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East Asia: A New Trading Bloc?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1994
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DURING the last three decades, East Asia has become one of the world’s most important economic regions. With the creation of trading blocs in North America and Europe, policy advisors are beginning to ask whether it is time for East Asia to form such a bloc as well One economist’s answer to this question is “probably not.”

Trade has been the undisputed engine of growth for virtually all the postwar East Asian economies. The annual growth rate of Korean exports has remained in the double digits, reaching a phenomenal 34 percent in the 1960s and 23 percent in the 1970s. In the 1980s—when world trade grew more slowly than in the previous two decades—China, Korea, Malaysia, Taiwan Province of China, and Thailand saw their exports grow by more than 10 percent annually.

In 1967, six East Asian countries made the first (and only) attempt at regional integration, forming the Association of South East Asian Nations (ASEAN). The goal of the six countries—Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand—was to promote intraregional trade through preferential trading arrangements among member countries. But the results have been less than spectacular: intraregional trade as a proportion of total trade among the ASEAN 4 (see box) grew from 3.2 percent in 1980 to just 4 percent in 1990. Of this small amount of intraregional trade, not even 5 percent was covered by preferential trading agreements.

There are ten major players in East Asia: the ASEAN 4—Indonesia, Malaysia, the Philippines, and Thailand; the newly industrializing economies (NIEs)—Hong Kong, the Republic of Korea, Singapore, and Taiwan Province of China; and China and Japan. In addition, numerous small countries—for example, Brunei, Cambodia, and Viet Nam—also have a part in the region’s burgeoning economy.

Recently, the North American Free Trade Agreement (NAFTA), the continuous widening and deepening of the European Union (EU)—previously the European Community (EC)—and the protracted negotiations at the Uruguay Round have rekindled interest in regional groupings in East Asia. On January 28, 1992, the ASEAN countries signed a framework agreement to create the ASEAN Free Trade Area (AFTA) by 2006. Policy advisors are beginning to ask a more ambitious question: should East Asia, too, form a region-wide trading bloc of its own?

On balance, both economics and politics are against a discriminatory trading bloc in East Asia. Historically, East Asia has benefited greatly from an open world trading system. Despite a redirection of trade toward itself in recent years, the region still ships two thirds of its exports to the rest of the world (Table 1). Almost without exception, studies of the newly industrializing economies (NIEs) draw a direct connection between growth in exports and growth in GDP. China, Indonesia, Malaysia, and Thailand have been repeating the experience of the NIEs.

Table 1Where East Asia’s exports go(percent)
Partner
ExporterYearNorth AmericaWestern EuropeEuropeEast Asia1Latin AmericaAfricaMiddle EastSouth Asia
North America198033.525.227.415.88.93.34.21.0
198544.419.321.015.55.92.53.21.0
199041.922.323.420.45.01.72.60.8
Western Europe19806.767.171.92.92.47.25.50.7
198511.364.968.93.61.65.25.00.9
19908.371.074.45.31.13.33.30.7
Europe19806.363.773.72.72.36.95.50.7
198511.063.569.2341.65.15.00.9
19908.270674.55.21.13.33.30.7
East Asia1198026.016.818.929.94.14.47.41.8
198537813.615.525.32.82.25.12.0
199031.919.820.732.31.91.63.01.5
Latin America198027.926.535.15.416.62.71.90.5
198535.825.930.47.112.13.73.00.7
199022.925.327.610.314.02.12.40.4
Africa198027.443.646.14.33.21.81.70.3
198514.864.969.31.84.25.12.20.7
19903.066.068.04.60.612.84.43.6
Middle East198011.540.341.528.75.01.54.12.5
19856.215.017.71.50.31.48.70.4
199017.848.653.09.11.23.68.50.9
South Asia198010.924.639.414.50.56.814.55.6
198518.420.837.016.40.44.611.04.4
199017.130.146.618.30.32.76.53.2
Source: UN Comtrade data.

Does not include China due to a lack of data for 1980 and 1985.

Source: UN Comtrade data.

Does not include China due to a lack of data for 1980 and 1985.

Given the importance of open markets to the region’s economic growth, the case for an East Asian bloc should be evaluated primarily in terms of the impact such a bloc would have on the world trading system. The region’s future interests will be best served by a strategy that promotes an open world trading system. A discriminatory trading bloc does not fit that bill.

