Tag: economy

Regional Trade Deals And The Death Of The WTO

  • Regional trade agreements (RTAs) like the RCEP and CPTPP have been, and will be, the preferred form of trade liberalisation in the long term
  • Once the RCEP comes into effect, it is slated to become the largest trading bloc in the world, displacing multilateral platforms like the WTO
Photo by Frank McKenna

The economic benefits of free trade is the prime mover for the multilateral trade liberalisation process which nearly every state in the world is party to. Compare this with the level of regional trade – free trade in a regional bloc. Many regional states enter into numerous bilateral and plurilateral trade agreements ranging from just one to more than twenty.

The reasons for this asymmetry are the result of the pressures of domestic and international life. For instance, states have to balance domestic forces that come into play which regularly threaten the public interest for the benefit of special interests. Certain industries are immensely profitable when globally-oriented, and these industries will tend to pressure the state to embrace regionalism.

More importantly the stage of domestic economic development is a decisive factor in who to partner in a trade agreement. Many regional trade agreements (RTAs) are formed by members in similar economic positions or with complementary economic agendas. 

Domestic pressures to form RTAs are confounded by international trends. The economist Richard Baldwin argues that a domino theory of regionalism explains a non-member state’s preference to join in a RTA whose members are buyers of its exports. A state’s export industry suffers a disadvantage if it does not join in such a RTA.

The domino theory explains the enlarging of large trading blocs like the Canada-US Free Trade Agreement, now the North American Free Trade Agreement (NAFTA) and the European Free Trade Association (EFTA), now part of the European Union (EU) and predicts a further expansion of other free trade agreements like the RCEP and CPTPP.

Problems with the WTO

The role of the WTO has also been criticised for allowing states to ‘get away’ with regional deals. Much of the criticism is directed at Article XXIV of the WTO constitution which amounts to a departure from the precept of non-discrimination and its associated Most Favoured Nation (MFN) principle.

The article, which grants exemptions for ‘customs unions and free-trade areas’ from the MFN rule is notably weak in enforcing the criteria spelled out for such exemptions. These problems are due to the fact that the requirements of Article XXIV that were intended to facilitate bona fide free trade have been largely ignored.

These include the inordinate decade-long duration of negotiations allowed under the auspices of any free trade deal and a vague requirement for the liberalisation on ‘substantially all’ trade between the FTA members.

Furthermore, FTAs entered into by developing countries are generally exempted from applying MFN tariffs through the enabling clause which has the effect of allowing developing countries to escape the MFN regime scot-free. States that wish to enter into an RTA need to report to the WTO for assessment of eligibility to Article XXIV, but evidence has shown that over the past two decades the special use of Article XXIV has instead transformed into the very common and abusive employment of its provisions.

The question then is whether or not the reasons for regionalism apply equally to the multilateral efforts of the WTO. The answers to this question are broadly divided into what are called the ‘stumbling block’ and ‘building block’ views on regional trade.

Are RTAs stumbling or building blocks of the WTO?

RTAs have been argued to contribute to a more rules-based system as codification, enforcement and compliance are generally more aggressive than in those found at the WTO.

The clearest example of rules-based governance is exhibited in Europe where regional integration has given way to a predominance over national trade policy. Even if such a system is not possible in every part of the world, RTAs tend to exert more pressure on member states to establish predictable trade behaviour since it is likely that a high degree of trust exists among member states in regional settings. 

More extensive liberalisation of other barriers to trade, such as in non-tariff, regulatory and structural barriers have also generally been more common when we compare RTAs to multilateral agreements.

The reason for this can also be attributed to trust and also because it has been notoriously difficult to accommodate the needs of every member in a multilateral agreement. These policies of liberalisation have, according to the WTO, ‘lock in’ effects on the MTL process in that they cause trade rounds to proceed on a more liberalised footing than they would otherwise. 

However, none of the reasons for the ‘building block’ case given address the central question on whether they positively affect the MTL process. Creation of a rules-based trading regime and intra-regional liberalisation can bring benefits to a regional bloc and still be coincident with the impediment of the MTL process especially if they act to substitute the larger process in the long run.

