Statements by Supachai Panitchpakdi, Secretary-General of UNCTAD (2008-2011)
Global Korea 2011: East Asia in the World - Prospects and Challenges
South Korea
24 February 2011
Visions and Prospects for East Asian Economic Integration
I. The drivers of regional economic integration
In 2007, UNCTAD´s Trade and Development Report drew attention to an important distinction frequently made between two historical drivers of economic integration. The first, termed "regionalism", is typically policy-led and involves formal economic cooperation arrangements among participants. The second, termed "regionalization", is principally market-driven and spurred by regional growth dynamics, the emergence of international production networks and related FDI flows . This paper will argue that integration in East Asia has historically been characterized more by regionalization than formal policy-induced integration. Indeed, relationships between countries in the region have in the past been of a more competitive nature than cooperative . However, since the Asian crisis, and in particular the recent global financial and economic crisis, regionalism has been gathering pace and promises to support the drive for further integration in the region.
As globalization increasingly erodes individual countries´ national policy autonomy, regional economic cooperation has served as a defensive response, softening, to some extent, the impact of global forces. Economic integration among developing countries has the potential to support national development strategies and to increase the bargaining power of countries in the global economic governance system. North America and Europe have perhaps used their strength as regional blocs to dominate rule setting in the global economy, and so regional accords by other regions, including East Asia, may be necessary so as they don´t lose out in the future . But in order for regional integration to be successful it has to extend beyond trade liberalization to include policy areas that strengthen the potential for growth and structural change. These include macroeconomic and financial management, as well as trade support and industrial policies.
Deepening regional economic integration has been a growing feature of the economic and political landscape over the past 20 years. The number of trade agreements notified to the GATT/WTO increased from 20 in 1990 to 86 in 2000 and currently stand at 193, in 2010. The agreements concluded over the past 20 years have been mainly bilateral, and primarily between developing and developed countries. They have increasingly included provisions aimed at "deep integration". This involves additional elements seeking the harmonization of national policies, often in line with a reform agenda favouring greater freedom for market forces - thus also promoting the freedom of movement of TNCs - and thereby reducing options for government intervention. Indeed, following the failure of the international financial institutions to manage the financial shocks and crises towards the end of the 1990s, and given the slow progress in multilateral trade negotiations, regional arrangements have become a more prominent feature of globalization and the international development agenda.
In general, countries may seek further economic integration for a number of reasons. Access to a larger market as a means of achieving scale economies and diversifying production has been a long-standing rationale for regional arrangements among developing countries. Industrial differentiation broadens the potential for expanding intra-industry trade. Among countries with similar economic structures and technological capabilities, firms that cross various thresholds in terms of size, productivity performance and technological know-how tend increasingly to trade abroad, giving rise to an interactive and cumulative process between internal and external integration. Exports allow scale economies to be further exploited, which can also attract FDI.
But for cooperation and integration to be more than just an exercise in regional diplomacy, the coverage of any agreement needs to be extensive and provide meaningful benefits for producers and consumers in the participating countries. An overarching agenda, which goes beyond trade, is also required in order to provide greater benefits to the regional community and bolster the region´s influence globally. Such an agenda may cover behind the border issues, such as non-tariff barriers, investment, financial and monetary issues, and regional public goods such as infrastructure, water, energy and the environment.
In East Asia, the historical trajectory of integration has followed such a blueprint for cooperation mainly since the Asian financial crisis. Prior to this region-wide shock, formal integration was essentially limited to a political union - ASEAN - the ASEAN Free Trade Agreement (AFTA) signed in 1992, ad-hoc partnership arrangements, sub-regional cooperation projects, such as the Greater Mekong Sub-region (GMS), Indonesia-Malaysia-Thailand Growth Triangle (IMT-G7) and bilateral ties. In the second half of the last century, East Asian countries´ development strategies favoured a strong trading orientation, open markets but with selective government intervention, for example via proactive industrial and macroeconomic policies. Economic growth was not fundamentally supported by economic integration; instead, economic integration has only grown latterly because of other economic factors such as the increase in FDI and the delocalization of production within the region. By the time of the Asian financial crisis, therefore, and in the absence of any region-wide economic agreement, East Asia was already de facto more integrated in terms of trade and investment flows, than other developing regions.
