China, to negotiate bilateral trade agreements with individual ASEAN economies, and by the willingness of an apparently growing number of ASEAN economies to accept the bilateral approach. The well-known domino effect, whereby smaller economies find themselves impelled to react to bilateral agreements between their competitors and larger common trading partners by seeking bilateral trading agreements of their own with the same trading partner, ensures that such a move toward bilateral trading agreements, once established, will tend to develop a momentum of its own.7 If bilateralism prevails in the ASEAN-plus-one context, this will be a major step toward the establishment of a conventional hub-and-spoke architecture of preferential trading arrangements in the Asia Pacific region, with Japan, China, the United States and possibly Korea acting as spokes, while the ASEAN economies and other smaller economies of the region occupy the role of spokes. The eventual pattern is likely to be complicated. Some of the smaller economies of the region such as Singapore and Chile have demonstrated clear ambitions to place themselves at the centre of their own network of PTAs. These economies can be envisaged as secondary hubs while at the same time serving as spokes within a number of hub-and-spoke patterns based around large primary hubs.

ECONOMIC WELFARE EFFECTS The purpose of this chapter is to consider the effect of East Asian economic integration on the Asia Pacific region. In doing so it is necessary to take account of each of the different paths along which East Asian economic integration is currently being pursued, as outlined above. Each of these paths involves the creation of new preferential arrangements in East Asia. As always with PTAs, an important dimension of their economic effects is the balance between the positive impact on members of the arrangements arising from trade creation, and any negative effect associated with trade diversion arising from the inherent discrimination against economies excluded from the arrangement. One conventional approach to assessing these effects is through computable general equilibrium (CGE) analysis of the economic impact of different integration

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arrangements. This can produce estimates of the impact on economic welfare, and on bilateral trade flows and domestic production at the sectoral level. PECC (2003a) includes a survey of the results of some forty CGE analyses of economic integration initiatives in the East Asian region. This chapter focuses on a representative sample of these results, reported in a series of papers by Scollay and Gilbert and others (Gilbert et al. 2002; Scollay and Gilbert 2001, 2002; Scollay et al. 2002; Scollay 2001), all using the same modified version of the standard GTAP (Global Trade Analysis Project) model documented in Hertel (1997). These papers include results for a number of bilateral PTAs as well as for larger bilateral configurations in East Asia, including an East Asian trade bloc based on the ASEAN-plus-three group, and separate PTAs between ASEAN and China and Japan, respectively. The results for the various PTAs are compared with the results for APEC liberalisation, both on the nondiscriminatory basis envisaged in the Bogor Declaration and on a preferential basis involving the creation of an APEC-wide PTA.8 These simulations were undertaken to provide quick indications of the potential welfare effects of different possible PTA configurations, and as such were restricted to comparative statics, using the basic perfect competition assumption. The reported results should therefore be treated as likely lower bounds of possible effects, since in cases where it has been possible to compare the results derived from comparative static simulations with those from dynamic simulations, and the results under the assumption of perfect competition with those derived under assumptions of imperfect competition, it has generally been shown that larger effects are generated by dynamic simulations and by simulations under assumptions of imperfect competition (see, e.g., Scollay and Gilbert 2000). In any event the principal interest here is in comparing the effects of different economic integration initiatives, in terms of the direction of change and the size of the impact in relative rather than absolute terms. On this basis the results reported here prove to be broadly consistent with the outcomes of the majority of the larger range of studies reported in PECC (2003a). In other words, while studies have differed in terms of model specification, and have differed in the absolute size of reported impacts, in relative terms the broad pattern of results reported here has proved reasonably robust across a large number of studies. The methodology used is discussed in some detail in the papers previously cited, and this discussion will not be repeated here. The PTAs covered in the simulations are each modelled as a traditional FTA; that is, involving the removal of all import tariffs on a preferential basis between the assumed members, with each member maintaining their own initial extra-FTA tariffs. While few regional trade agreements have been this clean in reality, the assumption provides a useful bound to the extent of regional liberalisation. In a number of the papers cited here, detailed results are presented and discussed for production and trade effects at the sectoral level. In this chapter, however, the focus will be on the effects on overall economic welfare, measured by the equivalent variation method, for both members and non-members of the proposed arrangements. In particular the focus is on how different PTA configurations differ in terms of their relative impact on the economic welfare of both members and non-members.

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Bilateral PTAs The results for bilateral PTAs reported in Scollay and Gilbert (2001) clearly indicate that bilateral PTAs between pairs of small Asia Pacific economies invariably have negligible effects on economic welfare. This is not surprising, since the trade flows affected by such PTAs are small, both in absolute terms and relative to the total trade of the countries involved. Also unsurprisingly, bilateral PTAs between small or medium-sized and large Asia Pacific economies generally generate substantial gains in economic welfare for the smaller partner. Thus there are substantial welfare gains for Singapore from its PTAs with Japan and the United States. At the same time these PTAs often have perceptible though small negative welfare effects on neighbouring economies excluded from the arrangement that also have substantial trade interests with the larger partner. Thus Singapore’s PTAs with Japan and the United States have adverse impacts on some of Singapore’s ASEAN partners. These negative effects are one of the factors behind the domino effect mentioned earlier, as the affected neighbours or competitors are prompted to advance their interests by seeking their own PTA with the larger partner. Trade blocs and ‘hub-and-spoke’ configurations Table 9.3 compares the welfare effects generated by the simulation of an East Asian trade bloc with those from ASEAN-China and ASEAN-Japan FTAs. The East Asian trade bloc generates welfare gains for each of its members. For a number of members these gains are very substantial, notably for Korea, Indonesia, Malaysia, Thailand, Singapore and Vietnam. On the other hand,

Table 9.3 Welfare effects of ASEAN-plus-three, ASEAN-China and ASEAN-Japan FTAs Effect on economic welfare, equivalent variation method (per cent of GDP) ASEAN-plus-three ASEAN-China ASEAN-Japan Australia New Zealand China Hong Kong Japan Korea Taiwan Indonesia Malaysia Philippines Singapore Thailand Vietnam

−0.2 −0.2 0.1 −0.9 0.2 1.1 −0.7 1.2 0.8 0.1 3.1 1.9 5.0

0.0 0.0 0.0 −0.2 0.0 −0.1 −0.1 0.2 1.1 0.3 3.4 0.4 2.0

−0.1 −0.1 −0.1 −0.2 0.0 −0.2 −0.2 0.4 0.5 0.2 2.4 1.9 4.0

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ASEAN total Canada United States Mexico Peru Chile Source: Model simulations.

1.5 0.0 −0.1 0.0 −0.1 −0.2

0.9 0.0 0.0 0.0 −0.1 0.0

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1.1 0.0 0.0 0.0 0.0 −0.1

there are serious negative effects on the economic welfare of Taiwan and Hong Kong, the East Asian economies omitted from the PTA, and to a lesser extent also on the economic welfare of Australia and New Zealand, both of which trade intensively with East Asia. The United States, Chile and Peru also register negative welfare effects from the formation of the East Asian trade bloc. While the welfare losses for the United States appear relatively small when expressed as a percentage of GDP, simulations of the FTAA on a comparable basis in Scollay et al. (2002) indicate that these losses are more than sufficient to offset the welfare gains potentially accruing to the United States from the FTAA. A notable feature of the ASEAN-China and ASEAN-Japan simulations is that in both cases the welfare outcome is less favourable for all three major Northeast Asian economies than in the case of the East Asian trade bloc. Compared to the East Asian trade bloc, China does worse not only under the ASEAN-Japan FTA, as one would expect, but also under the ASEAN-China FTA, and similarly Japan does worse under the ASEAN-Japan FTA as well as the ASEAN-China FTA. Not surprisingly Korea does much worse under the two arrangements from which it is excluded. Thus there are substantial opportunity costs for the three major Northeast Asian economies when they forgo the benefits of integrating trade among themselves. The ASEAN economies as a group also enjoy significantly lower welfare gains from the ASEAN-China and ASEANJapan FTAs than from the East Asian bloc, although some individual ASEAN economies do better under the more limited arrangements (the Philippines in both cases and Malaysia and Singapore in the case of the ASEAN-China FTA). An offsetting favourable effect of the ASEAN-China and ASEAN-Japan FTAs is that they generate smaller welfare losses for the excluded economies, especially those in the western Pacific. Simulations were not carried out of the scenario where the ASEAN-China and ASEAN-Japan FTAs proceed simultaneously but independently. It is possible that the ASEAN economies as a group could experience greater welfare gains in this case than under the East Asian trade bloc, but unlikely that this would be the case for the three Northeast Asian economies. Trade blocs and APEC Table 9.4 compares the welfare outcomes from the East Asian trade bloc with those from APEC-wide liberalisation, both in the case where APEC members liberalise on a nondiscriminatory basis as originally intended and in the case where APEC members liberalise preferentially toward each other. Not surprisingly, western Pacific APEC members excluded from the East Asian trade bloc all do much better under APEC-wide

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liberalisation. All three major Northeast Asian economies and all American APEC members except Mexico also do better. The results are more equivocal for ASEAN and APEC members in the Americas. The welfare outcome for ASEAN economies as a group is less favourable than under the East Asian bloc, although this is not true for all individual ASEAN economies, particularly in the case of APEC preferential liberalisation. In this latter case the margin of difference in welfare effects compared to the East Asian trade bloc is very small for the ASEAN economies as a group. For the East Asian economies as a whole the welfare gains from either APEC liberalisation scenario are decisively superior to the gains from the East Asian trade bloc. All APEC members in the Americas do better under APEC preferential liberalisation than in the case of an East Asian trade bloc, although a little surprisingly a parallel result does not uniformly hold in the case of APEC most-favoured-nation (MFN) liberalisation. Among all the APEC economies, only Malaysia, Singapore, Thailand and Mexico do worse under APEC preferential liberalisation than under an East Asian trade bloc. Multilateral liberalisation The global free trade scenario was not included in the simulations undertaken by Gilbert and Scollay using the GTAP5 database. Earlier simulations using

Table 9.4 Welfare effects of ASEAN-plus-three FTA and APEC liberalisation Effect on economic welfare, equivalent variation method (per cent of GDP) ASEAN-plus-three FTA APEC MFN APEC preferential Australia New Zealand China Hong Kong Japan Korea Taiwan Indonesia Malaysia Philippines Singapore Thailand Vietnam ASEAN total East Asia total

−0.2 −0.2

0.2 0.5

0.4 1.0

0.1 −0.9

0.2 1.7

0.4 2.2

0.2 1.1 −0.7 1.2 0.8 0.1 3.1 1.9 5.0 1.5

0.3 1.1 1.0 1.0 0.5 −0.3 2.0 1.2 2.2 1.0

0.4 1.3 1.0 1.3 0.7 0.1 2.4 1.6 5.8 1.4

0.3

0.5

0.6

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Canada United States Mexico Peru Chile Source: Model simulations.

176

0.0 −0.1

0.1 −0.1

0.2 0.0

0.0 −0.1 −0.2

−0.2 −0.1 0.1

−0.1 0.1 0.4

GTAP4 reported in Scollay and Gilbert (2001), however, clearly demonstrated the superior welfare outcome from global liberalisation for the world economy, the Asia Pacific region as a whole, and for the overwhelming majority of individual Asia Pacific economies. Implications The simulation results confirm the straightforward intuition that larger, more inclusive trade blocs among economies that trade intensively with each other are likely to produce more favourable outcomes for their members than smaller, more limited arrangements. An East Asian trade bloc is likely to produce better welfare outcomes for the majority of its members than more limited proposals. Adoption of one or other of the possible modes of APEC-wide liberalisation has the potential in turn to produce better welfare outcomes for almost all APEC members than an East Asian trading bloc, as well as for both the East Asian economies and all APEC members taken as a group. The analysis leads logically to the conclusion that multilateral liberalisation on a non-discriminatory basis will produce superior welfare outcomes to all regional initiatives including APEC. It is also important to note the result that a small minority of economies display superior welfare effects under an East Asian bloc than under APEC liberalisation. This is perhaps an illustration of the general point that there may always be some economies that can expect greater gains from preferential trading arrangements with limited membership than from wider arrangements such as APEC. On the other hand, the result that East Asian economies as a group exhibit greater welfare gains under the wider APEC approach suggests the potential for a negotiated outcome that would leave all economies better off, without exception. Another important result to note is that the economic losses of excluded economies are generally much higher in the case of the ASEAN-plus PTAs than in more limited PTA configurations. These losses are heavily concentrated on the economies that trade intensively with the members of the PTA, primarily other APEC economies. As the size of the PTA rises, the size of the losses also rises, while at the same time being concentrated on a progressively smaller group of Asia Pacific economies. The ASEANplus-three PTA, which of all the ASEAN-plus combinations produces the largest economic gains for members, also produces the largest economic losses for the remaining western Pacific non-members—Australia, New Zealand and Taiwan. Expansion of the ASEAN-plus-three PTA to include these economies would convert their economic losses into significant economic gains, while continuing to provide the same or larger benefits for the majority of the ASEAN-plus-three economies.

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There is thus a clear hierarchy of economic effects from the various prospective configurations of East Asian economic integration. The larger the group of East Asian economies, the larger the economic gains to the members of the arrangement, but the larger also the economic losses inflicted on other Asia Pacific economies with which the members trade intensively. The trade-off between increasing economic gains to members and increasing economic losses for non-members largely disappears, however, when liberalisation is undertaken at the APEC-wide level, so that all Asia Pacific economies that trade intensively with each other are included in the arrangement. The inclusive APEC-wide approach to liberalisation resolves this tension, delivering greater overall gains to APEC members while eliminating the losses imposed on the majority of excluded APEC economies by PTAs among the East Asian economies. The property of APEC that lies behind this result is that in accounting for more than 70 per cent of the trade of most of its members it covers a higher proportion of the significant trade flows both of the Asia Pacific region as a whole and of each individual economy in the region. Nevertheless it is also clear from the CGE results that whatever the advantages of an APEC-wide arrangement, an East Asian trade bloc is likely to be economically attractive to its members, assuming that the political and other obstacles to its formation can be overcome. Thus the concept of economic integration based on the concept of an East Asian, rather than Asia Pacific, region appears to have clearly emerged as a viable alternative to the APEC vision of an integrated Asia Pacific region embracing both sides of the Pacific.

FURTHER IMPLICATIONS OF PROLIFERATING BILATERALS AND HUB-AND-SPOKE PATTERNS The proliferation of bilaterals and the development of hub-and-spoke configurations have additional disadvantages that are not captured in the CGE analyses. As PTAs proliferate it is likely that individual economies will become involved in multiple PTAs and that there will be inconsistencies between the provisions of the different PTAs. Rules of origin are the most obvious and perhaps the most important potential source of these inconsistencies. The costs of complying with rules of origin, possibly already significant in a single PTA, are likely to escalate for exporters from economies that are involved in multiple PTAs, each with their own separate and mutually inconsistent rules of origin. Inconsistencies can also arise in other areas as well such as standards and conformance, customs procedures and quarantine procedures. Bhagwati et al. (1998) have suggested that as individual economies become involved in a growing number of PTAs, a ‘spaghetti bowl’ of inconsistent provisions will develop, imposing increased transaction costs on businesses involved in exporting and importing. The extent of these increased transaction costs is an empirical matter and no reliable estimates are yet available. In East Asia Singapore is already involved in multiple PTAs, and may prove to be a useful laboratory for the investigation of this issue. The disadvantages for the spoke economies in hub-and-spoke patterns of PTA development are well known. These patterns tend to reinforce the unequal bargaining strength of the parties, since the hub can exploit competition among the spoke economies, and use precedents established in PTAs with one spoke to strengthen the case for

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inclusion of similar provisions in agreement with other spokes. There are further inequalities in that the hub gains access to all the spoke markets whereas the spokes gain access to the hub alone unless they negotiate separate PTAs with each other. The greater size of market to which access is available from the hub also gives the hub an advantage over the spokes in attracting investment. An interesting indication of possible outcomes is found in Gilbert (2003), where thirteen possible US bilateral FTAs are simulated both on a stand-alone basis and on the basis that all thirteen FTAs proceed simultaneously. In the stand-alone simulations the larger proportionate gains accrue to the smaller bilateral partners, but when simultaneous implementation of all thirteen FTAs is simulated the situation is reversed and the larger proportionate welfare gains go to the United States. On the other hand it may be the case that successful spoke economies can derive almost all available gains from trade by securing PTAs with every major hub, perhaps supplemented by PTAs with other spokes with whom they have a significant trading relationship. Singapore is an obvious case in point in the East Asian region. However, those economies that are unable for whatever reason to secure PTAs with hubs face significant economic damage, while the exclusion of competing spokes may enhance the benefits to the successful spokes, perhaps beyond those they could expect from nondiscriminatory free trade. The potential for increased trade conflicts arising from these types of arrangements is also a risk that cannot be ignored. Even bilateral PTAs may upset excluded economies who find themselves newly discriminated against in the markets of neighbours or close trading partners. Hub-and-spoke patterns of PTAs may give rise to tensions between hubs vying for hegemonic influence and between spokes jockeying for favoured positions in the markets of the spokes. Unequal distribution of gains between hubs and spokes may also be a source of tension or conflict.

IS A ‘BENIGN PROGRESSION’ FEASIBLE AND LIKELY? Given the apparent existence of a hierarchy of possible outcomes in terms of their desirability, an obvious question to ask is whether these outcomes are necessarily mutually exclusive, or whether it is possible to envisage a ‘benign progression’ from less desirable to more desirable configurations, driven by the superior economic benefits to be derived from the latter. To borrow terms familiar from the regionalism-versusmultilateralism debate,9 the question can be presented in terms of whether the less desirable outcomes are ‘building blocks’ or ‘stumbling blocks’ to the more desirable outcomes. Proponents of bilateral PTAs in particular have been prone to argue for the ‘building block’ characterisation. New PTAs are routinely defended as being ‘WTO-consistent’, although in practice this claim has severely limited operational significance. Singapore’s prime minister has spoken eloquently of the role of bilateral PTAs in facilitating the achievement of APEC’s liberalisation objective. Others have emphasised the demonstration effect of high-quality PTAs. The doctrine of ‘competitive liberalisation’ currently being promoted by the US Trade Representative even seeks to make a virtue out of the trade diversionary effects of PTAs, arguing that this encourages trade liberalisation

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through the domino effect, by placing greater pressure on the excluded economies to engage more positively in trade liberalisation in both preferential and multilateral arenas.10 There are, however, practical and analytical reasons for some pessimism over the likelihood of a ‘benign progression’. At the practical level, one of the attractions of more limited PTAs is that they allow their participants to sidestep formidable political difficulties and economic sensitivities that stand in the way of more inclusive arrangements. Agriculture and regional politics loom large in this context. A notable feature of the five recently concluded PTAs involving East Asian economies is the absence of any significant element of agricultural trade liberalisation in all but one case, the exception being the Korea-Chile FTA. In that case there are many exceptions and deferred items in the coverage of agriculture by that agreement, but even so agricultural issues caused extensive delays in the negotiation of the agreement, and prolonged difficulties in the ratification process in Korea. The more bilateral and other preferential agreements with limited membership are perceived as offering an easier route to the exclusion of sensitive agricultural items, the less incentive countries will have to push for more inclusive arrangements.11 Regional politics are an obstacle to a number of potential plurilateral trade initiatives involving East Asian economies, from AFTA-CER to APEC. In particular, formidable political obstacles stand in the way both of an East Asian trade bloc and of liberalisation at the APEC-wide level. As noted earlier, Northeast Asia is the key to the feasibility of an East Asian trade bloc, and it is inconceivable that a trade bloc could be formed in the absence of an accommodation being reached among the three key Northeast Asian economies allowing them to liberalise trade among each other as part of the overall arrangement. There is, however, little sign that such an accommodation is likely between China and Japan in the near future. The position of Taiwan is another highly contentious issue that would presumably have to be addressed as part of any initiative to create an East Asian trade bloc. If an Asia Pacific-wide arrangement is being considered, the relationship between the three key Northeast Asian economies and the United States is likewise crucial. The political difficulties in the way of any early achievement of transPacific free trade involving these economic powers are clearly enormous, if not insuperable. By contrast, more limited arrangements offer the prospect of moving forward without the need to address these formidable political difficulties. A further potential obstacle to development of wider, more inclusive arrangements is that the evolution of multiple hub-and-spoke configurations is likely to result in competition between different PTA models favoured by the respective hubs. Each hub is likely to have preferences for features in PTAs that are likely to be unacceptable to other hubs. The US insistence on strong labour and environmental provisions and ‘TRIPs-plus’ intellectual property provisions, and Japan’s strong preference for excluding agriculture from PTAs, may be cases in point. Different systems of rules of origin are also likely to represent a significant area of difference if not incompatibility between competing models. If varying provisions become the norm within hub-and-spoke configurations, the eventual amalgamation of the separate configurations is bound to be more difficult.

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Analytical approaches to the issues also yield some discouraging conclusions. In principle a benign progression could be envisaged as occurring through one or all of the following routes: • Continued proliferation of bilateral agreements until they cover all bilateral trade flows within East Asia, and eventually within the Asia Pacific region. • Expansion or amalgamation of existing preferential trading initiatives until they merge into an East Asian trade bloc, and ultimately converge toward APEC’s trade and investment goals. • Parallel multilateral liberalisation achieved through the WTO process over a longer timeframe, eventually leading to the achievement of APEC’s trade and investment goals. Lloyd (2002) points out that achieving free trade among a large group of n economies through proliferation of bilateral trade agreements is a formidable task, requiring [n(n−1)/2] bilateral PTAs. Thus, for example, to achieve free trade among the twenty-one APEC members would require 210 bilateral PTAs. Gradual expansion and amalgamation of existing PTAs may appeal as a more efficient approach to the benign progression but is also not without its problems. While there may well be an incentive for excluded economies to seek membership of existing PTAs, as indicated in the earlier discussion of the domino effect, it is less clear that the same incentive exists for the incumbents to admit new members. Andriamananjara (1999, 2003) has pointed out that for the existing members of a PTA there are two opposing factors affecting their incentive to admit new members. On the one hand, they benefit from the expansion of the size of the market when new members are admitted. On the other hand, the entry of new members also affects them negatively by diluting their preferences in the PTA market, a point also highlighted in empirical analyses. Andriamananjara’s analysis shows that the market expansion effect tends to dominate in the early stages of the expansion of the PTA, but that eventually the preference dilution effect will take over, so that the incentive to expand the PTA peters out well before global free trade (or perhaps even APEC-wide free trade) is achieved. This is especially likely to be the case if the economies remaining to join in the latter stages of the process are small and thus offer little benefit to the existing members by way of market expansion. Economic analysis has also produced inconclusive but not especially encouraging findings on how preferential liberalisation may affect the incentives for multilateral liberalisation.12 In part the answer depends on whether the incentives are viewed from the perspective of the community as a whole, or from the perspective of the profits of domestic firms. If PTAs produce a lower level of overall economic welfare than multilateral liberalisation, then the community in at least one potential PTA member is likely to have an incentive to prefer multilateral liberalisation and thus reject the PTA option. On the other hand, trade diversionary PTAs may yield very sizeable economic rents to some domestic firms, even if their overall economic welfare effect is negative, and these rents may be larger the greater is the trade diversionary effect of the PTA. Once the PTA is in place these firms are likely to have an incentive to resist any multilateral liberalisation that would dilute their preferences and thus reduce their economic rents. PTAs may also provide an additional rallying point for opponents of trade liberalisation

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and globalisation, thus indirectly boosting the forces ranged against multilateral liberalisation. The existence of a potential benign progression, and the formidable obstacles in the way of that progression, leads inevitably to an emphasis on the importance of leadership. Bergsten (2000, 2001), among others, has emphasised the crucial role of visionary leadership in the successful achievement of any major economic integration enterprise, and concluded that such leadership will be essential also if ambitions for the establishment of an integrated East Asian economic bloc are to be realised. Strong leadership will also be needed if APEC’s trade and investment objectives are to remain realistic in the face of the current proliferation of PTAs, and of proposals for formation of economic mega-blocs on opposing sides of the Pacific. PECC (2003b) has emphasised that there can be no presumption that proliferating PTAs will lead automatically to the achievement of APEC’s goals, and has stressed the need for establishment and implementation of a common understanding of how the development of PTAs must be structured and managed in order to be genuinely consistent with those goals. Finally, continued progress in multilateral liberalisation at the WTO is essential, for at least three reasons. First, reduction of MFN barriers through multilateral liberalisation plays a vital role in minimising the trade diversionary effects of PTAs. Second, there are elements of some of the most sensitive issues, notably agriculture, that must be resolved in the WTO if these same issues are to be satisfactorily addressed in the preferential context. Third, the firm attachment of APEC’s largest economies to the principle of reciprocity in trade liberalisation negotiations, demonstrated clearly for example in the Early Voluntary Sector Liberalisation (EVSL) experience, means that APEC’s goals are unlikely to be achieved in the absence of very substantial progress on liberalisation at the multilateral level.

NOTES 1 The range is from US$35,060 per capita in the United States to US$430 per capita in Vietnam, measured at official exchange rates. The ratio of 81:1 for APEC members compares with a corresponding ratio of under 4:1 for the members of the EU15 and 11:1 for the members of the enlarged EU25. Measured at purchasing power parity exchange rates, the range among APEC members is from US$35,060 per capita in the United States to US$2,240 per capita in Vietnam, a ratio of 16:1. The corresponding ratio for the EU15 is 3:1 and 6:1 for the EU25. 2 At purchasing power parity exchange rates North America and Northeast Asia together accounted for 47.2 per cent of world GNP in 2002. 3 In Figure 9.2 the ‘wider Pacific region’ is defined to include South America, to facilitate a comparison of NAFTA export flows to East Asia with those to South America. Exports to the European Union are not included. In 2000–02 exports from Northeast Asia to the European Union were 56 per cent of exports to the NAFTA economies, while NAFTA exports to the European Union were 22 per cent higher than to Northeast Asia. 4 In 1998–2000, for example, NAFTA accounted for 23 per cent of Northeast Asian trade, compared to 22 per cent in 2000–02. Over the same period East Asia’s share of NAFTA’s trade fell from 26 per cent to 24 per cent. 5 See, for example, Scollay (2001) for a brief discussion. 6 A proposal to establish free trade between AFTA and CER lay dormant for many years, although the parties continued to pursue cooperation on trade facilitation issues. In mid-2004 the free trade initiative was revived and agreement was reached to commence negotiations.

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7 The concept of the ‘domino effect’ was initially put forward by Baldwin (1997) and has been subsequently adapted to the analysis of developments in the Asia Pacific region, for example in Scollay (2001). 8 There is currently no formal proposal for an APEC-wide PTA under active consideration by APEC governments, although a proposal for a Free Trade Area of the Asia Pacific (FTAAP) was included in the 2004 recommendations to APEC of the APEC Business Advisory Council (ABAC). The ABAC proposal is analysed in Scollay (2004). 9 See Krueger (1999) and Panagariya (1999) for surveys of the relevant literature. 10 This concept is explained in Bergsten (2002), for example. 11 Conversely, in informal discussions Japanese supporters of structural reform have suggested that PTAs offer greater prospects for making progress on liberalisation of Japanese agricultural trade, since they open the way for the argument that Japan will be ‘left behind’ in the PTA ‘game’ if its agricultural sensitivities prevent it from negotiating Article XXIVcompatible agreements. The results of Japan’s recently concluded negotiations with Mexico and the Philippines and current negotiations with Thailand may provide an interesting indication of how far this argument is borne out in practice. 12 See, for example, Bond and Syropoulos (1996), Levy (1997) and Krishna (1998). See also Findlay (2002) for a very useful survey of this literature.

