Changing Patterns of Economic Interaction in
Northeast Asia is known to be one of the most economically dynamic regions in the world. This dynamism is accompanied by major changes in economic relations among the market economies in the region and the United States. The relative position and the role of the major players are changing, and this change entails acute economic frictions and the need for adjustments. Moreover, China's reform policies (dating from 1978) and the Soviet Union's recent perestroika initiative under the leadership of President Mikhail Gorbachev have brought about profound changes in the geopolitical landscape in Northeast Asia, with far-reaching implications for economic relations, both within the region and with the United States.
This paper reviews these changing patterns of economic relationship and considers the prospects for economic cooperation among the economies of the region in the light of those changes. In this paper, "Northeast Asia" is defined to include the People's Republic of China (PRC), the Soviet Union, Japan, South Korea, North Korea, Taiwan, and Hong Kong. Since Taiwan and Hong Kong are not regarded as sovereign states, the terms "economies" will be used in place of "countries" to refer to the geopolitical entities in the region.
Why treat Northeast Asia as a unit for economic analysis? Apart from geographical proximity, the geopolitical interaction between the major powers (Japan, the PRC, the Soviet Union, and the United States) has been sustained and intense over the course of centuries. Around the turn of this century, two major international wars-the Sino-Japanese (beginning in 1894) and the Russo-Japanese (beginning in 1904)-took place exclusively in this region, with Korea as the principal theater of operations. The more recent and far more important conflict, the Pacific Theater of World War II, involved an extraregional superpower-the United States-as a principal participant, as well as the three Northeast Asian powers. World War II brought about-among other things-the liberation of Korea from Japanese colonial rule, only to be followed by the tragic division of Korea's territory into two parts. This in turn led to the Korean War, involving the United States and China as major participants as well as 15 other nations that participated under the U.N. flag. Thus it may be said that Northeast Asia has been a center of great power rivalry at least since the late nineteenth century, with the Korean peninsula as its focal point. This historical background has overshadowed economic relations and still remains as one of the major factors defining economic interaction in Northeast Asia, as will be discussed in what follows.
Several other factors also combine to give Northeast Asia a distinctive political and cultural character. First, except for the Soviet Union, the countries or economies of Northeast Asia all fall within the sinic cultural sphere, as identified by Toynbee and other scholars. More specifically, China, Japan, Korea, Taiwan, and Hong Kong have all been deeply influenced by both Confucianism and Buddhism. Confucian culture is often cited as partly responsible for the rapid growth of the market economies of the region, while it is also often seen as a partial explanation of the paternalistic and authoritarian tendencies in political and social life throughout the region.
Second, both major communist powers are represented in Northeast Asia, as is their ally, North Korea. Indeed, in no other area along their long common border do the political and economic interests of the Soviet Union and China so clearly intersect. The wide-ranging economic transformations now taking place in the USSR and the PRC bear directly on the future of economic relations within the region.
Third, Northeast Asia is also characterized by the active, long-term, and massive involvement of an extraregional power, the United States, in its economic and political affairs. The interactions of the United States with each of the four regional countries has been very different and will be examined later in this paper.
Fourth, Northeast Asia is the only subregion within the broader Asian-Pacific region that has not yet established a multinational framework of political or economic cooperation such as the Association of Southeast Asian Nations (ASEAN).
Since the 1960s, trade relations between the United States, Japan, and the East Asian newly industrializing economies (NIEs), in particular, have grown rapidly on the strength of differing factor and resource endowments and a favorable pattern of comparative advantage among these economies. After World War II, the United States provided the main impetus for economic development in noncommunist East Asia, including Northeast Asia, by exporting its capital, technology, and managerial skills, and importing large quantities of goods manufactured by those countries' "infant industries." Even today, the United States is the largest single national market for the exports of Japan and the East Asian newly industrialized economies (NIEs), notably South Korea, Taiwan, Hong Kong, and Singapore. In 1988, the U.S. market absorbed 34 percent of Japan's exports and a slightly smaller share of the exports of the NIEs, virtually all of which were manufactured goods. Indeed, the export-led growth of these countries would not have been possible without access to the huge U.S. market.