II. East Asian economic development
The pattern of economic development and integration in East Asia has resembled some of the features of European integration, although with distinct characteristics arising from the influences and legacies of their respective histories and the specific demands of late industrialization. For the smaller East Asian states, such as Singapore and Taiwan, the lack of abundant natural resource wealth was an important factor behind the rapid and early shift towards manufactured exports. Larger countries, such as Thailand and Malaysia, were able to exploit their natural resource wealth to build leading agro-based sectors, which subsequently became competitive on world markets. They also provided a foundation for industrialization through concerted diversification strategies. More importantly, nearly all East Asian economies maintained a very high level of investment: gross domestic investment, as a share of GDP, rose continuously throughout the 1970s and 1980s. By the early 1990s, for example, gross domestic investment reached over 30 per cent of GDP in most countries in the region, at a time when the average share for other developing countries was less than 20 per cent.
Leading economies in the region first upgraded their economic activity from simple labour-intensive and processing manufactures to more and more sophisticated manufactures. This opened up opportunities for their less developed neighbours in South-East Asia to enter into a regional division of labour by increasing their resource-based and labour-intensive industries. This "flying geese" pattern enabled trade and FDI to serve as vehicles for "recycling" comparative advantage. Beginning with post-war Japan, there was a deliberate use of pro-investment macroeconomic policies along with strategic industrial and technology policies. More recently, since the early 1990s, China has increasingly contributed to shaping this pattern of regional integration in East and South-East Asia.
East Asian economies also started to open up much earlier than many other developing countries, with a strong focus on export-oriented growth and development. They paid greater attention to institution building in general and the strengthening of the bureaucracy in particular. Another important feature of the East Asian experience was the high level of investment in education, in particular technical skills, and the training of civil servants at all levels. This was instrumental in the emergence of a robust network of government-business institutions consistent with strategic development goals. Stronger government-business links have been critical in the success of East Asian industrialisation. Across the region, there were consistent efforts to design policies that promoted the interests of the business sector as a whole and in a manner consistent with a broader national interest. Industrial policy for example has been a hallmark of the kind of policy space that was pragmatically applied in East and South-East Asia, and state intervention in the economy was generally motivated by ´pragmatism´ rather than ideology.
Trade liberalization and the integration of East Asian countries into the international economic system began much earlier than in many other countries. Importantly, however, the process of opening-up was measured and involved the careful sequencing of policy reform towards trade, capital flows and FDI. Different sectors were opened up to foreign competition to varying degrees and according to national development objectives. FDI, and capital inflows in general, were encouraged from the early stages of industrialization through a mix of monetary, fiscal and exchange rate policies, together with prudential regulation of capital flows and judicious use of direct control measures, such as limits on borrowing abroad, deposit and reserve requirements, and taxes on foreign exchange transaction. This was at the time seen by many observers as the right approach to controlling capital flows.
With increasing pressure for liberalization, and as other countries began to accelerate their industrialization process, more restrictive policies gave way to a hands-off approach. The private sector, for example, was allowed unrestricted access to external finance in the belief that, for private firms, the difference between domestic and external debt was not significant since they were expected to assess carefully the costs and benefits on which their survival depended. This helped to intensify intra-regional trade and capital flows but, by the end of the 1990s, the scale of private sector borrowing (or over-borrowing) led the region into debt and financial crisis. The crisis became one of the main contributing factors in a shift towards regional economic cooperation and integration .
III. East Asian Economic Integration
Among all developing regions, East and South-East Asia has achieved the highest level of economic integration. This is typified by ASEAN, for example, which has the highest share of intraregional trade in its total trade, now at nearly 35 per cent, as compared to 15 per cent for Latin America and 9.7 per cent for Africa. While the East Asian region has achieved the highest level of trade integration in the developing world, with highly integrated production networks, this integration, as already noted above, has been largely market-driven . The pattern of trade in the region is dominated by the trade in intermediate goods, which according to UNCTAD estimates, accounted for 57% of total exports in the region in 2009 .
China-ASEAN trade, in particular, involves intermediate goods trade linked to Global Supply Chains (GSCs) and processing, with China becoming increasingly important as an assembly powerhouse. In relative terms, Chinese intermediate exports to the East Asian region have been declining constantly since the early 1990s. Conversely, China has become an increasingly important market for regional suppliers of intermediates. This suggests that GSCs are increasingly fragmenting the production process, localizing their assembly operation to China, while delocalizing the supply of part and components to other countries in the region. As a region, East and South-East Asia now accounts for almost two-thirds of developing countries´ exports of intermediates. Latin America and East Europe (including economies in transition) represent another 30 percent. The remainder, less than 10 percent, is shared between South Asia, West Asia and North Africa, and Sub-Saharan Africa.