REFERENCES Andriamananjara, S. (1999) ‘On the size and number of regional integration arrangements. A political economy model’, World Bank—Country Economics Department Working Paper 2117, Washington DC: World Bank. ——(2003) ‘On the relationship between preferential trading arrangements and the multilateral trading arrangements’, presented at the PECC Trade Forum, Washington DC, April, available at http://www.pecc.net/trade/trade_washington.htm. Baldwin, R.E. (1997) ‘The causes of regionalism’, World Economy 20(7):865–88. Bergsten, C.F. (2000) ‘Towards a tripartite world’, Economist, 15 July. ——(2001) ‘America’s two-front economic conflict’, Foreign Affairs 80(2):16–27, March/April. ——(2002) ‘A renaissance for U.S. trade policy?’, Foreign Affairs 81(6):86–98, November/December. Bhagwati, J., D.Greenaway and A.Panagariya (1998) ‘Trading preferentially: theory and policy’, Economic Journal 108:1128–48. Bond, E.W. and C.Syropoulos (1996) ‘The size of trading blocs: market power and world welfare effects’, Journal of International Economics 40(3–4):411–37, May. Findlay, C. (2002) ‘Old issues in new regionalism’, in P.Drysdale and K.Ishigaki (eds) East Asian Trade and Financial Integration: New Issues, Canberra: Asia Pacific Press, ANU. Gilbert, J. (2003) ‘CGE simulation of US bilateral free trade agreements’, background paper for the Conference on Free Trade Agreements and US Trade Policy, Institute for International Economics, Washington DC, 7–8 May. Gilbert, J., R.Scollay and B.Bora (2002) ‘New regional trading developments in the Asia-Pacific: implications for East Asia’, report for the World Bank project on East Asia’s Future Economy, February. Hertel, T. (1997) Global Trade Analysis: Modeling and Applications, New York: Cambridge University Press. Krishna, P. (1998) ‘Regionalism and multilateralism: a political economy approach’, Quarterly Journal of Economics 113(1):227–50, February. Krueger, A.O. (1999) ‘Are preferential trading arrangements trade-liberalizing or protectionist?’, Journal of Economic Perspectives 13(4):105–24.

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Levy, P.I. (1997) ‘A political-economic analysis of free-trade agreements’, American Economic Review 87(4):506–19, September. Lloyd, P. (2002) ‘New regionalism and new bilateralism in the Asia Pacific’, presented at PECC Trade Forum, Lima, May, available at http://www.pecc.net/trade_lima.htm. Panagariya, A. (1999) ‘The regionalism debate: an overview’, World Economy 22: 477–51. PECC (2003a) ‘Summary of results of CGE analyses of Asia-Pacific RTAs’, appendix to ‘AsiaPacific RTAs as avenues for achieving APEC’s Bogor goals’, paper presented by PECC to the APEC Senior Officials’ Trade Dialogue, Khon Kaen, 27 May (APEC Document 2003/SOM II/RTAs/FTAs/012). ——(2003b) Asia-Pacific RTAs as Avenues for Achieving APEC’s Bogor Goals, Singapore: PECC. Scollay, R. (2001) ‘The changing outlook for Asia-Pacific regionalism’, World Economy 24(9):1135–60. ——(2004) ‘Preliminary assessment of the proposal for a Free Trade Area of the Asia-Pacific (FTAAP): an issues paper for the APEC Business Advisory Council (ABAC)’, October. Scollay, R. and J.Gilbert (2000) ‘Measuring the gains from APEC trade liberalization: an overview of CGE assessments’, World Economy 23(2):175–97. ——(2001) New Regional Trading Arrangements in the Asia-Pacific?, Washington DC: Institute for International Economics. ——(2002) ‘Impact of East Asian regional or subregional FTAs’, report for Australian Department of Foreign Affairs and Trade, May. Scollay, R., F.Gonzalez Vigil and J.Gilbert (2002) ‘Mega-blocs in East Asia: how might they affect each other (and the rest of the world)?’, LAEBA Working Paper No. 8, Washington DC: InterAmerican Development Bank.

10 The rise of services trade: regional initiatives and challenges for the WTO Philippa Dee and Alexandra Sidorenko

THE RISE OF SERVICES Services are a significant part of every economy in output and employment terms. Services trade is also significant, although it is severely understated in conventional balance of payments statistics. The share of services in gross domestic product is high, even in developing economies, and rises further with the level of economic development. The World Bank’s World Development Indicators show that the share of services in total value added of the least developed countries was 42 per cent in 2000, compared with 55 per cent in the middle-income countries and 69 per cent in the high-income countries. The services industries are big employers. Table 10.1 shows that in all the selected economies but China, the share of employment in services exceeds that in industry by a significant margin. The share of employment in services is probably understated in some of the developing economies, where many services activities are informal. Services are often delivered face to face. This means that trade in services often takes place through the movement of primary factors of production—people or capital. Services trade can occur when the consumer moves to the producer’s economy. This happens most clearly with tourism services, but it also happens with services such as education and health, when the student or patient moves to another economy for education or treatment. In the language of the General Agreement on Trade in Services (GATS) under the WTO, this mode of services trade is called ‘consumption abroad’. Alternatively, the producer may move to the consumer’s economy. This also happens in education, where teachers move to another economy to teach short courses. It is also very common for professionals to travel temporarily to the economy into which they are delivering professional services. In the language of the GATS, this mode of services delivery is called the ‘movement of natural persons’ (to distinguish it from the movement of corporate or other legal entities).

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Table 10.1 Disposition of employment in selected APEC economies (per cent) Share of Share of labour force in labour force services in industry Australia 21 Canada 23 Chile 26 China 22 Indonesia 16 Japan 31 Malaysia 32 Mexico 25 New Zealand 23 Peru 19 Philippines 16 Russia 29 Singapore 29 Thailand 18 United States 23 Source: Handbook of Statistics Online, UNCTAD, www.unctad.org/statistics/handbook, accessed 20 November 2003.

74 74 60 13 39 63 50 53 68 76 45 59 71 33 75

Many other services are delivered to other economies through the ‘commercial presence’ of firms. In banking and telecommunications, for example, it is common for companies to set up a permanent corporate presence in another economy and to make their sales from their foreign affiliate. The GATS also recognises commercial presence as a mode of services delivery. This has policy significance, because it means that the GATS is a vehicle for negotiating foreign direct investment issues in the services area. Another characteristic of services is that they are intangible. This means that where services are traded in the traditional cross-border fashion, e-commerce is an important vehicle for that cross-border trade. Three of these modes of services delivery are captured, to a greater or lesser degree of accuracy, in conventional balance of payments statistics. Commercial presence is not. There have been recent initiatives, especially by the OECD, to compile statistics on the activities of foreign affiliates (the Foreign Affiliates Trade Statistics, or FATS). On the basis of these and other statistics, Table 10.2 gives a very crude estimate of the extent of global services trade. It shows that reliance on balance of payments statistics alone can underestimate services trade by more than 50 per cent. Nevertheless, conventional balance of payments measures of cross-border trade are the most common indicator of growth rates of services trade.

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Table 10.2 Trade in services by mode of supply (US$ billion) Mode of supply

Proxy measure

Cross-border supply

BOP: commercial services exports (excluding travel) BOP: travel exports FATS statistics: turnover BOP: compensation of employees

Consumption abroad Commercial presence Movement of natural persons Total Source: Karsenty (2002).

Estimate 1,000

500 2,000 50 3,550

Table 10.3 Leading exporters and importers of commercial services in the Asia Pacific region Value in 2002 (US$ billion)

Annual change in 2002 (per cent)

Exporters United 272.6 States Japan 64.9 Hong 45.2 Kong China 39.4 Canada 36.3 Korea 27.1 Singapore 26.9 Taiwan 21.1 Australia 16.7 Thailand 15.2 Importers United 205.6 States Japan 106.6 China 46.1 Canada 41.9 Korea 35.1 Taiwan 24.3 Hong 24.2 Kong Russia 21.5 Singapore 20.6 Australia 17.5 Source: Handbook of Statistics Online, UNCTAD, www.unctad.org/statistics/handbook, accessed 20 November 2003.

1 2 9 20 −2 −4 3 9 5 18 2 0 18 −2 8 3 0 16 1 7

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Table 10.3 shows that some of these growth rates have been significant, at up to 20 per cent a year. Table 10.3 shows that the United States is the biggest importer and exporter of services through cross-border trade. It is also one of the few countries to publish crossborder services trade data on a bilateral basis, as well as publishing FATS data. Table 10.4 summarises this bilateral data for 1996, the latest year for which imports through the sales of foreign affiliates are available. While in aggregate, trade by foreign affiliates equals or exceeds cross-border trade, this does not necessarily hold country by country (Table 10.4). Not surprisingly, the countries that have been major destinations for foreign direct investment (FDI) worldwide tend to be the major sources of US services imports delivered through the sales of foreign affiliates. This includes Canada, Europe and Japan. To date, the ‘other countries’ that include most APEC member economies are much less important in US imports through commercial presence than they are in US imports through cross-border trade. Conversely, the United States, as a major source of FDI worldwide, is also a major exporter of services through FDI: exports go where US FDI has gone. So Europe features disproportionately as a destination for US services exports delivered through commercial presence. To date, the ‘other countries’

Table 10.4 US trade in services by partner region, 1996 (US$ million) Cross-border trade Imports Exports

Sales of foreign affiliates Imports Exports

Canada 12,239 19,331 27,282 21,160 Europe 55,078 80,959 101,296 128,655 Latin America and other 25,589 35,486 5,474 17,457 Western Hemisphere Australia 2,553 4,491 5,886 8,821 Japan 12,940 33,274 21,398 21,921 Other countries 26,245 42,056 6,211 22,594 China 1,937 3,166 n.a. n.a. Hong Kong 3,042 3,323 n.a. n.a. Korea 4,123 7,432 n.a. n.a. Malaysia 458 1,277 n.a. n.a. Singapore 1,823 3,849 n.a. n.a. Taiwan 2,709 4,046 n.a. n.a. International 2,246 5,792 898 2,567 organisations and unallocated All countries 136,885 221,390 168,444 223,175 Note: n.a. means not available. Source: US Bureau of Economic Analysis, www.bea.doc.gov/bea/di/1001serv/intlserv.htm, accessed 13 January 2004.

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are similarly less important in US exports through commercial presence than they are in US exports through cross-border trade. The purpose of this chapter is to review some of the policy issues in services trade, and to review the progress that has been made in services trade liberalisation in various forums—multilateral, plurilateral, bilateral and unilateral. Cooper (1988) stated that remarkably little homework had been done on what the objectives of services trade negotiations should be. Substantial progress has been made since then on defining the issues, if not achieving negotiated outcomes. The chapter concludes with some observations about the most promising forums for services trade liberalisation, and the most appropriate form of support to help economies achieve the best outcomes in those forums.

SERVICES TRADE LIBERALISATION When services are traded through the movement of people or capital, the transaction typically occurs behind the border. Even when cross-border trade takes place by ecommerce, it is not easily observed by customs officials. So services transactions are not amenable to tariff protection. Instead, services trade barriers are typically behind-the-border, non-price regulatory measures. Table 10.5 gives examples of the key trade barriers affecting trade in two different services—banking and legal services. Quantitative measures of the height of these trade barriers in Pacific and other economies can be found in Findlay and Warren (2000), Kalirajan (2000), NguyenHong (2000), Doove et al. (2001), Clark et al. (2001), Earth et al. (2002) and Fink et al. (2002).

Table 10.5 Description of barriers to trade in banking and legal services Banking

Legal services

Restrictions on: Restrictions on: —number of bank licences —form of establishment (e.g., partnership) —equity participation —equity participation —joint ventures —nationality or citizenship —raising funds —licensing and accreditation —lending funds —quotas or needs tests —other lines of business —advertising and fee setting —number of branches —multidisciplinary practices —temporary or permanent movement —activities reserved by law to the of executives profession Sources: McGuire and Schuele (2000); Nguyen-Hong (2000).

The key point to note about the measures in Table 10.5 is that they do not always discriminate against foreigners. In banking, the measures that affect only foreign participants are those that restrict equity participation, require it to take the form of a joint venture with a local partner, or

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restrict the temporary or permanent movement of executives. All other measures can apply equally to domestic new entrants. These include restrictions on the number of banking licences or number of branches, restrictions on where and how banks can raise funds or lend, and on whether banks can undertake other lines of business (e.g., insurance or securities). Similarly, for legal services, a few measures affect only foreign practitioners— requirements for nationality or citizenship, and whether quotas or needs tests are applied in order to practise. Other measures can affect domestic practitioners as well. These include restrictions on equity participation, since some economies place restrictions on whether non-lawyers can have an equity stake in a law practice. They also include restrictions on the form of establishment (e.g., whether corporate structures are allowed), licensing and accreditation requirements, restrictions on advertising or fee setting, restrictions on whether other disciplines (e.g., accountancy) can be practised out of a law firm, and the reservation of certain activities (e.g., conveyancing) to the legal profession. The GATS agreement similarly recognises that services trade barriers need not be discriminatory against foreigners. It recognises a specific list of (mostly quantitative) restrictions on ‘market access’ that are not discriminatory. Many analysts have extended the definition of market access to cover all measures that are non-discriminatory. The GATS also recognises ‘derogations from national treatment’, which is GATS-speak for discriminatory restrictions. Thus a key feature of services trade barriers is that they often protect incumbent service suppliers from any competition, be it from domestic or foreign new entrants. This is the most important feature distinguishing services trade barriers. It has implications both for the economic effects of services trade liberalisation and for the political economy of services trade reform. These implications are drawn out later in the chapter. Services is also an area where market failures can occur. Natural monopoly is a characteristic of some network industries such as telecommunications and air passenger transport—it may be economically inefficient to have key bottleneck facilities provided by more than one service provider, so regulation is required to prevent the abuse of this monopoly power. Information asymmetry is almost by definition a feature of professional services—the client is not in a position to judge whether the service being delivered is of reasonable quality, so licensing or accreditation requirements can help to bridge the information gap. Similarly, there is a legitimate role for prudential regulation of financial services to ensure systemic stability, and for safety regulation in air passenger transport. In these circumstances, services trade liberalisation may not deliver the anticipated benefits if it is not supported by the appropriate domestic regulatory regimes. For example, liberalising market access in financial services may not generate benefits if prudential regulation is either too heavy handed or too light handed. Similarly, allowing market entry in telecommunications may not reap benefits if new entrants cannot get access to the incumbent’s bottleneck facilities—the local loop—on reasonable terms. The GATS recognises the right of individual governments to regulate, but requires that domestic regulatory regimes be the ‘least burdensome’ necessary to achieve their objectives. A counterexample would be a requirement for foreign health professionals to retrain in a new economy. Here the legitimate domestic objective of ensuring quality could be achieved by the less burdensome requirement to resit a qualifying examination.

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While services are typically not protected by tariffs, services trade barriers may or may not be tariff-like, in the following sense. Some regulatory trade restrictions, particularly quantitative restrictions, create artificial scarcity. The prices of services are inflated, not because the real resource cost of producing them is high, but because incumbent firms are able to earn economic rents. Liberalisation of these barriers would yield ‘triangle gains’ in producer and consumer surplus associated with improvements in allocative efficiency, but would also have redistributive effects associated with the elimination of rents to incumbents. As Dee and Hanslow (2001) demonstrate, the former effects would not be trivial, but the latter effects could also be significant. Such rentcreating restrictions are tariff-like, with the redistribution of rent having effects similar to the redistribution of tariff revenue. Alternatively, services trade restrictions could increase the real resource cost of doing business. An example would be the above requirement for foreign service professionals to retrain in a new economy. Liberalisation would be equivalent to a productivity improvement (a saving in real resources), and yield roughly ‘rectangle gains’ associated with a downward shift in supply curves. This could increase returns for the incumbent service providers, as well as lowering costs for users elsewhere in the economy. The distinction is critical, for two reasons. First, in a unilateral or multilateral setting, rectangle gains are likely to exceed triangle gains by a significant margin, especially given the importance of the services sector in most economies. Second, in the context of preferential trading agreements (PTAs), the danger of net welfare losses from net trade diversion arises only if the relevant barriers are rent creating. This second argument is elaborated further below.

RATIONALE FOR RECIPROCITY Services trade liberalisation can take place unilaterally, or in multilateral or plurilateral forums. Before examining recent developments and prospects in each forum, it is worthwhile reviewing the case for reciprocity—that is, the case for using plurilateral or multilateral forums—in light of the special features of services trade liberalisation mentioned above. There are two rationales in the literature. One is the mercantilist rationale in either its naive or more sophisticated forms, both parodied by Krugman (1997), and another is the economic rationale outlined by Bagwell and Staiger (1999). The naive mercantilist view is ‘exports good, imports bad’. Thus liberalising import restrictions is seen as imposing a cost, which must be compensated for by receiving a similar concession from a trading partner. Of course, economic theory suggests that, in a world of perfect substitution, a small open economy will in fact gain from unilaterally lowering its import restrictions—what it loses in tariff revenue is more than made up for by access to lower-priced imports for use at home. However, this comes at the cost of some disruption in production in the domestic import-competing industry. So the more sophisticated version of the mercantilist view is that reciprocity is required for political economy reasons, to buy off the sectional interests in the import-competing industry. This presupposes that these sectional interests can be bought off by the prospect of gains to some other export sector, even though they cannot be bought off by gains to consumers.

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Clearly, when services trade barriers are tariff-like and discriminatory, the logic applies in the same way. But if services trade barriers are non-discriminatory, or are cost escalating, the need for reciprocity is less clear. If trade barriers are primarily market access barriers affecting any new entrant, then the domestic import-competing industry can be too small, not too big. Liberalisation can encourage additional entry by either wholly domestic firms or foreign multinationals into domestic production, and this can offset additional competition from cross-border trade, to the extent that this is also a feature of the market. Where heavily impeded cross-border trade is relatively unimportant (as is the case for many services), the size of the domestic industry can be bigger after liberalisation than before. The sophisticated mercantilist argument for the need to buy off adjustment pressures would still apply if it was the incumbent that needed to be bought off. But again, this presupposes that the incumbent could be bought off by the prospect of gains to some other export sector, even though they could not be bought off by gains to consumers and to other domestic new entrants. It is the concern of some developing countries that liberalisation of non-discriminatory market access barriers would encourage entry by foreign multinationals instead of domestic firms, and that given this first-mover advantage, this could prevent successful domestic firms from ever emerging. If the output of domestic firms and foreign multinationals were perfectly substitutable, this argument might have force. But services are highly differentiated products: • Services are commonly differentiated by economy. A domestic telephone call in the United States is not the same as a domestic telephone call in Australia, because the former may be between Washington and Los Angeles whereas the latter may be between Sydney and Melbourne. Similarly, the practice of law differs in the two economies, because the legal systems and legal traditions differ. What is more, some of the relevant trade restrictions in legal services are precisely to do with whether foreign legal professionals are able to practise host-economy law, home-economy law or international law in the host economy. • Services are also commonly differentiated by firm. This is because the production of services often involves firm-specific human capital. Microsoft is not the same as any other software firm because Bill Gates is not the same as any other software proprietor. And the development and maintenance of Microsoft required considerable fixed and sunk expenditure in research and development and other ‘headquarters services’. Thus the relevant industrial organisation model for services is the same model of firm-level product differentiation and economies of scale that has been used to characterise the multinational manufacturing enterprise (e.g., Markusen 1995). • Not only are services differentiated by economy and firm, they are also differentiated to the needs of individual customers. The legal services that a solicitor provides to an individual are not precisely the same as the services provided to all other clients, because all clients are unique. This characteristic was noted by Ethier and Horn (1991), and is one level of product differentiation below that now included in most trade models. This characteristic seems to be implicit in the choice of nesting structure of demand for varieties in some more recent models of services trade. This issue is discussed in more detail in Dee (2003).

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With services being highly differentiated, and with local service firms having a comparative advantage in tailoring services to meet local needs, it is not clear that foreign multinationals would always have the edge. But it is equally clear that in some key infrastructure sectors, such as banking and fixed-line telecommunications, they could. However, empirical research also shows that in these sectors contestability of the market by foreign multinationals, if not actual entry, does add significantly to economic performance, in terms of lowering prices to downstream users (Warren 2000; Kalirajan et al. 2000). In these circumstances, protecting the market for local players could impose a significant cost on the rest of the economy. A similar argument holds if trade barriers are primarily cost escalating. In this case, trade liberalisation can benefit everyone, even the incumbent. If there are sectional interests that need to be bought off, they are the people whose livelihoods depend on feeding the bureaucratic and red-tape processes associated with administering the costescalating barriers. They typically do not feature at the top of lists of political influence. The economic argument for reciprocity, as outlined by Bagwell and Staiger (1999), is a terms-of-trade argument. Many commentators are willing to dismiss such arguments as being irrelevant for small open economies. Such dismissal may be warranted in a world of perfect substitution. But as noted, services are highly differentiated products, so even small open economies may have some market power in the services they provide. In goods trade the rationale is that while tariff liberalisation will yield an unambiguous triangle gain in allocative efficiency it can also yield a terms-of-trade loss. So reciprocity creates a countervailing terms-of-trade effect in the other direction and can guarantee a Pareto improvement without the need for compensation. In services trade the argument will hold force if liberalisation yields a terms-of-trade loss. To the extent that services are delivered through commercial presence, the relevant prices are local prices and terms-of-trade effects are not relevant. If the barriers are cost escalating, it is much more likely that the rectangle gains from liberalisation would dominate any terms-of-trade losses. So again, the case for reciprocity is missing. Mattoo and Fink (2002:2) have used these arguments to show that preferential liberalisation of services trade on a bilateral or plurilateral basis is likely to provide gains to an economy, relative to the status quo: Compared to the status quo, a country is likely to gain from preferential liberalisation of services trade at a particular point in time—as distinct from the more ambiguous conclusions emerging for goods trade. The main reason is that barriers are often prohibitive and not revenue generating, so there are few costs of trade diversion. However, they note that non-preferential liberalisation is likely to produce larger gains than preferential liberalisation. Further, the sequence of liberalisation matters more in services trade than it does in goods trade (more on this later). The above arguments have shown that if a country is likely to gain from preferential liberalisation of services trade, relative to the status quo, it is primarily because the case for reciprocity is less strong than for goods trade—a country is more likely to gain, and

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arguably have fewer adjustment costs, if it liberalises its services on a unilateral basis, compared with the more ambiguous conclusions emerging from goods trade.

CHALLENGES FOR THE WTO The challenge for the WTO is clear. The GATS agreement was a monumental achievement in recognising what really mattered for services trade. It looked beyond conventional cross-border trade, and in recognising other modes of delivery put the contentious issues of investment and immigration directly on the negotiating table. It looked beyond discriminatory measures, and so put the issues of domestic regulatory regimes directly on the negotiating table. Yet these are issues that trade negotiators are not well equipped to deal with. And this is leaving aside questions of the limitations of the GATS architecture, which also contribute to a lack of reform momentum. How have services negotiations fared in a WTO context? Not surprisingly, most offers to date are standstill offers, even from the OECD economies, doing no more than offering to bind what has been achieved by unilateral liberalisation since the Uruguay Round. While the services negotiations are currently held hostage to other negotiating agenda items in the WTO, they have been advancing along two major paths. The mainstream negotiations on specific commitments have been conducted using bilateral requests and offers. In parallel, outstanding rule-making issues are being discussed. The Working Party on Domestic Regulations has been given the mandate to develop horizontal disciplines under GATS Article VI:4. Emergency safeguards, government procurement and subsidies in services are being dealt with by the Working Party on GATS Rules. Recognition of autonomous liberalisation and special treatment of the least developed countries (LDCs) have also been on the agenda of the Council for Trade in Services, with some significant breakthroughs achieved in the run-up to the WTO Ministerial Conference in Cancun. Negotiations on the outstanding rule-making issues, except for the safeguards, are scheduled to be completed by 1 January 2005, prior to the conclusion of the negotiations on market access. The deadline for emergency safeguards has been extended until 15 March 2004. Domestic regulation The major challenge for GATS rule making on domestic regulation has been to agree on the design of domestic regulation so that legitimate regulatory objectives are fulfilled without creating unnecessary barriers to trade in services. The work program on GATS Article VI:4 has evolved around developing horizontal disciplines for technical standards and for qualification and licensing requirements and procedures. Several instruments have been tested as a model for developing such horizontal disciplines. In the current GATS architecture, the article on domestic regulation concerns only non-discriminatory measures; that is, if no national treatment commitment is undertaken in the country schedule of specific commitments, there is little recourse to Article VI. If a domestic regulatory measure impedes market access, it can be protected by being listed as a limitation under Article XVI. If it impacts discriminatorily on foreign service providers, then it can be protected by being scheduled under the negative list of

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exemptions to national treatment under Article XVII. If the regulation is not listed as a limitation on market access or national treatment, then Article VI provides general disciplines requiring that it not be an unnecessary barrier to trade. There is a divide among GATS’ members on whether any horizontal disciplines for domestic regulation of services should be applicable across all sectors, or limited to committed sectors only, as Article VI:1 implies. Apart from the debate about the coverage of Article VI, there is also an issue of whether regulatory disciplines should be horizontal or sectoral. Sidorenko and Findlay (2002) discuss the issue in more detail. In summary, major benefits of horizontal disciplines include the reduction in the probability of regulatory capture, disentangling unnecessary policy linkages, potentially greater degree of liberalisation and automatic inclusion of new services. Systematic approaches to building horizontal disciplines at the multilateral level that maintain the national right to regulate involve: • an open international dialogue of domestic regulators and competition authorities to explore whether meaningful horizontal disciplines can be developed; • building a judicial system in which the key principles/disciplines are bound in an international agreement (such as the GATS), voluntary guidelines established as a benchmark for domestic policymaking, and other private and public bodies and associations left to develop sector-specific standards; and • developing horizontal disciplines along the lines of safeguarding the contestability of markets while recognising the national regulatory sovereignty in the areas pertinent to health, safety and prudential objectives. To strengthen GATS Article VI, proposals have been made to require explicit statement of the policy objectives achieved by a regulation, to clarify the concept of ‘quality of service’ and to ensure that regulation is limited to the minimum necessary. Performancebased regulations, market-based regulations and self-regulation by the industry are to be encouraged. Several instruments could be used to provide a starting point on developing horizontal disciplines for domestic regulation of services. The GATS Reference Paper on Telecommunications Services formulates regulatory disciplines for basic telecommunications that can be extended to other network services. These include competitive safeguards (access to essential facilities), transparency of the administration of any social objectives such as universal service obligations, transparency of licensing requirements and criteria for allocation of scarce resources, and an independent regulator. Regulations that are formulated in order to prevent other instances of market failure can be disciplined by a generalised necessity test. The Disciplines on Domestic Regulation in the Accountancy Sector adopted by the Council for Trade in Services on 14 December 1998 provide an example of a necessity test, as well as other principles that can be extended on a horizontal basis, such as transparency, including provision for a member to request information from another member on the rationale behind the domestic regulatory measure, and for prior information and an opportunity to comment on a proposed measure. The disciplines for accountancy state that licensing and qualification requirements and procedures should not be impediments in themselves, and should serve legitimate objectives. Technical standards should also be designed only to fulfil legitimate objectives.

