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Asia Business Development – Asia Business Consulting » Freeing up trade in Asia

SpirE-Journal 2008 Q3

Freeing up trade in Asia

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Freeing up trade in Asia

The financial crisis of 1997 demonstrated the interconnectedness of Asian financial flows. Against the backdrop of the breakdown of the Doha talks and a slowdown in the US, EU and Japan, emerging Asian countries are acting quickly to forge regional free trade agreements, as seen in the inking of free trade deals between ASEAN-China and ASEAN-India. This article looks at what these free trade deals will mean for Asia and whether they will cushion the effects of an increasingly dire global economic slowdown.

Trade liberalization goes East

Global free trade was envisioned in the immediate post-war period as a force for peace. The state-directed import substitution policies that dominated the thinking of emerging countries at the time of the Bandung Non-aligned conference of 1955 have steadily given way to an acceptance of free trade as a potential force for increasing growth and alleviating poverty – if implemented within the right policy framework.

The first coherent regional initiatives to step up intra-Asian trade, via the Association of Southeast Asian Nations (ASEAN), accomplished little until the advent of intra-ASEAN tariff reduction schemes such as AICO and its successor, AFTA, first mooted in the 1990s. As Europe and the US began to attach more importance to free trade agreements (FTAs) and the Asian Financial Crisis in 1997 brought home the region’s fierce dependence on trade, however, a new bout of integration started up in the East.

While the pace still leaves much to be desired, the evidence suggests that trade liberalization in Asia almost certainly stimulates economic growth and throws up opportunities for business. Studies predict world net welfare gains ranging from USD84 billion to USD287 billion by the year 2015.

Still, it is an open question whether these regional agreements will help to speed things up or confuse things, as Asian FTAs tend to overlap one another and, some believe, sap the momentum from completing the Doha round of WTO talks.

Rise of FTAs in Asia

The momentum behind Asian FTAs originated from regional groupings, with first the Association of Southeast Asian Nations (ASEAN) in 1967 and later the Asia-Pacific Economic Cooperation (APEC) in 1989. Major economic initiatives that were established and in implementation include the ASEAN Free Trade Area (AFTA), ASEAN Framework Agreement on Services (AFAS) and ASEAN Investment Area (AIA).

ASEAN members have made significant progress in the lowering of intra-regional tariffs through the Common Effective Preferential Tariff (CEPT) Scheme for AFTA. More than 99 percent of the products in the CEPT Inclusion List of ASEAN-6 have been brought down to the 0-5 percent tariff range1. ASEAN governments have also committed themselves to liberalizing their nations’ services sectors, the first milestone of which is to establish an ASEAN Open Skies Agreement in 2008.

As for APEC, it intends to meet the Bogor Goals of free and open trade and investment in the Asia-Pacific by 2010 for developed economies and 2020 for developing economies. However the tangible trade liberalization measures arising specifically from APEC are widely acknowledged to be minimal to date.

In the past two decades, many Asian nations have successfully pursued FTAs as part of their economic strategy (see Figure 1). By 2008, Asian countries had ratified more than 30 bilateral and regional FTAs and had another long list waiting in the wings (see Appendix for full list).

The proliferation of FTAs in Asia has led to what is widely seen as the “Noodle Bowl Syndrome” (see Figure 2) – a confusing array of overlapping FTAs that often results in companies not bothering to apply for FTA benefits when undertaking intra-regional trade. This is due to the administrative complexities of filing the necessary documents (particularly certificates of origin) but also due to a lack of clarity about what benefits apply in which cases. One additional damper: many Asian countries have been steadily lowering their general Most Favored Nation (MFN) import duty in any case, shrinking the gap between the FTA and MFN duty and reducing the benefit to the applicant.

According to the World Bank, construction and distribution services received the most attention in trade deals, with more than half of sub-sectors and modes showing improved or new liberalization commitments. These were followed by tourism, business, communications, and recreational, cultural and sporting services, where about 40 percent of sub-sectors and modes revealed that the FTA added value.

Generally, FTAs provide a framework to maintain an open trading system and minimize the likelihood of outright supply shortages in the event of commodity price hikes. Politically, FTAs can also be an important tool of commercial diplomacy to institutionalize economic partnerships.

Much like the EU and US, Asia’s giant economy China is next in pursuing FTAs with these foreign political and economic reasons in mind, possibly paving the way for the creation of the largest free trade area bloc in Asia.

China’s recent entry

Albeit a latecomer, China has been aggressive in its pursuit of FTAs since 2000. China has established nine FTAs with different
partners during its “Tenth Five-Year Plan” period (2001-2005), covering a quarter of China’s total foreign trade. To date, the mainland has completed three bilateral FTAs – Thailand in 2003 and Hong Kong and Macau in 2004 (with the 2008 FTA with Singapore pending ratification) – and is initiating another 17 bilateral and regional FTAs. 