In terms of formal, de jure efforts towards regional integration, initial attempts were made in the early 1990s by the then Prime Minister of Malaysia, Mahathir bin Mohamed, when he pushed for the establishment of the East Asian Economic Caucus (EAEC), in response to ASEAN joining APEC. However, without the active participation of Japan its ambition was limited. After the Asian financial crisis, a similar partnership, essentially ASEAN plus China, Japan and the Republic of Korea, did manage to establish possibly the most successful integration effort to date, the Chiang Mai Initiative (CMI). In the wake of the recent global financial crisis, the CMI has been extended - "multi-lateralised" - and various proposals for deeper financial integration are on the table (discussed below). With regards to trade, there are currently several modalities by which East Asia could pursue more formal integration .
The first concerns the East Asian Free Trade Agreement (EAFTA) between ASEAN, China, Japan and the Republic of Korea, or ASEAN + 3. At the same time, countries are also considering the Comprehensive Economic Partnership of East Asia (CEPEA) which would involve ASEAN, China, Japan, Republic of Korea, India, Australia, and New Zealand, or ASEAN + 6. This partnership is also potentially envisioned as a stepping-stone to a wider Asia-Pacific market and economic community, which could fall under the auspices of Asia-Pacific Economic Cooperation (APEC).
Regional integration is sometimes conceptualized as a stadial process, beginning with a free trade area and proceeding to a customs union and thence to deeper, more complex issues, such as finance . East Asia´s experience proves otherwise; that economic integration can be pursued along separate tracks not necessarily in order of complexity. Indeed, despite high levels of intra-regional trade (discussed below) it has in some ways proven harder for countries in the region to agree on the coverage of tariff reductions, for example in the case of the ASEAN + China FTA.
Nevertheless, as ASEAN economic integration gathers pace, through, for example, the formalization of a Comprehensive Investment Agreement (ACIA) in 2009 and the pursuit of an economic community planned for 2015, negotiations with China, Japan and the Republic of Korea have been intensified. This has lead to the signing of two FTAs with China and Korea. However, as a discussion on East Asia´s trade pattern below illustrates, ASEAN countries may need to conduct a through assessment of the pros and cons of deeper formal engagement with the much larger economies in the region such as China, Japan and Korea. The case of Mexico in NAFTA is an example of a relatively smaller economy that has benefitted from its participation in a common market but, to a large extent, has got stuck in lower value-added processing industries which export to higher value-added assembly operations in the US. Therefore, with intensification of the regional integration process, the ASEAN countries need to be cautious that a formal trade agreement doesn´t lock them into a low-value added production trap.
IV. Prospects for further integration in East Asia
(i) Trade
In some respects, the global financial and economic crisis has enhanced the need and prospects for further East Asian integration, illustrated by the multi-lateralization of the Chiang Mai Initiative (CMIM). The recent global economic crisis began as a Western finanical crisis that was transmitted via highly globalised trade and finance channels. Just as the West´s over-dependence on domestic consumption was exposed, so Asia´s reliance on exports, and the reinvestment of its current account surpluses in North America and Europe, was also shown to be a vulnerability. UNCTAD, among others, has drawn attention to the need for global economic rebalancing, which particularly concerns East Asia, as a surplus region with foreign exchange reserves of US$5 trillion . Such a rebalancing would require the promotion of domestic and regional markets to reduce the dependence of East Asia on Europe and North America for its exports.
In terms of the likely impact of a formal integration agreement on the region, a joint UNCTAD/JETRO study on South-South trade in Asia suggested that an FTA between ASEAN members and other countries in the region would exert a positive effect on trade and development. The report showed that: (1) the creation of an FTA would raise GDP in all signatory countries; (2) the reduction of non-tariff measures (NTMs) would potentially have a greater impact on GDP than tariff elimination; and (3) larger economic effects could be expected as the number of signatory countries increases. Studies based on economic modeling have shown that a regional agreement (East Asian FTA) would yield higher economic welfare gains and a greater economic impact to East and Southeast Asian economies as a whole, than any of the bilateral agreements. On economic grounds alone, the inclusion of more member countries would lead to a more desirable outcome.