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Emergency safeguards The emergency safeguards agenda has been pushed by the ASEAN economies, with the argument that such safeguards would lure more developing countries into making market access commitments that they otherwise would be reticent to schedule. The European Union and the United States are opposed to the concept of emergency safeguards in services, arguing that such measures applied to commercial presence would undermine investor confidence in the country and hence would impede the flow of foreign direct investment. The US Coalition of Service Industries (CSI 2002) argues that safeguards do not work in the services sector as data collection problems make it difficult to demonstrate a surge in imports, especially for cross-border trade. The deadline for negotiation on emergency safeguards has been extended to 15 March 2004, but there has been little progress so far in attaining common ground within the Working Party on GATS Rules. Subsidies Very little progress has been made to date with respect to subsidies in services. Yet to be clarified is the definition of subsidies in services, as well as the applicability of any multilateral disciplines to services supplied partially by the government. Some argue that the extent of trade distortion arising from the presence of subsidies should be weighed against the developmental objectives of developing countries, especially in the areas where domestic support programs are aimed at achieving social policy objectives. Government procurement The in-built agenda on government procurement in services has been interpreted differently by developed and developing countries. Developed countries aim at pursuing multilateral disciplines on the general principles of non-discrimination (most favoured nation and national treatment) and market access applied to government procurement in services, while developing countries perceive that these issues are explicitly outside the mandate, and that transparency in government procurement of services should be handled as part of the negotiations over the Singapore issues. Autonomous liberalisation The GATS requires a method to be established by which members would obtain recognition for liberalisation undertaken autonomously. In March 2003 the Council on Trade in Services approved a method to be applied in the current round of negotiations. Credits for unilateral liberalising efforts would be granted through bilateral negotiations. Unilateral liberalisation measures would be assessed using both qualitative and quantitative approaches. Criteria for evaluation of the autonomous liberalisation include the extent of sectoral coverage, the liberalising nature of the measure (its impact on market access, elimination of measures inconsistent with most favoured nation and national treatment), its duration and economic significance. Credits granted for unilateral liberalisation can take several forms, including a liberalising measure taken by a trading

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partner of the member, or refraining from pursuing a request to the liberalising member, or any other measure agreed upon in bilateral negotiations. Special treatment for LDCs Methods for ensuring special and differential treatment of LDCs in services liberalisation were adopted by the Council on Trade in Services on 3 September 2003. Examples include flexibility to open fewer sectors and liberalise fewer types of transactions. LDCs are not expected to make full national treatment commitments or to respond to the requests for ‘additional commitments’ that would stretch their administrative and institutional capacity. Other members are encouraged to engage in capacity building and technical assistance activities in order to facilitate LDCs’ engagement in international trade in services and to strengthen their domestic services capacity, in terms of capital, infrastructure and human resources. Members are also asked to extend commitments to market access in mode 4—the movement of natural persons—as requested by LDCs. Movement of natural persons The lack of commitments by developed countries to liberalise mode 4 has become a matter of frustration for developing countries. Proposals on domestic regulation by Japan and the European Union received criticism from several developing countries for avoiding discussion of mode 4 and relevant domestic regulation concerning visa procedures and requirements. Mode 4 liberalisation sought by developing countries covers not only professional service providers but also less-skilled workers in the services sector. Developing countries perceive that there are enormous economic benefits from freeing the movement of labour between developed and developing countries. Analysis of the effects of liberalising the temporary movement of natural persons is provided in Chanda (2001), Winters et al. (2003) and OECD (2003). Using the GTAP model, Winters et al. (2003) estimate that an increase in inflow of temporary skilled and unskilled foreign workers from developing countries, equivalent to 3 per cent of the total labour force of the developed countries, would generate an increase in world welfare of US$156 billion a year, shared between developed and developing countries. Notably, the largest gains to both developed and developing countries are attributed to the liberalisation of restrictions on unskilled rather than skilled labour. Chanda (2001) and Winters et al. (2003) discuss the major impediments to mode 4 trade in services. They are: • lack of transparency in regulation, licensing and work permits/visa arrangements for foreign service providers; • lack of recognition of qualifications, work experience and training; • differential treatment of foreign service providers; and • economic needs tests applied to foreign workers/service providers. Current GATS commitments in mode 4 are horizontal, mostly restricted to intra-company transferees, managers and specialists employed by a foreign service provider operating through commercial presence. Developing countries would like to see the issue delinked from commercial presence and with less of a bias toward high-skilled occupations. They

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proposed to introduce a model schedule for mode 4 commitments that would include new categories of service providers such as contractual service suppliers and independent professionals. It is proposed that existing horizontal commitments on mode 4 be strengthened with sector-specific commitments in the modes where trade in mode 4 is predominant and further liberalisation is sought (e.g., professional and business services). Administrative impediments to mode 4 trade include lack of transparency and procedural hurdles in obtaining visas and working permits. It has been proposed by the developing countries that a special ‘GATS visa’ should be introduced to streamline temporary movement of service providers. Economic needs tests have been criticised as artificial barriers preventing free movement of labour. Lack of recognition of qualifications and prior experience affects movement of skilled labour significantly. Progress in domestic regulation may be helpful in addressing this issue in relation to mode 4. In summary, negotiations on market access and rule making in services have yet to fulfil the mandate of the Doha Development Agenda. Given the apparent lack of consensus within the WTO currently on other major items such as agriculture, cotton and the Singapore issues, opinions were voiced that perhaps there should be a departure from the ‘single undertaking’ approach that nothing can be agreed until everything is agreed. Instead a substructure within the WTO could be created to allow those prepared to take extra steps toward liberalisation to bind them in a plurilateral agreement, creating a ‘WTO I’ and ‘WTO II’ structure (EC 2003). Whether such a structure would be consistent with the Doha Development Agenda remains open to debate. In particular, moving services out of the single undertaking could set an unfortunate precedent, while the benefits would be minor so long as negotiations yielded only standstill offers.

REGIONAL INITIATIVES—PREFERENTIAL TRADING ARRANGEMENTS Since the stalling of the WTO negotiations in Cancun, major players including the United States have stated their intention to pursue trade liberalisation through formal PTAs on either a bilateral or plurilateral basis. The economic analysis of PTAs in goods trade challenges the presumption that they are a step in the right direction.1 It concludes that although PTAs ease one economic distortion, namely, the average tariff on imports in general, they exacerbate another, namely, the geographical disparity in import tariffs. This is a classic situation of ‘second best’, with no clear presumption in favour of gains to either PTA members or the world as a whole. As noted earlier, Fink et al. (2002) have argued that the PTA route is more likely to lead to economic gains for services trade than for goods trade. But there is still the possibility of second-best welfare losses under the following combination of circumstances: • Preferential liberalisation. Note that not all services trade barriers are amenable to liberalisation on a preferential basis. For example, undertakings to more strongly enforce intellectual property rights, or to establish competition policy law, cannot be made on a preferential basis.

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• A trading partner who is not the world’s best producer of the particular service. • Liberalisation of measures that are tariff-like. As noted above, not all services trade barriers fall into this category. And as Baldwin (1994) has shown, liberalisation of cost-escalating trade barriers is always welfare enhancing, even if the trade partner is not the least-cost supplier. Preferential liberalisation of tariff-like measures with a trade partner who is not the world’s most efficient producer is problematic because a country can lose all the rents from the trade barriers, without receiving adequate compensation in the form of lower prices to consumers. This is the essence of the trade diversion problem in services. This loss could be offset if there was a sufficiently higher volume of trade with the new trade partner than with the old, so that the triangle gains in producer and consumer surplus from the higher trade volume offset the uncompensated loss of rents—trade creation could outweigh trade diversion. But the outcome is ambiguous. Adams et al. (2003) examined the effects of the trade and non-trade provisions of eighteen extant PTAs on bilateral trade and foreign direct investment flows of a number of countries over the period 1970–97 (for trade) and 1988–97 (for investment). It was not possible to examine the effects of services trade provisions on services trade flows directly, because no comprehensive bilateral services trade data exist. But the effects on investment flows are suggestive because, as Karsenty (2000) notes, a significant proportion of foreign direct investment is in service industries, supporting trade through commercial presence. Adams et al. confirm that the traditional merchandise trade provisions governing agricultural and industrial goods have tended to cause net trade diversion. Of the eighteen agreements studied in detail, twelve had diverted more trade from non-members than they had created among members. What is more, some of the apparently quite liberal PTAs—including the EU, NAFTA and MERCOSUR—had failed to create significant additional trade among members (relative to the average trade changes registered among countries in the sample). Part of the reason for the more negative finding than in previous studies was the more rigorous statistical test that was applied to ascertain whether intra-bloc trade was significantly greater after bloc formation (or expansion) than before. In the past, this was assessed, at best, only by reference to point estimates from various cross-sections. But the finding is also consistent with the observation that many of the provisions needed in preferential arrangements to underpin and enforce their preferential nature—such as rules of origin—are in practice quite trade restricting. The paper also examined the scant theoretical literature on the possible effects of nonmerchandise trade provisions, including those on services, investment, competition policy, government procurement, intellectual property rights, and the temporary and permanent movement of people. While the paper noted some of the above reasons why conventional concerns about trade diversion may be less important for services than for goods trade, it also noted circumstances where concerns remained. First, in an increasingly integrated world economy, even minor trade concessions could have a significant impact on investment flows. And if investment was attracted into one PTA partner in order to serve the markets of the others, then the trade from such ‘beachhead’ positions could constitute traditional trade diversion.

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Second, the non-trade provisions of PTAs, particularly those related to investment and services, could also have a significant impact on investment flows. But the preferential nature of the PTA provisions could mean that investment was diverted from a low-cost to a higher-cost host country, and such investment diversion could also be harmful. The analysis in Adams et al. (2003) is among the first to check these propositions empirically. It found little evidence of beachhead investment, or an unwinding of ‘tariffjumping’ investment, in response to the trade provisions of PTAs. In an update by Dee and Gali (forthcoming), only for SPARTECA (the South Pacific Regional Trade and Economic Cooperation Agreement) and the Andean Pact was there (weak) evidence of foreign direct investment responding in beachhead fashion to trade provisions. And only for EFTA (the European Free Trade Association) and CER (the Closer Economic Relations Agreement between Australia and New Zealand) was there some evidence of an unwinding of tariff-jumping investment. There was evidence that foreign direct investment responded significantly to the nontrade provisions of PTAs. And in five of the nine PTAs examined by Dee and Gali for investment effects, the non-trade provisions led to net investment creation. Although it was a weak test, this suggested that on balance, the non-trade provisions of these PTAs had created an efficient geographic distribution of FDI. This was consistent with the fact that at least some of the non-trade provisions were not strongly preferential in their nature. And if the non-trade barriers were cost escalating rather than rent creating, then preferential liberalisation would be beneficial, even in the absence of net investment creation. However, the trade that may have been generated from the new FDI positions may still have been diverted in the ‘wrong’ direction in response to the trade provisions of PTAs, and may therefore have contributed to the net trade diversion found in the paper. There are additional cautions about the finding that the services and other non-trade provisions of PTAs are more likely to be beneficial than the merchandise trade provisions. The first is the objection by Mattoo and Fink (2002:3) that the sequence of liberalisation matters more in services trade than it does in goods trade: In particular, the benefits of eventual non-preferential liberalisation may be different if it is preceded by preferential liberalisation. This is because location-specific sunk costs of production are important in many services, so even temporary privileged access for an inferior supplier can translate into a long-term advantage in the market. Thus, while the elimination of preferences may lead to a relatively painless switch to more efficient sources of goods supply, the entry of more efficient service providers may be durably deterred if their competitive advantage does not offset the advantages conferred by incumbency. A second objection comes from several recent papers on game theory in trade reform that examine whether preferential liberalisation is indeed likely to be followed by nonpreferential liberalisation. Some partial answers to these questions were provided by Krugman (1993), Deardorff and Stern (1994), Baldwin (1996), Levy (1997) and Krishna (1998). The most recent

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comprehensive analyses by Zissimos and Vines (2000) and Andriamananjara (2002) acknowledge that joining a PTA may be the best safe-haven strategy when other countries are doing so. But they find that since PTA membership confers a terms-of-trade gain to members at the expense of non-members, at least some members will be better off limiting PTA membership than allowing expansion to cover the world as a whole. These are further developments of the arguments about the negative externalities from terms-oftrade changes developed by Bond and Syropoulos (1996) and Bagwell and Staiger (1998, 1999), among others. In a sense, the situation is worse than a true prisoners’ dilemma. In a prisoners’ dilemma, every country would be made worse off by non-cooperative behaviour, so every country would have an incentive to agree in the WTO to instead act cooperatively. The findings of Zissimos and Vines (2000) and Andriamananjara (2002) suggest that at least some countries are better off acting non-cooperatively toward third parties in preferential arrangements than they are acting cooperatively in seeking multilateral free trade. The finding casts doubt on the likelihood of a successful redesign of the WTO rules disciplining the formation of PTAs. A final caution is that the theoretical literature on PTAs assumes that the preferential liberalisation removes all trade barriers against PTA partners. The WTO rules do contain a requirement that in PTAs among developed countries, ‘duties and other restrictive regulations of commerce’ should be eliminated on ‘substantially all trade’ in goods. The vagueness of this provision imposes little discipline, with PTAs as long-standing as the EU agreement containing significant exclusions for significant periods of time. The GATS agreement contains a similar Article V for services requiring ‘substantial sectoral coverage’, and the ‘absence or elimination of substantially all discrimination’. However, the article contains no requirements with respect to non-discriminatory market access restrictions or domestic regulatory regimes. In effect, this sanctions services provisions in PTAs that are explicitly about the redistribution of rents, rather than the introduction of additional competition to a sector. Under these circumstances, it is not surprising that PTA forums have been no more successful than the WTO in achieving significant services trade liberalisation, as Sauvé (2002) finds. But what is more, conceding to PTA provisions of this nature is unlikely to be the best safe-haven strategy under any circumstance. A concrete example is provided by the requests made by the United States in audiovisual services in recent PTAs. These have focused on freeing up local content requirements. But the broadcasting sectors in many countries are typically the subject of a much broader range of anti-competitive regulation than that. Further, some argue that there is a legitimate market failure rationale for local content regulation, at least in culturally sensitive sectors such as drama, documentaries and children’s broadcasting. A Productivity Commission study of the Australian broadcasting industry (Productivity Commission 2000) identified a number of additional entry barriers, including: • the profligate allocation of spectrum to incumbents, limiting that available to new entrants; • a regulatory ban on the entry of new television stations until 2006; • controls on foreign ownership;

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• cross-media rules preventing mergers between traditional media businesses of newspapers and free-to-air commercial radio and television, which prevented undue concentration in old media businesses, but did nothing about the new; and • ‘anti-siphoning’ rules, designed to ensure free-to-air coverage of major sporting events and preventing their migration to pay television, but having the perverse effect of reducing rather than increasing total customer access to broadcast sport. In the absence of measures to liberalise some of these more fundamental restrictions on competition, Australia’s relaxation of its local content restrictions would risk handing rents to foreign media producers without offsetting benefits to the Australian viewing public. And if Australians are ever to be persuaded to dismantle the additional barriers to competition in broadcasting, with the disruption to incumbents that this would cause, it is likely to be because they are persuaded of significant benefits to the Australian viewing public in terms of lower costs and greater diversity, not because of a relaxation of beef quotas into the United States.

OTHER REGIONAL INITIATIVES Not all regional initiatives are preferential—Asia Pacific Economic Cooperation (APEC) is an example of a non-preferential trading arrangement. APEC members are to liberalise on a most-favoured-nation basis so that non-APEC members will also receive equal access to APEC markets. This is in sharp contrast to a traditional free trade agreement or customs union, which are preferential in nature. In principle, APEC goes beyond WTO commitments, but is non-binding to members. Its major principle is unilateral reform. Members have endorsed the common liberalisation targets, and have full autonomy over the reform path pursued to meet these goals (the ‘concerted unilateralism’ effort). Much of the APEC agenda focuses on encouraging members to voluntarily enhance their WTO commitments in both goods and services. Several APEC initiatives illustrate how voluntary cooperation in the area of professional standards and recognition of qualifications and experience may contribute to liberalisation of the movement of professionals within the region. These programs include the APEC Business Travel Card and APEC Engineer programs. The APEC Business Travel Card program has been developed to facilitate the movement of business persons travelling frequently to conduct trade and investment activities in APEC economies by providing pre-cleared entry to participating economies as well as streamlined immigration control on arrival. Currently there are fourteen APEC economies participating in the scheme,2 although the eligibility criteria are sufficiently tight and advantages offered sufficiently few that there are few individual card holders. The APEC Engineer program has been established in eleven APEC member economies3 to facilitate cross-border mobility of professional engineers. Effectively there is an international standard established for accreditation of the engineering teaching programs and recognition of degrees and experience. An agreement on mutual recognition of engineering qualifications was signed in 1989 (the Washington Accord). The Washington Accord and the Engineering Mobility Forum (EMF) are distinct from the APEC Engineer initiative but are closely involved in coordination and mutual

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harmonisation of professional standards. Each participating economy maintains its own APEC Engineer Register. In August 2003 there were 467 members on the Australian Engineer Register, representing less than 5 per cent of those registered with the National Professional Engineers Register (NPER) but, according to NPER, there is a keen interest among the export-oriented engineering professionals to join the APEC Engineer Register. Several APEC member economies have recently expressed interest in liberalising trade in health services, including mode 4—movement of health service providers. Major impediments to the movement of professional health service providers (medical practitioners, dentists and nurses) are: • registration and licensing requirements and procedures for foreign-trained medical practitioners, including fees; • lack of agreement on mutual recognition of medical degrees; • limitations on the ability of foreign-trained practitioners to attract public/ private insurance benefits; • limitations on the mobility of locally trained medical practitioners (e.g., requirements to serve a certain time after graduation in certain areas, quotas); and • limitations on the mobility of foreign-trained practitioners (e.g., economic needs tests in granting work permits to foreign doctors, dentists and nurses, quotas). Many developing countries are looking at health tourism as a major export growth area. Singapore has announced its ambition to become a healthcare hub in Asia, planning to secure 2 per cent of the Asian healthcare market by 2007, increasing to 3 per cent by 2012 (Sidorenko and Findlay forthcoming). In Malaysia, another exporter of health tourism, foreign fee-paying patients represented 4.5 per cent of total patients in 2001. Other countries such as the Philippines and Indonesia have abundant human resources and are becoming the major source countries for trained nurses, recruited not only within the region but also in Europe and North America. The APEC Group on Services is discussing a proposal by Indonesia to develop APEC professional standards for nursing, in order to facilitate the movement of professional nurses within APEC. Harmonisation of nursing standards has been implemented in the Caribbean, and in East, Central and Southern Africa. The International Council of Nurses has been involved in developing standards for generalist nurses, and is planning to develop further standards for family nurses. Internationally accepted standards provide a useful benchmark for the local professional nursing bodies and contribute to the process of harmonisation. An alternative route to harmonisation of standards (which is often criticised for yielding the ‘lowest common denominator’ level of standard) is through Mutual Recognition Agreements concluded between like countries, such as those existing in the European Union and the Trans-Tasman Mutual Recognition Arrangement between Australia and New Zealand. It is worth noting that even in like economies such as Australia and New Zealand, complete harmonisation of standards has not been achieved, not even at a national level. In summary, there is a scope for non-preferential regional trade arrangements to provide useful testing grounds for exploring liberalising steps that can be further extended on a most-favoured-nation basis and bound in the WTO. As discussed earlier, the proposal for the ‘GATS visa’ matches the existing APEC Business Travel Card program, although the eligibility criteria for the proposed GATS visa are less demanding

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than those in the APEC program. Similarly, development of common APEC standards for professional training and core competencies (such as for engineers and perhaps nurses) creates opportunities for internationalisation of standards and, hence, for removing one of the significant barriers to the mobility of professional service providers. Back to basics—services trade liberalisation as domestic microeconomic reform The above review of achievements in various forums suggests that progress on services trade liberalisation in multilateral and plurilateral forums has been disappointing, except where the plurilateral initiatives have been voluntary and non-preferential. To some commentators, this has spelt disenchantment with either WTO or PTA forums, as they are currently constructed, as means of achieving liberalisation. And they have looked to reforms of the rules governing those forums as a possible solution. But as this chapter has argued, the fundamental problem is not with the architecture of the GATS or the nature of the WTO rules disciplining the formation of PTAs. The fundamental problem is that the logic for reciprocity in services trade liberalisation is absent—or is at least substantially weaker than for goods trade. A recent paper by Dee and Nguyen-Hong (2003) reviewed the Australian experience with domestic microeconomic reform in four key infrastructure sectors—financial services, communications, air transport and maritime. It catalogued the policy reforms of the 1980s and 1990s under three headings now familiar from the GATS—market access measures, national treatment measures and domestic regulatory reforms. The breakdown in terms of numbers of pages was instructive—just over half the measures were domestic regulatory reforms, involving overhauls of prudential regulations, establishment of access regimes for essential infrastructure, and so on. One-third were market access measures increasing the contestability of markets. And only one-sixth were the national treatment measures that are the ‘bread and butter’ of the current generation of trade negotiators, whose training has typically been in the field of goods trade. And what is significant, these Australian reforms were achieved unilaterally, under the rubric of domestic microeconomic reform. The Australian political process delivered these reforms because Australians were persuaded that they were in the best interests of the majority of Australians, and that the adjustment costs on those harmed by the reforms could be accommodated by existing social safety nets, by phasing in changes, or occasionally by special adjustment assistance arrangements. In part, Australia had no choice but to take the unilateral route, because until recently its main trade negotiating interest—agriculture—was off the negotiating table at the WTO. But it is doubtful that Australia would have achieved the same microeconomic reforms just because of the arm-twisting of trade partners. And it is hard to imagine how it could have been in Australia’s trading partners’ interests to sequence the reforms in the best way for Australians. In some industries, such as telecommunications, the reform sequence has been particularly long and complex. The establishment of an access regime for essential infrastructure has required the dismantling of retail price regulation in telecommunications, so as to allow for reasonable subscriber access charges, in addition to use-based call charges. This is because only when incumbents are covering the cost of the essential facility—the local loop—from

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subscribers in this way will they be willing to make it available to competitors on reasonable terms. But dismantling retail price regulation has required the establishment of alternative means to achieve the policy objective it was designed to deliver—universal service to all Australians at the same price, regardless of cost. Universal service is now funded by a financial contribution from all carriers, rather than from cross-subsidies built into the incumbent’s retail price regime. The WTO Reference Paper on Telecommunications Services recognises the need for cost-based access regimes for essential infrastructure. But it is silent on these sequencing issues, which need to be worked out within each economy. This chapter is not arguing to take services trade liberalisation out of the WTO. But it is arguing that the slow progress in that forum is simply to be expected. Some economies have a long way to go in implementing the appropriate domestic regulatory regimes and increasing the general contestability of the market. It is critical that they do this before offering up their national treatment restrictions to negotiation—otherwise, they are risking handing economic rents to foreigners for no return. It is also critical that they win the regulatory reform debate internally, rather than through arm twisting from trade partners. For while trade partners may have a common view about outcomes, they need not always have a common view about sequencing and the need for collateral reforms elsewhere. So what is required in the short term is capacity building to help economies win the internal debate. Only then should these economies be expected to come to the negotiating table to offer up their national treatment barriers in a multilateral forum. And in the meantime, they need to recognise many PTA proposals for what they are—proposals to redistribute rents, rather than to assist in genuine services trade liberalisation.

NOTES 1 The seminal work is Viner (1950). Other early contributions came from Gehrels (1957); Lipsey (1957, 1958); Johnson (1960); Mundell (1964); Corden (1972); and Riezman (1979). Comprehensive surveys of the literature are available in Baldwin and Venables (1995); Pomfret (1997); Bhagwati et al. (1999); and Panagariya (2000), among others. Two recent policy-oriented reviews are by the WTO (1995) and the World Bank (2000). 2 Australia, Brunei, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Peru, the Philippines, Taiwan and Thailand. 3 Australia, Canada, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Peru, Thailand and the United States.

REFERENCES Adams, R., P.Dee, J.Gali and G.McGuire (2003) ‘The trade and investment effects of preferential trading arrangements—old and new evidence’, Canberra: Productivity Commission Staff Working Paper, May. Andriamananjara, S. (2002) ‘On the size and number of preferential trading arrangements’, Journal of International Trade and Economic Development 11(3): 279–95. Bagwell, K. and R.Staiger (1998) ‘Will preferential arrangements undermine the multilateral trading system?’, Economic Journal 108(449):1162–82. ——(1999) ‘An economic theory of the GATT’, American Economic Review 89(1): 215–48.

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Baldwin, R. (1994) Towards an Integrated Europe, London: Centre for Economic Policy Research. ——(1996) ‘A domino theory of regionalism’, in R.Baldwin, P.Haapranta and J.Kiander (eds) Expanding European Regionalism: The EU’s New Members, Cambridge, UK: Cambridge University Press. Baldwin, R.E. and A.J.Venables (1995) ‘Regional economic integration’, in G.Grossman and K.Rogoff (eds) Handbook of International Economics, Vol. III, Amsterdam: Elsevier. Barth, J., G.Caprio and R.Levine (2002) ‘Bank regulation and supervision: what works best?’, mimeo, World Bank, January. Bhagwati, J., P.Krishna and A.Panagariya (1999) Trading Blocs: Alternative Approaches to Analyzing Preferential Trade Agreements, Cambridge and London: The MIT Press. Bond, E. and C.Syropoulos (1996) ‘The size of trading blocs: market power and world welfare effects’, Journal of International Economics 40(3–4):411–38. Chanda, R. (2001) ‘Movement of natural persons and the GATS’, The World Economy 24(5):631– 54. Clark, X., D.Dollar and A.Micco (2001) ‘Maritime transport costs and port efficiency’, mimeo, World Bank, available at econ.worldbank.org/files/11793_wps2781.pdf, accessed 23 July 2003. Coalition of Service Industries (CSI) (2002) Trade Remedy System under the WTO Framework: Functions and Mechanism, statement by Robert Vastine, CSI President, at the 2002 Annual Conference of the Advisory Committee of the Shanghai WTO Affairs Consultation Centre and 2002 WTO Forum, Shanghai, 5–7 November 2002, available at http://www.uscsi.org/pdf/1_17_ServiceSafeguards.pdf, accessed 17 November 2003. Cooper, R. (1988) ‘Survey of issues and review’, in L.Castle and C.Findlay (eds) Pacific Trade in Services, Sydney: Allen and Unwin, 247–62. Corden, M. (1972) ‘Economies of scale and customs union theory’, Journal of Political Economy 80(3):465–75. Deardorff, A.R. and R.Stern (1994) ‘Multilateral trade negotiations and preferential trading arrangements’, in A.R.Deardorff and R.Stern (eds) Analytical and Negotiating Issues in Global Trading System, Ann Arbor: University of Michigan Press. Dee, P. (2003) ‘Modelling the policy issues in services trade’, Economie Internationale (94– 5):283–300. Dee, P. and J.Gali (forthcoming) ‘The trade and investment effects of preferential trading arrangements’, in T.Ito and A.Rose (eds) NBER East Asian Seminar in Economics 14 Proceedings, University of Chicago Press. Dee, P. and K.Hanslow (2001) ‘Multilateral liberalisation of services trade’, in R.Stern (ed.) Services in the International Economy, Ann Arbor: University of Michigan Press, 117–39. Dee, P. and D.Nguyen-Hong (2003) ‘Domestic regulatory reform and liberalisation of trade in infrastructure services’, in A.Sidorenko and C.Findlay (eds) Regulation and Market Access, Canberra: Asia Pacific Press. Doove, S., O.Gabbitas, D.Nguyen-Hong and J.Owen (2001) ‘Price effects of regulation: international air passenger transport, telecommunications and electricity supply’, Productivity Commission Staff Research Paper, Canberra: Ausinfo. Ethier, W. and H.Horn (1991) ‘Services in international trade’, in E.Helpman and A. Razin (eds) International Trade and Trade Policy, Cambridge, Massachusetts: MIT Press. European Commission (EC) (2003) The Doha Development Agenda After Cancun, Brussels: European Commission Directorate-General for Trade, 25 September. Findlay, C. and T.Warren (eds) (2000) Impediments to Trade in Services: Measurement and Policy Implications, London and New York: Routledge. Fink, C., A.Mattoo and R.Rathindran (2002) ‘Liberalising basic telecommunications: evidence from developing countries’, paper presented at OECD-World Bank Services Experts Meeting, OECD, Paris, 4–5 March. Gehrels, F. (1957) ‘Customs union from a single-country viewpoint’, Review of Economic Studies 24(1):61–4.