The U.S. market is also becoming increasingly important for China as source of capital goods as well as absorber of labor-intensive products such as textiles. Between 1980 and 1990, two-way trade between the two countries increased from $4.7 billion to $11.7 billion. In contast, the trade between the United States and the Soviet Union has been erratic and stagnant, within the range of a few billion dollars during the 1980s.
In contrast to the United States, Japan has provided a very limited market for the exports of its major trading partners in the region. In 1988, Japan accounted for 12 percent of U.S. exports, up from 9.4 percent in 1980. Japan's share of total exports of the Northeast Asian developing countries, including China and North Korea, was 17 percent in 1988, an increase from the 7 percent recorded for 1980. The Japanese market has been far less significant to the Soviet Union, whose exports to Japan have not increased appreciably for the past ten years.
However, Japan has been a major factor in the development of the Asian NIEs through its exports and investment in return for access to the natural resources and the rapidly growing markets of the region. Much as the United States did in an earlier period, Japan has provided the developing countries of East Asia with financing, capital goods, and technology to assist their overall economic development and, more particularly, development of export and natural-resource based industries. Not surprisingly, these countries have tended to follow the Japanese model, beginning with exports of labor-intensive commodities and shifting to more skill- and technology-intensive exports as their economies developed.
The expansion in trade has been accompanied by rising regional investment flows. The United States had been a major source of international capital until it turned into a deficit country beginning in the early 1980s. Now Japan has taken over the position of major supplier of capital, much of which is concentrated in the United States. Japan accounted for more than 30 percent of capital inflows into the United States in 1988. The inflows of $84 billion far surpassed the $56 billion coming into the United States from the EC.
Japan and the United States are also the largest investors in the Asian NIEs and ASEAN countries. The appreciation of the yen, the new Taiwan follar, and the Korean won have propelled investment flows even faster. To reduce production costs, Japanese, Taiwanese, and Korean firms are investing notably in manufacturing facilities in the ASEAN countries and seeking investment opportunities in China and the Soviet Union.
Thus, economic relationships in trade and investment between the United States and the Northeast Asian region are now undergoing major changes. The U.S. role as a market for Asian exports and the United States' capacity to serve as a source of finance are decreasing, though its direct investment and technology exports remain important for regional economic development as a whole. On the other hand, Japan is becoming a leader in new technologies, increasing its intake of manufactured exports from Asian countries aided by the new policy emphasis on domestic-oriented growth. It is also expanding its financial flows in the forms of official Development Assistance (ODA), direct investment, and loans to Asian developing countries, although the total amount is dwarfed by its capital exports to the United States and the European Community. The NIEs are losing comparative advantage in labor-intensive manufactures and are shifting to more sophisticated products. They are also becoming suppliers of capital in their own right. China, likewise, is moving to expand its exports of manufactured goods, and its demand for imports of capital, technology, and durable goods is increasing.
The emergence of these new relationships has been characterized by growing trade imbalances between the United States and Japan and the United States and the NIEs. The United States has accumulated a large trade deficit, 68 percent of which is accounted for by Japan and other Northeast Asian economies in 1989. The large, chronic deficits that the Asian NIEs and other developing countries have with Japan have also been a major problem affecting economic cooperation in the region. Trade imbalance between the United States and Japan and between the United States and the NIEs has been a source of friction and increasing protectionist measures in the United States, culminating in the Omnibus Trade Act of 1988. Moreover, the U.S need to finance its deficits by foreign borrowing or by encouraging inflows of foreign investment has brought about an added imblance of financial flows, which again can be a source of tension.
The Reforms in China and the Soviet Union
The economic reform in China since1978 and the adoption of perestroika in the Soviet Union have added a new dimension to regional economic relationships. In each country the objective is to transform a nonmarket economy into a market-oriented economy. But there are considerable differences in their approaches and achievements thus far and in the problems faced by the governments of the two countries. The enormity of the tasks facing the reforming countries is daunting, and the chances of success remain uncertain; but their external economic relations with the market economies in the region, including South Korea, have been expanding in the area of trade and investment in recent years.
