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Political Economy Considerations of FTA Consolidation in Asia

Even if the consolidation of FTAs into a region-wide agreement—whether in the form of an EAFTA among the ASEAN+3 countries or a CEPEA among the ASEAN+6 countries—yields large economic gains to East Asia, it is not obvious that such a region-wide FTA can be created given political economy considerations. The PRC has been a strong supporter of an EAFTA, while Japan has put more emphasis on a CEPEA. In addition, political rivalry over FTA leadership in East Asia may hinder any such joint venture. Also, given the role of the US in Asia as a security anchor for many countries, one may argue that excluding the US from the Asian integration process may not be viable from a political perspective. Furthermore, the rising importance of European markets for many Asian economies suggests that involving Europe may also make sense.

We consider three competing scenarios for consolidation of various East Asian FTAs into a larger FTA: (i) an East Asia-wide FTA, either in the form of an EAFTA or CEPEA; (ii) a Free Trade Area of the Asia–Pacific (FTAAP) among APEC countries; and (iii) a Free Trade Area of Asia and Europe (FTAAE) among Asia–Europe Meeting (ASEM) countries. An East Asia-wide FTA, whether an EAFTA or CEPEA, addresses the noodle bowl problem among the production network countries, while an FTAAP or an FTAAE takes into account external markets as well. The idea of forming an EAFTA or CEPEA has been on the official agenda of the ASEAN+3 Leaders' process and East Asia Summit meetings. In the same vein, an FTAAP has been officially considered in the APEC Leaders' process. However, the idea of establishing an FTAAE has not attracted much attention so far.

To discuss these scenarios and their feasibility, some political economy considerations have to be made with regard to an East Asia-wide FTA (EAFTA or CEPEA) and an FTAAP.

4.1 Building Blocks for Wider Agreements

Due to a rise in the number of key players in official negotiations for FTAs, creating a large FTA can become more complicated. This suggests that forming an FTAAP would be more complex than forming a CEPEA, and that forming a CEPEA would be more complex than forming an EAFTA. Therefore, the first step toward consolidation of various FTAs might be to create preconditions—or building blocks—for a smaller region-wide FTA, like an EAFTA, and then to develop further conditions toward a wider FTA, such as a CEPEA or FTAAP. In this process, ASEAN will likely act as the integration hub or convener. The “+3 countries”—PRC, Japan, and Korea—would then need to coordinate their trade and FDI regimes. India, which has only recently moved away from its former protectionist enclosure, needs to pursue deeper structural and regulatory reforms addressing both tariff issues and “behind-the-border” red tape.

An EAFTA or CEPEA. An EAFTA or a CEPEA would likely be based on the existing ASEAN+1 FTAs with the “plus countries”—such as PRC, Japan, Korea, India, Australia, and New Zealand—as well as future networks of plurilateral and/or bilateral FTAs among these plus countries. Almost all of the five ASEAN+1 FTAs have been completed, with the ASEAN+India FTA expected to be signed soon. In contrast, other multilateral and/or bilateral FTAs are patchy and some important components—such as a trilateral FTA among PRC, Japan, and Korea or three bilateral FTAs among these three countries—are still missing (Table 1 [ PDF 69.1KB | 1 page ]). All these FTAs can facilitate the formation of an EAFTA or CEPEA as important building blocks. From this perspective, the successful formation of an EAFTA or CEPEA requires not only a set of ASEAN+1 FTAs, but also a series of agreements among the plus countries, particularly among PRC, Japan, and Korea.

In principle, ASEAN+3 or ASEAN+6 countries can begin EAFTA or CEPEA negotiations without some of these important building blocks among the plus-three countries in place, as these blocks can be created as a part of the EAFTA or CEPEA negotiations. Nonetheless, given that bilateral negotiations between the PRC and Japan will likely take time, it would be preferable to conclude such a contentious agreement before starting the official negotiation process for an EAFTA or CEPEA. With all the building blocks in place, EAFTA or CEPEA negotiations can lead to the early formation of a single, larger FTA through consolidation and harmonization of existing FTAs.

The respective cases vary for supporting an EAFTA and a CEPEA, yet they are linked. An important reason for an EAFTA is that the production network has been developed most significantly among the ASEAN+3 countries, and harmonizing rules of origin among these countries can produce a tangible benefit. In addition, India is perceived as a slow liberalizer and it would take more time to produce a region-wide FTA if India were included from the beginning. Once a process begins for EAFTA negotiations, pressure could then be applied to India to further open up its economy. On the other hand, a reason for advocating a CEPEA is that the production network is already developing beyond ASEAN+3 countries, encompassing India and Australia. In addition, the economic benefit from FTA consolidation is larger with a CEPEA than with an EAFTA.