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Johnson, H. (1960) ‘The economic theory of customs union’, Pakistan Economic Journal 10(1):14–32. Kalirajan, K. (2000) ‘Restrictions on trade in distribution services’, Productivity Commission Staff Research Paper, Canberra: Ausinfo. Kalirajan, K., G.McGuire, D.Nguyen-Hong and M.Schuele (2000) ‘The price impact of restrictions on banking services’, in C.Findlay and T.Warren (eds) Impediments to Trade in Services: Measurement and Policy Implications, London and New York: Routledge. Karsenty, G. (2000) ‘Assessing trade in services by mode of supply’, in P.Sauvé and R.Stern (eds) GATS 2000: New Directions in Services Trade Liberalisation, Washington DC: Brookings Institution. ——(2002) ‘Trends on services trade under GATS: recent developments’, paper presented at the WTO Symposium on Assessment of Trade in Services, Geneva, 14–15 March, available at http://www.wto.org/english/tratop_e/serv_e/%20symp_assessment_serv_march02_e.htm, accessed 20 November 2003. Krishna, P. (1998) ‘Regionalism and multilateralism: a political economy approach’, Quarterly Journal of Economics 113(1):227–51. Krugman, P. (1993) ‘Regionalism versus multilateralism: analytical notes’, in J.de Melo and A.Panagariya (eds) New Dimensions in Regional Integration, Cambridge, UK: Cambridge University Press. ——(1997) ‘What should trade negotiators negotiate about?’, Journal of Economic Literature 35(1):113–20. Levy, P. (1997) ‘A political-economic analysis of free-trade agreements’, American Economic Review 87(4):506–19. Lipsey, R. (1957) ‘Mr Gehrels on customs unions’, Review of Economic Studies 24(2): 211–14. ——(1958) The Theory of Customs Unions: A General Equilibrium Analysis, PhD thesis, University of London. McGuire, G. and M.Schuele (2000) ‘Restrictiveness of international trade in banking services’, in C.Findlay and T.Warren (eds) Impediments to Trade in Services: Measurement and Policy Implications, London and New York: Routledge. Markusen, J. (1995) ‘The boundaries of multinational enterprises and the theory of international trade’, Journal of Economic Perspectives 9(2):169–89. Mattoo, A. and C.Fink (2002) ‘Regional agreements and trade in services: policy issues’, World Bank Policy Research Working Paper 2852, Washington DC: World Bank, June. Mundell, R. (1964) ‘Tariff preferences and the terms of trade’, Manchester School of Economic and Social Studies 32:1–13. Nguyen-Hong, D. (2000) ‘Restrictions on trade in professional services’, Ausinfo, Canberra: Productivity Commission Staff Research Paper. Organisation for Economic Cooperation and Development (OECD) (2003) ‘Service providers on the move: labour mobility and the WTO General Agreement on Trade in Services’, OECD Policy Brief, Paris: Organisation for Economic Cooperation and Development, August. Panagariya, A. (2000) ‘Preferential trade liberalization: The traditional theory and new developments’, Journal of Economic Literature XXXVIII(2):287–331. Pomfret, R. (1997) The Economics of Regional Trading Arrangements, Oxford: Clarendon Press. Productivity Commission (2000) Broadcasting, Report No. 11, Canberra: Ausinfo. Riezman, R. (1979) ‘A 3x3 model of customs unions’, Journal of International Economics 9(3):341–54. Sauvé, P. (2002) ‘The relationship between regional trade agreements and the multilateral trading system—services’, Paris: OECD Working Party of the Trade Committee, Trade Directorate, 19 October. Sidorenko, A. and C.Findlay (2002) ‘Horizontal versus sectoral disciplines for services regulation’, in S.Stephenson, C.Findlay and S.Yi (eds) Services Trade Liberalisation and Facilitation, Canberra: Asia Pacific Press.

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——(forthcoming) The Costs and Benefits of Health Services Trade Liberalisation: The Case Study of Australia, Singapore and Malaysia, Report for the APEC Project CTI 17/2002T, May (forthcoming as APEC publication). Viner, J. (1950) The Customs Union Issue, New York: Carnegie Endowment for International Peace. Warren, T. (2000) ‘The impact on output of impediments to trade and investment in telecommunications services’, in C.Findlay and T.Warren (eds) Impediments to Trade in Services: Measurement and Policy Implications, London and New York: Routledge. Winters, L.A., T.Walmsley, Z.K.Wang and R.Grynberg (2003) ‘Liberalising temporary movement of natural persons: an agenda for the Development Round’, The World Economy 26(8):1137–61. World Bank (2000) Trade Blocs, Washington DC: World Bank. World Trade Organisation (WTO) (1995) Regional Trading Arrangements and the World Trading System, Geneva: WTO. Zissimos, B. and D.Vines (2000) ‘Is the WTO’s Article XXIV a free trade barrier?’, CSGR Working Paper No. 49/00, Centre for the Study of Globalisation and Regionalisation, University of Warwick.

11 The movement of people in the Asia Pacific region Mei Ling Sieh Lee and Fon Sim Ong

INTRODUCTION The importance of human capital to economic development has long been recognised. Adam Smith considered a man’s talents to be part of his fortune and that of the society to which he belonged. Alfred Marshall believed that the most valuable of all capital is that invested in human beings. Economic rationales for human resource planning revolve around three main goals: 1) to balance labour supply and demand; 2) to contribute to social equity; and 3) to improve the trade-off between inflation and unemployment. Recognising that human capital has a pivotal role in development and economic growth, governments pay considerable attention to human resource planning. Because the movement of people from one country to another in search of employment influences both the demand for and supply of labour, migration is a key part of the economic development story. Around 175 million people reside outside the country of their birth, and almost one of every ten people living in developed countries is a migrant. Annually, about 2.3 million migrants from less developed countries move to developed countries. The United Nations Population Division has estimated that migration from less developed countries makes up approximately two-thirds of population growth in advanced economies (UNDP 2003). Migration is motivated by both push and pull factors. It can benefit both laboursending and labour-receiving countries, although it is more common for labour-receiving countries to express concerns about the social and political consequences of migration. Of those who seek employment outside their own country for economic reasons, some do so legally and settle permanently in the destination country, often with their immediate family. They are usually well-educated people who move for lifestyle and career reasons. Some are granted work permits and are employed temporarily on an individual contract or as part of a team. Their length of stay is usually restricted to the period of the job or by a regulatory limit. Others are illegal migrants in search of better lives, seeking to move to developed countries for economic or political reasons. Politically driven migration tends to be correlated with levels of political instability. The number of refugees rose after the conflicts that followed the 11 September 2001 terrorist attacks. The mostly Afghan asylum seekers who attempted to land in Australia in 2001 are examples. The problem of political refugees seeking asylum or trying to escape adversity is important enough that a

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special agency, the United Nations High Commission for Refugees (UNHCR), exists to safeguard the interests of refugees in search of a country for resettlement. Reverse trends can be also observed with homeward-bound returnees seeking reunification with their families when conditions in their home countries improve. Technological advances and the globalisation of production and marketing have intensified linkages between businesses and economies, and therefore increased the opportunities for migrant workers. The number of countries from which migrants are drawn has also widened, reflecting declining transportation costs and the increase in countries joining the global economy. Migrant workers are no longer just moving across borders but are appearing from far-flung regions. For the first time, Asia is becoming a destination for workers from Eastern Europe and Africa. In Asia economic disparity has been a major factor contributing to migration. Unskilled and less-educated workers from countries such as Thailand, Indonesia, the Philippines and Malaysia have sought employment in Japan, Taiwan, South Korea, Singapore and Hong Kong. Countries that promote emigration have good reasons to do so; namely, to reduce unemployment and earn foreign exchange through remittances. The World Bank reported that migrant workers worldwide sent a total of US$72.3 billion back to their home countries in 2001 (World Bank 2003). For these reasons the Indonesian government’s five-year plans usually include targets for sending workers overseas (Wickramasekara 2002). During the 1997–98 Asian economic crisis the Thai government announced that 250,000 workers would be sent abroad as an emergency unemployment measure. Despite often-voiced social and political concerns, an influx of foreign workers can increase economic growth and aid structural adjustment in labourreceiving countries. In an increasingly knowledge-based global economy, the services sector has become a major employer, and the movement of people for the purpose of delivering a service has increased. When services personnel move across national borders for the purpose of exporting a service or performing a service, the World Trade Organisation categorises this as the temporary movement of natural persons under mode 4 of the General Agreement on Trade in Services (GATS). Mode 4 does not involve permanent migration or work in the manufacturing and primary sectors. Rather it involves the short-term movement of people for the delivery of services in a way analogous to the movement of goods and capital (World Bank 2003). However, the limited commitments for liberalising labour movement made so far under the GATS favour higher-level skilled personnel over lower-skilled workers. Winters et al. (2003) argue that both developed and developing countries stand to gain by allowing labour to respond to the incentives to trade services between countries. They estimate that if developed countries increased temporary inflows of both skilled and unskilled workers by an amount equal to 3 per cent of their labour forces this would increase world welfare by US$156 billion a year. This chapter discusses some of these issues in greater detail by using migration data and other data from country sources to map the movement of people in the Asia Pacific Economic Cooperation (APEC) region, with emphasis given to ASEAN countries (seven of which are also APEC members). Although imperfect, migration records are the best method for estimating the temporary movement of people under mode 4, as there is no common method for gathering data on GATS-related movement of people.

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Migration raises a number of issues for policymakers, particularly concerns about social problems and threats to security. Cooperation among countries will be needed to resolve some of these issues. Cooperation between countries over labour resources lags far behind cooperation on goods trade and capital movements. Although mode 4 includes low-skilled labour services, where developing countries have a comparative advantage, developed nations are pushing for the liberalisation of higher-skilled services. For labour-abundant developing economies, the failure to liberalise mode 4 limits the overall value of the GATS (Rupa 2001). Despite the problems that can be associated with migration, a greater effort at matching demand and supply by skill level is likely to benefit both developed and developing countries.

LABOUR MIGRATION IN THE ASIA PACIFIC REGION Labour migration in the Asia Pacific region has been fostered by labour supply and demand imbalances created by differing patterns of economic growth within the region. Some Asian countries are traditional labour-sending countries, others traditional labourreceiving countries, while others can be described as both labour-sending and labourreceiving countries. Bangladesh, China, Nepal, Indonesia, the Philippines, Sri Lanka and Vietnam are net labour-sending countries. Brunei, Taiwan, Japan, South Korea, Hong Kong and Singapore, which have greater job opportunities and higher wages, are net labour-receiving countries. India, Malaysia, Pakistan and Thailand are both laboursending and labour-receiving countries (Wickramasekara 2002). Japan, South Korea, Hong Kong, Singapore, Taiwan and Malaysia employed approximately five million foreign workers in the mid-1990s. Foreign workers, often called guest workers, are mostly employed on temporary, fixed-term contracts. Skilled personnel are preferred except in cases where work conditions are poor or the pay is low. Long-term settlement tends to involve workers with specific or higher-level skills moving from countries such as Malaysia and Singapore to countries such as Australia, New Zealand and the United States. To encourage skilled migrants or to counteract this brain drain, governments have offered permanent migration to skilled workers, often under minimum restrictions and using incentives. The increase in the number of workers moving across national borders has given rise to agents to facilitate the flow. Some are involved in an illegal trade in workers, circumventing rigid immigration rules and regulations. The Philippines has been the largest exporter of labour in the region since the mid1980s (Table 11.1). Consistent with this trend, remittances are the largest foreign exchange earner for the Philippine economy. Indonesia and India also have large numbers of workers abroad. The outflows shown in Table 11.1 will be underestimates as illegal workers are not captured in official data. Economic growth rates and sectoral demand within host countries often explain changes in migration flows. The oil price boom of 1973 sparked a large inflow of migrant workers from Asia to the Middle East. The number of immigrants in the seven states of the Gulf Cooperation Council rose from 1.1 million to 5.2 million between 1975 and 1990 (Stalker 2000).

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In the 1990s intra-Asian labour flows started to rise in response to the impressive growth experienced by the newly industrialised countries of Singapore, Hong Kong, South Korea and Taiwan, as well as industrialising countries such as Malaysia and Thailand. Table 11.2 shows that labour flows to the Middle East from most Asian countries, especially Southeast Asian countries, have declined while intra-regional flows have increased. By 1997, 64 per cent of Thai migrant workers went to East Asia, compared to 26 per cent to the ASEAN region (Table 11.3). One estimate put the number of foreign workers in Japan, South Korea, Malaysia, Singapore, Thailand, Hong Kong and Taiwan at 6.5 million in 1997 (Wickramasekara 2002).

Table 11.1 Migrant workers from major labourexporting countries in the Asia Pacific region, 1976–98 (000) India Indonesia Philippines Thailand Pakistan Bangladesh Sri Lanka 1976 4.2 1.9 47.8 1980 236.2 16.2 214.6 1985 163.0 54.3 389.2 1990 143.6 86.3 598.8 1995 415.3 120.9 488.6 1998 355.2 411.6 562.4 Source: Wickramasekara 2002:15.

1.3 21.5 69.7 63.2 202.3 175.4

41.7 129.8 88.5 115.5 122.6 104.0

6.1 0.5 30.1 7.6 77.7 12.4 103.8 42.7 187.5 172.5 267.7 158.3

Table 11.2 Migration flows to the Middle East and Asia from major labour-exporting countries in the Asia Pacific region, per cent of total recorded emigration Middle East 1993

Middle Asia East 1993 1998

Asia 1998

Bangladesh 94.1 60a 5.9 40.1b c India 96.7 93.4 3.3 6.6c Indonesia 57.6 69.4 42.4 30.6 Pakistan 99.7 96.2 0.3 3.8d Philippines 74.9 47.1 24.1 48.3 Sri Lanka 93.2 96.7 6.8 3.3 Thailand 12.2 9.3 84.7 64.4 Notes a 1997. b Malaysia only. c excluding the others category, which cannot be allocated to either region. d others category, which does not separate out Asia. Source: Wickramasekara 2002:17.

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Table 11.3 Thai migrant workers by region 1990 1991 1992 1993 1994 1995 1996 1997a Middle 43.5 33.7 28.2 12.3 10.4 9.9 12.2 9.7 East East Asia 19.4 26.5 30.6 56.3 62.3 66.5 59.6 63.5 ASEAN 27.4 33.7 38.2 29.7 26.3 22.9 27.2 25.5 West 9.7 6.1 3.0 1.7 1.0 0.8 1.0 1.3 Total 100 100 100 100 100 100 100 100 Note a January to November 1997. Source: Department of Employment, Ministry of Labour and Social Welfare, Thailand (http://www.thaieconwatch.com/articles/m98_2/m98_2t7.htm).

The 1997–98 Asian economic crisis showed that foreign contract workers are vulnerable to the forces of demand and supply. The crisis caused sharp contractions in demand for labour in some sectors. The decline in the movement of Indonesians workers to Asia was illustrative of their involvement in construction, which was badly affected by the crisis. Other sectors where export markets were not seriously affected were more resilient, such as the plantation industry. There was a sharp drop in the number of migrant workers in Malaysia in 1999 as authorities began to deport workers (Table 11.4). Note that poor data and the large number of illegal workers, particularly from Indonesia, make it difficult to estimate the size of the foreign workforce.

Table 11.4 Inflow of documented migrant workers, Malaysia (000) Year 1993 1995 1997 1999 Source: Kassim (2001):5.

Migrants 532.7 642.1 1,471.6 985.4

The feminisation of the migrant workforce has been occurring since the 1980s. It is estimated that young, unmarried women account for almost 48 per cent of migrants worldwide (Migration Policy Issues 2003). Indonesian women account for 78 per cent of Indonesian workers migrating through official channels for employment abroad (ILO 1996). The Philippines is another country to have experienced the emigration of large numbers of female workers. Rapid growth and equal access to education in industrialising countries have increased female participation in the workforce, boosting demand for domestic helpers. In Asia female migrant workers are concentrated in the domestic industry (Singapore, Hong Kong, Malaysia, Taiwan), the entertainment industry (Japan) and the nursing industry. Male workers are mostly in the construction (Singapore, Malaysia, Brunei), plantation (Malaysia), fishing (Thailand) and manufacturing

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(Malaysia, South Korea, Taiwan, Japan) industries. Of the approximately 988,000 foreign workers in Malaysia in 2000, 36.8 per cent were in manufacturing, 27.9 per cent in the plantation industry and 20.3 per cent were domestic maids (Kassim 2001). The majority of female labour came from Indonesia (which is culturally homogenous with Malaysia) and the Philippines.

POLICY RESPONSES TO MIGRATION Legal migration Most countries place limits on the number of visas that can be issued to temporary overseas workers and subject temporary workers to regulations on length of stay. Application and processing procedures for visas and permits can be time consuming, requiring exhaustive details about the employer, the job and wages, details of the candidate’s experience, skills and training, and verification of other personal information. Employers may have to provide evidence of an extensive search for a local person and demonstrate difficulties in training a local person. Often wages must be on a par with local pay, thus negating the cost advantage of employing foreign labour (Rupa 2001). Long and tedious immigration processes hurt service sectors where personnel need to be moved overseas at short notice and where delays mean a loss of opportunities and business. Such biases mainly affect developing countries. Eligibility tends to be biased against middle- and lower-level personnel as they are seen to be displacing local workers. Regulations concerning the recognition of qualifications, work experience and training are further barriers. These barriers disproportionately affect professionals, such as doctors, lawyers and accountants, because qualifications and certifications are a fundamental requirement of the service. Singapore’s policies are designed to facilitate growth by targeting an appropriate skill mix. In the early 1970s, when there was high economic growth and full employment, labour shortages were filled by unskilled migrant workers from Malaysia and later the Philippines, Bangladesh, Thailand, India, Sri Lanka and Indonesia. Immigration policy has evolved in response to falling economic growth rates and political pressures. Now unskilled workers are only able to stay a short period and must pay permit fees. A levy system equalises the cost of foreign labour relative to local labour. Foreign workers were repatriated during the recession of 1985–86. The Singapore government sets ceilings on the share of foreign workers that firms in each sector are allowed to employ. Work permits for unskilled workers are valid for two years, renewable only once. Permanent settlement is discouraged by curtailing the personal freedom of unskilled workers and prohibiting marriage to a Singapore national or the immigration of dependants. Unskilled workers must leave the country seven days after their work permits expire. Workers in the construction, marine and harbour craft sectors are granted work permits of up to three years, renewable for a total of up to ten years. The fee is lower than that charged to unskilled workers. Work permits are also available to skilled and professional staff of foreign firms operating in Singapore. Skilled workers with tertiary or professional qualifications and entrepreneurs are eligible for employment passes and can apply for permanent residency

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after six months. No fee is charged for an employment pass. Permanent residents and skilled workers holding work permits and employment passes are granted entry and reentry permits. The government also subsidises health care, education and housing. The Social Integration Management Service encourages integration into the labour force. After a period of two to ten years, depending on the government’s criteria, permanent residents can apply for citizenship (Ruppert 1999). In 2000 Singapore had 755,000 non-resident foreign workers, equivalent to 19 per cent of the population, and 290,000 permanent residents (Firdausy 2003). Of the 600,000 foreign workers in work, around 110,000 were higher-skilled holders of employment passes. The remaining 490,000 were lower-skilled workers in industries such as construction (210,000), manufacturing (150,000) and domestic services (130,000). Singapore also sets sectoral restrictions by nationality, for instance stipulating that the manufacturing and services sectors employ foreign nationals from Malaysia, Hong Kong, Macau, South Korea and Taiwan (Ruhs 2002). Malaysia has been Singapore’s main source of foreign workers since the early 1970s (Sieh 1988) and migrants played an important role in sustaining high economic growth (Firdausy 2003). While earlier immigration policy was largely motivated by economic factors, similarities in culture were later taken into consideration to minimise social conflicts. Singapore is not alone in the use of restrictions based on nationality. Kuwait has a preference for foreign workers from Asia over Arab workers, while Switzerland gives first preference to European Union citizens and admits workers from other countries only in exceptional cases (Ruhs 2002). Malaysia considers both cultural and religious homogeneity, giving preference to domestic workers from Indonesia over those from the Philippines, Cambodia and Myanmar. Malaysia does not encourage permanent settlement and permits only short stays for unskilled workers. It accepts workers from such countries as the Philippines, China, Indonesia, Thailand, Cambodia, Bangladesh and Myanmar, and has formal arrangements with some of these countries. These agreements may include terms and conditions on certain jobs, such as domestic services. Unskilled foreign workers are allowed entry to meet labour shortages and strict conditions are set on work permits to discourage illegal immigration. Malaysia also has a levy system to manage the inflow of foreign workers. Unlike Singapore’s system of encouraging skilled foreign labour with a lower levy, Malaysia protects local skilled labour by imposing a higher levy. The annual levy for an employment pass is RM840 for unskilled workers, RM1,200 for semi-skilled workers and RM1,800 for skilled workers. Illegal migration Just as in Europe, the United States and many other developed countries, Asian countries face the problem of illegal workers who overstay their permitted period of residence. Table 11.5 gives estimates of legal and illegal migration in selected Asia Pacific countries. Owing to the clandestine nature of illegal immigration, the data are likely to be artificially low. As an illustration of this problem, during a clampdown on illegal immigrants in South Korea in 2003, 120,000 undocumented immigrants, mostly Asians, left the country (The Star, 16 November 2003).

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Illegal migrants who enter without the proper documents are often driven by the hope of employment opportunities and a better standard of living. The reluctance of receiving countries to admit unskilled workers has contributed to illegal immigration. Rigid immigration laws and cumbersome and expensive approval procedures induce many foreign workers to take a short cut through illegal channels (ILO 1999). In Asia Malaysia and Thailand face the largest number of illegal foreign workers (Wickramasekara 2002). Between 1992 and June 2000, about 1.8 illegal immigrants from over thirty countries were apprehended in peninsular Malaysia. The largest numbers were from Bangladesh and ASEAN, in particular Indonesia. For Indonesians, emigration is seen as the best way to escape

Table 11.5 Estimates of the stock of legal and illegal immigration in selected countries Country

Year

Australia

April 1999 January 1999 1998 1998

Japan Indonesia South Korea

Legal

Illegal n.a.

53,143a

n.a.

271,048

33,295 11,143 (professionals) 30,180 (trainees) 1998 1,127,652 1998 530,000 1998 89,862

n.a. 99,537

244,730b 23,000c 897,027 (1998) 652,878 (1999) Notes: Wickramasekara uses the terms regular and irregular; n.a. means not available. a unlawful citizens (overstayers) only. b estimates of the number of illegal migrants differ owing to the absence of official records. c apprehensions only. Source: Wickramasekara (2002:23). Malaysia Singapore Thailand

poverty. The Philippines is also a major source of migrant workers, but workers are spread across a number of countries (Wickramasekara 2002:27). Illegal foreign workers are often vulnerable to the practices of unscrupulous recruitment agencies. Kassim (2001) has highlighted the burden of the foreign worker levy in Malaysia as a disincentive to seek work permits through the proper channels. The Malaysian government has experimented with public campaigns to reduce the number of illegal migrants, has used amnesty periods to allow illegal migrants to leave or to obtain proper papers that permit their staying on as foreign workers, and has even engaged in mass repatriation exercises. During the Asian economic crisis many illegal migrant workers were deported to protect the jobs of locals. The largest official deportation was during the height of the crisis in 1998 (Hugo 1999). Malaysia sent back some 200,000 Indonesian workers.

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Despite these efforts, the number of illegal immigrants remains large, as they are willing to take up jobs that locals shun and are a source of cheap labour. Malaysia’s plantation sector and the rice milling, agriculture and fishing industries in Thailand depend on foreign workers. The experiences of these countries show that it is near impossible to solve the problem of illegal migration. Malaysia’s long coastline is difficult to patrol, and for more than twenty years domestic law enforcement has been unable to prevent illegal Filipino migrants travelling to Sabah on false or stolen identity cards and passports. The large number of illegal migrants creates social problems and threats to security. Kidnapping and smuggling are common in certain parts of Sabah. More recently Malaysia has been seeing another type of illegal immigrant—Chinese street peddlers selling cheap goods from home. The government of Thailand has stepped up enforcement at checkpoints along Thailand’s borders, but illegal immigrants continue arriving from neighbouring countries where unemployment is high. From the end of the 1980s to the early 1990s, the government of Taiwan issued work permits for contract workers, a system that checked the problem of illegals to some extent. Japan and South Korea have avoided forming an explicit policy on migrant workers and this position has indirectly encouraged illegal workers, attracted by the buoyancy of these economies.

SERVICES TRADE As business becomes globalised and activities are outsourced or contracted out along the production chain, there has been a significant growth in services trade and employment. The General Agreement on Trade in Services (GATS) has identified four modes in which services can be traded among WTO members. They are: • mode 1—cross-border supply in which services trade takes place across borders; • mode 2—consumption abroad in which services trade is effected by the movement of consumers to the home country of the service supplier; • mode 3—commercial presence in which services trade occurs when the serviceexporting firm establishes itself in the importing country, often with capital investment; and • mode 4—the temporary movement of personnel for the purposes of supplying a service. In essence, mode 4 of the GATS covers the following: 1) service providers that obtain a contract to supply a service to a host-country company and send employees to provide the service; 2) service providers that market and promote a service to a host-country company or individual; and 3) people employed by a foreign company in the host country (excluding nationals of the host country). Mode 4 service suppliers gain temporary entry to conduct services trade and leave the host country after the service is rendered, without invoking migrant status. They are neither migrating on a permanent basis nor seeking entry to the labour market as

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independent workers. They are normally confined to one sector, as opposed to workers entering under general migration or asylum programs, who may move between sectors. In addition, the sectors include only those where a country has made commitments of market access and national treatment within the framework of the GATS. WTO members are free to interpret the term ‘temporary’ as they wish in their schedule of offers, although the notion of non-permanence, that is entry without right of permanent residence, is an accepted principle. Categories of temporary movement of persons include business visitors, workers employed short term from a few months to a few years (e.g., transfers within a multinational company) and service suppliers on contract with foreign or domestic firms (Arkell 1998, in Nielson 2003). Mode 4 includes people of all skill levels, although foreign service suppliers tend to favour skilled workers. The software sector in India illustrates the importance of mode 4 services trade for an economy. India exports 62 per cent of its software to the United States and 24 per cent to Europe (Shah and Parikh 2002). Service suppliers are needed to install and support the software. If immigration procedures hinder mode 4 movement to support the effective delivery of software, mode 1 trade may be rendered ineffective. The lack of accurate data on mode 4 services trade hampers the ability to analyse the magnitude of the movement of people for services trade. Migration data provide the best source at present, but the statistics do not adequately capture mode 4 activities. Balance of payments statistics only give major categories of services, such as travel, transport, finance and communication. Employment figures provided by foreign service suppliers are also unreliable because they usually include both foreign and local workers. The diversity and complexity of national labour market regulations discourages the cross-border movement of labour. Even in the European Union, where labour market integration has been occurring since the 1957 Treaty of Rome, a number of impediments remain (Lloyd 2002). Despite a series of European Parliament and European Council directives on the mutual recognition of professional qualifications, there is no common market for labour in the European Union (Lloyd 2002). Impediments include an absence of an EU-wide system of social security, as well as language and cultural barriers. In NAFTA, where there is a reciprocal arrangement for the temporary entry of people for business-related purposes, member countries have recognised that national regulations continue to prevent national treatment in many cases (Lloyd 2002). The temporary entry provisions of NAFTA apply to four categories of business people: business visitors, traders and investors, intra-company transferees and professionals. Skilled workers benefit most from the agreement. An annual quota of 5,500 Mexican business personnel who may enter the United States was agreed between Mexico and the United States, whereas there are no quotas on the movement of business people between the United States and Canada or from the United States to Mexico. Other regional trade agreements (e.g., Canada-Costa Rica, Canada-Chile, Mexico-Chile) have all contained temporary entry provisions. The temporary TN (Trade NAFTA) visa allows sixty-three occupational groups to work within NAFTA, one year at a time, with unlimited extensions (Martin 2003). In 2001, 92,951 Canadians and 2,571 Mexicans entered the United States under the TN visa. The same year, 8,326 Americans and 101 Mexicans entered Canada on the TN visa (Martin 2003).