Is there a role for an alternative form of regionalism in East Asia? An approach that encourages regionwide trade liberalization on a nondiscriminatory basis may still hold some promise. In the long run, this approach could serve as a stepping stone for Japan and China to assume a leadership role in promoting global free trade similar to that played by England in the 19th century and the United States in the postwar era. Unfortunately, such liberalization is unlikely, because of short-term adverse effects on the region’s terms of trade.

East Asia today

The countries in the region are at very different levels of development. Japan, with a per capita income of $23,800 in 1990, is the richest (Table 2). Per capita incomes in the remaining countries range from a low of $327 in China to $11,490 in Hong Kong, with the NIEs enjoying significantly higher levels than the ASEAN 4. Of the NIEs, Singapore and Hong Kong have higher per capita incomes than Korea and Taiwan, while Malaysia and Thailand have the highest incomes of the ASEAN 4 countries.

Table 2East Asian countries are a diverse group(economic indicators, 1990)
GNP per capita (dollars)Share in world GDPShare in world exportsShare in world importsExport-to-GDP ratio
(percent)
ASEAN 48531.232.722.9032
Indonesia5700.480.800.6524
Malaysia2,3200.190.920.8769
Philippines7300.200.270.3920
Thailand1,4200.360.720.9929
NIEs6,8502.196.697.8944
Singapore11,1600.161.651.81152
Hong Kong11,4900.270.912.4649
Korea5,4001.062.032.0727
Taiwan Province of China17,9500.702.101.5543
China3701.641.951.5917
Japan25,43013.209.006.8910
East Asia2,63018.2520.3519.2716
East Asia (excluding Japan)7765.0511.3612.3732
United States21,79024.1811.6515.377
Germany22,3206.6712.4810.1727
Source: 1992 and 1993 World Development Reports: Bank Economic and Social Database (BESD), World Bank.

Data for Taiwan Province of China were not available in the World Development Reports: therefore, data from GESD were used.

Source: 1992 and 1993 World Development Reports: Bank Economic and Social Database (BESD), World Bank.

Data for Taiwan Province of China were not available in the World Development Reports: therefore, data from GESD were used.

As well as being the region’s richest, the Japanese economy is by far the largest. In 1990, its share of world GDP was 13.2 percent; within East Asia, its share was approximately 70 percent. Without Japan, East Asia’s share of world GDP drops from one fifth to one twentieth. China lags behind Japan but is rapidly becoming another major player in the region. Using GDP figures based on purchasing power parity (exchange rates adjusted for variations in buying power across countries) for 1990, the IMF puts China’s share of world GDP at 6 percent—below Japan (7.6 percent) but above Germany (4.3 percent).

In general, trade regimes in East Asia can be characterized as open, though the level of protection varies widely across countries. In terms of trade-to-GDP ratios, the region’s smaller economies are very open. Table 2 shows that exports and imports as a percentage of GDP are high for all countries except China and Japan. Singapore has by far the highest levels: in 1990, they rose to more than 100 percent. For the NIEs, the proportions are both close to 40 percent; for the ASEAN 4 as a group, more than 30 percent.

Hong Kong and Singapore are textbook examples of free trading economies, with no quantitative restrictions and low tariffs. Korea, Malaysia, the Philippines, and Thailand all but eliminated their quantitative restrictions on manufactures in the 1980s. Reductions in tariff rates were not as dramatic, and in some of these countries, especially Indonesia and Thailand, tariffs remain high. Though China has liberalized its import regime considerably since the early 1980s, its remaining formal restrictions place it among the most protected countries of the region.

The openness of Japan’s trade regime has been a matter of some controversy. In terms of formal barriers, Japan’s trade regime is as open as those of other industrial countries. There are virtually no quantitative restrictions on manufactures, and tariff rates are low. Yet Japan’s import-to-GDP ratio is well below those of other countries of comparable size and with similar income levels. This fact has led some observers to argue that Japan’s markets are protected by informal trade barriers and are thus relatively closed to outsiders.

A discriminatory bloc?

While proponents of a discriminatory bloc resembling NAFTA or the EU argue that economics favors their position, detractors claim that both economics and politics are against such a bloc. The detractors may be closer to the truth.

What about economics? The economic desirability of an East Asian trading bloc depends on two factors: the effects on real incomes in member countries (taking the world trading system as a given) and the effects on the incomes resulting from the bloc’s impact on the openness of the trading system. Because the second factor is the more significant for large regions such as East Asia, an East Asian bloc must be evaluated primarily in terms of its impact on the global trading system. Advocates of such a grouping can offer two supporting arguments.

