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Asian Trade: The Way Forward

The Asian trade is a broken glass – it cannot be refitted. In fact, global trade itself has collapsed and has been wrecked by the financial meltdown which has played havoc with the real economy with a time lag. The monetarists and those at the helm of affairs in the advanced economies paid obeisance to market and kept faith in it for too long. Until the last day when the crisis struck, they did not hesitate to say, “The market would correct.”

It began in the U.S. and spread to Europe even as countries in Asia were complacent that they were shielded from the crisis due to their later day emergence in global trade and economy. They were lulled into a state of euphoria by concepts like BRICS floated by investment consultants. Many leaders in developing countries even imagined that they were ‘decoupled’ from the western economies and could provide a buffer to lift the developed economies in recession. It is not practicable, nor necessary, to deal with the implications of the global crisis on emerging economies. Any number of reports by international agencies like the UN, UNDP, UNCTAD, ILO, IMF, World Bank and a large number of research institutions have brought out the collateral damage of the crisis on poorer economies. The situation was (and remains) grim with no prospects of growth and equity in the near future. Unfortunately, there has been no effort to arrive at a global agreement to deal with the crisis. The report of the UN Group led by Prof. Stiglitz and its recommendations have been ignored.

Ever since the crisis erupted, the world has been witness to several meetings of Ministers, Heads of States, etc. Even as a tactical show of friendly gesture to emerging economies, the G7 has been transformed into G-20 which includes members of the developing world, the interests of developing economies have not received the attention they deserve. Much of the effort during all these months has been concentrated on efforts to bail out the banks and financial institutions in developed countries which were responsible for the crisis. Though high flown much rhetoric has been flowing from Summits (London, Pittsburgh, etc), there is no evidence of any program to help and promote growth in emerging economies.

The IMF has opportunistically used the crisis to find a new avatar for itself and get large funding. But all this funding estimated atm$1.2 trillion has been used to bail out the so-called transition economies in East Europe, especially the western banks which are deeply involved in those countries with unsustainable debt. On date, these efforts have not borne out any fruit especially if we look into the crisis brewing in Europe where sovereign debt default is threatening the EU. It even suggests the break up of the EU.

Greece is where the crisis is brewing and it drags along others like Spain, Portugal, and Italy. Even Germany is not said to be free and the U.K. is being written off by rating agencies. There are also reports about the U.S. economy is being in jeopardy amid its fiscal deficit and debt scenario. Discussion about continuance of “stimulus” has become a nasty word. FED continues to maintain loans at zero or below zero rates and is hesitantly withdrawing some of the facilities like TARP and TALF. There is the implicit assurance that they will modify and continue the facilities if the situation warrants. It is however realised that that there are fiscal limits to continuing with the program in the context of inflationary threats and accumulating debt burden and bond market behaviour.

The stimulus programs put through by the advanced countries so far have not been of much avail in promoting growth or creating employment. Indeed, there is group-think which has been fostered by Fed propaganda that the global economy is emerging from the crisis. Mr. Bernanke began to witness “green shoots” by April last year. Even after a lapse of ten months, those shoots are yet to turn into green leaves. U.S. employment languishes at 10 percent or lower and there are no signs and bank credit moving to companies to promote new investment. Small and medium enterprises get the worst treatment notwithstanding President Obama’s repeated pleadings to the bankers. On the stimulus, the tragic story is that there was (and is) no common ground among the authorities in the U.S., U.K. and European Union. Each has gone its own way and pumped in trillions of dollars. So far, they are estimated to have sunk 25 percent of their GDP in stimulus programs. Their banks are awash with liquidity which is moving like waves into emerging economies, especially Asia, and bloating asset and property prices. Stock markets are booming without any ostensible gain to the resident public. Many economists, especially those in the Bank for International Settlements (BIS), have warned about lowered risk standards generated by easy credit leading to another crisis. There is no agreement on the “exit” policies. The fear is that these economies cannot float without the stimulus and may sink if the stimulus is withdrawn. Debate on “exit” strategies have turned theological.

Under conditions of such global macroeconomic turbulence, trade has to lumber along. Trade credits and finance had frozen and are yet to reach pre-crisis levels. IMF’s offer of trade credit to developing countries was a pittance and has not taken off. More, trade has to meet with ‘protectionist’ trends across the globe, the break up of global supply chains, loss of market access, currency value fluctuations, the fear of dollar value and it role as a reserve currency, uncertainties attached to capital flows and threats to economic relations arising from security concerns. It is a long laundry list and more can be added with reference to specific region or country. What seems clear is that the whole situation is in a state of flux. We have to give up the assumptions or near certitudes about trade flows and links which governed our action and policies in the last decade.

Unfortunately, for long, indeed too long, policymakers in developing countries were held captive to pro-market policies. These were central to the ‘reforms’ or structural adjustment programs enforced by the Washington Twins. Export led growth was the major mantra and the slogan was “Export or perish.” Current events seem reverse the slogan to “Export and perish!” Washington pundits have been advising China to turn inwards and have changed their tunes. The record is pathetic. In India, more than 3 million persons employed in diamond cutting, textiles, etc have lost their jobs. There are several UN and ILO documents which provide a grim picture.

It is interesting to look back into recent history and recapture how we inherited the syndrome. Developing countries were in fact responding to developments taking place in the western economies and to the conditions and/or demands set by them. Globalization was the catchword and multinational corporations had become the agents of global change. Western countries along with the IMF and the World Bank became the advocates of policies which facilitated the global growth of corporations, especially financial institutions. Think tanks, economists and politicians became the outriders advancing globalisation paradigms regardless of the warnings issued by Nobel Laureates like Stiglitz and a host of other welfare economists on the adverse of impact of those policies on poorer economies and their people.