Although, as was mentioned above, intra-regional trade is currently buoyed by intermediate goods trade in the absence of an East Asian FTA, an Agreement could further expand trade especially through addressing non-tariff measures (NTMs). Non-tariff measures, such as standards, technical regulations, conformity assessment systems, complex rules of origin, subsidies and restrictive trade-related financial and investment regulations, have a growing importance in shaping the participation in GSCs. The removal of such barriers, which could be envisaged by deeper integration through an FTA is expected to greatly facilitate trade in intermediate products among members. In general, regional trade agreements do facilitate the delocalization of production processes by removing behind-the-border obstacles to trade.
As East Asia moves from market-led regionalization to a policy-led regionalism, a number of political and technical obstacles may present themselves. With regards to trade, the most obvious concerns the definition of non-tariff measures (NTMs) and to what extent regional cooperation can address them. As an agreement will likely reduce tariff barriers, NTMs will rise in relative importance as a trade policy tool, as they have been doing at the multilateral level . The possibility of trade discrimination, whether through tariffs of NTMs, also raises the prospect of trade disputes and so a properly functioning FTA will require a coherent legal structure, and dispute settlement mechanism with institutions able to investigate, arbitrate and uphold challenges to individual countries´ trade policy. Such a structure would also have to deal with the issue of competition for example. Currently, ASEAN is the only organization with a functioning and legally established secretariat, but it lacks the full participation of key players in the region .
(ii) Financial and monetary initiatives
The strengthening of the Chiang Mai Initiative (CMI) during the recent economic crisis, through an increase of its funds from US$ 80 billion to US$ 120 billion and an extension of its swap facility, demonstrated the seriousness with which policymakers considered regional, "home-grown" solutions to external threats. Despite not having been truly tested by a run on a currency, or a (threatened) default, the system has nevertheless grown in scope and importance and could potentially rival the IMF in terms of its influence in the region - especially as multilateral reform appears to be taking longer to effect. Moreover, the development of regional mechanisms, such as the Chiang Mai Initiative in Asia, benefit from efficiencies of scale and an institutional structure tailored to regional specificities.
There is an acknowledgement that the accumulation of large foreign reserves by individual countries, while an understandable response to an unruly global financial system, is an expensive and inefficient form of protection against shocks and crises. The CMI is one, more efficient mechanism of mutual protection from financial shocks, and could one day be scaled-up to the equivalent of an Asian Monetary Fund, which might include other countries in the Asian region; already, multi-lateralization of the fund in March 2010 has increased its potential. Further development of a region-wide monetary mechanism will in the first instance require greater surveillance and the creation of a successful monitoring mechanism. Other policy responses include a mechanism for mediating between the region´s large savings pools and investment needs, especially in region-wide infrastructure projects . Lastly, deeper financial and monetary integration could also attempt to tackle the coordination of exchange rates and improve the effectiveness of the Asian Clearing Union, though more comprehensive participation. One day, an East Asian currency union may be envisaged, and studies, based on European economic convergence criteria have shown that the region is suited to such an initiative .
It is, however, necessary to be realistic about the pace of development of such regional initiatives. As with the European experience, there are significant differences between the region´s big economies: in Europe it took more than 40 years to reach a mature level of integration, such as the launch of a single currency, which has in any case progressed at two speeds. So, the development of regional cooperation and integration mechanisms in the medium-term will take time and require the gradual evolution of institutions and relationships, which may take up to 20 years before full integration is achieved .
(iii) Infrastructure development
One of the most beneficial results of regional cooperation in the East Asian region will be infrastructure development, and in particular for trade and transport. The Asian Development Bank (ADB) estimates Asia´s infrastructure needs at US$ 750 billion a year between now and 2020 . However, the benefits of sub-regional infrastructure projects, for example in the Greater Mekong Sub-region, in terms of increased trade and private investment are likely to outweigh the costs by a ratio of just under 2 to 1 . In addition to mobilising savings for investment in infrastructure, as mentioned above, other financing initiatives need to be evolved at the regional level. One such example concerns the ADB´s active engagement in the ASEAN+3 Asian Bond Markets Initiative, which is working to deepen domestic capital markets and promote local currency bond issues, and a pilot Credit Guarantee and Investment Facility, which is expected to be operational next year within ASEAN+3 countries.