By way of comparison, in the field of economic reform China is better situated than the Soviet Union, not only because the former initiated reform about ten years earlier than the latter but also because of other factors. First, it is often said that in terms of national character and other cultural factors, the Chinese people are more adaptable to political and social change than are the peoples of the Soviet Union. Second, given the weight of 70 years of the Soviet "indigenous" system, as compared with China's 40 years (including the ten-year period of the "Cultural Revolution") of experience with a communist system transplanted from the "West," Soviet society has been rendered less flexible because of the entrenched interests of both the ruling elite and the humbler orders of society. Third, China could draw upon the experience of Hong Kong, Taiwan, and some 10 million overseas Chinese spread over the Southeast Asian countries, whereas the Soviet Union lacks such transplanted exemplars of the market economy. Fourth, there are key differences between the two reform strategies. China began with agricultural reform and achieved remarkable success, freeing people from the scourge of hunger, while the Soviet Union placed more emphasis on nonagricultural changes. Finally, China has been able to carry out economic reform in a sustained and consistent manner by maintaining the existing political system and its leadership, while in the Soviet Union perestroika has led to the disintegration of political power and the system itself, making economic reform extremely complex and difficult.
The Market/Nonmarket Relationship
The economic relationship between the market and nonmarket economies has been and still is conditioned by highly intricate geopolitical obstacles that impede expansion of trade and investment between the two sides. For example, the United States and Japan imposed economic sanctions for two years as a political response to the Tiananmen Square incident of June 1989, and Japanese-Soviet economic cooperaiton is still held hostage to the northern territories issues. The triangular economic relationship among the PRC, Taiwan, and Hong Kong is also delicate and uncertain, because of the political relations between Taiwan and the mainland. Furthermore, the scheduled British transfer of Hong Kong in 1997 poses serious problems for Taiwan. The relationship between South and North Korea is even less promising, without any sign of breakthrough in the stalemate that has lasted for more than four decades.
Finally, but most importantly, the U.S.-Soviet economic relationship has been characterized by what may be called political protectionism. On the Soviet side, protectionism is an integral part of its economic system: Everything is under the strict control of the government. On the U.S. side, selected protectionist policies have less to do with economic interest than with other issues; they are directed at perceived Soviet threats to national security and to American values, such as human rights. Consequently, the United States has implemented a number of restrictions on the Soviet Union (involving trade, technology, and financial flows) for political reasons during the 1980s.
Fortunately, however, the economic relationship between market and nonmarket economies is improving. Trade and investment have expanded as a result of the economic reforms underway in the PRC and the Soviet Union, and the generally cautious but positive response to it came from the United States, Japan, and other neighboring economies in the region. In this connection, the Malta and Washington summit meetings (December 2, 1989) augured well for closer economic cooperation between the two superpowers.
Given this general picture of changing economic relations in the region, what are the major challenges to enhancing economic cooperation in the region as a whole? Four major areas draw our particular attention.
The foremost task facing the region today is to reduce trade imbalances among the United States, Japan, and the NIEs. These are a major source of protectionism and economic friction in the region. This problem has many facets and requires adjustments in both domestic and external government policies.
Looking at the problems involving the United States, it is important to recognize that the chronic large trade deficits of the United States are mainly attributable to three major factors: (1) fiscal deficits and overconsumption; (2) deterioration of the international competitive power of U.S. industry; and (3) economic stagnation of the debt-ridden Latin American countries, which are major traditional U.S. export markets.
The principal policy efforts of the United States have been directed to currency realignment vis-a-vis the trade surplus countries combined with protectionist trade policies and pressure on Japan and the NIEs to further open up their markets to U.S. goods and services. There have also been some measures aimed at reducing fiscal deficits and improving industrial productivity. Yet there has been no significant reduction in the massive U.S. current account deficits. The lesson to be learned from these experiences is that unless the U.S. changes its underlying macroeconomic policies-cutting the budget deficit and increasing savings-the protectionist policlies directed to Japan and the NIEs will not substantially alter the overall U.S. trade balance.
Needless to say, trade balance cannot be accomplished by one nation acting in isolation. It can be achieved only through cooperation and coordination of relevant policies by all the principal players. In the case of Japan, this requires a major shift of economic priorities in favor of a more open domestic market and more expansionist fiscal and monetary policies. To some extent, Japan is already moving in this direction, as reflected in its rapidly growing volume of imports from the United States and the developing countries. But continuing policy efforts by Japan in this direction are crucial to reducing its surpluses not only with the United States but also with the Asian NIEs, whose economies would be most vulnerable to the deflationary effect of U.S. policy adjustment aimed at reducing the twin deficits.
