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p. 71 of 77 BACK | NEXT Foreword, Acknowledgments, Contents, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic trends and prospects in developing Asia III. Routes for Asia's Trade Introduction The drivers of trade and integration in Asia The rise of bilateralism Trade scenarios: Potential benefits and risks An agenda for trade and integration in Asia Conclusions Endnotes and references Statistical appendix

Asian Development Outlook 2006 : III. Routes for Asia's Trade

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The drivers of trade and integration in Asia

Developing Asia's trade performance in the last two decades has been remarkable. From 1984 to 2004, its exports expanded almost 10-fold. Over the same period, world exports grew just fivefold (Figure 3.1). As a consequence, developing Asia's share of world exports almost doubled over the same period, and by 2004 had reached 21.3%. This mushrooming of trade was in substantial measure due to the performance of East Asia, but was also supported by steady expansion in South and Southeast Asia. Central Asia's trade expanded rapidly over the last several years, and has even outpaced that in other subregions, but this was from a low base after the acute contraction that occurred with the breakup of the Soviet Union.

Arguably, trade expansion has been a significant contributory factor in the strong growth performance of many of Asia's developing countries (Box 3.1). Fast growth of trade has also been associated with rising intraregional trade shares. For example, in 2004, intraregional trade in developing Asia was about 40% of total exports, up from just 22% in 1980. Despite this steep rise, intraregional shares in Asia are still lower than comparable shares in North America (46%) and the European Union (EU) (64%).³

Trade and integration in developing Asia

What are the forces driving the growth of trade in Asia and what explains evolving patterns of trade integration?

On the demand side, a progressive reduction of trade barriers resulting from trade liberalization through successive multilateral trade negotiating rounds under the General Agreement on Tariffs and Trade (GATT) and, more recently, the World Trade Organization (WTO) is thought to have played an important role in boosting trade at a global level, though evidence on this point is mixed.⁴ Asian countries that adopted outward-looking policies appear to have benefited disproportionately from this broader global trend.

On the supply side, technological advances that have lowered transportation costs are another factor that has spurred Asia's trade. Indeed, increases in trade efficiency and reductions of "trade costs" may have had a more powerful effect on trade than trade liberalization itself (Engman 2005). Improved trade efficiency has occurred through application and diffusion of informatics and improved telecommunications in international transactions, the development of port and other "behind-the-border" infrastructure, improvements in customs procedures, and a variety of other measures that have reduced frictions to trade.

Important institutional and policy changes have also helped gear developing Asia's economies for greater trade openness. Asia has often moved ahead of WTO obligations. Unilateral trade liberalization, including the early elimination of tariffs on capital and intermediate goods and the reduction of nontariff barriers, played a prominent role in igniting and then sustaining growth of trade. Later, the net of trade liberalization was widened. For example, in 1995, Indonesia adopted a medium-term program of tariff reform aimed at lowering almost all tariffs for manufactured goods on an MFN basis to a maximum range of 5-10% by 2001.⁵

Institutional innovations, some pioneered in developing Asia, such as special export processing zones and bonded industrial warehouses, as well as duty drawback schemes, have also propelled trade (ADB 1997, Petri 2006). The world's first export processing zone for manufacturing was established in Kaoshing in Taipei,China in 1966. By the 1970s, the Republic of Korea had established two large export processing zones and had over 200 bonded warehouses. By 1980, 74% of Malaysia's total exports came from export processing zones. Elsewhere, in Indonesia (Batam Island), the PRC (Shenzen), and the Philippines (Subic Bay and Clark) special economic zones were also created, providing conditions that mimicked "free trade for exporters." A later challenge for governments was to extend these experiments from limited areas to the economy as a whole, as is now being attempted in the PRC and Indonesia.

More recently, regional cooperation efforts, such as those in the Greater Mekong Subregion (GMS), which have focused on investments that improve physical connections between neighboring countries, have opened up new opportunities for trade and have helped deepen integration within the region. Initiatives within GMS to improve customs procedures and reduce legal and policy barriers to the cross-border movement of goods and people engaged in legitimate commercial activity complement investments in physical infrastructure. Other cooperation initiatives are being carried out in South Asia (South Asia Subregional Economic Cooperation—SASEC), Central Asia (Central Asia Regional Economic Cooperation—CAREC), the Pacific Islands, and among Brunei Darussalam, Indonesia, Malaysia, and the Philippines (the East ASEAN Growth Area or BIMP-EAGA). These and other experiments in cooperation are helping strengthen links within and between subregions (ADB 2002).

There is, however, a question mark over the impact that preferential trade agreements (PTAs) have had in promoting growth of regional trade and regional integration. It is certainly true that intraregional trade in developing Asia has grown at a faster pace than the rate of growth of world trade in most years since 1980 (Table 3.1). But in addition to the technological, policy, and institutional factors cited above, rising intraregional trade shares are, to some extent, a direct consequence of fast regional economic growth itself. Other things equal, trade among countries that are growing fast will tend to rise more quickly than trade among countries where growth is slower. ADB (2002a) concluded that, while at a worldwide level PTAs have probably increased trade, their impact on the Asia and Pacific region has been quite small. Intrabloc trade within the Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA) would appear to be no larger than it would be without the agreement.

Petri (2006) has analyzed Asian trade integration over a long historical period. His analysis shows that after a protracted period in which the economies of East and Southeast Asia became more closely tied to the rest of the world, an increasing bias toward intraregional trade can be observed from the mid-1980s. This turning point coincides with a boom in intraregional foreign direct investment, following the Plaza Accord and an appreciation of the yen against the US dollar (Kawai 2005). It also occurred at a time of concerted unilateral trade liberalization in some countries of East and Southeast Asia (Thee 1991 and 2003). Interestingly, the onset of the trend toward increasing regional trade integration predates any formal initiatives to promote trade integration within the region through PTAs.

