Economic Cooperation in Northeast Asia in the Age of Regionalism


Paper prepared for the Conference of the International Economics Association at Pohang University, June 24-26, 1993.


               As we all are aware, the tide of regionalism is running high in the world today, while the global approach to a new world trade regime in the Uruguay Round has been faltering. In particular, we have come to realize that our own Asia-Pacific region is being divided into several trading blocs. Australia and New Zealand have been linked through the Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCER) since 1983; the ASEAN summit agreed to form the ASEAN Free Trade Area or AFTA in January last year; and now NAFTA, signed on December 17, 1992, is about to emerge in North America as the major trading bloc in the region and, indeed, in the world. Such being the case, Northeast Asia-as defined to include Japan, China, North and South Korea, Taiwan, Hong Kong, the Russian Far East, and Mongolia-alone remains outside any free trade pact on the map of the Asia-Pacific region.

In addition to the trade blocs, there are several regional organizations primarily designed for economic cooperation in the Asia-Pacific region, such as the Pacific Basin Economic Council (PBEC), the Pacific Economic Cooperation Council (PECC), and Asia-Pacific Economic Cooperation (APEC). PBEC, founded in 1968, is a private organization of businessmen in the region, while PECC, started in 1980 in Canberra, Australia, is characterized by the tripartite participation of government officials, businessmen, and academics. APEC came into being in 1989 as the major intergovernmental organization in the Asia-Pacific focusing on consultation about matters of regional economic cooperation. As APEC is still in the formative stage, its true nature and potential have yet to be seen.

Unlike the regional consultative bodies mentioned above, creation of a free trade pact is bound to have a direct and far-reaching impact on the trade and investment patterns of Northeast Asian countries. It should be noted, however, that there are vast differences among the three Asia-Pacific trading blocs in terms of their scale and impact on regional economies. In the case of AFTA and CER, their trade among themselves is rather small relative to their trade with nonmember countries in the Asia-Pacific region. More specifically, the volume of intraregional trade of ASEAN in 1990 accounted for less than 20 percent of its total trade, the corresponding figure for CER being about 10 percent. Thus, the impact of the two trading blocs on the Pacific trading system may not be too great.

NAFTA, on the other hand, is an entirely different story. When ratified by the three national legislatures, it will emerge as one of the largest trading blocs in the world with 360 million people and a $6 trillion GNP. Trade among the three members far outweighs trade with nonmembers. Canada and Mexico both ship more than 74 percent of their exports to the United States annually. For the United States, Canada, and Mexico are the largest and the second-largest markets for their exports, respectively. However, Canada accounted for only 21 percent and Mexico for only 7.2 percent of U.S. exports in 1990. Thus, trade within the bloc is much more important for Canada and Mexico, given the sheer size of the U.S. market, while the trade with other Asian countries is equally or even more important for the United States than trade with the two neighbors.

It is premature to fully assess the impact of the free trade accord on the regional and global trading systems. The initial reactions from Asian countries have not been very encouraging. The prevailing worry among Asian countries seems to be that the pact could be arbitrarily implemented and might not be consistent with GATT principles, notwithstanding the U.S. arguments to the contrary. In particular, Japan's major concern is that the agreement will raise the required local content of products such as automobiles to qualify for preferential tariff treatment. Asian developing countries are worried that their market share in the United States and Canada will decrease in favor of Mexico, which would enjoy preferential treatment for its exports. The Asian NIEs expect that Mexico will become a powerful competitor in international markets, including North America, as it will develop export industries such as electronics, semiconductors, computers, automobiles, and textiles on the strength of rich natural resources and cheap labor at home combined with capital and technology from the United States and Canada. ASEAN countries fear that the trade pact could lead North American and Japanese businessmen to redirect investment from Southeast Asia to Mexico. Overall, Asian countries seem to fear that the trade pact could have a negative impact on their economies.