The increasing role of Japan as an absorber of exports from Asian developing countries is well reflected in the share of manufactured goods in total Japanese imports, which grew from 27 percent in 1983 to 49 percent in 1988. However, this figure is still much lower than the 79 percent recorded for the United States in 1988. Moreover, the increase in manufactured imports has been concentrated on a few items such as iron products, ceramics, leather, and wooden items; while imports of more sophisticated products, such as machinery and transport equipment, remain minimal. Hence, Japan has a long way to go in strengthening its capacity to absorb foreign goods in favor of correcting its trade imbalances with the United States and the Asian developing countries. In this connection, it is hoped that valuable results emerge from the current bilateral negotiations between the United states and Japan on the so-called Structural Impediments Initiative. The thrust of these talks is to remove barriers to trade-such as the bias against imports inherent in the distribution system-and other restrictive practices.
As for the NIEs, both Korea and Taiwan have substantially opened their home markets to manufactured imports, while revaluing their currencies upwards by 25 and 52 percent, respectively, between the Plaza Accord of September 1985 and the end of 1989. Korea and Taiwan together with Japan are expected to play active roles in restoring their trade balances with the United States by continuing to open their markets to foreign goods and services and by better protecting intellectual property rights of foreign companies to facilitate technology transfers.
Industrial Adjustments and Division of Labor
The major source of economic dynamism in the Northeast Asian region has been trade expansion based on the international division of labor, in keeping with shifting patterns of comparative advantage among the countries in the region. Large exchange-rate realignments have enhanced changes in the pattern of comparative advantage that have occurred in the Asia-Pacific region. They have forced Japan to restructure its economy at an even faster rate toward more high-tech intensive goods and have pushed many Japanese firms producing standardized goods to relocate their plants abroad. The appreciation of the new Taiwan dollar and the Korean won, combined with escalation of wage rates at home, has propelled Taiwanese and Korean firms to invest in manufacturing in the ASEAN countries and to seek investment opportunities in China and the Soviet Union. This adjustment in response to shifting patterns of comparative advantage contributes to the industrialization of the Asian developing countries and increases their interdependence. However, the necessary adjustment is often hampered by the vested interests of declining industries and the short-term political gain of protecting them. A concerted international effort is necessary to facilitate industrial adjustment in line with shifting comparative advantage.
Increased participation by China and the Soviet Union in Asian-Pacific trade is likely to have a great impact on the pattern of specialization and trade in the region. First, China has little choice but to specialize in labor-intensive goods, and, given the sheer size of its population and economy, China can easily flood world markets with cheap goods, even though its export capacity is constrained by the need to supply the domestic market. In this way, China will increasingly affect the export position of the ASEAN countries and, to a lesser degree, the Asian NIEs, creating potential sources of economic friction. Already, China has been subject to antidumping actions by the EC on account of its socialist pricing practices.
Second, primary resources exported from China (such as cotton, crude oil, coal, metal ores, and scrap metal) and from the Soviet Union (such as timber, mineral fuel, and metal ores) to neighboring Japan, Korea, and Taiwan will compete with similar exports of the resource-rich Pacific countries such as the United States, Canada, and Australia. Unless the Japanese and Korean economies continue to grow fast enough to absorb the additional supply from the newcomers without prejudice to their traditional suppliers, such exports may also become a new source of economic friction. To minimize this sort of friction, international economic cooperation may be needed to help the socialist countries diversify their exports and to participate more fully in the open international trading and financial systems.
Direct investment by the United States and Japan has been critical in the economic development in the Asia-Pacific region during the past three decades. From the Asian point of view, however, there are some less-than-desirable aspects of the foreign investment pattern of the "big two." The bulk of U.S. investment is in Canada and Western Europe. Indeed, a greater share of U.S. investment is in Latin America and the Caribbean than in the Asian NIEs, China, and ASEAN. Japan's volume of foreign investment has also been concentrated in the United States, the EC, Latin America, Canada, Australia, and New Zealand, with only 17 percent of its total investment in 1981 through 1986 going to other Asian countries.
