A Broad Asian FTA Will Bring Big Gains

Economic regionalism is starting to take root in East Asia. For the past 25 years, rapid expansion in trade -- both to developed markets outside the region and increasingly within East Asia itself -- is accelerating the process toward economic integration. Trade helps drive investment, both foreign and domestic, which in turn helps stimulate trade. Foreign direct investment, in particular, brings with it external funding, better production technology and management know-how, and efficient distribution channels linked with outside markets. These are the seeds of economic integration, as has already happened in North America and Europe, and is now happening in East Asia.

In the absence of a comprehensive World Trade Organization Doha deal, free trade agreements, or FTAs, are proliferating globally, including in Asia. Notwithstanding their possible costs -- such as discrimination against nonmembers and trade and FDI diversion -- properly designed FTAs can keep trade and FDI flowing. However, the current plethora of overlapping and complex FTA arrangements in Asia carries the risk of becoming unwieldy and makes doing business cumbersome. Surveys conducted by the Japan External Trade Organization and the Asian Development Bank in Japan, Singapore and Thailand suggest that firms that rely on trade -- particularly small and medium-sized enterprises -- consider FTAs to be costly.

How best to simplify matters? Even as the Doha Round remains stalled, no one is remaining idle. Is it more advantageous to countries to negotiate bilateral agreements or to find a way that maximizes benefits to a collegial bloc? Should, for example, the Association of Southeast Asian Nations' FTA be expanded to Asean Plus Three (including China, Japan and Korea), or Asean Plus Six (further adding Australia, India and New Zealand), or beyond?

There is a groundswell of talk among business, governments, academics and multilateral groups on the merits of consolidating these multiple and overlapping FTAs into a single East Asian FTA. Doing so, the argument goes, can help mitigate the harmful "noodle bowl" effect of different or competing tariffs, standards and rules. In particular, differing speeds of liberalization and the myriad "rules of origin", or roos, that determine whether a product qualifies for preferential status, are a problem. Establishing a broader-based, regional FTA will make it easier to do business, attract FDI and embrace small and low-income countries. It will also reduce trade-related business costs, particularly for smes and thus promote more inclusive regional cooperation and integration.

What is interesting is that, as FTAs have proliferated, issues outside the WTO requirements have crept into various agreements. These "WTO-plus" issues include trade facilitation, investment, government procurement, competition policy, intellectual property, environment and labor, among others. That these issues have proven sufficiently valuable to governments to include them in negotiations and concluded FTAs suggests the need for them to be further expanded and coordinated in a regional FTA format.

As the chart nearby shows, a recent study done by the authors shows that FTA consolidation at the Asean Plus Six level would yield the largest gains to East Asia among plausible regional trade arrangements -- leaving potential losses relatively small to nonmembers of the agreement. An Asean Plus Three FTA is less beneficial than an Asean Plus Six but provides far larger gains than any of the FTA's between Asean and individual countries outside the bloc.

For FTA consolidation to occur, Asean would have to act as East Asia's regional hub by further deepening its economic integration as it carries on with its plan for an Asean Economic Community by 2015. The plus-three countries of China, Japan and South Korea need to collaborate more closely for coordinated trade and FDI regimes, and India -- which has only recently moved away from its former protectionist enclosure -- needs to pursue deeper structural and regulatory reforms addressing not only tariff issues but also "behind-the-border" red tape.

Furthermore, substantial international support is required to strengthen the supply-side capacity of the poorer members of Asean -- including the building of trade-supporting infrastructure in transport, energy and telecommunications, for example -- so that they can take advantage of integrated regional markets while narrowing the income and other development gaps within Asean.

The economy of Taipei,China is rapidly integrating itself with other East Asian economies, particularly with mainland China. As it is not part of the Asean Plus Three or Asean Plus Six group, the territory is better off pursuing unilateral liberalization -- through the opening of its economy to other East Asian economies without any negotiation. Taipei, China can also unilaterally adopt other key measures of the behind-the-border type agreed upon among the Plus Three and Plus Six countries. This will make Taipei, China's trade policy consistent with those of others in the region and further accelerate its integration with the regional and global economy.

Relationships with the United States -- and increasingly with the European Union -- are critical for the East Asian region, both economically and politically. Asia-Pacific Economic Cooperation, or APEC, remains important for both East Asia and the U.S. because it is the only multilateral economic forum that connects the two. A natural approach for East Asia once it has established a regional FTA would be to strengthen economic ties with the U.S. One possibility would be through the formation of an East Asia-North America Free Trade Area FTA (or an FTA for the Asia-Pacific region). While several East Asian countries have agreed on bilateral FTAs with the U.S., some have reservations about a comprehensive agreement with Washington. Deeper questions also remain as to whether the U.S. is ready to agree to an FTA with the whole of East Asia -- one that includes China -- and whether the U.S. Trade Promotion Authority (which expired in June 2007) will be reinstituted before too long.

Though connecting East Asia with Europe has not been intensively discussed yet, the European Commission has been negotiating "new age" FTAs with South Korea, Asean and India. When Japan and China come into this discussion, a solid foundation for an East Asia-EU FTA will be created.

While consolidating FTAs within East Asia is clearly desirable -- and an eventual connection with the U.S. and Europe is next on the agenda -- it is important for the East Asian economies to make existing bilateral and plurilateral FTAs more multilateral-friendly. By expanding what they have done over the years and by adopting some innovative measures, the process can be made much easier. Examples include using forums such as APEC to strengthen trade and FDI facilitation, unilaterally reducing most-favored-nation tariffs, coordinating FTA completion dates, eliminating exceptions, putting more WTO-plus elements into agreements, simplifying ROOs, putting consolidation as the key agenda of regional gatherings, and allowing cumulative value-added content requirements across countries that conclude FTAs with each other.

FTAs carry benefits and costs, and designing them to maximize benefits is, naturally, the most desirable strategy. With nearly all East Asian economies currently pursuing FTAs, crafting them in a way that induces domestic structural reforms and ensures consonance with WTO rules is a realistic approach.

By designing FTAs properly, dynamic gains can be achieved by generating greater trade and investment among members -- through liberalization, as well as facilitation, of trade in goods and services and of investment and through complementary domestic structural reforms. Once such structural reforms are pursued, it is much easier for a country to provide greater market access to nonmembers through WTO or other FTAs.

With or without the success of the WTO Doha Round, the global trend toward more FTAs will continue. That is why there is an even more urgent need to make FTAs, and particularly a regional one, a stepping stone toward greater liberalization and, ultimately, global integration. For this purpose, East Asia needs to design best practice FTAs so that their benefits can be maximized and costs minimized. The region must also manage the proliferation of FTAs so that they function as a means for reducing domestic protection and expanding trade and FDI. For this purpose, FTAs must enforce substantial domestic reforms to allow domestic industries to cope with greater competition from abroad.