Recall that the United States began a reversion of their multilateral approach after the Tokyo Round. The US-Canada FTA marked the start of a significant shift in the US position towards regionalism which has not reverted.

The economist Jagdish Bhagwati argues that the US shift diverted political will away from the multilateral framework and lead to ‘trade fatigue’ across the globe as states began to focus their energies on regional and bilateral projects.

Progress during the Uruguay Round was sluggish in part because regional efforts to create NAFTA and the European market were elevated in precedence and in part because large regional blocs could be played as trump cards during trade rounds.

The US shift also created a void in the multilateral process, leaving the WTO (then-GATT) member states without hegemonic leadership to prevent free riding. The result was that the WTO’s agenda no longer had powerful support and states were not as keen to go along a path of liberalisation unhedged against the high likelihood of defaulting states.

But the US shift was not accidental even though Europe and Japan had by then become sizeable trading forces. The US pursuit for market access through bilateral and regional agreements was an attempt to stop its rising trade deficit with the rest of the world, a demonstration of how international aspirations are often supplanted by domestic concerns.

Now that two of the largest trading nations, China and the US, have given preference to regionalism and bilateralism respectively, the search for consensus in the multilateral framework is even more unlikely, given that both are also currently in the thick of a trade war.

Photo by VanveenJF

Is regionalism better for all?

Discriminatory trade has had a long history of winners and losers. From as early as the 17th century, Portuguese traders stationed in Macau received handsome profits by acting as middlemen during a Chinese trade embargo on Japan following Hideyoshi’s invasions of Korea in the late 16th century. Trade distortion as a result of discriminatory trade is bound to benefit some and hurt others in all its multifarious forms.

The late Jacob Viner argued that a customs union (CU) is substantially better for the world economy if the combined effect of increased trade within the bloc (trade creation) exceeds the diversion of imports away from efficient non-members to less efficient members owing to a relative increase in tariffs outside the bloc after liberalisation (trade diversion).

Trade diversion transpires when members in a CU are not low-cost producers and if there is high import demand for those goods in member states. Likewise, the effect of trade diversion is muted if the share of trade among member states was large prior to the establishment of the CU.

This was the case in Western Europe before the European Free Trade Association, and as a consequence, exacted marginal costs on countries outside the CU. 

Another instance of the asymmetric effects of trade creation and trade diversion concerns China’s trade engagement with ASEAN. China has not entered into a customs union with ASEAN, but its FTA with ASEAN (ACFTA) exhibits trade creation just like any other RTA. This effect of trade creation within the ACFTA is likely to benefit Chinese exporters to a much larger degree than regionalism with Taiwan and Hong Kong.

Trade creation effects of RTAs and other forms of discriminatory trade regularly assigns winners to states with high levels of pre-existing trade. However, where there is low pre-existing trade and if the agreement involved a large trading nation and a small trading nation (a hub-and-spoke arrangement), an FTA between the two is likely to damage the world economy because the large state pays a small economic price for political support while the small state – with little significance to the world economy – benefits disproportionately from free trade.

Hub-and-spoke arrangements do not have substantial diversionary effects but they throw light on another question – to what extent are states and blocs willing to levy costs on the world economy through trade diversion for the purposes of self-aggrandisement?

Terms of trade and beggar-my-neighbour effects

Discriminatory trade improves the terms of trade for the trade bloc because more exports can now exchange for tariffed imports, and carries with it an increase in the national total benefit from trade.

In addition, because larger trading blocs (like customs unions) have greater monopsony power, the optimum common external tariff (CET) is usually higher and in inverse relation to the price elasticity of import supply.

The tendency for trade blocs is hence two-fold: expand membership and raise tariffs on non-members in order to improve the welfare of its residents and its terms of trade with respect to the rest of the world.

Such a situation is, of course, undesirable if you so happen to find yourself part of the rest, and gives further support to Baldwin’s ‘domino theory’ and Krugman’s three trade blocs hypothesis. 