First, an East Asian bloc may serve as a deterrent to the formation of closed trading blocs around the world. According to this argument, the world is already dividing into blocs. To ensure that they do not become overly protective of and limit access to their own markets, East Asia should be united and in a position to retaliate. Unilateral actions such as those taken by the United States under its Super 301 provisions, for instance, would be harder to implement with a united East Asia.

Second, the formation of regional blocs could facilitate future rounds of the General Agreement on Tariffs and Trade (GATT). The Uruguay Round was protracted in part because of the large number of participants and the “free rider” problem such a number generates. One reason for the success of past GATT rounds was that the United States could deal with the EC as a single unit. This fact has led many to conclude that a small number of blocs could make future GATT negotiations more manageable. Such blocs would also assume responsibility for many intraregional trade issues, so that the GATT process could be used primarily to resolve problems between regional trading areas—and to bring down barriers—swiftly and efficiently. Thus, the EU, an East Asian bloc, and an extended NAFTA could speed up the opening of global markets.

Both of these arguments have merit but are highly contentious. Critics note that blocs enjoy more market power than individual countries, so that, in principle, nothing prevents blocs from raising rather than lowering trade barriers. As a deterrent, then, blocs function only as long as they do not carry out the threat to raise barriers. Once the threat is carried through and a trade war breaks out, retaliatory actions are likely to be more severe than they would be without blocs.

In addition, critics note that small numbers do not necessarily mean faster progress in trade talks. The EC process that began in 1957 is still working toward a Single Market. In the meantime, the region’s nontariff barriers have proliferated: the coverage of these trade restrictions expanded fivefold between 1966 and 1986.

Is a bloc politically feasible? As these arguments indicate, the economic desirability of a trading bloc in East Asia is difficult to assess. But its political feasibility—or lack thereof—is more predictable.

Internally, there are at least three interrelated factors working against a regionwide free trade area (FTA). First, the major players in the region have historically been political rivals. Though time, trade, and intraregional investments have gone a long way toward bringing these former enemies closer, the countries do not appear ready to unite in an FTA. In this respect, the situation in East Asia differs fundamentally from, for instance, Western Europe after World War II. Then, with US support (offered for economic as well as geopolitical reasons), Europeans were able to conclude treaties establishing the European Coal and Steel Community and later the European Economic Community. No similar influences are affecting East Asia today.

Second, the East Asian countries have very different levels of protection and are at very different stages of development, suggesting that the distribution of gains from an FTA would be uneven. The poorer and often more protected countries would be likely either to lose more or to gain less than their relatively open and richer counterparts. In an FTA, each member eliminates tariffs against other members but not against outsiders. Under such a scheme, members’ gains accrue largely from preferential access to each other’s markets rather than from domestic liberalization. By definition, the high-tariff countries give a greater margin of preference than they receive from their low-tariff counterparts and so gain less. This unevenness in gains raises the issue of compensation, a barrier not easily overcome.

Third, East Asia comprises a large number of countries, making negotiations for an FTA a daunting task. It has been difficult for the ASEAN countries to make progress with just six members. For 25 years, despite many efforts, success in promoting trading was minimal. Although the upsurge of interest in regionalism in North America did lead the ASEAN countries to sign the framework agreement for AFTA, serious preferential liberalization has not even begun. Considering this background, it is not clear how disparate countries such as China, Japan, Korea, and the members of ASEAN can be expected to form a regionwide bloc.

The external factors at work against an East Asian FTA are even more formidable. Because many countries view Japan’s markets as closed to outsiders, for the last 20 years the United States has repeatedly made Japan the target of unilateral policy actions, including voluntary export restraints, structural impediments initiatives, and Super 301 threats. Countries in the region that have relatively small economies, such as Korea and China, not only face an environment hostile to an East Asian FTA but also are vulnerable to retaliatory actions by the United States. In 1990, Korea and China both sold a quarter of their exports to the United States. Considering the extent of this trade, these countries face immense risks in supporting a bloc that could divert trade from the United States.