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Aggregate data by region and visa type are presented in Table 11.6. These statistics give some idea of mode 4 movement to the United States. In the United States there are about twenty programs that allow for the temporary employment of non-immigrants. Specialty occupations (H1B visa) make up the largest group of temporary visa holders. By region, Asia has been the most significant recipient of this visa. Europe dominates the category for workers with extraordinary abilities/achievements (O1) and other North American countries account for the majority of non-agricultural workers performing services unavailable in the United States (H2B). Non-immigrant workers engaged in seasonal or temporary jobs are usually on H2A or H2B visas for farm work and unskilled non-farm work, respectively. The number of illegal immigrants in the United States was estimated to be around 7 million in 2000, representing an increase of 100 per cent from 1990.1 About 2.3 million had overstayed their visas. Mexico continued to be the leading source of illegal immigrants, with a total of 4.8 million. About 4.5 million illegal immigrants lived in five states: California, Texas, New York, Illinois and Florida. Migration is a priority issue for the Mexican government since migrant workers in the United States remit approximately US$10 billion a year back to their home country. In 2001 a four-point migration plan was proposed that included: (1) the legalisation of Mexicans working illegally in the United States, (2) a new guest worker program, (3) cooperative measures to end border violence, and (4) changes in US law to exempt Mexicans from immigrant visa ceilings (Martin 2003). However, the momentum stalled after the 11 September attack and the economic slowdown in Mexico. The three countries that accounted for much of the growth in unauthorised immigrants from Asia were China, India and South Korea. Between 1990 and 2000 the number of illegal Chinese immigrants increased from 70,000 to 115,000, while the number from India increased from 28,000 to 70,000 and South Korea from 24,000 to 55,000. Congress has been divided over proposals for a guest worker program that would reduce illegal immigrants by allowing workers to join the workforce temporarily but leave the country once their job ends. The United States also has border patrols to prevent illegal immigrants from crossing the 12,880 kilometres of land and sea borders. For Australia, the number of business visitors serves as an estimate of mode 4 entrants. Of the 35,006 temporary business visas granted in 1999–2000, 43 per cent were granted to professionals, 24 per cent to associate professionals and 24 per cent to managers/administrators. Trades and related workers at 4 per cent and other at 5 per cent made up the remainder (Nielson

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Table 11.6 Temporary entrants to the US by geographic origin (categories most relevant to mode 4), 1999 All Europe Asia Africa Oceania North Caribbean Central South countries America America America Registered 534 124 190 12 11 nurses (H1A) Specialty 302,326 96,618 136,738 6,988 7,497 occupations (H1B) Non35,815 1,895 1,633 177 582 agricultural workers performing services unavailable in the United States (H2B) Industrial 3,462 1,304 1,016 75 90 trainees (H3) Workers with 15,946 9,895 1,881 259 934 extraordinary ability/ achievement (O1) Workers 3,248 1,508 678 59 87 accompanying and assisting in performance of O1 workers (O2) Intracompany 234,443 121,514 55,131 2,555 9,009 transferees (L1) Source: Adapted from Nielson and Cattaneo 2002:22.

153

46

5

44

27,834

2,890

2,418

26,135

30,627

5,362

2,392

794

760

30

61

212

1,591

225

79

1,347

675

200

9

231

27,868

1,225

1,634

17,991

and Cattaneo 2002). The top five occupations were: computing professionals (12.6 per cent), self-employed (10.4 per cent), general managers (8.3 per cent), accountants (5.2 per cent) and chefs (4.4 per cent). The majority of business visitors were from the United States (2,748), China (2,218), Britain (1,597), India (879) and Japan (832). However, some degree of overestimation (by including workers in non-service sectors) and underestimation (by covering only some categories under mode 4) is likely. In ASEAN, under the provisions of ASEAN Framework Agreement on Services (AFAS), member countries have made commitments to liberalise in different services sectors, with business services having the most commitments. Malaysia has the greatest number of services commitments (70), followed by Singapore (60), Thailand (59),

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Indonesia (46) and the Philippines (38). Statistics on work permits granted to skilled workers provide a rough guide to the size of mode 4 movement. For example, Malaysia granted 60,000 work permits to skilled workers in 2000 (Manning and Bhatnagar 2003). In 2002 Thailand had a stock of nearly 60,000 skilled foreign workers, mainly managers and executives. Japan was the largest source country, providing 13,675 of these workers, while the United Kingdom and India each contributed slightly over 5,000 (Manning and Bhatnagar 2003). The AFAS can be described as a GATS-plus agreement, as the ten ASEAN members have made commitments over and above those of the GATS. Vietnam and Laos are not yet members of the WTO but are able to obtain benefits because they are parties to the AFAS. The progressive liberalisation of services trade will help address some of the issues discussed in this chapter. An AFTA or AFAS visa, similar to the proposed GATS visa and the current APEC visa for business people, could be a way to promote greater cooperation, hence contributing to the goal of ASEAN economic integration by 2020. More accurate data on mode 4 movement will be needed to facilitate such a scheme.

CONCLUSION Compared with the cross-border movement of goods and capital, the movement of people has been much more restricted. Despite the fact that mode 4 movement of personnel is becoming even more important as the range of commercially tradeable services increases, many issues hinder the access of personnel for effecting services trade in other countries, including immigration laws and entry conditions, as well as the lack of recognition of standards, qualifications, training and experience. For professional and business services trade, the recognition of qualifications still needs to be negotiated among WTO members. The lack of data on mode 4 movement of people for services trade inhibits understanding of the patterns of temporary or short-term labour movement. Before policy can be formulated to regulate or support services trade, trading partners need to understand the patterns of trade, the types of service industries involved and the country of origin of the services imported. There is no doubt that the movement of people benefits both sending countries and receiving countries. However, countries in the Asia Pacific region differ in whether they want to facilitate the temporary flow of foreign workers. Malaysia and Singapore have well-conceived policies while Japan and South Korea have only just begun to consider policy issues on foreign workers. The experiences of these countries suggest that legalising foreign workers will help address problems of illegal entry, but that illegal entry will continue because employers use these workers as a safety valve to hire and fire according to changing economic situations. Policies toward unskilled foreign workers are often overly restrictive in terms of approval costs and procedures. Skilled workers face fewer problems given their qualifications and bargaining power (Wickramasekara 2002). Appropriate policies are needed so that workers, particularly unskilled workers, will not be encouraged to take the illegal route if the policy bias is toward skilled migrants. Most countries facing large numbers of illegal workers have tightened immigration rules and regulations particularly for semi-skilled and unskilled workers. These policies

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have not completely stemmed the flow of illegal migrant workers. Notwithstanding the fact that countries have different needs and priorities with respect to foreign workers, there is a need to reduce the incidence of unlawful, often unskilled, people movement and to regulate the flow of skilled and knowledgeable professionals across borders. But what are the best ways to do so? As a strategy to avert potential social and cultural conflicts, immigration rules are moving toward incorporating political and cultural rationale as well as economic justifications. The experiences of Malaysia and Singapore suggest that policies can influence the composition of foreign labour in terms of skill levels, cultural affinity, gender and age. On a multilateral level, the GATS is one mechanism for establishing principles for cooperation on people movement. Mode 4 commitments will be important for services trade to expand, as the case of the Indian software industry illustrates. Signatories to the GATS will have to pay attention to visa and work permit systems if they wish to promote flows of unskilled and skilled short-term workers. Governments will also need to agree to recognise or harmonise qualifications and standards for skilled labour and professionals. The reluctance of governments to make commitments under the GATS multilateral process reflects their lack of belief in the principle of non-discriminatory movement of labour. The multilateral non-discriminatory approach envisaged at the launch of WTO seems to have given way to highly discriminatory bilateral and regional trade agreements, some of which have addressed cross-border labour flows. The Trans-Tasman Travel Arrangement (TTTA) between Australia and New Zealand allows the unrestricted movement of workers without the need for harmonisation of labour market qualifications (Lloyd 2002). The agreement also covers bilateral social security agreements. The FTA between the United States and Singapore is expected to increase the flow of business visitors because commercial presence is usually accompanied by the movement of natural persons. Some countries had envisaged bilateral and regional cooperation as building blocks for wider multilateral agreements. However, recent negotiations suggest that governments pursue bilateral and regional agreements more as a safeguard against a breakdown in negotiations at the multilateral level. In view of the increased trade in services and developments in technology that facilitate services trade, resolving issues surrounding the movement of people is necessary at all levels of economic cooperation. However, closer cooperation will depend on better data and a greater understanding of the issues raised in order to steer along uncharted, even risky, paths when concern over security is so high. Regardless of bilateral or multilateral agreements between countries, the movement of labour will depend on supply and demand conditions in sending and receiving economies, as well as refugee flows from political conflicts. Labour-short economies will continue to welcome foreign inflows, and economies with high unemployment will continue to see immigration as a solution or will resist inflows from other countries.

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NOTE 1 Statistics are available from http://www.immigration.gov/.

REFERENCES Arkell, J. (1998) ‘Statistics on the presence of natural persons’, prepared for UNCTAD, reference in J.Nielson (2003) ‘A needle in a haystack: migration statistics and GATS mode 4’, Working Paper No. 1, March, Paris: OECD. Firdausy, C.M. (2003) ‘Labour mobility within ASEAN countries: issues and policy implications towards ASEAN economic community’, presented at the 2003 ASEAN roundtable, Road Map to an ASEAN Economic Community, 20–1 August, Singapore. Hugo, G. (1999) ‘The crisis and population movement in Indonesia’, prepared for the ILO Employment Mission, ILO Area Office, Jakarta, July. International Labour Organisation (ILO) (1996) Emigration Pressures and Structural Change: Case Study of Indonesia, Geneva: ILO. ——(1999) ‘Migrant workers report III (part 1B)’, presented to the International Labour Conference, Eighty-seventh Session, Geneva: ILO. Kassim, A. (2001) ‘Recent trends in international migration in Malaysia’, presented at the First Population Forum in the New Millennium, organised by the Population Studies Unit, Faculty of Economics and Administration, University of Malaya, Kuala Lumpur, 11 July. Lloyd, P.J. (2002) ‘Facilitating free movement of people in an Australia-US FTA’, presented at the Impact of an Australia-US Free Trade Agreement: Foreign Policy Changes and Economic Opportunities conference, National Press Club, Canberra, 29–30 August. Manning, C. and P.Bhatnagar (2003) ‘The movement of natural persons in Southeast Asia: how natural?’, presented at the Division of Economics Seminar Series, Research School of Pacific and Asian Studies, the Australian National University, Canberra, 25 November. Martin, P. (2003) ‘Mexico-US migration’, Institute of International Economics Working Paper, Davis, California: University of California, July. Migration Policy Issues (2003) ‘Facts and figures on international migration’, March (2), International Organisation for Migration, http://www.iom/int/documents/%20publication/en/mpi_services_No.2.eng.pdf. Nielson, J. and O.Cattaneo (2002) ‘Current regimes for temporary movement of service providers: case study—Australia’, prepared for joint WTO-World Bank Symposium on the Movement of Natural Persons (Mode 4) under the GATS, Geneva, Switzerland, 11–12 April. Ruhs, M. (2002) ‘Temporary foreign worker programmes: policies, adverse consequences, and the need to make them work’, CCIS Working Paper No. 41, San Diego: University of California. Rupa, C. (2001) ‘Movement of natural persons and the GATS’, World Economy 24(5): 631–54. Ruppert, E. (1999) ‘Managing foreign labor in Singapore and Malaysia: are there lessons for GCC countries?’, World Bank Policy Research Working Paper No. 2053, New York: World Bank. Shah, A. and Vaibhav Parikh (2002) Movement of Natural Persons under GATS in the Software Services Sector, Mumbai: Nishith Desai Associates. Sieh, M.L. (1988) ‘Malaysian workers in Singapore’, Singapore Economic Review 33(1): 101–11. Stalker, P. (2000) Workers Without Frontiers: The Impact of Globalisation on International Migration, Geneva: ILO. United Nations Population Division (UNPD) (2003) International Migration Report 2002, New York: UNPD. Wickramasekara, P. (2002) Asian Labour Migration: Issues and Challenges in an Era of Globalisation, Geneva: ILO, International Migration Program.

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Winters, A., T.L.Walmsley, Z.K.Wang and R.Grynberg (2003) ‘Liberalising temporary movement of natural persons: an agenda for the development round’, The World Economy 26(8):1137–62. World Bank (2003) Global Development Finance 2003: Striving for Stability in Development Finance, Washington DC: World Bank.

12 Asia Pacific regional architecture and financial market integration Wendy Dobson

INTRODUCTION The architects of Asia Pacific regional financial integration face a paradox. The region’s economies have substantial financial clout—they hold nearly half the world’s foreign reserves, account for a third of the world’s saving and host nearly a fifth of global foreign direct investment (Table 12.1). Yet they are still addressing the challenges of fragmented financial markets and immature domestic financial systems. Sound and transparent financial institutions and efficient markets are foundation stones of regional financial architecture. Asia Pacific’s financial reforms and integration also have significance beyond the region. It is an increasingly important pole of economic activity. Asia Pacific including Japan accounts for nearly 22 per cent of world GNP and 23 per cent of its trade. Intraregional trade accounts for a growing share of total trade. But Asia Pacific is still closely tied into the rest of the world economy through global supply chains, through the export markets for its end products and through the world’s financial centres that intermediate the region’s capital. This integration into the international system has significant benefits. Foreign capital inflows increase domestic investment over what is possible by relying only on domestic savings. Inflows of foreign direct investment (FDI) fan the winds of domestic competition by encouraging rapid technological change and the acquisition of modern management, marketing and other skills. Yet volatility of exchange rates, interest rates and real economic activity caused by sharp and unanticipated reversals of short-term capital flows can exact high costs. It is the determination to reduce this vulnerability that motivates many in their approaches to regional architecture. As this chapter will argue, however, such approaches need to recognise that while the 1997–98 financial and economic crises revealed flaws in the functioning of the international financial system, they also revealed weaknesses in domestic policies and financial systems. In the intervening period, these sources of vulnerability have been recognised, but the pace of change has slowed as recovery has taken hold.

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Table 12.1 East Asia: Economic and demographic indicators, 2001 I. 2001 Share of world: II. GDP1 Population1 Trade2 Inward Foreign Savings1 Foreign reserves FDI reserves less stock3 less gold gold4 2001 (US$ billion) Japan 13.56 2.07 6.04 0.73 18.49 20.13 314.43 China 3.70 20.72 4.09 5.77 10.09 6.36 171.56 S. Korea 1.34 0.77 2.34 0.68 4.80 2.11 81.76 Hong 0.51 0.11 3.14 6.60 5.20 0.73 88.44 Kong Taiwan 0.97 0.36 1.84 0.46 5.72 – 97.24 Thailand 0.36 0.99 1.02 0.41 1.51 0.61 25.74 Indonesia 0.46 3.37 0.71 0.83 1.27 0.52 21.68 Philippines 0.22 1.25 0.51 0.20 0.62 0.18 10.69 Singapore 0.29 0.05 1.90 1.52 3.52 0.67 59.97 Malaysia 0.27 0.38 1.30 0.77 1.42 0.51 24.24 Vietnam 0.10 1.27 0.24 0.23 0.17 0.09 2.92 Laos 0.005 0.08 0.007 0.008 0.01 0.01 0.10 Cambodia 0.009 0.20 0.02 0.02 0.03 0.00 0.47 Myanmar 0.84 0.73 0.04 0.05 0.01 – 0.32 Total 21.74 32.38 23.25 18.34 52.91 31.92 899.60 Notes 1 World Devellopment Report 2000–01, World Bank; exceptions are Taiwan and Myanmar where the source is Key Indicators, 2000, Asian Development Bank. 2 Trade is defined as exports plus imports. 3 Inward FDI stock is the value of the share of capital and reserves (including retained profits) attributable to the parent enterprise, plus the net indebtedness of affiliates to the parent enterprise. The values are presented at historical cost, reflecting prices at the time when the investment was made. 4 Total reserves less gold is defined to include the monetary authorities’ holding of special drawing rights, reserve position in the IMF and foreign exchange. Sources: World Development Report 2003, World Bank; Key Indicators 2002, Asian Development Bank; World Investment Report, UNCTAD; International Financial Statistics, IMF.

The purpose of this chapter is to evaluate the issues in financial market integration and regional financial architecture. It discusses two basic building blocks of financial and monetary integration: domestic financial systems (including financial intermediaries and capital market institutions) and exchange rate regimes. The chapter reviews post-crisis

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financial reforms and analyses the prospects for current initiatives for deeper financial integration. While initiatives to create bond markets attract considerable attention, such initiatives must also be complemented by domestic financial system reforms. Regional financial integration is a major project that will need to be undertaken in stages. The first stage is to build a strong foundation consisting of sound and strong domestic financial systems. Governments must keep their eyes firmly fixed on this primary goal because successful recovery has strengthened the hands of vested interests opposed to necessary reforms and the pace of reform has slowed.

THE ISSUES Domestic financial systems reform Although the crisis economies have strengthened their domestic financial systems, more than six years after the East Asian crises these are still potential sources of vulnerability. Traditionally bank-dominated, domestic financial systems rely heavily on debt finance. As economies develop and become more complex, diverse and transparent financial systems are necessary for savers and investors to interact with confidence with borrowers and issuers who are unknown to them. Stronger banks and capital market institutions that supply a greater diversity of financial instruments (e.g., bonds and securitised instruments), flows of transparent information, and payment and settlement systems all contribute to deep and liquid financial markets that are better able to withstand external shocks. Stronger supervisory oversight and enforcement of prudential standards, adequate infrastructure, and modern accounting and legal frameworks to promote transparency are also required. At the same time, governments must rely more on market discipline in financial markets to eliminate moral hazard (the traditional expectation has been that if problems occur government bailouts will ‘socialise’ any losses). Several constraints also need to be addressed in strengthening domestic systems. These include the lack of trained manpower and independent financial supervisors, and pressures from vested interests to retain existing practices. While there have been improvements since the crises, financial systems in the region still trail best international practice.1 Issuers and intermediaries are part of the problem. Many corporations became highly leveraged during the high growth years; they also lacked transparency in financial disclosure and in their corporate governance practices (problems not unique to corporations in the region). Opaque relationships among governments, banks and firms in business groups and family conglomerates marginalised minority shareholders and created asymmetric information problems for investors and lenders. Some firms also borrowed heavily abroad in unhedged foreign currencies. One of the initial consequences of the unanticipated external shocks was a rise in corporate defaults and increase in nonperforming loans in financial institutions. But several years later, indicators of corporate health (IMF 2002a) continue to show that although the high average levels of leveraging have declined from their 1997–98 peaks, reliance on short-term debt remains high and relatively stable. By these indicators of leverage, solvency, liquidity and profitability, the

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East Asian corporate indicators of health are weaker than those in other emerging markets. Much work is still being done to address the debt overhangs left by the crises. Asset management corporations have had varying success with removing non-performing assets from the books of corporations and banks.2 Other incentives have encouraged restructuring, including new bankruptcy codes, favourable tax treatment for debt, and negotiations among creditors.3 But the increased public ownership of banks and corporations in the crisis economies has complicated crisis resolution by signalling the possibility of public-sector bailouts. Work is also underway to develop capital market institutions. To take one example, in 2001 Thailand’s Securities and Exchange Commission (SEC) moved to develop corporate and government bond issues as well as a secondary market. Regulations on the disclosure of private placements of corporate paper were tightened, and requirements for credit ratings of paper were introduced (Bank of Thailand 2003). As the government debt market grew post-crisis (budgetary requirements expanded with the recapitalisation of the financial system) a benchmark was created in 1998 and liquidity in the secondary market increased. Tax obstacles to bond market development were also eased (including the reduction of business taxation of capital gains and personal income taxation of interest income). The SEC improved infrastructure to facilitate fund raising through the equity markets. While primary listing criteria were relaxed and obstacles to private company restructuring were removed, information disclosure requirements were tightened. Guidelines for foreign investor participation were also changed, and the SEC and Thailand’s stock exchange delineated their responsibilities more clearly. Liberalisation of foreign entry requirements is another channel to recapitalise weak financial institutions, introduce modern financial instruments and provide management and skills training. Both Thailand and South Korea have liberalised entrance requirements, but Thailand’s success has been limited by political reluctance; foreign equity participation is regulated although foreign entities receive national treatment with respect to permitted activities. In South Korea foreign institutions have brought significant new sources of competition and modernisation into the financial sector, as well as new sources of capital. This discussion of domestic reform would be incomplete if foreign participation were seen only as a source of recapitalising weak domestic institutions. Foreign ownership positions in, or 100 per cent ownership of, banks, insurance companies and investment banks, if managed carefully, can make important contributions to reform. Foreign players introduce greater competition, bring new products and technology, provide skills training and require regulators to make rules and standards transparent to ensure compliance.4 Among the crisis economies, South Korea seems to have made the most progress in restructuring but much more remains to be done. The OECD’s 2002 survey of Korea applauds this progress, but concludes there is still a long way to go before the government allows resources to be reallocated from the failing banks and chaebol (conglomerates) to more profitable new enterprises (OECD 2003).

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Exchange rate regimes and macroeconomic fundamentals The second building block is domestic monetary frameworks. Since the crises, managed floating has replaced unsustainable fixed-but-adjustable exchange rate pegs. Among the larger economies, fixed exchange rates are now found only in Hong Kong, China and Malaysia (Table 12.2). Even so, most governments are reluctant to allow exchange rates to float freely, reflecting fears that real and nominal exchange rate volatility will undermine their export-led growth goals. Managed floating has been successful in both Singapore and Taiwan, but for good reason. These economies have large stocks of foreign reserves, disciplined macroeconomic policies, and well-developed, sophisticated and liquid financial systems. In the former crisis economies, immature financial systems, structural problems and debt overhangs make managed floating very risky. Such a practice easily turns into a soft peg, with the associated liability that, by inviting speculation in times of adversity, the risks of crisis are magnified. Other intermediate exchange rate alternatives, such as basket pegs and regional currency units, have been suggested to provide authorities with more modest combinations of exchange rate stability and monetary policy independence despite capital mobility (Frankel 1999; Ito et al. 1999; Williamson 2000; Ministry of Finance 2000; Bergsten and Park 2002). But in practical terms, such alternatives are complicated. Finding optimal weights for currency baskets is a major technical challenge. Another challenge is to

Table 12.2 Exchange rate arrangements in East Asia, 1997 and 1999 Economy

1997

China Hong Kong Indonesia Malaysia

Peg Peg Peg Peg Intermediate Managed float Intermediate Peg

1999

Notes Plus capital controls Currency board Partial capital controls since 1997

Philippines Intermediate Managed float Singapore Intermediate Managed float South Korea Intermediate Managed float Thailand Intermediate Managed float Peg 1970–97 Taiwan Intermediate Managed float Source: Fischer (2001); Exchange Arrangements and Exchange Restrictions, IMF, various years.

satisfy market participants’ demands for transparency. Loose arrangements with wide bands are worth examining, but with open capital markets, these bands are likely to be tested by the markets. The intermediate option is relevant to China. Its competitors have recently been shrill in their assertions that the yuan is undervalued, by as much as 40 per cent by some claims. Without evaluating the merits of the respective arguments in this debate, China’s case illustrates a basic principle relevant to the topic of this chapter. If the yuan is

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wrongly valued, then appropriate alternative monetary framework choices available to the Chinese authorities are constrained by the immaturity of its financial system. China does not yet have a modern commercial banking system that efficiently intermediates savings into viable credits. The asset positions of most large banks are sufficiently precarious that they need to be recapitalised (and reorganised to improve their ability to evaluate and manage credit). These reforms are necessary prerequisites to permitting the freer play of market forces in the capital and foreign exchange markets. If, as seems likely, the Chinese economy is nevertheless reaching a stage where greater exchange rate flexibility would be in its own long-term interest, gradual moves to an intermediate option would seem to be the most advisable route to take. In the more advanced economies, such as Singapore, Taiwan and South Korea, which have legacies of low inflation and moderate inflation expectations, inflation targeting and a more flexible exchange rate provides yet another alternative monetary framework. Such a framework requires central bank independence and a low target for inflation (in the 1–3 per cent range). The central bank cannot target the exchange rate, but must allow it to float relatively freely (although Masson et al. 1997 observe that crawling pegs or target zones could, in theory, coexist with an inflation target as long as the target is clear and is given priority in the event of conflict among objectives). Such a framework must include explicit identification of, and commitment to, inflation targets as well. Since 1997 South Korea has made much of its transition to this regime. The central bank is independent; price stability is the central policy goal; the target and the plan for achieving it, as well as the conduct of policy, are transparent; the bank is accountable to the National Assembly; and the exchange rate is relatively flexible. Regional financial arrangements In drawing their own lessons from the crises, East Asians recognise the need to remove structural obstacles to the freer play of market forces in their economies, but they argue that these changes cannot realistically be made overnight. More than that, there is a strong sense that the United States and the International Monetary Fund (IMF) cannot be relied upon to handle future crises well. For this reason, there is strong support for the economies in the region to use their financial clout to develop their own capacity to prevent and manage financial crises—and eventually to stabilise intra-regional exchange rates. Further reforms are also called for to the ‘supply’ side of international finance (see, e.g., Park and Bae 2002). Regional financial arrangements can take several forms, each with a progressively more challenging objective (de Brouwer 2002). One objective is to provide short-term liquidity to bridge temporary balance of payments shortfalls. The IMF does not provide this type of funding, but other central banks can. A second objective is to prevent financial crises. Since many crises develop when external shocks overwhelm weak domestic fundamentals, surveillance is desirable to encourage preventive action. Financial markets, however, can wrongly perceive a weakening of fundamentals. If that is the case, substantial amounts of liquidity may be necessary to head off a crisis and can come from several sources: a country’s own reserves, swap arrangements or IMF lending facilities. A third objective is to resolve a financial crisis once it begins, and this is where the IMF becomes involved with large lending packages.

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The appearance of contagion in the East Asian crises (changes in investor sentiment toward an economy with good fundamentals as a result of its neighbour’s or close trading partner’s problems) led to the creation in 1999 of the IMF’s contingent credit line (CCL), as a new lending facility available to such countries to boost their reserves.5 The first step toward regional financial arrangements began at the subregional level with the creation of informal currency swap arrangements among the ASEAN economies in 1996–97. These agreements had relatively little effect during the financial crises, but cooperative arrangements took a major leap forward when the idea was expanded and formalised among the ASEAN-plus-three central banks in May 2000. Financial arrangements negotiated in the Chiang Mai Initiative (CMI) aimed, initially, to address the first and second objectives of bridging balance of payments shortfalls and preventing financial crises. But the CMI is also interpreted by some of its architects, such as Malaysia, as providing, over the longer term, the basis for closer monetary cooperation to achieve exchange rate stability. There is a new determination to map the road to closer monetary cooperation as a basic building block for eventual currency union. This issue is discussed further below. The CMI includes ASEAN-plus-three central bank governors and finance ministers who have agreed to bilateral swap arrangements among central banks in the three Northeast Asian economies (China, Korea and Japan) and those in the Southeast Asian economies. These arrangements are part of a network of bilateral swap arrangements that will supplement the foreign exchange reserves of the Southeast Asian countries with those of China, Korea and Japan. In 2001–02 Japan finalised swap arrangements with China, South Korea, Malaysia, the Philippines and Thailand that will permit borrowers to draw 10 per cent of their allowance without conditions; beyond that amount IMF conditionality applies. Since then, South Korea and China have finalised similar agreements.6 In relation to total foreign exchange reserves held in the region, the amounts are still modest. But in relation to IMF quotas, their significance increases. Henning (2002) estimates the total for bilateral swaps plus the ASEAN swap arrangement was US$25.5 billion as of 31 December 2001. IMF quotas totalled another US$10.1 billion. Within the established framework these amounts can be changed quite easily; that is, upward in the event of a real or threatened crisis. Throughout these negotiations, a key issue was what conditions would be imposed on borrowers and how they would be applied. Initial reluctance to impose any conditions reflected traditional preferences for non-interference in domestic policies. But Northeast Asians were not about to see their resources used without appropriate policy adjustments by borrowers. Eventually conditionality arrangements were agreed that ensure consistency with IMF conditionality.7 International experience (e.g., in the Group of Seven) indicates that potentially powerful incentives for good domestic policy can be supplied by intergovernmental forums for cooperation. In East Asia the Manila Framework Group (MFG) filled the policy vacuum left in the wake of the 1997–98 crises. The central bank forum, the Executives’ Meeting of East Asia and Pacific (EMEAP), has also undertaken effective technical cooperation since 1997 (Table 12.3). Several information exchange and cooperation processes have emerged in the region since 1998, including the ASEAN Surveillance Unit (ASU) and the Asian Development

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Banks’ Regional Monitoring Unit (RMU). ASEAN-plus-three bureaucrats have also debated, but could not agree to, a proposal to create an independent group to carry out objective analysis on which surveillance and peer pressure might be based (PECC 2002). In summary, it is still unclear if and when governments might accept constructive criticism and peer pressure from other members about their domestic financial and economic policies and economic performance. Some ASEAN governments do have reservations, but much will depend on the Chinese government’s willingness to engage in such processes.