The effects that perpetuate these costs on non-members are termed ‘beggar-my-neighbour’ effects, a reference to the all-or-nothing card game that young teenagers played for leisure. These effects have serious consequences for the MTL process since affected nations are expected to take retaliatory measures against new FTAs through protectionism or by expanding their own network of FTAs, possibly through regionalism. 

Customs unions that are sensitive to the potential for trade wars caused by ‘beggar-my-neighbour’ effects should adjust CET levels so that trade with non-members remain at pre-bloc levels. This proposition is the grounds for some recommendations which have called for the awarding of concessions and ‘lump-sum transfers’ to sectors that lose out from the creation of the CU by sectors that win so as to increase welfare for both members and non-members of a CU.

Trade diversion after the formation of a trade bloc is not the only attendant outcome on the world economy. Nuno Limao has argued that MFN tariffs could have been much lower on US Preferential Trade Agreement (PTA) goods in the absence of those PTAs.

He suggests that US PTAs acted as stumbling blocks to its own MTL that the US was pursuing prior to the Uruguay Round. States like the US would have had better chances of even freer trade had they continued along the path of multilateralism. But in defence of US doctrine, it is possible, if not, probable that that path was already moot.

New economic issues surface when we consider the nature of a RTA, FTA or PTA. All of these agreements are never as liberal as they appear and occasionally accomplish less than a multilateral agreement. For example, not all economic sectors are liberalised in Japanese agreements with other states. Protectionism continues to be the rule of thumb for agriculture, a desperately uncompetitive sector in Japan.

Coupled with domestic pressures discussed in the first part of this paper, most governments will succumb to industrial lobbying and take conservative approaches to trade liberalisation. A reduction of tariffs on substantially all trade within a trade bloc is a reasonable hope only if we pretend that weak traditional sectors and structural unemployment are small problems with quick solutions.

It is for this reason that Bhagwati insists that regional agreements should only exist if they lead to common markets. Trade, investment, migration barriers and barriers to the movement of the factors of production are eliminated in a common market so that states do not regress to selective protectionism as a failsafe option whenever liberalisation is inconvenient for their purposes.

A common market might also prevent forms of trade distortion caused by transshipment as is the case when a PTA non-member exploits a member’s low tariff rate as a conduit for entering the trading area. PTAs try to avoid this situation by instituting rules of origin (RoO) to identify goods eligible under the PTA, but RoOs are extraordinarily difficult to implement because a single product might have parts and materials from a whole chain of manufacturers situated in different countries.

The fact is that no matter the degree of intra-regional liberalisation of trade, protectionism is a real tendency that is impossible to eliminate in full.

Regionalism’s impact on trade flows 

The amount of trade diversion is small if RTAs are made by ‘natural trading blocs.’ According to Krugman, these natural blocs also happen to form the majority of trading agreements. Low transportation costs within natural trading blocs is a key advantage that encourages trade even before the formal establishment of the bloc.

Trade diversion is unlikely to surge since member countries will continue to capitalise on low transportation costs and a large volume of preexisting trade. Krugman concludes that for the most part, RTAs are benign for the world economy, but only if (a large ‘if’) they do not result in a ‘totally fragmented world’ of small, numerous agreements which reduces world welfare. 

Though regional trade blocs also have a tendency to increase tariffs, the level of tariff increase may be mitigated beyond a certain threshold of trade bloc expansion. The reality is quite consistent with this hypothesis and the few trade blocs that can reasonably threaten the world economy – NAFTA, EU and the Asian bloc – will tend to have tariffs that even each other out.

The result is that states will become subject to essentially equal external tariffs once they have consolidated. Of course, despite a powerful mutual incentive for trade blocs to implement beggar-my-neighbour strategies, it will be in everyone’s best interest if all acted to reduce tariffs rates multilaterally. 

Ever since US disengagement from the multilateral process, the proliferation of RTAs has not been commensurate with equal development in the multilateral process. The death knell of the WTO has come with the CPTPP in effect and the forthcoming signing of the RCEP. These agreements are a signal to the rest of the world that RTAs will most certainly be the preferred form of trade liberalisation in the long term.