The trade-FDI nexus and regional integration in developing Asia

The growth of multinational enterprises and foreign direct investment (FDI) has, in recent decades, provided a boost to Asian trade, both intraregional (parts and components, assembly operations) and interregional (imports and exports of capital goods, intermediate goods, and final products). The additional trade and production resulting from the lowering of trade costs, liberalization of trade, and emergence of international production sharing have provided Asia with new sources of income and employment gains. Manufacturing exports in particular have expanded quickly with FDI (Hill 1988, Dobson and Chia 1997).

International production sharing—the fragmentation of vertical supply chains according to location-specific advantages within production networks—has been associated with a high and rising degree of intraregional trade in parts and components that are produced and assembled into final goods within Asia, particularly in East and Southeast Asia. Outward FDI to the PRC and Southeast Asia, particularly from Japan and the newly industrialized economies of Hong Kong, China; Korea; Singapore; and Taipei,China has played a significant role in the development of Asian production networks (Figure 3.2) (Kojima 1990, Kawai 2005). Development of Asian production networks has also been stimulated by FDI from European and North American multinational firms that have found Asia to be a low-cost and efficient location for production and assembly operations (Caves 1996, Dobson and Chia 1997).

The multinational enterprises that have invested in affiliates located in Asia or that have linked up with Asian contract component suppliers have global distribution and marketing capabilities that are among these firms' most valuable intangible assets. The extensive marketing abilities of multinational firms are another reason that explains why foreign-owned enterprises tend to have higher export-output ratios than firms that are domestically owned (Box 3.2) (Ngoc and Ramstetter 2004, James and Ramstetter 2005, Ramstetter 1999). The fact that multinational firms have plants located in more than one country also allows multinational parents to easily conduct international transactions with their affiliates. Although no reliable data are available on the size or share of intrafirm trade in Asia, some idea of the importance of such trade may be inferred from the growing role of foreign-owned enterprises in exports from the PRC and other developing Asian countries.

Advances in computer and information processing technologies, and in telecommunications, have dramatically lowered the cost of dividing up production along the supply chain in production-sharing networks (Box 3.3) (Petri 2006). The ease of conducting intrafirm or intra-industry trade (in the case of contract component suppliers and assemblers) has also facilitated the fragmentation of production processes along lines of comparative advantage, sometimes including local input suppliers and contractors.

The rise in production sharing has become particularly noticeable since the mid-1980s and has now been extensively documented (among others, Ng and Yeats 1999). For example, developing Asia's share of world trade in parts and components rose from 16% in 1992 to 32% in 2003, exceeding the share of the North American Free Trade Agreement (NAFTA) and equaling the share of the EU in 2003 (Athukorala and Yamashita 2005). Despite the significant volume of trade in parts and components within developing Asia, the ultimate destination for most final assembled products remains outside the region, chiefly in the markets of the EU and US. In fact, recent empirical research demonstrates that developing Asia is growing more, not less, dependent on these large markets for final consumption of the outputs of the Asian production networks.⁶

It would seem that PTAs have had very little if any influence on these investment decisions. In some cases, the margin of preference offered by tariff concessions in the PTAs in the region has been too small to compensate firms for the costs of complying with the rules of origin that are necessary to enforce these agreements.⁷ For example, less than 10% of all intra-ASEAN trade is under the ASEAN Free Trade Area's common effective preferential tariff (CEPT) scheme (The Economist 2004). Obtaining an AFTA certificate of origin is apparently difficult in terms of paperwork and costly because it necessitates face-to-face meetings with customs officials, so many ASEAN businesses just elect to pay the MFN tariff. Multinationals in high-tariff sectors (automobiles, for example) may find it worthwhile to obtain the certificate of origin but this is not the case in sectors where tariffs are low or duty drawback is available for imported inputs that are used to produce products for export (e.g., electronics and office equipment). Preferential agreements in South Asia (SAARC Preferential Trading Arrangement) have failed to create much intraregional trade for similar reasons.

The availability of tariff preferences in nearby markets has not deterred US- and EU-based multinationals from investing in nonpreferential markets in Asia. In fact, many US multinationals have preferred to locate in Asian countries despite the FTAs that the US Government has negotiated within North America (NAFTA) and Central America (CAFTA). The profit motive has led multinational firms to seek locations with cost advantages, and many of these locations have been in Asia. Decisions by many nonregional multinationals to locate manufacturing production facilities in Asia reveal their preference for locations that have abundant supplies of skilled and semiskilled labor, less expensive nonproduction managerial workers and engineers, and growing potential domestic markets. The economic stability and predictable business environments found in locations such as Malaysia, Singapore, and Thailand have also attracted investment. The expansion of FDI and FDI-related intra-industry and intrafirm trade that has led to increased integration within Asia, like the growth of intraregional trade, all began well before the recent explosion of PTAs involving Asian developing countries.

In summary, technological changes and market forces unleashed by policy initiatives to unilaterally open up Asia to foreign investment and trade have thus far played the crucial role in deepening regional economic integration and in linking Asia to the largest global markets of the EU and US. This would appear to be in contrast to the formal institutionalization of regional integration in Europe and, more recently, in the Americas, where tariff preferences have played a major role. However, there are clear signs that this dynamic may be changing and that, going forward, more formal institutional trade agreements may be important in shaping the future of Asian trade.

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