From the viewpoint of the smaller economies, this external environment is quite different from what Mexico faced in the NAFTA negotiations. The United States is unlikely to retaliate against its negotiating partner, and Mexico is not very vulnerable to retaliatory actions by other countries. In 1990, Mexico exported 71 percent of its goods to North America; only 13 percent went to Western Europe and just 6 percent to East Asia-½ of 1 percent of total imports for these two regions.

A case for open regionalism …

A discriminatory bloc is not a very feasible proposition in light of the above arguments, but there is another regional approach—centered around GATT-style, nondiscriminatory liberalization—that could be considered. Using this approach, the East Asian countries would come together at a common forum and, in the spirit of the GATT rounds, negotiate reductions in trade barriers. Any concessions one country made to another would automatically be extended to all members.

Several arguments can be offered in favor of this approach. First, because trade liberalization would be nondiscriminatory, there would be no trade diversion. One important objection to a discriminatory bloc would be removed: countries with high initial tariffs would not feel threatened by liberalization, since the consumers inside these countries would be the winners.

Second, this type of regionalism would not face a serious challenge from the United States, for nondiscriminatory liberalization would also improve US access to East Asian markets. Indeed, the negotiations could go a long way toward resolving US complaints about the lack of openness of East Asian markets in general and of China’s and Japan’s in particular.

Third, because liberalization would take place simultaneously in all the major countries of the region, short-run adjustment costs would be minimized. In true GATT style, liberalization would take place in areas of mutual interest. Therefore, export prospects would improve for all countries at the same time that import-competing industries were exposed to more foreign competition.

Fourth, during the last decade, the United States has become what the economist Jagdish Bhagwati calls a “diminished giant.” As the United States has diminished in relative economic importance, the East Asian countries, particularly Japan and China, have emerged as major global economic powers. While other parts of the world have suffered from severe recession, this region has grown at healthy rates. Gradually, commensurate with their current economic weight and future potential, Japan and the greater China region (including China, Hong Kong, and Taiwan) could become the leaders in global economic affairs. Japan has already emerged as one of the world’s most important donor countries, and China is rapidly becoming a driving force in Asian growth. According to a recent World Bank report, greater China has become the world’s “fourth growth pole” after Europe, North America, and Japan.

… and against

These long-term gains make nondiscriminatory liberalization an attractive option. Unfortunately, the short- to medium-term economic effects of this approach are unfavorable, for several reasons.

First, because existing tariff levels, at least in Japan, are relatively low, potential gains from lowering this most transparent trade barrier are limited. Japan also gives extensive trade preferences to its East Asian trading partners under the Generalized System of Preferences (GSP). For example, 88 percent of the Japanese tariff lines for Korean goods are either at zero or below the most-favored-nation level; for approximately two thirds of the tariff lines, the GSP gives Korea duty-free access. A similar pattern applies to other East Asian countries. If Japan were to lower its tariffs in a nondiscriminatory fashion, these developing countries would lose the tariff preferences they currently enjoy.

Second, because tariff levels across the other countries are highly variable, the scope for negotiating reduced barriers is limited. Thailand, Indonesia, and arguably China have the highest tariff levels; Korea’s and the Philippines’ are moderate (generally below 20 percent); and Singapore and Hong Kong are virtually tariff-free. Given this varied structure, the scope for reciprocal tariff reductions is limited.

Third, in any East Asian negotiations, Japan must assume the leadership role the United States played during the GATT negotiations. But with so few formal trade barriers, Japan may have difficulty. It must either find a way to negotiate the so-called informal trade barriers or use its aid and investment leverage in the region to induce other countries to liberalize their regimes.

Finally, and perhaps most important, even if substantial trade barriers in Japan and other countries could be identified and negotiated away on a nondiscriminatory basis, the likely decline in the region’s terms of trade with outside countries would be substantial. Because two thirds of the region’s goods are traded with outside countries, a major liberalization would involve unilateral concessions. The GATT negotiations sidestepped this problem, as the former EC, the United States, and Japan negotiated tariff reductions simultaneously. They were able to carry out substantial liberalization without making major concessions to nonnegotiators, most of which were developing countries.

It is difficult to take an optimistic view of regionalism in East Asia. A discriminatory bloc is neither particularly desirable nor feasible. A nondiscriminatory approach could yield high returns in the long run, but because its short-term effects on the terms of trade are likely to be negative, it is an unlikely development.

This article is based on the author’s paper, “Should East Asia Go Regional? No, No, and Maybe” (World Bank Working Paper Series 1209, Policy Research Department, Trade Policy Division).

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