REGIONAL ARCHITECTURE: FUTURE ISSUES AND THEIR IMPLICATIONS Strengthening regional institutions The ambiguity of the CMFs long-term objectives noted above raises questions about whether a financing mechanism could provide the basis for the much deeper monetary cooperation that is necessary to stabilise intra-regional exchange rates and to pave the way for a regional currency unit or currency. Such a sequence is a reasonable one. Economic analysis and European experience, however, suggest caution about the difficulties of execution.

Table 12.3 Regional forums for financial cooperation, East Asia, 2002 Forum

Year Membership founded

SEANZA 1956 (Southeast Asia, New Zealand, Australia) ASEAN 1967 (Association of Southeast Asian Nations; 10 members) SEACEN 1982 (Southeast Asian Central Banks; 11 members) APEC (Asia Pacific Economic Cooperation forum; 21

1989

Mandate

British Commonwealth Contact among central bank governors banking supervisors in the region Brunei, Cambodia, Economic Indonesia, Laos, development, Malaysia, Myanmar, security Philippines, Singapore, Thailand, Vietnam Indonesia, Korea, Cooperative Malaysia, Myanmar, research, Mongolia, Nepal, training (runs a Philippines, Singapore, research and Sri Lanka, Thailand, training centre) Taiwan Pacific Asia, North and Finance South America ministers cooperate on stabilising capital flows,

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members)

development of capital markets EMEAP 1991 Australia, China, Hong Information (Executives’ Kong, Indonesia, exchange and Meeting of East Japan, Korea, cooperation on: Asia and Malaysia, New payment and Pacific; 11 Zealand, Philippines, settlement central banks) Singapore, Thailand systems, financial markets, banking supervision Four Markets 1992 Australia, Hong Kong, Specialised Group (finance Japan and Singapore cooperation on ministry and financial central bank market officials) functioning and regulation Manila 1997 Finance and central Enhanced Framework bank officials economic and Group (14 technical APEC cooperation members) following the crises on financing, surveillance and technical cooperation ASEAN 1998 ASEAN membership Information Surveillance exchange; early Process warning and peer review; monitoring global developments ASEAN-plus- 2000 ASEAN economies Strengthen three plus China, Japan and economic South Korea policy dialogues and cooperation using Asian Development Bank Regional Monitoring Unit Sources: Ito (2002); de Brouwer (2002).

Economic analysis suggests that certain optimal conditions are necessary for a common currency arrangement to be sustainable. Differing economic and financial conditions among participating countries can lead to internal tension and conflict if there

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are differing adjustments, such as monetary and exchange rate changes, to aggregate supply or demand shocks. Studies comparing the East Asian economies with optimal currency area criteria suggest that certain crucial conditions necessary for smooth adjustment to external shocks do not yet exist. Eichengreen and Bayoumi (1996) conclude that the standard criteria for the adoption of a common monetary policy fit East Asia about as well as for Western Europe. Kohsaka (2000) makes a similar determination.8 Eichengreen and Bayoumi (1996) also carry out a cost-benefit calculus in which they observe that intra-regional trade and investment have grown to relatively high levels, adjustment to shocks is relatively quick, and supply and demand disturbances are small and symmetric by European standards. These findings imply that East Asia’s small open economies would benefit from a reduction in exchange rate uncertainty. On the other hand, domestic financial systems are not yet mature, there is a political tolerance of ambiguous policy goals, and clear determined political leadership is lacking. Taken together, these three factors pose non-negligible risks that a common basket peg, for example, would suffer the unfortunate fate of the Mexican crawling peg in 1994. European experience demonstrates that achieving supranational institutions, monetary union and a single currency as goals requires significant and prolonged political leadership and many compromises. Political commitment and leadership and common institutions are essential elements of the architecture. In effect, some modicum of domestic autonomy must be traded for meaningful surveillance in the group. The review of the existing mechanisms for policy dialogue (Table 12.3) is hopeful, but not conclusive. Between 1956 and 2002, a variety of financial forums were created in the Asia Pacific region, with varying mandates and memberships. Almost without exception, however, these mandates are limited to ‘soft’ forms of cooperation and information exchange that do not begin to approach the deeper (‘harder’) cooperation that is required for meaningful policy monitoring and policy bargaining. Still, a cooperative process has begun, even though it is difficult to see the basis for the objective of deeper monetary integration. The East Asian Vision Group (EAVG 2001) report to ASEAN-plus-three leaders in 2001 expressed ambition about the possibility of East Asia evolving into a common currency area (‘if and when economic, political, social and other linkages develop to a point where tighter forms of monetary integration become feasible’). A subsequent report of the East Asia Study Group on implementing the recommendations (EASG 2002) backed away, acknowledging the pursuit of a ‘closely coordinated regional exchange rate mechanism consistent with both financial stability and economic development’ and recommending ‘further study with high priority’, but observing that: Presently, it may not be possible for the financial authorities in the region to come up with firm rules, but frequent consultation among regional authorities and some coordinated actions in both monetary and foreign exchange areas can be sought. (EASG 2001, paragraph 138) Eichengreen (2002) systematically evaluates the viability of a common basket peg using several criteria: the credibility of participants’ commitments to defend the exchange rate

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regime, their flexibility to allow adjustments when needed, the existence of a mechanism to coordinate adjustments, and adequate financial support. Credibility requires political commitment sufficient to sacrifice domestic policy autonomy to sustain exchange rate stability in a world of mobile capital. Flexibility requires a cooperative mechanism to bring about necessary adjustments in a timely way. The CMI is not yet, but conceivably could become, a mechanism to coordinate adjustments among governments willing to participate. Finally, the CMI is a potential source of financial support, but the liquidity available to individual countries is small unless countries pool a portion of their reserves. This they are unlikely to do unless a robust surveillance mechanism exists that can prevent crises and manage them when they occur. Each criterion, to be met in a credible way, requires willingness by governments to give up some degree of sovereignty to a cooperative mechanism that is capable of forcing countries with weak currencies or fundamentals to adjust their policies. It is difficult to disagree with Eichengreen’s conclusion that deeper monetary and exchange rate cooperation is not the right project for East Asia at the present time. Some of the rhetoric in the region in 2003 implied that two tracks to deeper integration are possible: capital market development, particularly bond markets, and deeper cooperation on strengthening financial markets and institutions. Such a distinction is artificial; essentially these tracks are complementary. Bond market development ultimately depends on strong and sound domestic financial systems. Domestic financial systems can be strengthened, but without the development of capital markets they will remain immature, unnecessarily restricting the choice, and raising the risks and costs, of external finance available to rapidly growing firms. While these developments are complements, it is useful to examine them separately. Developing Asian bond markets Successful development of a regional bond market would confer advantages on issuers and investors throughout the region. But these advantages would only accrue over time. An Asian bond is one issued by Asian borrowers (governments, corporations and financial institutions) in the region for sale in the respective issuing countries and denominated in foreign currencies. Investors in these bonds would come from anywhere in the world. Bond markets already exist in Tokyo, Hong Kong and Singapore but these markets lack depth and liquidity and, owing to capital account and other restrictions, are not accessible to most borrowers in the region. Korea’s recent deregulation of capital market activities has permitted foreigners to issue bonds denominated in Korean won and other currencies, but few issuers have yet taken advantage of this market. The advantages of a regional bond market lie mainly in the efficiency gains that would accrue to the region’s borrowers. As the recent crises underlined, the problem of double mismatches of currencies and maturities must be resolved. A logical response is to make local currency instruments more readily available. Asian bonds would provide safer and (perhaps) cheaper sources of finance. The market would also intermediate more of the region’s savings within the region. In the past, Asian savers have been risk averse, investing their savings in riskless assets available in the world’s money centres, in part because they have not had ready access to risk-management technologies and to information needed to make informed choices.

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Park and Bae (2002) examine the depth of financial ties among the Asia Pacific economies compared to their ties with the rest of the world. They find stronger ties with the advanced countries than with one another. One of the main reasons they identify is that non-regional financial institutions dominate the capital markets because of their technical superiority to penetrate the markets. The gap between local and foreign technology and expertise is large. Indeed these authors suggest the gap will be difficult to close because of the implied need for a rapid and costly build-up of human capital and the ‘backbone’ infrastructures of information and telecommunications services, regulatory oversight and modern governance practices. The other advantage of a regional bond market is that it would be a building block to global markets. More plentiful opportunities for bond finance would reduce reliance on banks and provide superior risk-management options to investors and a superior diversification for institutional investors. More sophisticated and diversified financial markets with longer-term instruments would not only attract more global investors but also enhance the capabilities of the region’s issuers and investors to participate in global markets. What are some of the main elements in a road map that would make this possible? As Park and Park (2003) point out, the first step is for governments to undertake sufficient domestic financial liberalisation to allow the issuance of bonds in foreign currencies. Another step is to permit competition among domestic bond markets as a stimulus to modernisation and change. A third step is to create the essential infrastructure of payment and settlement systems. Government would also have to cooperate in the development of legal, regulatory and accounting infrastructures to support bond markets. Cross-border infrastructure, such as a single securities depository for the region, is one example. Regional credit agencies, cross-border securities borrowing and lending and creditenhancement mechanisms, as well as credit guarantee agencies, would also be necessary. Some activity in these directions was begun in 2003. On the demand side, for example, EMEAP central banks established an Asian Bond Fund to invest in US dollar bonds issued by Asian governments. This activity may be diversified into local currency bonds in future. On the supply side, the Asian Development Bank’s bond initiative is working toward creating well-functioning and efficient local currency bond markets. But progress is slow and the sizes of these initiatives are modest. For local currency markets to grow Asia Pacific central banks will have to relax restrictions on the use of their currencies, which in turn implies less monetary policy control. Unless this reluctance to see their currencies held by foreigners is overcome Asian bonds have to be denominated in one of the three major international currencies, or in the currencies of the region’s international financial centres. In summary, in order to create regional bond markets of significance governments should consider strengthening and liberalising domestic financial systems and cooperating in encouraging appropriate but essential regional infrastructural support. Cooperating to encourage domestic financial reform It is imperative for the region’s governments to create incentives to step up the pace and deepening of domestic financial reforms. Such cooperation would also serve as a stepping stone to future cooperation on monetary issues. Weaknesses in bank-centred

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financial systems need to be corrected by training and appropriately rewarding bank supervisors and by training bank staff in modern banking practices. Yet more than six years after the crises, no region-wide evaluation of domestic reforms against best-practice benchmarks has been made available. Many domestic reforms have been initiated, but the remaining gaps in implementation need to be identified and addressed. What do we know about the competitiveness of the region’s banking sectors? What do we know about governments’ progress in regulatory and supervisory reforms? What is the state of banks’ ability to evaluate and monitor risks? Are the weaknesses being addressed? What are the most effective methods that have been employed for achieving these objectives? Can these be identified and disseminated? Claessens and Glaessner (1998) made an early attempt at such monitoring. Table 12.4 provides a summary of comparative openness in financial services as an example of what is possible. Deeper cooperation is needed for another reason as well. As competition increases among the region’s financial institutions, regulatory authorities will have to coordinate among themselves or lose capital market activity to those jurisdictions with the leastonerous rules and standards. Diverse tax and regulatory regimes will therefore need to be harmonised to reduce obstacles to intra-regional cross-border capital flows. Eichengreen (2002) argues that deeper cooperation should be supported by an institution. He proposes the creation of an Asian financial institute on

Table 12.4 An index of openness in financial services, 1997 Banking Securities Insurance Commitment Practice Commitment Practice Commitment Practice Hong 4.20 4.75 Kong Indonesia 3.15 3.20 South 1.10 1.70 Korea Malaysia 2.40 2.40 Philippines 2.80 3.35 Singapore 2.25 2.50 Thailand 2.95 2.85 India 2.70 2.25 Average 2.69 2.88 Note: 1=most closed, 5=most open. Source: Claessens and Glaessner (1998).

4.00

4.40

4.40

4.00

3.50 1.70

3.00 2.10

3.10 1.20

2.60 2.60

2.50 2.40 2.70 2.00 2.50 2.66

2.50 2.40 2.70 2.00 2.10 2.65

2.10 2.90 4.10 2.80 1.00 2.70

2.10 2.80 4.10 2.80 1.00 2.75

the ASEAN-plus-three platform to provide reserves-management, clearing and settlement services to member central banks along the lines provided by the Bank for International Settlements, as well as a venue for the negotiation of regional agreements on standards for information disclosure, capital adequacy, and so on, that would best reflect circumstances in the region. The functions Eichengreen specifies foreshadow the need for common infrastructure for regional markets. One can also envisage such a platform performing other functions as well, such as analysing progress on domestic reforms and providing training and

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technical assistance, as well as being a place for policy dialogue among the public sector, market participants and others. Whether or not one agrees with the details of Eichengreen’s institutional proposal, it raises the compelling and important question of how much deeper Asia Pacific cooperation can become without more institutionalisation. At present, independent empirical enquiry is the only way to identify and assess reform across the region. CMI institutionalisation suggests two other issues. One is CMI membership. At present there is no accession clause in the bilateral swap agreements and therefore no mechanism to admit other countries as members. In theory, any country willing to provide a swap line with at least two-thirds of the existing membership could be allowed to join. Alternatively, members that have ‘financial capacity’, measured by reserves or capacity to borrow, could also be allowed to join. The second issue is the CMFs capacity and mandate. The mechanism has developed to this point with the implicit premise that it is possible to deepen cooperation without institutionalisation. There is no secretariat, not even one that rotates among member governments.9 Nor is there an independent surveillance mechanism that could carry out the objective analysis of members’ policies and performance that is essential for peer monitoring. Could peer monitoring be initiated with the practical focus on encouraging (and evaluating) the strengthening of domestic financial systems? If so, experience could then provide the basis for the more controversial monitoring of fiscal and monetary policies that will be necessary for deeper monetary cooperation (or to prevent the onset of a future crisis). Regional or global institutions? A related architectural issue is the relative roles of regional and global institutions. International experience shows that the central objective of cooperative financial institutions and arrangements is to preserve and enhance financial stability. How best to achieve this aim? It is clear that there is a role for regional financial arrangements, but the degree of interdependence among open economies is such that a global financing capacity (i.e., the IMF) is critically important. If funding is to be provided to head off a crisis, appropriate conditions are required to ensure remediation of real or perceived underlying problems and to prevent or minimise contagion. An adequate level of knowledge and understanding is also required of domestic financial systems and their particular characteristics. The IMF’s ability to marshal large amounts of support in the face of cross-regional contagion is unique. It is the world’s expert in managing crises after they have occurred, facilitating debt write-down and imposing conditionality. But, as stressed earlier, the IMF is widely seen in the region to have imposed inappropriate conditions in the crisis countries because it lacked sufficient flexibility and adequate levels of local knowledge. Seven years after the East Asian crises, the depth and persistence of support for a regional self-help capacity should not be underestimated. But there is also a widespread perception that regional financial cooperation is complementary to, rather than a substitute for, the IMF. Indeed, there is a place for a regional financial institution in East Asia. A regional institution can draw more readily on local knowledge in developing appropriate conditions. In theory, it is more likely to be able to marshal peer pressure from close

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neighbours to bring about adjustments that will prevent crises; however, the longstanding commitment to consensus in ASEAN would have to be overcome for this to be true in the future. Alternatively, non-ASEAN members must be relied upon for such peer pressure. Those countries closest to a troubled neighbour are also more likely to muster support for a financial rescue package, a factor that is especially true given East Asia’s large foreign reserves. Finally, a credible regional mechanism is more likely to be able to prevent contagion within the region. A basic principle of global and regional financial arrangements is that they be complements, not substitutes. Their goals and operations should also be consistent to prevent arbitrage and such distortions as moral hazard. Henning (2002) summarises the history of the IMF’s relations with regional financial arrangements, from the European Payments Union to the North American Framework Agreement. He notes that despite this history, no standards or criteria for evaluating regional arrangements have been developed or applied. Indeed, in the absence of a definition of ‘complementarity’, there are no guidelines to evaluate proposals such as the Asian monetary fund idea when it appeared in 1997. To address this issue, he proposes the creation of a financial equivalent of GATT Article XXIV that would provide agreed principles of regionalism as criteria for guiding and evaluating regional arrangements. Mechanisms are also required on the supply side of global capital markets to reduce the dangers of volatility by changing incentive structures for the institutions that supply short-term capital flows and for their official overseers. Dobson and Hufbauer (2001) identified the suppliers of short-term capital as 200 very large financial institutions in ten OECD countries. The work of the Financial Stability Forum and the Basel Committee on Banking Supervision notwithstanding, coordination among the financial regulators in these countries needs to be stepped up and these very large global financial institutions need closer monitoring and better coordination among regulators to reduce herding and concentration of risk. This route, they argue, represents a better allocation of government effort to crisis prevention. The only other alternative is to improve the instruments for crisis management through the arduous and lengthy legislative process required to change the IMF Articles needed for a sovereign debt restructuring mechanism (to allow a country breathing space to restructure its debts if these become unsustainable). For the time being, however, governments have decided to take the latter route, as the recent study of the proposed sovereign debt restructuring mechanism demonstrates (IMF 2002c). The roles of the plus three and the United States A final dimension of regional financial architecture is the roles of and relationships among the plus three—China, South Korea and Japan—and the United States. Stable relationships among China, Japan and the United States will be necessary if regional institutions are not to be submerged by geopolitical issues. Since the 1997–98 crises, support from the ‘plus three’ in Northeast Asia has been key to the CMI initiative. Despite old antagonisms, leaders of the three economies have demonstrated their commitments to cooperate on regional issues. But the depth of such cooperation is limited. South Korea played a major role in leading the East Asian Vision Group, but its ambitions seem not to have been carried through in the East Asia Study Group. China and Japan must provide the leadership to CMI, but they have differing interests in and

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strategies for East Asian integration. China seems to be more interested in ASEAN than in deeper integration with South Korea and Japan. It remains to be seen whether the China-ASEAN FTA will be accompanied by a Chinese willingness to expand the bilateral swaps with ASEAN, favouring an ASEAN-plus-one rather than ASEAN-plusthree. These strains and uncertainty about China’s commitment to a credible surveillance mechanism will in turn affect the credibility of the CMI as a platform for deeper cooperation. China is playing an increasing regional leadership role as its economy develops. The Chinese authorities managed successfully through the East Asian crises and they are perceived to have correctly resisted pressures to devalue the yuan at the time. China has demonstrated its ability to implement major domestic structural changes. It is now a major destination for regional exports. But its persistent internal economic imbalances could have a negative impact on its neighbours. The state-owned enterprises’ continuing business and fiscal problems have frustrated attempts to create a modern commercial banking system. Asset-management companies created to work out the nonperforming loans of the four large state-owned policy banks are themselves in trouble. The magnitude of bad loans has continued to be very large. These problems in the financial system constrain China’s options for introducing more flexibility into its exchange rate regime, despite strong external pressures in 2003 to do so. China’s persistent challenges in balancing economic reform and its social consequences could spill over into the region. The most obvious channel for spillover is through trade. If the authorities are unable to stabilise aggregate demand growth without abrupt quantitative restrictions, imports from its neighbours could suffer disruptions. Since China is now the region’s engine of growth, such disruption could be significant. The other channel is financial. China is also a magnet for FDI from the region; to the extent these investments create excess capacity, the drying up of profits could produce negative spillovers. Furthermore, if China were to decide to adjust its monetary framework, any misstep that produced abrupt exchange rate movement would likely cause negative consequences in the banking system that could spill over to the neighbours. The United States, distracted since 11 September 2001 by homeland security and fighting a war, has shifted its views of the region and its individual economies. Foreign economic policy is now driven by the security imperative of whether countries are ‘with us or with the terrorists’ (President Bush speaking to Congress, 20 September 2001). Initiatives promoting regional integration and financial institution building are more likely to be evaluated in terms of their alignment with these security interests than was the case in the past.

CONCLUSION Regional financial architecture is already an important part of the evolving Asia Pacific economic order. While the current enthusiasm for regional bond markets to aid capital market development is creating momentum, the more difficult and fundamental task of domestic financial system reform is lagging in the face of restored economic growth. As argued earlier in this chapter, domestic reform and capital market development are complements, not substitutes. Successful bond markets will thrive in sound and strong

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financial markets. Stronger domestic markets that continue to rely on bank-dominated finance will remain immature and will restrict the choices for external finance available to rapidly growing corporations, restrict the options for managing risk and raise the cost for borrowers over what would be available in more mature financial systems. Domestic financial reform provides the foundation for the much-touted long-term goal of deeper monetary integration in the region. It is the first milestone on a very ambitious (but ultimately attainable) route that requires new processes and institutions to be built in stages. Yet this first milestone has not been reached, in part because successful recovery has strengthened the hands of vested interests resisting reform. The next step is clear. Incentives are required to reward progress and discourage foot dragging on domestic reform, through peer pressure. The Manila Framework Group tried to play that role in the immediate aftermath of the crises. But it has since been superseded, at least for the members of ASEAN and CMI, by their own cooperative forums for leaders, finance ministers and central bank governors. These arrangements are important to educate policymakers and the general public about the merits of closer cooperation and of the endgame of deeper monetary integration in the region. But here too progress on creating an incentive system for reform is slow; the existing mechanisms are not yet seen as credible forums where governments engage in objective analysis, monitoring and peer pressure for good policies that both serve national interests and prevent future crises. Membership is also incomplete, with important economies in the region not yet included. Future developments will depend rather heavily on the Chinese government’s support for the CMFs objectives, processes and membership. In the long run, deeper monetary cooperation will need to build on success in these earlier, more practical initiatives. Deep links in factor and product markets are necessary for deeper monetary cooperation, and close cooperation is required for convergence, as the European project demonstrated in the 1980s and 1990s. Too early an effort may divert resources from the reform process that is argued for in this chapter.

NOTES The support of the Canadian Department of Foreign Affairs and International Trade for attending the PAFTAD conference is gratefully acknowledged. While they bear no responsibility for the final product, Gordon de Brouwer, Hugh Patrick, Peter Drysdale and Mahani Zainal-Abidin provided valuable comments on an earlier draft. 1 See Dobson and Jacquet (1998); Claessens et al. (2001). 2 Indonesia’s centralised asset-management companies do not seem to have achieved their goals of expediting bank and corporate restructuring. Malaysia has been more successful, helped by a strong bankruptcy regime. Thailand has used a decentralised framework that has not been regarded as very successful, in part because of a weak institutional framework (accounting and legal rules, capital positions of banks and ownership links). 3 Thailand, Korea and Malaysia have each developed procedures whereby majority accords among creditors can be used to force all creditors into debt restructurings; Indonesia has moved more slowly in this direction. 4 The benefits of foreign entry are not undisputed. Some argue that foreign banks ‘cherry pick’ the most desirable markets and customers. Others argue that their methods for evaluating credit risk can have undesirable consequences for industrial structures. The empirical

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evidence tends to confirm the greater efficiency of foreign-owned banks, their beneficial impacts on competition and evidence of their stabilising impact on, and long-term commitment to, local markets once they have entered (see IMF 2002a: Chapter VI and Annex II). 5 No country signed up, however, because of the negative signal that entry or exit might send to the markets (e.g., if a country had to exit because it no longer qualified owing to deteriorating fundamentals), thereby exacerbating the possibility of a loss of confidence and a crisis. 6 By the end of 2003 both Japan and China had finalised bilateral swap arrangements with all major ASEAN economies. 7 See Henning (2002) for calculations illustrating this point. 8 See Bergsten and Park (2002) for a survey of the issues and a proposal for a regional monetary arrangement. 9 Even the informal Group of Seven (G7) finance ministers and central bank governors rotate the secretariat functions according to the country hosting the current year’s leaders’ summit.

REFERENCES Bank of Thailand (2003) http://www.bot.or.th/, accessed November 2003. Bergsten, C.Fred and Yungchul Park (2002) ‘Toward creating a regional monetary arrangement in East Asia’, ADBI Research Paper 50, Tokyo: Asian Development Bank Institute, at www.adbi.org/research. Claessens, Stijn and Tom Glaessner (1998) ‘Internationalization of financial services in Asia’, New York: World Bank, unpublished manuscript. Claessens, Stijn, Daniela Klingebiel and Luc Laeven (2001) ‘Financial restructuring in banking and corporate sector crises: what policies to pursue?’, NBER Working Paper 8386, Cambridge, Mass: NBER, July. de Brouwer, Gordon (2002) ‘The IMF and East Asia: a changing regional financial architecture’, Pacific Economic Papers 324, February, Canberra: Australia-Japan Research Centre, The Australian National University. Dobson, Wendy and Gary Hufbauer (2001) World Capital Markets: Challenge to the G-10, Washington DC: Institute for International Economics. Dobson, Wendy and Pierre Jacquet (1998) Financial Services Liberalization in the WTO, Washington DC: Institute for International Economics. East Asia Study Group (EASG) (2002) ‘Report of the East Asia Study Group’, delivered at the ASEAN-plus-three Summit, Pnomh Penh, 4 November, at http://www.aseansec.org/, accessed March 2003. East Asia Vision Group (EAVG) (2001) ‘Towards an East Asian community: region of peace, prosperity and progress’, East Asia Vision Group Report, at http://www.aseansec.%20org/, accessed March 2003. Eichengreen, Barry (2002) ‘Whither monetary and financial cooperation in East Asia?’, prepared for the PECC Financial Forum Meeting, Honolulu, August. Eichengreen, Barry and Tamim Bayoumi (1996) ‘Is Asia an optimum currency area? Can it become one? Regional global and historical perspectives on Asian Monetary Relations’, at www.elsa.berkeley.edu/eichengreen, accessed November 2001. Fischer, Stanley (2001) ‘Distinguished lecture on economics in government. Exchange rate regimes: is the bipolar view correct?’, Journal of Economic Perspectives 15(2): 3–24. Frankel, Jeffrey A. (1999) ‘No single currency regime is right for all countries or at all times’, Essays in International Finance 215, Princeton, N.J.: Princeton University, International Finance Section.

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Henning, C.Randall (2002) ‘East Asian financial cooperation’, Policy Analyses in International Economics 68, Washington DC: Institute for International Economics, September. International Monetary Fund (IMF) (2002a) International Capital Markets: Developments, Prospects, and Key Policy Issues, Washington DC: IMF, September. ——(2002b) World Economic Outlook, Washington DC: IMF, September. ——(2002c) The Design of the Sovereign Debt Restructuring Mechanism—Further Considerations, Washington DC: IMF, November. ——(various years) Exchange Arrangements and Exchange Restrictions: Annual Report, Washington DC: IMF. Ito, Takatoshi (2002) ‘Regional surveillance mechanisms in East Asia’, paper prepared for PECC Finance Forum survey of financial and monetary cooperation among the PECC economies, at www.pecc.org/finance. Ito, Takatoshi, Eiji Ogawa and Yuri Sasaki (1999) ‘A regional currency system in East Asia’, in Stabilization of Currencies and Financial Systems in East Asia and International Financial Cooperation, Tokyo: Institute for International Monetary Affairs. Kohsaka, Akira (2000) ‘Macroeconomic interdependence in the APEC region’, in Ippei Yamazawa (ed.) APEC: Challenges and Tasks for the Twenty-first Century, London: Routledge. Masson, Paul R., Miguel A.Savastano and Sunil Sharma (1997) ‘Can inflation targeting be a framework for monetary policy in developing countries?’, Washington DC: World Bank, at http://www.worldbank.org/, accessed 19 January 2003. Ministry of Finance (Japan) (2000) ‘Exchange rate regimes for emerging market economies’, discussion paper prepared by French and Japanese staff, at http://www.mof.go.jp/. Organisation for Economic Cooperation and Development (OECD) (2003) Economic Survey: Korea, Paris: OECD. Pacific Economic Cooperation Council (PECC) (2002) ‘Prospects and challenges for regional financial and monetary cooperation among PECC economies’, PECC Issues 3/2002, Singapore: PECC. Park, Yung Chul and Kee-Hong Bae (2002) ‘Financial liberalization and economic integration in East Asia’, paper prepared for PECC Finance Forum, Honolulu, August. Park, Yung-Chul and Daekeun Park (2003) ‘Creating regional bond markets in East Asia: rationale and strategy’, paper presented to PECC Finance Forum, 8–9 July. Williamson, John (2000) Exchange-Rate Regimes for Emerging Markets: Reviving the Intermediate Option, Washington DC: Institute for International Economics.