In 2002, China and ASEAN concluded a framework for an FTA, which includes an agreement to remove tariffs on all goods by 2015. In 2005, ASEAN became China’s fourth largest trading partner, after the EU, US and Japan. Studies estimate that the ASEAN-China FTA might increase bilateral trade by 50 percent. There is potential for the ASEAN-China FTA to become the world’s largest free trade area with intraregional trade totaling USD1.2 trillion.

The prospect of regional free trade in Asia is believed to produce strong economic incentives among member nations and trading partners. With Vietnam’s entry into the WTO in 2007 and the slew of FTAs that China is initiating in Asia, the resulting trade liberalization will be a big fillip to intra-Asian exports.

Growth in Asia’s trade

Intra-bloc exports of Western Europe, Asia and North America accounted for half of the world total in 2000. For a decade, intra-Asia trade has grown by an annual average of 8.5 percent, higher than the world average, despite the sharp economic recession and severe trade disruption suffered by most Asian economies during the 1997 financial crisis. In fact, trade was the most important factor in Asia’s post-crisis recovery.

Exports from Western Europe have been lessening while trade relations between North America and Asia are being strengthened, shifting the centre of international trade from the Atlantic region to the Pacific:

Between 1997 and 2003, world trade increased by a third to USD15.4 trillion and in the same period, intra-Asian trade increased further by about 50 percent to reach USD949 billion.
The US trade with Asia at USD685 billion a year has, for more than a decade, exceeded US trade with the EU at USD577 billion a year

Between 1996 and 2005, the aggregate trade surplus of ex-China Northeast Asia (Japan, Korea, Taiwan and Hong Kong) increased by USD61 billion, while that of the ASEAN-5 rose by USD96 billion. Much of these trade surpluses were driven by trade with China.

China is not just an export platform but has also become an increasingly important end-market for the rest of Asia. China’s customs data indicates that about half of its imports are for domestic uses. This is especially the case for raw materials and machinery imports such as fuel from Indonesia and Singapore, timber from Malaysia and Indonesia, iron ore from Australia, and machinery from Japan, Korea and Taiwan.

As a result, China has been the highest growth market for most Asian exporters over the past decade, with its share in total exports of these economies more than doubled (see Figure 3). China is now the largest export market in Asia, ranked top in Hong Kong, Korea and Taiwan, second in Japan and India, and third in Thailand and the Philippines.

India is another hot spot in Asia’s trade, albeit to a much lower extent than China. It accounts for just over one percent of total intra-regional trade in Asia,and around one-tenth of China’s trade with the region. However, India’s trade with Asia grew over 30 percent annually between 2002 and 2005.The products traded with India are somewhat different from those among the rest of Asia. Raw and basic materials like fuels, mineral ore, animal and vegetable oils constitute the dominant parts of India-Asia trade.

Compared with that of the EU and North American Free Trade Agreement (NAFTA), intra-Asia trade still accounts for a relatively small share of the region’s total trade. This underlines the immaturity of economic integration within Asia, but also implies that growth potential for intra-Asia trade and economic integration remains substantial. What does this mean for companies? FTAs will accelerate the growth of the economic pie in Asia but more importantly, they are a powerful argument for locating more production, and sourcing for that production, in the Asian region, so as to gain the advantage over competitors who are exporting into Asia from production bases in the US, EU or elsewhere.

The FTA bargain

Nations prefer FTAs to multilateral negotiations because of the quicker pace of decision-making and the greater ability to fine-tune the deal to protect domestic constituencies.

The FTA format design is typically attractive to smaller countries:

FTAs enable small countries to strengthen their bargaining power with bigger nations at the multilateral negotiating table.
Small and medium enterprises (SMEs), which dominate the economy in smaller countries, typically have limited access to investment capital and are disproportionately impacted by trade barriers, rejoice at the reduced cost of doing business overseas. FTAs allow SMEs to grow at a much faster rate.

Benefits of FTAs to business

In general, companies can take advantage of FTAs in several ways:

FTAs can be used by companies to expand and penetrate overseas markets. With the easier market access, businesses can embark on joint ventures or acquisitions in the overseas market.
The elimination of import duties on negotiated products serves as an opening for products to be introduced into the overseas market, apart from increasing existing market share. Manufacturing companies would have an edge over competitors from countries not enjoying preferential treatment.
FTAs frequently offer privileged access for acquisition and investment as well
FTAs would enable industries to source inputs at more competitive prices.
Bilateral FTAs enable a nation to expand its services and products into third countries through partnerships with enterprises from FTA members.
FTAs would offer trade facilitation measures for industries to expand trade, as well as capacity building to improve and enhance competitiveness.

The US-Singapore FTA, for instance, has pleased businesses from both countries. With the agreement in force, Singapore’s trade enjoys 100 percent preferential duty-free treatment, so long as the goods satisfy the rules of origins under the Agreement. According to US statistics, exports from Singapore,worth USD499 million, gained tariff-free access to the US market in 2004. Singapore’s exporters also saved USD25 million as a result of the waiver of the merchandise processing fee.

US companies in Singapore have also tasted economic benefits from the agreement. Over 1,500 American companies operate in Singapore and many have announced plans to increase their investment and activities locally.