While the real impact of these mega-RTAs on the world economy is still uncertain. Future trends, political exigences and present forms of regionalism that pursue strategic and foreign policy advantages over economic rewards will play a large role in the final analysis.

By Raymond Gallego

Editor’s note: The author has exercised his full exclusive rights over the article so our content policy does not apply. Please send all requests for use to editor@allasiaaffairs.com.

Asia’s Future In The Fourth Industrial Revolution

  • The Fourth Industrial Revolution (4IR) will create deeper inequalities across Asia by consolidating intellectual capital in a few already advanced states
  • The barriers to entry to developed status will be much higher than in the past and take far longer than it used to – “development limbo” will be widespread across Asia
  • On the political front, left-wing political platforms may become increasingly popular in Asian developing states as social mobility remains depressed
  • This would herald prolonged competition and conflict between the new Left and the still existing military establishment in many Asian states
Photo by Ali Yahya

We never fully understand the impact of revolutions until the next one comes along. We have seen this before when the Third Industrial Revolution’s breakthrough in internet connectivity resulted in the kind of networked revolts in the Middle East (early 2010s) and the type of online activism across the Western world against sexual harassment, climate change, and police brutality, many years after the Revolution began.

The “Fourth Industrial Revolution” (4IR) is well underway, and like the ones that came before, its effects will only be known much later on. But we can make some reasonable guesses as to its political consequences in specific areas by putting together what we know are the entrenched interests in those places and how those interests might be endangered by the changes to economic and social life.

Popular anticipation of Asia’s rise in the 21st century belies the many challenges that it faces in the 4IR. For one, economic development is not uniform across the region, even within sub-regions such as Southeast Asia and South Asia.

As the 4IR accelerates the speed in which technological progress occurs, states that already enjoy a talent and capital advantage will continue to benefit disproportionately.

In the 4IR, the driving force of economic growth will switch from advanced manufacturing to hyper-skilled talent resources. And states that are able to marshal these talents through not just high salaries, but also “perks”, “liveability”, and the other intangible qualities of a society that attract will become new areas of competition.

A few places that are in pole position – Japan, South Korea, Singapore, Hong Kong SAR, and Taiwan – to reap the most rewards from the 4IR will also be places that will need to decide what level of economic dynamism will come at the expense of some social harmony.

As talent is highly mobile, competing for the best talent will inescapably involve liberalising migration policies – in addition to optimising business set up procedures and reducing corporation taxes – but these are also frequently the sources of economic dissatisfaction among locals.

Asian economies that have not matured will face much higher barriers to development than those faced by the four “Asian Tigers” after the 1960s.

A positive loop of development and prosperity will operate in the 4IR. Countries that have the necessary infrastructure to host an ecosystem of innovation will stand to gain the most in the 4IR, and others who fail to do so will find it increasingly difficult to build alternative ecosystems because flows of talent will not be responsive to costs determinations alone.

Instead, talent and capital will move to places where R&D funding, high quality education standards, rapid testbed-ding, and other efficiencies prevail; and these have been harder to achieve than merely driving costs down.

The growth of the middle classes in Asia, oft-seen as the panacea for the global economy in the 21st century, is unlikely to rise steadily or quietly. The idea that a large middle class would set countries up towards a more progressive politics has been largely debunked. The middle class in the developed world today are some of the most vulnerable constituencies.

In the US and in Europe, moderate political platforms have been displaced by populist movements. And while there is a creeping sense in which those trends will affect Asia, the more likely scenario is that we will see a deep split in the sociopolitical climate between the developed states and those still undergoing developing.

In developed states, conflicts between local workers and expatriate or new migrants will become profound due to talent mobility in the 4IR. Political contests will also be defined more frequently on the question of native rights.

Corporations that wish to survive the discord need to be more active in making their hiring practices transparent or to present them more publicly if they are already transparent. Corporation-society relations ought to be a much more heavily invested function of any multinational operating in Asia.