13 Politico-strategic dimensions of economic cooperation in the Asia Pacific Andrew MacIntyre and Hadi Soesastro

INTRODUCTION In important respects, the prevailing pattern of regional economic cooperation has shifted since the mid-1990s, with the pace of change accelerating from the late 1990s onward. These trends can be summarised as follows: • the rise of preferentialism in regional trading arrangements with the sharp swing toward FTAs since the late 1990s; • the rise of significant financial cooperation; and • the growth in momentum for East Asian-only regional cooperation. Free trade agreements themselves are not new to the Pacific region; what is new is the dramatic growth in the number of arrangements that have been signed or are under negotiation (Findlay et al. 2003). Most of the wealthy industrial economies—Australia, Japan, New Zealand, Singapore, South Korea and the United States—have moved to negotiate or sign one or more agreement in the last few years. And China and the ASEAN states—collectively and individually—have been quick to follow. The result is a plethora of bilateral and regional multilateral compacts. It may well be that a number of the FTAs that have been mooted or are currently under negotiation will not, in fact, ever come to fruition. But even allowing for this, the sudden rush to pursue preferential trading arrangements around the region is an extraordinary change on the recent past and has pushed the old principles of economic regionalism very much into the background. The second big development has been the rise of an increasingly serious interest in financial cooperation within East Asia. The pivotal change was the May 2000 Chiang Mai Initiative (CMI), under which a number of East Asian countries have made bilateral agreements to extend liquidity support to each other in the event of a financial crisis. While trigger mechanisms for the CMI remain closely tied to the International Monetary Fund (IMF), regional funding commitments for the swap arrangements now total about US$40 billion (de Brouwer 2003; Bergsten and Park 2002; Soesastro 2003). Regional financial cooperation is still only in its infancy and there are numerous obstacles ahead: for instance, multilateral policy dialogue and surveillance are still weak, financial markets and institutions in many parts of the region are still weak and exchange rate regimes vary greatly. Nevertheless, it is increasingly apparent that there are benefits in pushing for enhanced financial cooperation within East Asia and that there is significant momentum behind this movement (de Brouwer and Ito 2003). Indeed, in many respects the prospects for advancing regional economic cooperation seem more promising on the

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financial front than the trade front. In June 2003 agreement was reached for central banks from eleven East Asian countries to contribute a total of US$1 billion in reserves to an Asia Bond Fund and a proposal for basket currency is under discussion (Ito 2003). The third major trend is the emergence of an increasingly East Asian orientation to the overall pattern of economic cooperation. This is evident on both the trade and financial fronts. Whereas before the primary thrust of efforts to promote economic cooperation was pan-Pacific in character, since the late 1990s it has increasingly assumed an intraEast Asian character. This has taken various forms, with the flurry of intra-East Asian bilateral FTA initiatives and the more ambitious East Asian multilateral FTA initiatives: the acceleration of the ASEAN Free Trade Agreement (AFTA) and the ASEAN-plusChina, ASEAN-plus-Japan and, more distantly, ASEAN-plus-three agreements. There have also been trade initiatives across the Pacific: for instance, the US-Singapore FTA, the US-Australia FTA, the Japan-Mexico FTA and the Enterprise for ASEAN Initiative proposed by the United States. The situation on the financial front is broadly comparable in this respect. Much greater effort and attention is being focused on the various intraEast Asian initiatives being explored under the auspices of ASEAN-plus-three collaboration, rather than pan-Pacific initiatives (principally, the Manila Framework Agreement). While East Asia remains fundamentally connected to global multilateral financial arrangements under the IMF, as with trade, the trend is toward intra-East Asian collaboration. From the late 1980s until the mid-1990s there was wide support for an economic order based on pan-Pacific non-discriminatory trade liberalisation. The Asia Pacific Economic Cooperation (APEC) forum was its institutional embodiment. As the 1990s progressed, policy movement in this direction lost momentum and has since been displaced by movement in a different direction, as described above. The result is a new pattern of regional economic cooperation, the outlines of which now seem reasonably clear. The distinguishing features are a turn from non-discriminatory to preferential trade cooperation, a new emphasis on financial cooperation and a shift in emphasis from panPacific cooperation to intra-East Asian cooperation. This chapter briefly maps these new trends and analyses some of the key factors that lie behind them. There is growing recognition that politico-security factors, and noneconomic factors in general, are an important part of this story, but they are rarely the subject of sustained analytic attention. One of the main objectives, therefore, is to help illuminate the impact of politico-strategic variables. The newly emergent economic order is subject to further change and the chapter concludes with some thoughts about this.

THE CHANGING ASIA PACIFIC ECONOMIC ORDER Looking back, the early APEC period—roughly the late 1980s through until the 1994 Bogor Summit—was quite distinctive. The focus of activity was on economic issues and a loose, consensual style of decision making that moved no faster than the slowest member was willing to proceed. This earned APEC criticism in some quarters, as an ineffectual and open-ended talkfest.1 But as with ASEAN before it, this gentle, even tentative modus operandi was probably essential to begin with, given the all too stark economic, political and social differences that characterised the Asia Pacific. At that

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stage, the cleavages and suspicions that criss-crossed the region were probably so great that a pan-Pacific multilateral venture could not have survived without something approximating a veto for all members and a general emphasis on voluntary rather than binding commitments. Particularly important in this respect was the pattern of trade liberalisation at the time, often termed ‘open regionalism’, under which countries unilaterally lowered national barriers to trade on a completely non-discriminatory basis. In many western Pacific countries during this period, governments chose—very largely for domestic reasons—to reduce protectionist barriers unilaterally. The irony here was that this loosest of regional arrangements was associated with the strongest of outcomes in terms of trade liberalisation, since unilateral and non-discriminatory tariff reductions was a more exacting standard than that of the GATT/WTO itself. APEC did not drive this process of unilateral liberalisation—its operations being voluntary and non-binding. But it did provide a forum that encouraged and facilitated the process. Although APEC’s formal agenda for regional economic collaboration was modest, for most countries there were important wider foreign policy calculations involved. The precise mix of priorities varied by member country, but three in particular stood out: putting pressure on Europe in GATT negotiations, keeping the United States focused on and engaged with East Asia and, above all, building mutual understanding, trust and confidence among governments within Asia and around the Pacific. At the base of all the shared interests in constructing a framework for Asia Pacific economic cooperation was the desire to minimise the risk of major political or military disruption to the region’s deepening trade and financial flows. There was seen to be a virtuous cycle: regional peace and stability facilitated open commerce, and open commerce in turn facilitated regional peace and stability. APEC was an institutional mechanism that, at least to begin with, seemed to hold out the promise of advancing all these goals simultaneously. Causes of change Three broad factors brought change to this system: a growing political commitment to achieving some form of institutionalised East Asian cooperation, pessimism about the prospects for accelerating multilateral trade liberalisation globally, and strategic positioning by national governments in the context of an evolving regional balance of power. A key factor driving change in the Pacific economic order has been the growing groundswell of support among both policymakers and publics across East Asia for the idea of building an East Asian framework for government-to-government cooperation. This impulse, fundamentally political in nature, has been growing for some time. It was first formally articulated by former Malaysian Prime Minister Dr Mahathir’s proposal for an East Asian Economic Group (EAEG) as an alternative to APEC. The idea has taken different forms over time, but at its core lies a region-wide unease about US hegemony. It grew originally from the confluence of two historic developments in world affairs in the late twentieth century: the economic rise of East Asia, and the passing of the Soviet Union and the Cold War. The former underpinned a growing sense of national selfconfidence and assertiveness across East Asia, while the latter led to a sense of increased freedom of foreign policy movement among East Asian states that had (formally or informally) sided with the United States through the Cold War. Together, these forces

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gave rise to a growing unwillingness among East Asian policymakers and publics to accept unquestioningly US political dominance in regional and world affairs. Mahathir’s original proposal did not go far, however, because, despite growing sympathy for it, key East Asian states (most importantly, Japan) were unwilling to act upon it, in large measure because their concerns about other possible security threats in the region— principally China—meant that they ultimately remained beholden to the United States.2 Political interest in some form of East Asian grouping surged dramatically with the onset of the Asian financial crisis. While there was certainly recognition among policy elites across the region of serious domestic failures contributing to the economic mayhem of 1997–98, more striking was the widespread sense of disappointment and resentment at what was seen as the unsympathetic and even unhelpful response by the United States to the dramatic plight of afflicted East Asian economies. The net effect of this was a regionwide consensus about the need for East Asian self-help strategies, which crystallised in the form of the ASEAN-plus-three framework. December 1997 saw the first ASEANplus-three heads of government meeting, and the process has been ratcheting up steadily since that time through successive ministerial and leaders’ meetings (Soesastro 2003). While the Asian financial crisis had a crucial impact in focusing concerns, East Asian political unhappiness about US dominance is broader based. Ahn (2003) identifies the underlying phenomenon when he speaks of Asia’s nationalism, and more specifically of a ‘wounded nationalism’. This captures both accumulating general resentment toward America’s capacity to impose its preferences unilaterally, as well as specific focal points for anger in those countries that host large American military presences and endure repeated social transgressions. Similarly, Wanandi (2004) identifies the emergence of an East Asian regional identity as one of the most important trends in the region, and worries about the possibility of Washington reading and handling issues such as the rise of China, tensions on the Korean peninsula and Islamic militancy in Southeast Asia in ways that are insufficiently sensitive to Asian interests. A second key factor driving change in the prevailing pattern of regional economic cooperation has been growing pessimism about the prospects for advancing multilateral trade liberalisation at the global level. The failure of WTO ministerial talks in Seattle in 1999 and the disappointment at the 2003 Cancun Ministerial appear to represent a reduced commitment globally—but especially among the major countries—to trade liberalisation. US trade policy is pivotal in this respect. Whatever its true objectives, the Bush-Zoellick strategy of ‘competitive liberalisation’ is now widely interpreted as a retreat from championing free trade.3 Within the United States, critics of the BushZoellick policy argue that along with damaging broad US economic interests, it risks seriously setting back pan-Pacific economic cooperation and encouraging East Asia to turn inward (Gordon 2003). Whatever specific responsibility properly attaches to Washington, the fact that the three big Pacific economies—the United States, Japan and China—have been actively launching negotiations or studies of the feasibility of various FTAs has surely escalated the problem and prompted other countries now scurrying to follow suit. A third basic driver of shifts in the prevailing pattern of economic cooperation is the competing strategic calculations of individual states. Along with nationalist pressures in domestic politics and judgements about the prospects for multilateral trade liberalisation under the WTO, calculations by governments about strategic positioning, national

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advantage and, ultimately, security have also played a powerful role. Frequently underplayed in discussions of international economic cooperation, these variables are nonetheless an important element in the equation. For all states in the region, economic cooperation has always carried important strategic implications. For instance, it is now generally recognised that in the post-Cold War context of the early 1990s APEC was seen as a vehicle for keeping the United States engaged in Asia and reducing the risk of any fundamental cleavages opening up between the Americas and East Asia (Soesastro 2003). Strategic considerations are just as important today. As a general proposition, all states share a fundamental interest in continued regional stability and expanding opportunities for international commerce. This, of course, is the reason for pursuing government-to-government economic cooperation in the first place. But as the realist tradition of international relations theory reminds us, because geopolitical circumstances and endowments differ—geography, population, political frameworks, wealth, technology, military capabilities—and because all states seek to maximise national interests, there is also rivalry and an imperative to compete. Ultimately, this comes down to a state’s ability to provide for its security—either on the basis of its own resources, or in conjunction with other ‘allied’ states. Again, as a general proposition, more powerful states are typically concerned to limit the ability of other powerful states to dominate their sphere of interest, while less powerful states seek to steer a path among the big powers and ensure that no one of them completely dominates the neighbourhood.

INTERESTS OF INDIVIDUAL STATES How do these considerations bear upon approaches to economic cooperation in the Asia Pacific region? Space constraints preclude a full mapping out of the calculations of all countries, but for illustrative purposes we can briefly sketch in the basic strategic calculus of the biggest states—China, Japan and the United States—and, in summary fashion, the ASEAN states. China has a powerful interest in ensuring that neither the United States nor Japan is able to dominate East Asia or seriously constrict Chinese interests. This points toward a strategy of trying to win friends and influence around the region, while not alarming Tokyo and particularly Washington. Regional economic cooperation is one important tool for doing this; especially since, inevitably, China’s size and the speed of its economic growth has been a source of much concern around the region. Indeed, China’s rise represents an historic shift in the strategic environment of the Pacific region. That other countries in the region should be anxious about this in economic, political and, ultimately, security terms is only to be expected. More remarkable for present purposes is the extent to which China has succeeded through its campaign of economic diplomacy of the last few years in encouraging other countries to view it as economic partner and source of opportunity, rather than as an economic threat. The ASEAN states in particular have been the subject of a sustained and sophisticated diplomatic ‘charm offensive’. The proposal in 2000 for a China-ASEAN free trade area was followed in 2001 by the offer to accelerate this under the ‘early harvest’ plan, and most recently at the October 2003 ASEAN Summit in Bali, China not only formally acceded to ASEAN’s core Treaty of

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Amity and Cooperation, it succeeded in having the ASEAN states sign on to its new China-ASEAN Strategic Partnership. Forging cooperative economic ties and institutionalising this within a formal framework builds closer relations. Drawing the other smaller East Asian states closer is powerfully in China’s strategic interests, bringing both economic and security benefits. As one ASEAN official was saying at the time of the Bali Summit: ‘This is a long-term game China is playing. They want a situation in Southeast Asia that automatically takes into account China’s interests. The whole objective of the policy is to avoid strategic encirclement by the U.S.’ (Far Eastern Economic Review, 20 November 2003:31). Japan’s circumstances are different, but it too has a powerful strategic interest in building cooperative economic relations with the rest of East Asia. Tokyo’s driving concern is to ensure that China does not come to overshadow the rest of the region as this could directly threaten Japan and diminish its influence. But Tokyo also does not wish to become too heavily dependent on, or dominated by, Washington. In practice, this means that while maintaining its alliance relationship with the United States, Japan seeks to build frameworks for East Asian collaboration in which it has a prominent position. The key element is striving to ensure that neither Chinese nor US influence crowds out Japanese influence. We can see this as a driving consideration behind moves such as supporting the development of the ASEAN-plus-three framework, anchoring the new architecture for Asian financial cooperation, following China’s proposal of a ChinaASEAN free trade area with a parallel Japanese proposal, and bringing ASEAN leaders to Tokyo for an inaugural ASEAN-Japan Commemorative Summit and simultaneously announcing that it is prepared to sign the ASEAN Treaty of Amity and Cooperation. Having long enjoyed a comfortable position of economic leadership in East Asia, Japan is now vigorously pursuing options to build cooperative economic frameworks across the region designed to preserve a central position for itself and to make sure it is not overshadowed by the rise of China. And so too with the United States. Long-term US interests lie in making sure that China’s seemingly inexorable rise does not lead to a serious diminution of US influence, or worse an East Asia dominated by China. More broadly, it has an interest in ensuring that East Asia as a whole does not come to dominate in a determined fashion to the exclusion of Washington—whether such a process be driven by Beijing, Tokyo or some widespread pan-Asianism. But these long-term interests have been less clearly in focus because of Washington’s preoccupation with terrorism since 11 September 2001. While Washington has been focusing on fighting terrorism, its interests in Asia have received less attention (Gordon 2003). It has made lukewarm efforts to reach out to ASEAN states with a proposal for a series of bilateral economic relationships. But before long, East Asia will once again be brought sharply back into US foreign policy focus—just as it was before 11 September. China’s continued rise ensures that Washington will not long be able to focus so exclusively on the war against international terrorism. For the big powers in the Pacific, regional economic cooperation represents an important instrument in wider calculations about advancing strategic interests. The big powers each seek to ensure that the influence of the others does not expand at its own expense. Central to this strategic rivalry is the courting of other East Asian states, principally the ASEAN states. For the United States, China and Japan, securing the support of the ASEAN states—or, at minimum, ensuring that they do not move too close

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to either of the other two—is a key variable in the regional power balance. On the horizon, India too now is entering the game by signing ASEAN’s Treaty of Amity and Cooperation. It is not that the ASEAN states are powerful or strategically determinative in their own right, but that they represent most of the rest of East Asia. As such, they can be thought of as the strategic ‘swing states’ of East Asia (MacIntyre 2003). What of the position of the ASEAN states themselves? Generalising about ten distinct actors is difficult, but, broadly, all have been concerned at various times about domination by the United States, Japan and China, and all have been frustrated by the limitations of their own regional body. Unable to escape these constraints completely, their general interest lies in pursuing cooperative relationships and cooperative frameworks in which their number gives them more leverage than they might otherwise have and through which they might be able to balance the big states off against one another. In this context, India’s interest in entering the region has been welcomed. For the ASEAN states, almost all the multiple frameworks for regional economic cooperation are strategically advantageous. Although costly to service, they offer a way of engaging, balancing and possibly constraining the big powers. To summarise, in the Pacific, regional economic cooperation is an important instrument in the strategic positioning of all states. Despite their differences, China and Japan share a common interest in promoting intra-East Asian cooperation, enabling East Asian states to come together without the United States. In addition, however, they compete for the affections of the other East Asian states, offering rival frameworks for more narrowly focused East Asian cooperation. The ASEAN states welcome this. The United States, preoccupied with the campaign against international terrorism, has been less active in this game than it would otherwise be. And the net effect of all these forces is a clear shift in the locus of economic diplomacy from a pan-Pacific footprint to various East Asian footprints.

CONCLUSION This chapter has identified three broad changes to the pattern of economic cooperation in the Asia Pacific region: the rise of preferential trade arrangements, the emergence of meaningful financial cooperation and the growing momentum for East Asian-only regional cooperation. What is the significance of these changes? Are these likely to be enduring, and do they presage a swing toward an increasingly inward-looking pattern of economic cooperation within East Asia, at the cost of economic cooperation across the Pacific? Certainly there are grounds for concern here. Some of the changes—if continued unchecked—could indeed lead to a less open commercial environment and even a more inwardly oriented East Asia. But on balance, a strong and sustained move in this direction is unlikely. There are several reasons for believing there will be limits to these trends. First, it is important to recognise that the key changes we have identified do not all point in exactly the same direction. Trends in East Asian trade cooperation and financial cooperation are not the same; the arrows in fact point in diverging directions. Where the former is taking an increasingly preferential character that is suggestive of a turn inward

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if unchecked, this is not the case in the financial sector. Here, the initiatives are all very much IMF-consistent and do not threaten wider global norms in international finance. Second, there are likely to be major obstacles to nascent aspirations for East Asian trade cooperation. Indeed, many of the very same structural obstacles that impeded APEC will also impede ASEAN-plus-three trade initiatives. For instance, Japanese and Korean pressures to protect agriculture. Additionally, the plethora of cross-cutting FTAs further complicates the prospects for meaningful East Asia-wide trade cooperation. Third, there are important strategic considerations that are likely to limit movement in a strongly inward regionalist direction. Too many East Asian countries would be concerned by the prospect of a major regional institution that had the effect of marginalising the United States. For all the frustration and outright anger with Washington around the region, for most countries not only does the United States remain a key market, it is seen as the indispensable force for balancing China’s growing regional power. Reciprocally, although the war on terror continues, the United States is likely soon to ‘rediscover’ its priorities in East Asia. Overall, the pattern of regional economic cooperation is likely to stay in flux, featuring further experimentation with combinations of participants and institutional framework. Importantly, however, this is not likely to spell the demise of APEC. Indeed, ironically, the changes highlighted in this chapter are likely to play an important role in its rehabilitation. Having drifted in the late 1990s, APEC could now emerge as a crucial regional forum, and one with an increasingly politico-strategic character. The 2003 Bangkok Summit provided an early indication of this. APEC’s evolution in this direction will not be without difficulty. Events in East Asia need to be reconciled with the development of APEC, and at present they appear to be pulling in different directions. Reflecting on the Bangkok Summit, Narongchai Akrasanee has observed that APEC is expected to become more explicitly involved in political and security issues, but that the United States will need to exercise considerable care in handling these issues within APEC if it is to avoid alienating East Asian states. But as Long Yong-tu has noted,4 the potential gains from the reinvigoration of APEC as forum in which all heads of government can confer on the big issues of the day are so great, that it is likely to endure.

NOTES 1 For a comprehensive overview of APEC’s development and the debates about its effectiveness, see Ravenhill (2001). 2 Not all East Asian countries fell into precisely this pattern—for example, Indonesia opposed the Mahathir initiative for a range of more local political reasons. 3 For a defence of the administration’s approach, see Bergsten (2002). 4 The remarks by Narongchai Akrasanee and Long Yong-tu were made at the Twenty-Ninth PAFTAD conference in Jakarta (December 2003), where this chapter and the others in this volume were presented.

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REFERENCES Ahn, Byung-joon (2003) ‘The strategic environment: U.S. Power and Asian regionalism’, in Narongchai Akrasanee et al., ASEAN-Japan Cooperation—A Foundation for East Asian Community, Tokyo: Japan Centre for International Exchange, 204–22. Bergsten, Fred (2002) ‘A renaissance for U.S. trade policy?’, Foreign Affairs 81(6): 86–98. Bergsten, Fred and Y.C.Park (2002) ‘Toward creating a regional monetary arrangement in East Asia’, Asian Development Bank Institute Research Paper 50, Tokyo: Asian Development Bank Institute. de Brouwer, Gordon (2003) ‘Financial markets, institutions, and integration in East Asia’, Asian Economic Papers 2(1). de Brouwer, Gordon and Takatoshi Ito (2003) ‘Financial, monetary and economic cooperation in East Asia: where we are, where we want to be, and how we get there from here’, paper presented at the PECC Finance Forum Meeting at Hua Hin, Thailand, 8–9 July. Findlay, Christopher, Mohammed Haflah Piei and Mari Pangestu (2003) ‘Trading with favourites: risks, motives and implications of FTAs in the Asia Pacific’, paper presented at the East Asian Trade Policy seminar, Asia Pacific School of Economics and Government, The Australian National University, 20–1 March. Gordon, Bernard K. (2003) ‘A high-risk trade policy’, Foreign Affairs 82(4). Ito, Takatoshi (2003) ‘Japan’s approach to bilateral FTAs’, paper presented at the Asia Pacific School of Economics and Government, The Australian National University, 7 November. MacIntyre, Andrew (2003) ‘American and Japanese strategies in Asia: dealing with ASEAN’, in Ellis Krauss and T.J.Pempel (eds) Beyond Bilateralism: The U.S.—Japan Relationship in the New Asia-Pacific, Stanford: Stanford University Press. Ravenhill, John (2001) APEC and the Construction of Pacific Rim Regionalism, Melbourne: Cambridge University Press. Soesastro, Hadi (2003) ‘ASEAN-Japan co-operation toward East Asian integration’, in Ryokichi Hirono (ed.) Regional Co-operation in Asia, Tokyo: Japan Institute of International Affairs, 24– 49. Wanandi, Jusuf (2004) ‘Strategic trends in the Asia Pacific’, paper presented at the Second Asia Pacific Security conference, the Institute of Defence and Strategic Studies, Singapore, 23 February.

Index Africa, 18, 20, 24, 27, 30, 43n, 161, 220, 228 aggregate measure of support (AMS), 24 agriculture, 24–5, 40, 48–9, 50, 53, 74, 76, 83, 84, 85, 89, 91, 92, 94, 95, 115, 119n, 120n, 126, 135, 222 direct-income farmer support, 28 FTAA, 160–1 MFN statutory applied tariff, 88 NAFTA, 42n, 72 OECD countries, 24 protection, 15, 24, 30, 74, 97, 101 subsidies, 6, 24–5, 28, 35, 74 Andean Community, 142, 146, 147, 154, 155, 156, 175, 216 antidumping, 6, 21, 26, 28, 30, 42n, 91, 164 APEC (Asia Pacific Economic Cooperation forum), xiii, 2, 3, 5, 8, 9, 11, 15, 37, 46, 50, 73, 78, 79, 82, 91, 97–122, 127, 129–21, 130, 182, 229, 265, 266, 268, 272 agriculture, 127 Business Advisory Council (ABAC), 110, 111, 118 Business Travel Card, 119n, 219, 221, 240 competition policy, 94, 119n criticism of, 97, 101, 103–4, 266, 271 development cooperation, 116–17 e-APEC program, 102 ECOTECH program, 102, 103, 116, 120n, 127 effectiveness, 104–5 Eminent Persons Group, 50 Engineer program, 219–20 establishment, 92, 129 facilitation role, 114, 116, 117, 118, 120n future of, 15, 103, 104–5, 272 GNP share, 182 Group on Services, 220 health services, 220–1 International Assessment Network (APIAN), 119n investment code, 101 Leaders’ meetings Auckland, 94 Bangkok, 73, 272 Manila, 51 Osaka, 50 Manila Plan of Action, 93, 127 members, trade, 183, 201, 203, 223n Seoul Declaration, 99 Osaka Action Agenda, 100, 101, 102, 120n, 127

Index

252

objectives, 98–100 Secretariat, 117 Shanghai Accord, 119n strategic interests, 269–71 tariff elimination, 93–4 trade flows, 184 trade liberalisation, 100–1, 183–5 trade, trans-Pacific, 182, 183, 184 2010/2020 deadlines, 50, 93, 94, 97, 100, 109, 110–11, 116, 118 voluntary nature of cooperation, 103, 104, 107, 117, 129, 219 WTO relationship, 8, 97, 108–10 Argentina, 19, 21, 26, 144, 159, 165, 167, 168, 171 ASEAN (Association of Southeast Asian Nations), 7, 46, 55, 73, 79–80, 127–9, 135, 229, 234, 261, 266, 269 Australia relationship, 9 and China, 14–15, 73, 76, 77, 79, 80, 265, 269, 270 currency swap arrangements, 250, 262n economic community (AEC), 128 emergency safeguards agenda, 212 export specialisation patterns, 62 exports, 56, 73 Framework Agreement on Services (AFAS), 14, 128, 135, 240 Free Trade Area (AFTA), 51, 93, 123, 127, 129, 132, 183, 265 intra-ASEAN trade, 128 Investment Area (AIA), 94, 128, 135 -Japan Commemorative Summit, 270 leadership, 95 Secretariat, 128 services liberalisation, 240 Surveillance Unit (ASU), 251 trade liberalisation, 126–9, 185–6 ASEAN6, 127 exports, 57, 58, 59, 125 ASEAN10, 128, 132 ASEAN-plus-three, 10, 14, 123, 137, 250, 253, 257, 259–60, 265, 267, 270, 272 Asian Development Bank, 251 Australia, 3, 10, 49, 51, 56, 73, 91, 94, 101, 113, 114, 115, 221, 221–2 agriculture, 77, 222 Closer Economic Relations agreement (with New Zealand) (CER), 51, 73, 93, 185, 216 Engineer Register, 220 export/GDP ratio, 61 exports, 57, 58, 59, 60 free trade agreements under negotiation, 73 Japan trade cooperation, 49 labour movement, 238–9 preferential agreements, 8–9 -Singapore FTA, 73, 93 -Thailand FTA, 73, 93 Trans-Tasman Travel Arrangement (TTTA), 241–2 -US FTA, 73, 74, 79, 93, 108, 115, 119n, 120n, 163, 177n, 265