Japan's investments in Asian developing countries are widely thought to represent an attempt by Japanese firms to secure supply of natural resources, to evade protectionist policies, to strengthen their foothold in these markets, and, in recent years, to establish supply bases for their own domestic market. As for Japan's investments elsewhere, there is a growing perception that Japanese foreign investment represents more of a problem than a solution. Japanese investment in real estate and takeovers of existing enterprises are often seen as "takeovers of national assets," and are perceived as making little contribution to the economic growth of the country concerned. From the perspective of regional cooperation, it can be argued that a much greater amount of Japanese and U.S. investment should find its way to Asian developing countries, including China and the Soviet Union, making greater contributions to regional economic development as a whole.
Accommodation of Nonmarket Economies
Another challenge facing the Northeast Asian countries and the United States is how to incorporate China, the Soviet Union, and perhaps eventually North Korea into the international market system, assuming that these nonmarket economies make continued progress toward political and economic pluralism. The market-oriented countries must understand that the reform process will in no way be an easy task and that it may experience setbacks, stagnation, and even retrogression. Insofar as the change in the communist countries is believed to be irreversible, the market-oriented countries can well afford to show patience over the gradual progress of reform in the former. In this context, it is encouraging to hear that the Soviet Union plans to adapt the Chinese system of special economic districts for use in the Soviet Far East as a means of introducing elements of the market economy in cities or regions segregated from the rest of the economy. This experiment may prove to be a realistic approach to transforming the Soviet economy in a more orderly manner. It could avoid economic chaos that might result from a radical departure of the whole economy from existing institutions and practices. It is also often suggested in the international community that the Soviet Union should play a greater role in the international economic system by participating in multilateral organizations such as the World Bank (International Bank for Reconstruction and Development-IBRD), the Asian Development Bank (ADB), and eventually, the IMF and GATT. At some point such a role would also presumably entail the adoption of ruble convertibility.
Although economic cooperation with the nonmarket economies cannot be insulated from the political and security concerns of the countries in question, it is also true that economic cooperation extended to socialist countries provides better opportunities for cooperation in political and security areas by facilitating their evolution toward pluralism, which in turn would enhance economic interdependence between the two groups.
What, then, could be a feasible approach to economic cooperation with the socialist countries engaged in political and economic restructuring? There are several promising approaches. Former U.S. national security adviser Zbigniew Brzezinski urges that the West and Japan to undertake a "comprehensive program of staged economic and technological assistance" to foster peaceful transition within the communist World. He further suggests that special training and exchange programs for political leaders in the reformed communist systems may be needed to familiarize them with the details of-inter alia-parliamentary procedure and operation. Western nongovernmental actors such as trade unions, press associations, environmental groups, and others have greater opportunity now than ever before, he argues, to forge links with their incipient counterparts in Eastern Europe. Brzezinski's suggestion may also be applied to China and the Soviet Union with necessary modifications.
Second, economic cooperation requires harmonization of the interests of all the countries involved. This consideration is important in view of the complex intersecting of strategic interests in this region. No country in the region wants economic domination by any single nation. China, for example, has been mindful of avoiding too much economic dependence on Japan as reflected in its import controls vis-a-vis the latter. In spite of its increasing role in the region, Japan has been somewhat inhibited in dealing with regional affairs and has often exhibited a passive attitude, simply following the lead of the United States or other countries in the region for fear of creating the impression that it is attempting to revive economic domination over the region. However, there appears to be growing nationalist sentiment in Japan that its foreign policies should be more assertive and independent from the influence of the Western powers, the United States in particular.
Among other things, the Soviet Union wants to ensure safe passage for its vessels along the sealanes stretching from the Indian Ocean through the Taiwan Strait and the Bashi Channel chokepoint to Northeast Asia, which is known to be one of the focal points of Soviet naval strategy. At the same time, the USSR is seeking wider participation in the development process of the Asia-Pacific region in connection with perestroika. China is likely to build up its military power as its economy develops, while Japan's military posture remains uncertain because of her constitutional constraints, even though the military strength of her Self-Defense Force has grown formidable. Given this situation, the role of the United States as a balancing power in Northeast Asia will in no way be diminished. On the contrary, the United States still remains the military superpower guarding regional security and it will remain as the single largest market and one of the major sources of advanced technology for Asian countries. Furthermore, its intellectual leadership role is unmatched by any nation in the region, including Japan.