The developing states – in particular those in Southeast Asia – will experience a different challenge. As the 4IR advances, inequalities resulting from higher returns on hyper-skilled talent over labour will exacerbate social tensions.

These inequalities will not be felt merely at the level of incomes (in fact many Asian countries have shown to have declining inequality since the 1990s), but on a emotive one as well. Opportunity inequalities will begin to matter more because cross-country comparisons has become easier to make for the average citizen. And the sense of opportunity at home is increasingly being lost from poor governance and outward migration to more developed cities.

On the political front, left-wing political platforms are set to gain renewed popularity across Asia. These New Left movements are likely to guarantee the middle classes a minimum and universal standard of living as a response to rapid automation and capital outflows resulting in the lost of a vast number of low-skilled jobs.

The appeal of the New Left will be felt most keenly in the developing Asian states where the military establishment retains a strong hand in the economy, not least because the latter has benefited tremendously from their close corporate compacts with big businesses for decades. Any calls to dismantle those relationships would deeply threaten the establishment’s survival, eliciting a strong and potentially violent response.

While Asia’s military establishments have survived for decades through many past economic crises, the old formula of state capitalism has been threatened by the need to adapt quickly to disruptive technology that has thus far exceeded the ability of most governments to regulate effectively.

The future of Asia in the 4IR is a future of enormous value though concentrated in pockets of Asia’s most developed cities. Elsewhere, prolonged social conflict is expected due to the difficulties faced by the middle classes to transform into a hyper-skilled workforce.

How prolonged and how intense these conflicts will be will depend, among other things, on the resolve of governments to distribute the (little) gains there are left in a far more equitable and just manner than before.

By Elizabeth P Tang

Why Korea Is More Than Just K-Pop In Indonesia

  • Indonesia, the 4th most-populous country and the 16th largest economy in the world, is becoming an increasing important country for South Korean businesses
  • A total of USD 7.3 Billion has been invested by South Korea since 2014 in a wide range of industries, including submarine technology and the construction of electric vehicles
  • South Koreans in Indonesia form a well-organised network of expatriates, who are greatly respected and admired by the locals due to their mastery of Bahasa Indonesia and familiarity with local customs
kpop brown eyed girls korea
Photo by Jeon Han

South Korea and Indonesia are two countries which one does not typically associate with each other. One is a wealthy East Asian country known globally for its technological prowess and mesmerising Pop Culture, while the other is a developing nation in Southeast Asia known for its Muslim-majority and its abundance of natural resources. They don’t seem to share much in common.

Yet despite these differences, both nations have had contact with each other for centuries. What’s more, the influence of South Korea in Indonesia is only set to grow thanks to ever-increasing business ties. It is no wonder then that South Korea ranks among the top 10 FDI sources for Indonesia, investing a total of 7.3 billion US dollars since 2014.

For instance, Hyundai Motors has recently pledged to invest USD 1.55 Billion to build an electric car factory in Indonesia, the first of its kind in Southeast Asia.

However, the relationship between the two countries does not limit itself to economics alone. There has been a recent intensification of cultural contact between South Korea and Indonesia – and it goes both ways.

Indonesians aren’t simply embracing the hallyu like everyone else. Many South Koreans are learning Bahasa Indonesia and choosing to live in Indonesia as well. But how did we get here?

Relations Before The 21st Century

Long before there was a unified South Korea, there were the Three Kingdoms, one of which was Silla. And long before there was Indonesia, there was the Buddhist Kingdom of Srivijaya, whose capital was located in the island of Sumatra.

Srivijaya was renowned internationally as a centre of Buddhist studies, so foreign East Asian monks would routinely spend some time in Sumatra studying Sanskrit before continuing their pilgrimage to India.

Hyecho, a monk from Silla, may have stopped by Srivijaya, but he did not stay long in order to focus on his journey to India in AD 723.

A more concrete example of Korea-Indonesia relations can be found in the 15th Century. Back then, the Kingdom of Majapahit, which many Indonesians consider to be the spiritual predecessor of their country, was the dominant power in the Indonesian archipelago. Chen Yen-Xiang, an ethnic Chinese official working for the Majapahit Court appeared in Korean records from 1406.