While all East Asian countries, except for the Lao People´s Democratic Republic, have access to the sea, further integration will depend on the development of inland road, waterways and rail access to link rural areas and increase overland connections to parts of China for example. The North-South corridor linking Yunnan Province of China with the North of Thailand through Lao Peoples´ Democratic Republic is one such investment in this direction. One study has shown that while an additional 1,000 km by sea raises transportation costs by 4% on average, the same distance by land amounts to a 30% increase . Thus, improving transport links inland could have a dramatic impact on trade costs.
Trade costs could also be reduced, not only through investment in physical infrastructure, but also by increased cooperation on trade facilitation measures. Regional cooperation and integration can target a number of complementary measures needed to allow countries to take advantage of market access opportunities. These include efficient customs and ports administration, and the compatibility of rules and regulations, which can have dramatic effects on transport costs, especially at border crossings. The harmonization of standards and regulations affecting trade and transport should also be extended to other areas, such as safety and environmental policies.
V. Conclusion
Looking at other regional initiatives, such as the EU, it is clear that regional cooperation will not work unless there is a strong political will and desire for countries to find regional solutions to such problems as transport and trade facilitation, labour mobility, trade policy and financial cooperation, as well as other issues, such as environmental and security concerns. However the regional integration and cooperation process in each region will have to be designed in a manner to fit the development characteristics of countries in the region.
The experience of Europe offers a useful precedent for the East Asian region. It is clear that one of the key challenges facing integration concerns uneven levels of economic development between countries and between regions within countries. The European project has been evolving for more than 50 years, and it still faces major problems of economic unevenness between its core and periphery. Although it has been successful at redistributing funds to less developed regions, such as to Ireland and Spain in the 1980s, it cannot act as freely as the United States of America, for example, which has been even more successful at equalizing economic difference between regions (states). It requires a strong political will, often against stiff resistance to the idea of ceding national sovereignty greater good of the region as a whole.
Not all European countries have pursued integration at the same rate. With the single currency for example, there are now two tracks whereby some countries have gone ahead with further integration and others, such as the UK, have preferred to wait and see; an attitude which it has extended to issues of labour mobility as well. Harmonization of laws and policies is an important area of integration, but countries can also proceed at their own pace. The point to remember is that the sequencing of integration should take account of different country needs and capacities - in the same way that sequencing is essential in multilateral harmonization efforts, where the differences between countries are even greater.
There are no right or wrong answers to the timing, sectoral scope and sequencing of integration. While Europe offers some instructive examples, it is clear that the Chiang Mai Initiative and discussion of an Asian Monetary Fund were, in some respects, ahead of the curve. There was objection to this idea when it was first proposed as a response to the Asian Crisis. Ironically, European countries were among those who objected, although European countries themselves are now considering the establishment of a European monetary fund with an aim to provide a framework of how to deal with Euro area member countries in financial difficulties. The recent US$ 1 trillion fund created between the European Central Bank and the IMF is a step towards such an outcome.
Whilst the East Asian region has made rapid advances at integrating trade and is moving ahead with further efforts to cooperate on financial issues, there is still much to be done on the harmonization of rules and procedures in many areas, from labour mobility to educational qualifications. It may be that formal, policy-led integration, which aims at much deeper commitments among countries, could take a long time. Fundamentally, any further integration efforts, assisted by the ADB or ASEAN secretariats, will need to honestly assess the capacities of participating countries - something which has put considerable strains on the EU single currency, for example.
Nevertheless, the main effects that may follow from an FTA would be deeper trade and economic policy integration (harmonisation and removal of behind the border measures), infrastructure development, the free flow of goods and services as well as deeper financial and monetary integration. An East Asian FTA would need to ensure that it contributes to greater coherence in regional integration efforts.
Currently, there are a number of overlapping regional arrangements:
ASEAN (economic/political/security); Chiang Mai Initiative (monetary); and FTAs (trade/economic), which involve different countries, although there are several common countries to all of these mechanisms. The interface between these initiatives and an East Asian FTA should ensure that they are complementary and hence build up, rather than undermine, Asian regional cooperation and integration.
http://www.unctad.org/templates/webflyer.asp?docid=14602&intItemID=3549&lang=1