The officially appointed study group for a CEPEA has agreed that ASEAN+3 countries should focus on trade and investment liberalization as the first priority, facilitation as the second, and technical cooperation as the last, and that ASEAN+6 countries may focus on technical cooperation as the top priority, trade and investment facilitation as the next, and liberalization as the least. The study group's description of the difference in terms of priorities between an EAFTA and a CEPEA implies that an EAFTA should proceed first, followed by a CEPEA. This sequenced approach would be realistic.

A PRC–Japan–Korea FTA. One of the most important preconditions for an EAFTA is the creation of either a trilateral FTA among PRC, Japan, and Korea (CJK FTA) or three bilateral FTAs between pairs of these countries. However, differences in the eagerness of forming FTAs exist among these three countries. The PRC is keen on establishing FTAs with Japan and Korea, but both Japan and Korea have some reservations over entering into FTAs with the PRC.

The Japanese government is concerned about the rising competitiveness of the PRC's manufacturing sector and the competitiveness of the PRC's agricultural products. Japan wishes to treat the PRC as a non-market economy so that it can use safeguard measures against a rapid increase of PRC imports into the Japanese markets, but the PRC's government insists upon market economy status for itself. Japan also argues that the PRC has yet to clearly demonstrate progress toward implementation of WTO entry commitments, including the treatment of Japanese firms in the PRC, clarity of regulations and rules over firms, and protection of intellectual property rights. Food safety issues are also a concern for Japan. The Japanese government has taken the position that an investment treaty should be a first condition before starting an EPA negotiation.

Korea is concerned about excessive dependence on the PRC market and the lack of an overall policy on how to position itself in terms of trade and investment vis-à-vis the PRC. Korea is also concerned about the PRC's agricultural competitiveness.15

Japan and Korea are interested in concluding an FTA with each other, but each country has concerns. Japan's primary concern over a Japan–Korea EPA is the competitiveness of Korea's agriculture and fishery sectors. In contrast, Korea is concerned about Japan's competitiveness in manufactured products (intermediate inputs), Korea's large tariff concessions required due to high most favored nation tariffs, and the risk of greater bilateral trade deficits with Japan.

Despite these problems, if the three countries can negotiate mutually agreeable FTAs, they can provide a strong foundation for a possible EAFTA, and eventually a CEPEA and FTAAP. This will require joint political commitment from the governments of all three countries.

An FTAAP. As with an EAFTA or CEPEA, an Asia and Pacific-wide FTA requires a series of plurilateral and/or bilateral agreements among key players, particularly those for the US with ASEAN, PRC, and Japan (the US–Korea FTA has been concluded). Given that the US provides the most open market for Asian products and a security umbrella for key East Asian economies, the region's relationship with the US is critical, both economically and politically.

APEC remains important for both East Asia and the US because it is the only multilateral economic forum that bridges the two. The US has advocated strengthening economic ties among APEC members through the formation of an APEC-wide free trade area (e.g., an FTAAP). While several East Asian countries have concluded bilateral FTAs with the US, others have reservations about a comprehensive agreement with the US. Deeper questions remain as to whether the US is ready to agree to an FTA with the whole of East Asia—one that includes the PRC—under the current political environment.

An FTAAP could increase two-way trade of partner countries in a significant way, and could be a useful way of reviving the stalled Doha Round or offer a “Plan B” hedge should the Doha Round permanently fail (Bergsten 2007; Hufbauer and Schott 2009). An FTAAP was proposed for consideration at the APEC Summits in 2007 and 2008. The formation of an FTAAP is expected to take many years and involve studies, evaluations, and negotiations among all 21 member economies. Given that the number of APEC member economies is so large, a smaller group may be more appropriate to initiate the process (e.g., an EAFTA).

A recently emerging FTA, called the Transpacific Strategic Economic Partnership Agreement (Transpacific SEPA), is attracting a growing number of countries sympathetic to its goal of high-standard liberalization (Markheim 2008). The Transpacific SEPA, also known as the Pacific Four (P4) agreement, is a plurilateral FTA among Brunei Darussalam, Chile, New Zealand, and Singapore that came into force in May 2006.16 The aim of the agreement is to eliminate 90% of all tariffs among member countries upon entry into force and reduce all trade tariffs to zero by 2015. The Transpacific SEPA is a comprehensive agreement covering many WTO-plus elements, including ROOs, trade remedies, sanitary and phytosanitary measures, technical barriers to trade, intellectual property, government procurement, and competition policy. As part of the conclusion of negotiations, the P4 countries agreed to negotiate on financial services and investment within 2 years of Transpacific SEPA's entry into force.