However, not all companies profit equally. FTAs can result in trade imbalances and domestic companies can lose out to foreign players operating on lower costs or global players aiming to usurp the lion’s share of the local market. Tensions within some pillar industries have arisen from FTAs between Thailand and China, between India and Thailand as well as between Malaysia and the US/Japan.

Thailand-China FT

In the first year of the FTA between Thailand and China, fruit exports increased dramatically on paper.For example, durian exports to China rose by almost 20,000 percent, fresh longan by 140 percent and mangosteen by 2,300 percent. However, such figures are largely illusory. For instance, the increase in durian exports was from a low base and a substantial part was reexported to Hong Kong.

Thai imports of food and agricultural products are, in actuality, growing at a faster rate than exports. Between 2003 and 2006, fruit and vegetable exports to China increased by 58 percent annually. But imports of fruits and vegetables from China grew by 72 percent per year. Many of these imports compete against local production and prices of garlic, red onions and onions declined between 40 to 80 percent, yielding greater value for consumers even if this posed difficulties for some local producers.

Malaysia-Japan and Malaysia-US FTA

The US and Japan are among Malaysia’s largest trading partners. In Malaysia’s FTA with Japan, rambutan, durian and papaya exporters were elated that Japan had removed all tariffs, but car manufacturers Proton and Perodua saw Japanese cars flooding into Malaysia duty-free.

Similarly, Malaysia may experience negative effects in trade with the US. Nearly 20 percent of Malaysia’s exports are to the US, comprising mainly electrical, electronics, wood and rubber products. According to the US National Association of Manufacturers, manufactured exports to Malaysia could double to RM22 billion by 2010. That could affect the nation’s current trade surplus.

India-Thailand FT

India, once one of the most closed countries in the world, is opening to imports from partners like never before. Manufacturers of a range of items including auto components, cordless phones, colour televisions, refrigerators and airconditioners, are able to import their wares much more cheaply than before the FTAs.

From the impending India-Thailand FTA, the automotive sector in India is the one most affected. Thailand has a robust automotive assembly industry, spanning over 2,000 manufacturers including giants Suzuki, Honda, and General Motors 7, and represents more threats than opportunities. While India represents a sizeable market for automakers based in Thailand, the same optimism cannot be said for Indian automakers hoping to tap into the smaller Thai market.

Numbers game

In addition, FTAs may confuse companies with their multiple regulatory regimes, such as the different rules of origin (ROOs). ROOs exist to determine which goods will enjoy preferential bilateral tariffs and thus prevent trade deflection among FTA members. Out of the concluded FTAs in Asia, the majority – many involving Japan, Korea and Singapore – have adopted a combination of the different ROO types rather than applying a single rule.

FTAs also add to the complexity of trade in Asia when coupled with MFN tariffs. Many countries have been cutting their general MFN tariff outside of FTAs such that the two are now not much different, resulting in companies opting to trade under the MFN regime, which generally requires much less documentation.

As MFN clauses promote non-discrimination among countries, they also tend to endorse the objective of free trade in general. However, MFN rules of extending the same offer to all countries without bias may well conflict with the objective of regional economic integration.

Regionalism on the distant horizon

The rise of intra-Asian trade does not negate the fact that Asian countries, excluding Japan, generally still export more to the US, EU and Japan in combination than they do to one another. However it is equally undeniable that the trend is towards intra-Asian trade taking a larger share of Asia’s total trade. China lies at the heart of this network, sucking in imports of materials and components from Northeast Asia and ASEAN and exporting massively, primarily to the US, EU and Japan. India, Vietnam and possibly Indonesia are fast-growing manufacturing locations in this network that will play more of a China-like role in future, as their infrastructure improves and China’s costs rise.

The proliferation of FTAs linking Asian countries with one another, and with more economically developed countries, poses several interesting opportunities to the private sector.

Firstly, these FTAs are likely to stimulate economic growth in the region. The extent of the stimulus may not outweigh the current global economic slowdown, but it will be significant in the medium to longer term.

Secondly, while it is too early to measure the actual impact of such FTAs and while their effects sometimes confuse rather than assist, they help Asian countries argue the case for more concessions in multilateral platforms such as the Doha round of WTO talks – nurturing global trade and with it the fortunes of international companies.

Thirdly, FTAs among Asian countries strengthen the case for international firms to locate production and sourcing for that production in the Asian region. Going forward, this will help keep the growth of Foreign Direct Investment (FDI) on track, benefiting not only China but emerging locations for manufacturing FDI like India and Vietnam.

In the longer-term, given the vast historic and political differences among Asian countries, Asia is unlikely to consolidate the multiple, overlapping FTAs into a single Asian agreement with ASEAN as the regional hub – at least not in the short-term. The regional financial cooperation and coordination of exchange rate policy which this would entail would not be politically feasible for some time to come. In the next five years, the main impact of Asian FTAs would be to increase pressure on global economies to lower MFN tariffs – and to pursue the stalled Doha round to a successful conclusion.

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