Index

253

Bangkok Declaration, 73, 79, 80 Bangladesh, 230, 231 Bank for International Settlements (BIS), 37 banking see financial sector Batam, 120n Bogor Declaration, 50, 51, 94, 97, 101, 104, 108, 109, 116, 118, 119n, 127, 130, 138, 266 border barriers, 25, 97, 100, 101, 105, 106–10, 113, 118, 119n, 120n Brazil, 10, 19, 21, 29, 74, 142, 154, 158–9, 165, 167, 168, 169, 170, 171, 173, 176 Cambodia, 126, 133, 134, 234, 245, 252 Canada, 25, 42n, 70, 88, 120n, 136, 137, 142, 143, 144, 145, 148, 158, 160, 161, 164, 178n, 185, 201, 203, 237, 238 agriculture, 89, 94 exports, 57, 58, 59, 69, 202 imports, 69, 202 NAFTA experience, 76 -US FTA, 93, 94, 146 Caribbean Basin Initiative Act, 175 CARICOM, 146, 148, 154, 175, 177 Central America, 30, 42, 115, 140–80 -US FTA (CAFTA), 30, 146, 148, 169, 170, 175, 177 Chiang Mai Initiative (CMI), 250, 251, 254, 257–8, 259–60, 261, 264 Chile, 42n, 73, 108, 137, 144, 147, 153, 158, 159, 163, 165, 166, 167, 168, 174, 176, 177n, 183, 184, 185, 186, 189, 191, 195, 204, 237 China, 3, 4, 9, 10, 16, 46, 73, 77, 92–3 antidumping, 26, 42n and ASEAN, 14–15, 73, 76, 77, 79, 80, 265, 269, 270 comparative advantage, 46, 60, 68, 71, 77 comparative disadvantage, 68, 76 currency, 71, 80, 249, 262n current account, 72 domestic trade liberalisation, 51 exports, 58, 59, 60, 86 labour-intensive, 54, 55, 56, 60, 68, 71 manufactures, 84 share of world export growth, 70 finance cooperation, 259–60, 261 foreign direct investment (FDI), 70–1, 127, 128, 260 free trade agreements, 73, 76 -Hong Kong FTA, 73 hub in East Asia, 5, 11, 125 imports, 7, 68–9, 71, 125–6 manufactures, 84 internationalisation of economy, 7, 67–72, 77, 78, 130, 135 political tensions, 72, 76 labour costs, 60, 68, 138 leadership on trade, 78–80, 95, 260 major trading partners, 70 manufacturing, 54, 55, 72, 83, 84, 138 openness, 93, 119n

Index

254

political system, 68 preferential agreements, 8, 9, 12 resources, 68, 76 strategic interests, 269–71 tariffs, applied, 91 textiles, 49 United States balance, 15 -United States trade, 50, 72 WTO commitments, 72 WTO entry, 51, 71, 72, 73, 127 yuan, undervaluation, 71, 249, 260 civil society, 33, 39, 156, 157 comparative advantage, 6, 17, 26, 27, 28, 35, 39, 47, 49, 52, 54, 71, 77, 100, 107, 124–5 APEC, 102, 103 changing, 56, 60, 62, 124 China, 46, 60, 68, 71, 77 East Asian, 60 Japan, 48 services sector, 208 comparative disadvantage China, 68, 76 competition, 13, 21, 22, 75, 76, 94, 116, 123, 219 domestic, 22, 244 effect of PTAs, 29 Global Competition Forum, 37 international, 107, 108 policy, 8, 13, 35, 92, 94, 97, 110, 111, 113, 119n, 126, 146, 153, 171, 173, 215, 216 components, 60, 63, 64, 125 Costa Rica, 144, 153, 159, 168, 237 cotton, 24, 48, 214 customs procedures, 20, 21, 33, 101, 103, 110, 126, 128, 129, 138, 160, 173, 193, 204 unions, 48, 50, 97, 98, 123, 146, 147, 153–4, 219 developing countries anti-export bias, 20, 21 PAFTAD attendance, 1 trade shares affected by agricultural subsidies, 25 discrimination see preferential trading arrangements (PTAs) Doha Declaration, 85 Doha Development Agenda, 18, 34, 82–96, 214 see also World Trade Organisation, Doha Round Doha Round see World Trade Organisation, Doha Round Dominican Republic, 144, 175 Drysdale, Peter, 1–4 Early Voluntary Sectoral Liberalisation (EVSL), 100, 127 East Asia Study Group, 138, 253–4, 259 East Asia Vision Group (EAVG), 137, 253, 259

Index

255

East Asia current payments surplus, 67 economic and demographic indicators, 245 economic relationships, trends, 15 future, 271–2 exchange rates, 14, 18, 248–9, 250 export/GDP ratio, 54, 61 exports, 7, 54, 55, 56, 57, 58, 59, 60, 63, 65, 83–5, 86–7, 124, 125–6 fragmentation trade, 63, 74, 76, 80 free trade area, 137–9 GDP-PPP growth, 53 GNP, share of world, 182 growth, 52–64 imports, 54, 65, 67, 124 intra-East Asia trade, 7, 15, 46, 56, 65–7, 80, 85, 124, 125, 126, 265 MFN statutory applied tariff for agricultural products, 88 MFN statutory applied tariff for non-agricultural products, 90 regional identity, 267, 268 tariffs, 7, 12, 20, 88, 90 trade structure, 83–5 East Asian Economic Group (EAEG), 123, 127, 129, 267 economic crisis see financial crisis El Salvador, 144, 171 Eminent Persons Group, 50 Enterprise for ASEAN Initiative (EAI), 132, 265 environmental issues, 28, 31, 146, 153, 165, 166, 170, 174, 195 Europe, 8, 56, 64, 79, 203, 234, 266 Europe, Central, 130 Europe, Eastern, 20, 60, 130 Europe, Western, 127 European Community, 2 European Free Trade Association (EFTA), 136, 216 European Union, 11, 12, 18, 30, 31, 40, 48, 50, 54, 65, 102, 112, 129, 138, 212, 216, 221, 234, 237 agriculture, 24, 42n, 49, 89, 127 antidumping, 26 Economic Partnership Agreements with African, Caribbean and Pacific (ACP), 30 Everything But Arms (EBA), 27, 28 export/GDP ratio, 61 exports, 57, 58, 59, 60 labour, 237 manufacturing, 89 Single Market Agenda, 8, 102, 110 textiles and clothing, 42n -US agreement, 114 Executives’ Meeting of East Asia and Pacific (EMEAP), 251, 256 financial crisis, 9, 46, 53–4, 72–3, 80, 92, 100, 102, 103, 123, 126, 127, 129, 130, 139, 228, 231, 244, 247, 251, 260, 261, 267 financial sector, 14, 15, 102–3, 116, 123, 221, 244–63, 271–2 Asian bond market, 254–6, 261, 265

Index

256

Asian financial institute, 256–7 banking, 166, 201, 204, 205, 246, 247, 262n, 265 basket currency, 265 benchmarking, 14 capital movements, 106 Chiang Mai Initiative (CMI), 250, 251, 254, 257–8, 259–60, 261, 264 common currency, 253, 265 cooperation for domestic financial reform, 256–8 domestic financial systems, 246–8 exchange rates, 14, 18, 248–9, 250 Group of Seven (G7), 262n institutions, 102, 258–9 openness index, 257 regional arrangements, 249–51 regulatory standards, 37 vulnerability, 244 Foreign Affiliates Trade Statistics (FATS), 201, 203 foreign aid, 24, 102 foreign direct investment (FDI), 1, 30, 53, 124, 126 APEC code, 101 competition for, 127, 128, 130 diversion to China, 70, 80n, 124, 127, 128, 260 diversion to NIEs, 124 diversion to Southeast Asia, 124 foreign exchange reserves, 251 inflows in East Asia, 71 services sector, 201, 203, 212, 217 foreign ownership, 127, 178n, 218, 247 Fraser, Prime Minister Malcolm (Australia), 3 free trade agreements (FTAs), 8–12, 73, 74, 78, 131, 132 bilateral agreements, 5, 9, 10, 13, 74, 129–30, 136, 193–4, 242, 264 currently under negotiation, 73, 136 reform, 11–12, 13, 79 risks of proliferation, 78–9 sizes of, in East Asia, 133 see also preferential trading arrangements Free Trade Area of the Americas (FTAA), 9–10, 19, 41, 120n, 127, 130, 139, 142–80 agriculture, 160–1 benefits, 157–9 characteristics, 147–53 customs unions, 154–6 future of, 174–6 government procurement, 163–4 history, 142–4 intellectual property rights, 164–5 investment, 163 labour and environment, 165–6 Miami Ministerial Declaration, 159, 171–3, 178n monetary cooperation, 166–7 negotiating objectives, 159–67 perceptions of, 171–6 services, 162–3

Index

257

trade remedy actions, 164 General Agreement on Tariffs and Trade (GATT), 34, 38, 43n, 47–8, 50, 73, 74, 78, 79, 97, 99, 100, 106, 115, 119n, 130, 144, 266 textiles and agriculture exceptions, 48–9 General Agreement on Trade in Services (GATS), 14, 27, 128, 200, 205, 206, 209, 212, 214, 218, 221, 228, 229, 241, 259 four modes of services trade, 236 ‘GATS visa’, 214, 221, 240 rule making on domestic regulation, 210–12 Working Party on GATS Rules, 210, 212 Generalised System of Preferences (GSP), 27 Global Development Network, 39 globalisation, 9, 10, 47, 60, 74–8, 228, 236 government procurement, 35, 92, 146, 163–4, 210, 212, 216 Great Britain, 27 Group of Twenty (G20), 95, 126 Hawke, Prime Minister Bob (Australia), 3 health services, 200, 206, 220–1, 232 Hong Kong, 4, 67, 73, 80n, 93, 124 -China FTA, 73 exports, 84, 86 growth, 54 imports, 85 openness, 53, 93, 257 services, 92 textiles, 49 hub-and-spoke structures, 5, 10–11, 115, 132, 137, 193–4 import-substitution, 29, 142 income, 22, 23 high, 30 low, 29, 33, 36, 39, 40, 43n, 124, 138 per capita, Western Hemisphere, 145 India, 9, 21, 50, 270, 271 labour exporter, 230, 231 tariffs, applied, 91 Indonesia, 21, 68, 120n, 272n agriculture, 84, 92 banking, 261n components, 125 domestic trade liberalisation, 51 exports, 84, 86 labour exporter, 230, 231 manufactures exports, 84, 89, 91 manufactures imports, 84, 85 nurses, 220 restructuring, 261n openness, 119n, 257 protectionism, 91

Index

258

Soeharto government, 51, 72, 127 textiles, 49 inflation, 142, 166, 227, 249 information exchange, 30, 39, 41, 101, 102, 105, 251 information technology, 100, 101–2, 103, 107, 118 see also technology Information Technology Agreement, 100, 107, 118, 127 institutions, i, 117, 129, 258–9 domestic, 8, 20, 21, 22, 35, 36, 40, 43n, 247 international, xiii, 5, 6, 7, 14, 27, 28, 34, 37, 40, 47, 50, 72, 92, 101, 118, 247, 258–9 appropriate tasks for each forum, 6, 19 regional, 2, 3, 5, 8, 14, 15, 16, 37, 49–50, 123, 251–4, 258–9, 269 research, 2 see also Asia Pacific Economic Cooperation; World Trade Organisation integration, 181–6 deep, 5, 6, 9, 18, 19, 29, 31, 32, 33–6, 38, 41, 42n, 50, 52, 56, 63, 72, 78, 135, 259 financial market, 244–63 North-South, 29–30, 40 policy driven, xiii intellectual property rights, 33, 110, 126, 153, 164–5, 170, 171, 174, 215, 216 International Conference on Financing for Development, 40 international cooperation, 12–13, 17–45, 105–19 International Council of Nurses, 220 international economy, 52, 53, 65–7, 72, 77, 78 International Labour Organisation, 37 International Monetary Fund (IMF), 14, 129, 249, 250, 251, 258, 264 International Telecommunications Union, 37 intra-industry trade, 63–4 investment, 20, 34, 38, 52, 68, 92, 93, 94, 101–2, 106–16, 118 climate, 19, 30, 43n flows, 124, 129, 215–16 FTAA, 163 policy options, 109 restrictions, 26–7, 128 see also foreign direct investment; trade and investment liberalisation (and facilitation) Islamic militancy, 268 see also terrorism Japan, 4, 5, 10, 26, 46, 48, 64, 67, 91, 93, 94, 95, 108, 113, 114, 115, 123, 124, 203 agriculture, 15, 42n, 49, 50, 67, 79, 89, 93, 126, 135 Australia trade cooperation, 49 antidumping, 26, 42n and ASEAN, 14 components, 125 currency swap arrangements, 250–1, 262 demographics, 54 economy, 2 export specialisation patterns, 62 exports, 54, 55, 56, 57, 58, 59

Index

259

capital intensive, 54, 56 labour-intensive, 55, 56 footwear, textiles and clothing, 25, 48, 49, 56 FTAs under negotiation, 73 growth, 54 manufacturing, 48, 49, 54, 55, 89 -Mexico FTA, 135, 265 preferential agreements, 8–9 -Singapore FTA, 73, 135 strategic interests, 269–71 Korea, 14, 21, 48, 68, 73, 93, 94, 95, 108 agriculture, 15, 50, 67, 79, 93 exports, 58, 58, 59 FDI, 54 manufacturing, 83 textiles, 49 see also North Korea; South Korea labour, 14, 31 female, 232 flexibility, 23, 42n, 60 flows, intra-Asian, 230–1 FTAA, 165–6 health services, 220 illegal, 231, 234–5, 241 liberalising movement, 213–14 lower-wage countries, 124–5 migration, 229–32 percentage in industry (APEC), 201 percentage in services (APEC), 201 skilled, 229–30, 240 unskilled, 228, 234, 241 see also people movement Laos, 126, 133, 134, 240, 252 Latin America, 10, 20, 40, 91, 130, 142–80 least-developed countries (LDCs), 18, 24, 32, 39 EU Everything But Arms (EBA) program, 27, 28 exports, 24 services sector, 210, 213 trade shares affected by agricultural subsidies, 25 legal services, 112, 204, 205, 208 machinery, 56, 60, 62, 86, 124 Malaysia, 21, 68, 72, 95 exports, 84, 86 foreign worker levy, 235 health services, 220 illegal workers, 234–6 labour exporter, 234

Index

260

labour inflow, 232, 234 Mahathir, Prime Minister, 123, 127, 267, 272n manufactures exports, 84 manufactures imports, 85 restructuring, 261n textiles, 49 Manila Framework Group (MFG), 251, 261, 265 manufacturing, 25–6, 43n, 83–5, 89–91, 124, 138 capital-intensive, 54, 56 internationalisation, 60 labour-intensive, 25, 26, 54–5, 56–7, 80n protectionism, 6, 101 see also textiles and clothing market access, 6, 7, 17, 18, 23–7, 28, 29–30, 31–42, 85, 89–90, 160, 210, 212, 214 Negotiating Group on Market Access, 95 MERCOSUR, 10, 29, 31, 154, 162, 171, 174, 175, 176, 216 Mexico, 21, 30, 31, 64, 73, 75, 128, 130, 136, 137, 142, 143, 147, 164, 168, 173, 177n, 178n, 185, 190, 191, 198n, 201, 237, 265 exports, 57, 58, 59 -Japan FTA, 135 labour entry to US, 237 migration, 238 migration, 14, 210, 227–43 feminisation of workforce, 232 illegal, 14, 228, 231, 234–6, 238, 241 policy responses, 232–6 see also people movement Millennium Development Goals, 33 Mongolia, 92 most-favoured nation (MFN) principle, 6, 19, 25, 27, 32, 41, 47–8, 49, 73, 82, 93, 127, 221 applied tariff for agricultural products, 88 applied tariff for non-agricultural products, 90 tariffs by region, 20 movement of people see people movement Multifibre Arrangement (MFA), 33, 48, 49, 115 Multilateral Agreement on Investment (OECD), 94 multilateralism, 9, 10, 12, 13, 18, 19, 30, 34, 35, 37, 39, 41, 46–51, 72, 73, 74–6, 78–80, 85, 91, 92, 94, 95, 98, 99, 103, 105, 106, 107, 108, 112, 120n, 123, 126, 129, 135, 136, 137, 139, 140, 144, 157, 161, 171, 174, 175, 181, 190–1, 194, 196–7, 204, 206–7, 211, 212, 218, 221, 223, 241–2, 264, 265, 266, 267, 268 multinational enterprises, 69, 124, 143, 165, 207, 208, 237 Mutual Recognition Agreements, 221 Myanmar, 133, 134, 234, 245, 252 network industries, 42n, 162, 205, 211 see also transport; telecommunications New Zealand, 10, 51, 56, 94, 221 agriculture, 77 Australia relationship, 9, 115

Index

261

Closer Economic Relations agreement (with Australia) (CER), 51, 73, 93, 185, 216 export/GDP ratio, 61 exports, 57, 58, 59, 60 -Singapore FTA, 73 Trans-Tasman Travel Arrangement (TTTA), 241–2 newly industrialising economies (NIEs), 48, 54, 55, 56, 62, 70, 71, 124, 125, 130, 132 North America, 3, 64, 65, 127, 130, 142–80, 183 export/GDP ratio, 61 exports, 57, 58, 59, 60 see also Canada; United States of America North American Free Trade Agreement (NAFTA), 9, 30, 31, 42n, 75, 76, 93, 94, 124, 127, 129, 135, 136, 147, 216 agriculture, 178n labour movement, 237–8 North Korea, 4, 139 North-South integration, 29–30, 40 Ohira, Prime Minister (Japan), 3 Okita, Saburo, 3 open regionalism, 6, 7, 8, 16, 29, 46, 47–52, 72, 73, 93, 100, 117, 123, 127, 129, 266 Organisation for Economic Cooperation and Development (OECD), 3, 7, 18, 27, 32, 35, 37, 40, 117, 201, 210, 213, 259 agriculture policies, 24–5 effect of liberalisation policies, 32–3 Global Competition Forum, 37 manufacturing, 33, 89 Multilateral Agreement on Investment, 94 subsidy reforms, 25, 42n trade policy transparency, 33, 43n Organisation for Pacific Trade and Development (OPTAD), 3 Osaka Action Agenda, 100, 101, 102, 120n, 127 Pacific Area Forum on Trade and Development (PAFTAD), xiii, xiv, 1–4 Pacific Economic Cooperation Council (PECC), 2, 3, 49, 119n, 120n ‘Pacific model’, 37–9 Pakistan, 229, 230, 231 people movement, 13, 14, 19, 42n, 106, 200, 201, 204, 217, 227–43 services sector, 213–14, 220–1 see also migration Philippines, 68 agriculture, 92 components, 125 domestic trade liberalisation, 51 exports, 84, 86 labour exporter, 230, 231 manufactures exports, 84 manufactures imports, 85 nurses, 220 openness, 119n, 257 Ramos government, 51

Index

262

textiles, 49 policy-driven integration, xiii politics and economic cooperation, 7, 11, 15, 18, 24, 41, 48, 50, 68, 70, 71, 72, 73, 75, 76, 77, 78, 79, 91, 96, 100, 101, 102, 120n, 128, 129, 132, 135, 138, 139, 157, 162, 163, 165, 166, 168, 171, 173, 192–3, 194, 195, 207, 227, 228, 233, 242, 247, 259, 264–73 poverty/poverty reduction, 17, 18, 24, 29, 31, 32, 35, 38, 41, 43n, 74, 187–93, 235 preferences, 27–9 preferential trading arrangements (PTAs), 8–12, 18, 27, 29–33, 34, 38, 40, 42, 82, 91–2, 93, 97–8, 101, 105, 107–8, 112–15, 123–4, 127, 129, 146, 194–7 advantages of, 134 disadvantages/criticisms of, 98, 108, 112–16, 129, 136–7 effect of, 31, 47, 130–7 features of, 130–7 list of trading arrangements in East Asia, 131 services sector, 215–29, 223 audiovisual area, US requests, 218–19 see also free trade agreements; Free Trade Area of the Americas; North American Free Trade Agreement protectionism, 6, 15, 18, 21, 91, 95, 97, 100, 104, 106, 115, 126 public administration, 20, 22 regional trading arrangements (RTAs), 97, 103 see also preferential trading arrangements regionalism, xiii, 6, 29, 129–41, 181–99, 242 open, 7, 8, 16, 47–52, 73 regulation, 12–13, 18, 19, 21–2, 39, 41, 110, 118, 205–6, 211–12, 247, 255 heavy, 22, 23 regional cooperation, 30, 32, 42n horizontal vs. sectoral disciplines, 211–12 necessity test, 211–12 resource intensive areas, 36, 37 resources/resource-based products, 67, 68, 71, 76 rice, 108 rules of origin, 9, 11, 28, 63, 74–5, 78, 98, 115, 116 Russia, 4, 50 security, 13–14, 268–9, 269 see also terrorism services, 12–15, 19, 22, 26–7, 28, 200–26 cost of, 21 differentiation, 208 employment, 200, 201, 236–40 exporters and importers, 202 FTAA, 162–3 government procurement, 212 industries, 32–3 labour-intensive, 27 LDC special treatment, 213 migrant labour, 232–3 movement of natural persons, 213–14, 228–9

Index

263

preferential trading arrangements, 215–19 qualifications, recognition of, 110, 112, 210, 212, 214, 219, 220, 233, 237, 240, 241, 242 reciprocity, 206–9, 221–2 subsidies, 212 tariff protection, 204 trade barriers, 205, 206, 207 trade by mode of supply, 202 trade liberalisation, 204–9, 212–13 US trade by partner region, 203 WTO challenges, 209–14 Singapore, 67, 108, 113, 114, 135 -Australia FTA, 73, 93, 136 -European Free Trade Association, 136 exports, 84, 86 growth, 54 -Japan FTA, 73, 135 manufacturing, 83, 233 exports, 84 imports, 85 migrant policies, 233–4 -New Zealand FTA, 73, 136 openness, 53, 93, 135, 257 services, 92, 220, 233 textiles, 49 -US FTA, 73, 120n, 241 Singapore issues see World Trade Organisation South Africa, 21, 26, 220 South America, 142–80, 183 South Korea, 123 central bank, 249 components, 125 exports, 84, 86 manufactures exports, 84 manufactures imports, 85 restructuring progress, 247–8 see also Korea South Pacific Regional Trade and Economic Cooperation Agreement (SPARTECA), 216 Soviet Union, 4, 48 special and differential treatment (SDT), 13, 17–18, 19, 32, 94, 134, 137, 213 Sri Lanka, 230, 231 steel, 26, 120n, 164, 169 Sub-Saharan Africa, 18, 20 sugar, 24, 42n, 115, 119n Summit of the Americas, 147 Switzerland, 234 Taiwan, 4, 10, 48, 67, 73, 83, 124 exports, 84, 87 foreign labour, 236 growth, 54

Index

264

manufactures exports, 84 manufactures imports, 85 textiles, 49 WTO entry, 51, 73 tariff-rate quotas (TRQs), 24, 25 tariff bindings, 33, 43n technical assistance, 13, 31, 37, 39–40, 43n technology, 22, 29, 54, 92, 100, 101–2, 105, 106, 255 telecommunications, 42n, 101, 147, 162, 178n, 201, 205, 206, 208, 211, 222, 255 WTO Reference Paper on Telecommunications Services, 222 terrorism, i, 77, 101, 116, 260 11 September 2001, i, 260, 270 see also security textiles and clothing, 25–6, 48, 49, 62, 89, 91 import quotas, 43n 1995 WTO Agreement, 26 Thailand, 68, 73 agriculture, 92 -Australia FTA, 93 exports, 84, 87 illegal workers, 234, 235 labour exporter, 231 manufactures exports, 84 manufactures imports, 85 restructuring, 261–2 Securities and Exchange Commission, 247 textiles, 49 tourism, 100, 200 health, 220 trade behind-the-border, 7, 8, 19, 21–3, 30, 34–6, 38, 41, 204 complementarity index, 65, 66, 124 cross-border, 27, 201–2, 203, 204, 237, 240 intensity indexes, 65, 66, 80n intra-regional, 7, 15, 46, 56, 65–7, 80, 85, 124, 125, 126, 265 openness, 22, 23, 53, 93, 101, 108, 257 quotas, 24, 26, 34, 43n sanctions, 6, 20, 31, 37, 130 trade agreements see free trade agreements; preferential trading arrangements trade and investment liberalisation, 53, 96, 100–1, 105, 106–16, 126–9, 130, 134, 137, 138, 139, 181, 183–6, 204–6 policy options, 109 trade and investment liberalisation and facilitation (TILF), 99, 102, 103, 105, 106, 109, 118, 127, 134, 137, 181 trade policy, traditional, 34 Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement, 33, 35, 36 Transatlantic Economic Partnership, 114 transport, 22, 42n, 100, 110, 117, 124, 128, 130, 146, 205, 221, 228, 237 Treaty of Amity and Cooperation, 269, 270

Index

265

United Nations Conference on Trade and Development (UNCTAD), 27, 43n United Nations High Commission for Refugees (UNHCR), 228 United States of America, 5, 11, 12, 30, 40, 47, 73, 77, 91, 93, 101, 115, 129, 249, 266, 267 African Growth and Opportunity Act (AGOA), 27, 28 agriculture, 24, 42n, 48, 74, 77, 89, 126 antidumping duty determinations, 26, 42n and APEC, 15 and ASEAN, 270 -ASEAN Initiative, 129 Asian financial crisis, reaction to, 9, 267 -Australia FTA, 73, 74, 79, 93, 108, 115, 119n, 120n, 163, 177n, 265 Bush administration, 73, 147, 260 -Canada FTA, 93, 94 -Central America FTA, 30, 146, 148, 169, 170, 175, 177 -Chile FTA, 177n China balance, 15 -China trade, 50, 72 Clinton administration, 147 deficit, 67 early interest in East Asia, 2–3 -European Union agreement, 114 exports, 57, 58, 59, 60, 62, 203 Farm Bill, 94 footwear, textiles and clothing, 25 foreign direct investment, source of, 203 hub, 137 imports, 89, 120n, 203 industrial products, 42n Kennedy administration, 48 labour movement, 237–8, 239 manufacturing decline, 72 manufacturing products, tariffs, 89 preferential trading arrangements, 9, 18, 218–19 resentment toward, 267–8 Roosevelt administration, 48 security issues in East Asia, 269–71, 272 services trade, 203 -Singapore FTA, 73, 120n, 177n, 242, 265 terrorism, i, 260, 270, 271 trade sanctions, 130 Truman administration, 48 ‘Washington consensus’, 129, 142, 167, 168 see also Free Trade Area of the Americas; North American Free Trade Agreement Uruguay Round see World Trade Organisation US Coalition of Service Industries, 212 Venezuela, 144, 159, 168, 176

Index

266

Vietnam, 4, 48, 49, 54, 64, 68, 71, 113, 126, 133, 134, 188, 189, 191, 197n, 198n, 229, 240, 245, 252 exports, 87, 125 textiles, 49 welfare see poverty/poverty reduction West Africa, 24 World Bank, 103, 119n, 200, 228 World Customs Organisation (WCO), 37 World Trade Organisation (WTO), xiii, 5, 6, 7, 9, 12, 19, 24, 29, 31, 32, 34, 38, 39, 40, 41, 42, 43n, 47, 50, 72, 79, 85, 94, 95, 96, 98, 99, 101, 105, 106, 107–10, 114, 115, 116, 117, 118, 119n, 120n, 123, 126–9, 130, 134, 135, 136, 137, 139–40, 218, 221, 228, 234, 240, 266 African members, 43n Agreement on Textiles and Clothing, 26, 43n agriculture policy, 89, 222 APEC relationship, 8, 91, 92, 97, 108–10 Cambodia entry, 126 China entry, 51, 71, 72, 126, 127 Council for Trade in Services, 210, 211, 213 ‘development credibility’, 32 divisive issues, 30 Doha Round, 7, 12, 18, 34, 35, 41, 49, 72, 73, 79, 80, 82, 91, 95, 96, 108, 126, 135 facilitation role, 111–12 financial relationship with plus three, 259–60 member subsidies, 24, 25 MFN principle, defending, 41 Ministerial conferences Cancun, 35, 79, 82, 91, 92, 93, 95, 126, 210, 215 Seattle, 72, 85, 92, 126 Singapore, 35, 51 plus three relationship, 259–60 reciprocity dynamics, 32–3, 221–2 Ruggeiro, Renato (first Director-General), 51–2, 74, 78 rules, 33, 34–5, 74, 78, 94–5, 218, 221 services sector challenges, 209–14, 212, 222–3 Singapore issues, 7, 35, 40, 43n, 95, 126 single undertaking rule, 33 strategic interests, 269–71 Supachai, Panitchpakdi, Director-General, 115 Taiwan entry, 51, 72, 73, 126 Uruguay Round, 24, 25, 34, 50, 79, 85, 93, 94, 104, 130, 210 Working Party on Domestic Regulations, 210