One implication of the above observation is that multilateral rather than bilateral arrangements may be the best suited for regional economic cooperation. The multilateral approach would provide more and better opportunities for coordination of the economic cooperation programs of individual countries, maximizing the overall efficiency of these programs while minimizing political misunderstandings and suspicions that may arise in the case of bilateral dealings. This is an added reason why the Soviet Union should participate in international institutions such as the World Bank and the ADB, as recommended earlier.
This chain of reasoning leads to the fourth point: Regional banks such as the ADB can and should do more to facilitate economic cooperation between the market and nonmarket economies in the region. Some thought, however, might be given to the possibility of establishing in Northeast Asia a regional development bank that would not specialize only in financing development projects in the region but would also serve as a catalyst-transplanting elements of the market system (business organization, accounting, trade practices, etc.) to nonmarket economies. All countries in the region, including North Korea, Mongolia, Taiwan, and Hong Kong, should participate in the bank, along with major Western nations if they wish. The capitalization of the bank could be made in both hard and soft currencies of the participants, following the practices of various international institutions such as the ADB.
The basic idea underlying this proposal is to meet the specific economic needs of those countries in the unique geopolitical setting of Northeast Asia, which is not found elsewhere in the Asia-Pacific region. It is to be hoped that such an institution might contribute both to assisting economic transformation and to developing nonmarket economies in line with the free enterprise system and thereby help create economic conditions congenial for ending political rivalries in the region.
Finally, though Northeast Asia is the only subregional unit in the Asia-Pacific region without its own multilateral cooperative body, such a body does not appear to be either feasible or necessary, at least at the present, in view of the heterogeneous political and economic systems under review and the different stages of economic development of the countries involved. In recent years the idea of forming free trade agreements between the market economies under consideration has been aired on the both sides of the Pacific Ocean. Studies so far made, however, suggest that although this may be desirable, it is hardly feasible yet for the reasons cited above. What we might hope for at present, therefore, is an incipient form of cooperative organ such as a regional bank.
At any rate, it should be stressed that the Northeast Asian countries are expected to play an increasingly important role in the broader context of the Asia-Pacific region as a whole. As the current movement for Asian-Pacific cooperation embodied in the Pacific Economic Cooperation Conference (PECC) and APEC is based on the principle of nondiscrimination with other regions, any attempt at regional cooperation in Northeast Asia should not be prejudicial to Asian-Pacific cooperation. The scope of economic interdependence is far greater in the Asia- Pacific region than in the narrower confines of Northeast Asia.
In Conclusion: A Historic Opportunity
To summarize, what should be done by major players to resolve the macroeconomic imbalance among the economies involved is reasonably clear. To prevent further errosion of its leadership role in the region, the United States must reduce its fiscal deficit, increase domestic savings as well as industrial productivity, and promote a freer and more open international trading system.
Japan has to assume a greater leadership role commensurate with its economic power by absorbing more goods and services from the United States and the rest of the economies in the region. It must also make better use of its trade surplus in such a way as to stimulate economic growth and development and to promote the regional division of labor-more particularly horizontal or interindustry division of labor-between countries in different stages of development. This approach would do much to help reduce the chronic trade imbalances between Japan and the rest of the countries in the region.
The Asian NIEs must continue their efforts to modernize their institutions and policy frameworks and to liberalize and open their economies to the international economic system. They should also expand their financial and technological contributions to the development of latecomers in the Asia- Pacific region on the basis of their own development experience and capabilities.
Let me conclude by stressing once again that the political and economic reforms in the socialist countries provide us with a great and historic opportunity for opening up economic exchanges on a vastly wider scale between the market and nonmarket economies. Such exchanges can bring us much closer to realizing the enormous regional potential for promoting common economic prosperity throughout the region and, above all, for ensuring that the former Cold War between the communist and noncommunist world will never be resumed.
The chances of success for the political and economic transformation in the socialist countries remains uncertain, but it may well be irreversible, particularly in the area of economic reform. If so, it is then imperative that the market economies in the region extend their help to foster conditions conducive to the success of the socialist countries' reforms. Since economic cooperation is inseparable from geopolitical interests, any approach to regional economic cooperation has to take this reality into consideration. It is therefore our suggestion that a multilateral rather than bilateral approach should receive greater emphasis and, from that point of view, some sort of multilateral coordinating mechanism may be in order, if not a subregional organization in the Asia-Pacific region. A multilateral regional development bank could prove to be a viable candidate for that purpose.