The Transpacific SEPA has the potential to grow to include many other nations under the agreement's accession clause. In September 2008, the US announced it had decided to enter into negotiations to join the group. Australia and Peru also expressed interest in similar negotiations. Thus, the Transpacific SEPA could expand and strengthen US economic and strategic ties to the APEC region and could lay the foundation for a wider FTAAP.

There are two possible avenues to creating an FTAAP: one through an EAFTA or CEPEA, and the other through an expanded Transpacific SEPA. However, there are several noteworthy stumbling blocks in pursuing the Transpacific SEPA route. First, APEC is a voluntary, non-binding organization; however, forming an FTA requires the concerned governments' binding commitments to trade liberalization, which means that this route should be pursued outside of the formal APEC process unless the mandate of APEC changes.17 Second, the Transpacific SEPA route neglects the importance of ASEAN as the hub for East Asian integration, especially given that not all ASEAN countries are APEC members. Currently, only Brunei Darussalam and Singapore are Transpacific SEPA members from ASEAN and it is highly unlikely that the other ASEAN countries that are also APEC members could join the Transpacific SEPA within a reasonable time frame because the agreement is a high-standard and comprehensive liberalization agreement. Third, India is not an APEC member and, therefore, it would take some time for India to join the Transpacific SEPA.

Links with Europe. Though connecting East Asia with Europe is a relatively new idea, the European Commission has already begun negotiating FTAs with ASEAN, India, and Korea. Once the PRC and Japan come into this discussion, a solid foundation for an East Asia–EU FTA (an FTAEE, or even a wider FTA among the ASEM countries) will be in place.

4.2 Likely Scenario: Sequencing of FTA Consolidation

Given the prominence of political economy considerations as they relate to ASEAN regional economic integration, it would likely be difficult to expand the Transpacific SEPA to all of East Asia within a short period of time. FTA consolidation in East Asia is likely to proceed along the line of an ASEAN-centric EAFTA or CEPEA. The most likely scenario would be the following consolidation sequence:

  • acceleration of an ASEAN Economic Community (AEC) to be created by 2015;
  • completion of ASEAN+1 FTAs with each of the “plus” countries;
  • creation of a CJK FTA either through a PRC–Japan–Korea trilateral FTA or three bilateral FTAs among the three countries;
  • formation of an EAFTA among the ASEAN+3 countries through mechanisms to connect the ASEAN+1 FTAs and a CJK FTA by allowing simplification, cumulation, and harmonization of ROOs;
  • formation of a CEPEA by including India and Australia and New Zealand; and
  • connection between East Asia and the US through an FTAAP, and with Europe through an FTAAE.

The dynamics of this “likely scenario” can evolve over time, with each step creating incentives for the next step to be taken. First, completion of an ASEAN Economic Community (AEC) is vital to FTA consolidation in East Asia as this will strengthen ASEAN's ability to play the region's integration hub role. Once an AEC is in place, ASEAN will be transformed into a much more coherent entity and, building on this strength, can substantially improve the quality of ASEAN+1 FTAs—to be formed with the “plus” countries of PRC, Japan, Korea, India, and Australia and New Zealand.

Next, creation of a CJK FTA (or three bilateral FTAs among PRC, Japan, and Korea) is a necessary building block for the formation of an EAFTA because without it, integration of the ASEAN+3 countries through a formal institutional arrangement is impossible. The political decision by Japan and the PRC to form an FTA (or EPA) is the cornerstone. ASEAN may play a key role in encouraging Japan and PRC (and Korea) to agree on a Northeast Asian FTA. Once a CJK FTA (or at least a bilateral FTA between the PRC and Japan) is formed, it can be connected with the ASEAN+1 FTAs through various mechanisms that allow simplification, cumulation, and harmonization of ROOs. This development will put competitive pressures on India, an excluded party, to further liberalize so that India will be eventually included in a larger FTA, thus forming a CEPEA.

Along this line of sequencing, several East Asian APEC economies (e.g., Japan and Korea) may join the Transpacific SEPA, and the US may conclude an FTA with ASEAN as an ASEAN+1 partner.18 Indeed, by that time the US and Europe will likely have concluded a series of FTAs with several key East Asian economies so that it will be possible to eventually connect the whole of East Asia with the US (possibly through an FTAAP), and with Europe (possibly through an FTAAE). All of these nested approaches are important and can potentially accelerate the process of East Asian integration and, more broadly, transpacific economic integration.

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