The anxiety of Asian countries may be tempered, however, by somewhat different observations. Jeffery J. Schott, for example, made the point that in most cases NAFTA preference will not have a significant impact on foreign suppliers to the U.S. market for the simple reason that existing barriers to the U.S. market are already low and the additional discrimination implied by the NAFTA should be quite limited. Echoing this view, South Korean officials estimated that roughly 35 percent of its exports to the United States remain subject to import duties, which could be further reduced through the Uruguay Round and bilateral negotiations. From the regional perspective, the trade pact could lead to more investment not only in Mexico, but also in China and ASEAN countries, because Japan, Korea, and Taiwan will be prompted to make use of the cheap labor in those areas in an effort to maintain the competitive edge of their products against Mexican competition in the world market. In short, it is likely that the growth effect of NAFTA may spill over to the Asian countries.

One can also argue that creation of the free trade bloc is not necessarily a permanent setback for the current multilateral effort intended to reform GATT to maintain an open global trading system. It has been customary in multilateral negotiation that several major players in the negotiation built up the basis of agreement among themselves, and then broaden the basis to include the majority of minor members in a negotiated multilateral framework-usually on their terms. The EC and NAFTA, the major free trade blocs in the world, both argue that they stand firmly in favor of an open global trading system and that their free trade agreements are consistent with GATT. The United States in particular is currently touting the slogan of "open regionalism" to stress that NAFTA will not contradict the cause and provisions of the GATT. Given this common ground professed by the two major players, there seems to be room for optimism that they will manage to bring the Uruguay Round to successful conclusion by the end of this year.

At any rate, the basic problem with free trade areas and customs unions is that they are inherently discriminatory. They are designed to accord benefits only to goods produced in the pact region-not goods made wholly or in large part in other countries. As such, free trade pacts fundamentally run counter to the principle of unconditional most-favored-nation treatment that has been the foundation of trade negotiations for decades and is stated in Article 1 of the GATT. To be sure, free trade areas have long been permitted by special exception in the GATT in the hope that such arrangements would tend to liberalize trade. Yet they are permitted only on the condition that they must not result in barriers to outside countries higher than preexisting levels, and that they must cover "substantially all" trade between the participating countries (Article 24 of GATT). It was reported that if NAFTA is to meet this test, many of the protectionist deals currently under negotiation would have to be phased out over the next five to ten years.

What, then, can Northeast Asian countries do to meet the challenge from NAFTA, EC, and other trading blocs? Many observers seem to be thinking about the possibility of forming a Northeast Asia Free Trade Areas comprising China, Hong Kong, Taiwan, Japan, and South Korea, to begin with, to counteract other trading blocs (Eastern Siberia in Russia, Mongolia, and North Korea may be considered as candidates for membership).

However, apart from the complex political problems involved, there are at least two economic factors that seem to militate against the formation of a free trade bloc in Northeast Asia. First, China has yet to transform its entire economy into a market-oriented system even though its rapid economic transformation in the east coast area has been quite impressive. China has yet to satisfy some conditions necessary to be able to join GATT. It will take China some time before its economic system becomes comparable to that of other countries in the region. Second, it is difficult to identify any country in Northeast Asia able and willing to take initiative or leadership to organize such a regional scheme. This is simply because of the fact that Japan, Korea, and larger China-including Hong Kong and Taiwan-depend all too heavily on the U.S. market for their exports: The United States absorbs nearly one-third of the total exports of each country in question. The other side of the coin is that the intraregional trade in Northeast Asia is relatively small, accounting for about 20 percent of their total trade combined. Given these realities, the case for a free trade pact in Northeast Asia seems to be less than a real possibility.

There is other speculation that some Northeast Asian countries may join NAFTA-subject, of course, to the consent of the three founding members of NAFTA as stipulated in their agreement. In fact, former U.S. President Bush made a statement at the time of his election campaign last year that membership in NAFTA may be broadened to include Asian countries. There is also a proposal for a Pacific-Asia Free Trade Area (PAFTA) voiced by the Eminent Group, an advisory group to APEC, convened in Singapore last March. The Clinton Administration has reportedly decided to give priority to APEC in the development of U.S. economic relations with the Asia-Pacific region, and, at the same time, seems to be willing to consider PAFTA as a long-term goal and to urge APEC to begin taking steps leading to an eventual agreement. However, in all probability, such an agreement is a long way off, perhaps more than ten years, considering the many difficult problems involved.