Back then, it was common for Southeast Asian Kingdoms to employ ethnic Chinese envoys as the leaders of trade and diplomatic missions to China and other East Asian countries.

Chen’s delegation, which mainly consisted of subjects of Majapahit, was likely attacked by Japanese pirates when his ship was sailing near Korean territory. Although many members of his crew were either killed or captured, Chen along with 40 crew members managed to escape.

They were well-received in the Korean Court, which also provided them with a small ship for their return journey. Chen later expressed his gratitude to the Koreans in 1412 telling them in a letter that he would send his grandson to the Korean Court to convey the Majapahit Empire’s appreciation.

While these episodes of Korea-Indonesia interactions happened centuries ago, there have also been more modern examples.

During the Japanese Occupation, the Japanese would often employ ethnic Korean soldiers in their overseas campaigns. In 1942, a soldier named Yang Chil-Sung was stationed in Indonesia as a prison guard.

When Japan surrendered in 1945, the Indonesians and Koreans took this opportunity to declare their independence. However, the Dutch who were Indonesia’s colonial masters before the Occupation, refused to grant Indonesia its independence, and launched a brutal war of re-conquest.

Yang Chil-Sung who by then had become fond of the Indonesians, took on a local name, Komaruddin, and helped the Indonesians in guerrilla warfare until he was executed by the Dutch in 1949. He is remembered by both the governments of Indonesia and South Korea for his heroic sacrifice.

South Korean Investments In Indonesia

With the horrors of the Second World War over, South Korea could finally focus on industrialising and developing their country. The Miracle on the Han River transformed South Korea’s economy into one of the Asian Tigers.

Soon, South Korean companies began expanding into Indonesia. In 1973, Miwon Specialty Chemical Co., Ltd opened up a factory in East Java. Various other South Korean companies would follow suit during the 70s and 80s. These investments also brought with them the first wave of South Korean expatriates who would go on to settle in Indonesia.

It is not hard to see why South Korean companies would be especially interested in Indonesia. It is the largest economy in Southeast Asia, with more than USD 1 Trillion in nominal GDP, and it is forecast to join the top 5 economies in the world by 2030 as measured in PPP, with a GDP of USD 10 Trillion.

South Korea’s recent investments in Indonesia include the building of a Light-Rail Transit as well as cooperation in the transfer of technology to procure Chang Bogo-class submarines for the Indonesian navy. With South Korea’s recent focus on its “Southern Strategy” to engage more with its Southeast Asian neighbours, we can be sure to expect more cooperation with Indonesia.

Korean submarine Indonesia
Photo by RHK111

Cultural Interactions

Besides the economic aspect of South Korea-Indonesia relations, it is also important to take a look at the cultural aspects. Usually, the relationship is seen one way, where South Koreans export their K-Pop music and K-Dramas to other countries that gobble them up with enthusiasm.

However, it is interesting to note that Indonesians themselves seem to have captured the hearts of some South Koreans as well.

Many South Koreans study in Indonesian universities and many of them master the local language of Bahasa Indonesia. There are instances of both children of long-time South Korean expatriates as well as recent arrivals from South Korea who go to local universities and plan to stay after graduation.

Some South Koreans have found success by making YouTube channels and vlogging about Korean and Indonesian culture too. And there are even some rare instances of Koreans embracing Islam after spending some time in Indonesia. As a result of these exchanges, Korean expatriates are one of the most respected nationalities in Indonesia.

The South Korea-Indonesia relationship is certainly an interesting one. It has had humble beginnings, but it has now grown to be a mutually beneficial relationship. For now, Indonesia’s biggest investors are still Singapore, China, and Japan, but we can expect Korea’s contribution to become even bigger, especially as Korea seeks to edge out its traditional rival, Japan.

For investors in the region, it would be wise to pay attention on how this unique relationship will develop further in the future as Korean businesses and expatriates gain more influence in Indonesia.

By Lin Lintaro

Editor’s note: Not all links are in English.