The United States has been opposed to any new subregional grouping in the Asia-Pacific region, as was well illustrated by its negative reaction to the proposal of forming the East Asian Economic Caucus proposed by Prime Minister Mahathir of Malaysia a few years ago. The negative U.S. assessment of the EAEC was echoed by Japan and other Asian countries. Responding to such unfavorable reactions, Prime Minister Mahathir explained in his statement of May 13, 1993 to the Asia Society that he was not proposing a closed, inward-looking trading bloc for East Asia nor any kind of East Asia trading bloc. Rather, he said, the proposed caucus was merely intended to be a loose consultative forum to discuss how to act in concert to improve the chances of success of the Uruguay Round and sustain the global trading system. Nonetheless, there seems to be growing sentiment in East Asia that some kind of organized effort is necessary to counterbalance not only NAFTA but also the EC-EFTA European Economic Space and to protect the economic interests of East Asia as a whole. This sentiment will be further heightened if NAFTA in effect is found to be highly inward-looking and overly discriminatory against nonmember Asian countries.

Such being the case, I am led to conclude that forming another free trade bloc, either in East or Northeast Asia, is a remote possibility as far as the present perspective is concerned. This does not mean, however, that there is no chance for Northeast Asian countries to form a subregional group suitable to address their own problems. Indeed, we might identify a host of problems that are unique or characteristic to the region, which could be discussed by regional member themselves without involvement of other countries outside the region. One such example is found in the Senior Officials Meeting on Environmental Cooperation in Northeast Asia that took place in Seoul in February 1993. To my knowledge, it was the first meeting of its kind to take place in Northeast Asia and augurs well for similar regional consultation and agreement on various economic matters, including trade, investment, and finance.

As for the area of finance, I proposed a few years ago to set up a Northeast Asian Development Bank with participation not only of Northeast Asian economies but also any of the major countries outside the region. The primary purpose of the bank would be to increase capital flow into and within the region for development purposes and to facilitate the exchange of information and views on matters of mutual interest of the regional members. This would also help forge a climate in which regional development efforts proceed on the basis of mutual understanding and trust, which have been conspicuously absent in the region.

While the proposal seems to be drawing increasing interest from the international community, the major skepticism expressed so far is that it would duplicate the function and activities of the existing Asian Development Bank. However, such duplication of business among banking institutions may not be a problem as long as it serves to enhance the role and contribution of the financial system as a whole. As a matter of fact, there is a degree of duplication in the businesses of the IBRD and ADB and other regional development banks. Yet there is no doubt that those development banks together have been making a significant contribution to the development of many countries throughout the world.

There are good reasons to believe that the proposed bank will be a valuable addition to the international financial system. For one thing, there has been a strong view among Northeast Asian countries that in spite of the two largest capital surplus economies located in the region-namely Japan and Taiwan-relatively smaller proportions of their surplus funds have found their way into the needy countries in our region-particularly China, the Russian Far East, and Mongolia-to support their development efforts. This may be explained in part by the absence or weakness of regional financial institutions channeling financial resources available in the international financial market to the region. The region certainly deserves to have such a financial institution, commensurate with its enormous development potential and increasing importance in the world economy. The rising demand for development financing cannot possibly be met adequately by private banking and private investment alone, nor by the ADB. Moreover, it is reasonable to expect that there will be a growing number of development projects involving several countries, one such example being the Tumen River Economic Zone project, which has been under negotiation by countries involved under the aegis of the UNCTAD. In addition, a regional development bank along the lines of ADB will be better suited than private banking to initiate and foster international development, particularly in Northeast Asia where the role of the government is preeminent and, therefore, the bank's ability to negotiate and coordinate with the government involved is essential.

In conclusion, in the age of regionalism, what is most desirable for Northeast Asian countries is to promote the role of APEC and other similar regional bodies instead of seeking to form their own free trade bloc in addressing their economic interests, while at the same time making greater concerted efforts to sustain the global trading system. On the other hand, the region will be facing a growing need for an organized effort in dealing with international affairs involving countries outside of the region, as well as in coping with intraregional problems arising from the ever-increasing economic interaction among the regional members. It behooves all parties concerned in the region to make a well-organized endeavor to realize their tremendous development potential to the maximum extent possible. The proposed Northeast Asian Development Bank could be a first step in that direction.