Under pressure from funding agencies, emerging economies were opened up. Foreign Direct Investment (FDI) was the tool and, it was argued, the spread of FDI would lift poor countries to higher levels of development and growth. Yes, once there is growth, welfare would trickle down to the poorer sections! FDI itself was facilitated by developments in technology and the ability of the companies to segment production chain and manufacture them in suitable locations abroad. Labour intensive segments were located in low wage emerging economies and parts and components (P&C) were shipped to other locations for assembly or final production. These were facilitated by the tax policies adopted by countries like the U.S. offering exemptions or rebates on overseas production under section like U.S. 802. Outsourcing was the battle cry. What began in small volumes assumed the dimensions of torrents engulfing half the globe, country after country.

Japan was the pioneer and began to locate production in East Asia. As a UNDP Report explained, “… fragmented vertical chain required, inter alia, specialization to benefit from the economies of scale and firm specific assets of the local or affiliated firms in different countries. Initially, the Japanese Government and firms played an important role in the development of the chain and the network. The appreciation of the Japanese yen after the Plaza Accord in 1985 was influential in changing the Japanese Government’ policies towards outward FDI.” (South-South Regionalism and Trade Cooperation in the Asia-Pacific Region, Policy Paper, UNDP Regional centre, Colombo, August 2008.) With spread of Japanese outward FDI, this pattern was glamorised as the flying geese model. With the U.S. companies joining the fray with the location of microprocessor based industries, many parts of East, South East and South Asia came under the rubric. They gave it another name and described it as “New International Division of Labour” which would replace dear Ricardo’s comparative cost theory. Leaving aside the theories, it did create a regional pattern of industrialisation in Asia.

China stole the model and adapted it with ‘Chinese characteristics.’ It was included in Premier Deng Xiaoping’s strategy of modernising China’s economy and integrating it with the global economy. By 2004 China had emerged as the third largest exporter in the world and in later years emerged as the largest exporter in the world. The uniqueness of the Chinese experience was that it was aimed at integrating Hong Kong in advance with the mainland. In the initial years, overseas Chinese in neighbouring areas, especially Hong Kong and Taiwan made significant contributions. More than 80 percent of FDI came from the overseas Chinese. Creation of exports zones in coastal areas in the South ensured the success of both political and economic aims.

One of the early World Bank Papers described the situation well. (The Emergence of China and its Impact on Asian Trade, Gillaume Gaullier, Francois Lemone and Deniz Unal Kesenci, World Bank, September 2006.) As it reported, “China enlarged its share of intra-Asian trade from 13% in 1993 to about 22% in 2004. China has overtaken Japan as the major importer of Asian manufactured goods and has caught up with Japan as the major exporter of manufactured products to the region.” The Paper went on to explain how foreign affiliates were the engines of China’s rise in international and in Asian trade. By 2005, wholly owned foreign affiliates were responsible for almost 40% of China’s exports and imports. In time, Japan and East Asian Dragons shifted their own production facilities to China and this led to important shifts in their trade patterns. A ‘triangular’ trade pattern emerged. China became the export hub for the firms located in advanced Asian economies which now exported intermediate goods to their affiliates in China. FDI in the narrow sense of investment by foreign (US or European) companies came from their joint ventures in Asia.

What has created optimism over the possibility of an Asian Union analogous to the European Union (EU) is the rise in Asian integration, especially trade. South-South trade has been on the rise. It is assessed that more than half of Asia’s trade is with developing countries, especially intra-Asian. Intra-regional trade accounts for 51% of total Asian exports against 9.2% in 1990 and trade among emerging Asia now accounts for more than 40% of total trade against 9.8% in 1990. This rise in the volumes of intra-Asia trade generates a zeal for greater union. However, it also masks harsh realities.

The intra-Asian trade is dominantly in the form of intermediate and semi-processed goods and takes place within vertically integrated regional supply chains before shipment to western countries. China has turned into a manufacturing hub and a powerful magnet which attracts FDI. The attraction is the “China price.” Many authors have written about the “China Price” which attracts FDI into China. There are six features which make for the substantial price advantage for production in that country. It is estimated at a minimum of 30 percent and higher in many items. The features are: Low wages for high quality work; Piracy; minimal worker health and safety standards; lax or low environmental regulation and enforcement; export subsidies; and industrial networking clusters. It is not practicable to go into these in detail. Yet, it is indeed true that China offers low wages with high skills and low labour, environmental, etc standards. This has helped western companies to arbitrage on regulation (and standards) and shift production away from U.S. and Europe with higher safety and environment standards. No doubt, in recent years there have been improvements in labour conditions as also environment and safety standards in China. These again are due to pressure from social activists located abroad or within China. The most important attraction comes from its exceptional infrastructure facilities such as roads, ports, power, etc. Power and utility charges are low and can be alleged to be subsidised. Most of them are owned by the government or supplied by state owned enterprises. It is for this reason that in the WTO China still carries the status of a “non-market economy.” This status makes it vulnerable to attacks in the WTO under anti-dumping provisions. Leaving aside others, the foremost feature of China’s production chain is that arising from “industrial clusters”, technology parks and networks. Globally, there is no parallel to these and vast areas are allotted for the production of the same or similar products with timely accessibility to parts and components. This is the paradise of what Japanese entrepreneurs call “Just in time supplies” or JITS. Production schedules and deliveries do not fail and slippages are rare. Wal-Mart was allowed to use special harbours creating for exports from China.

There is the most disputed advantage afforded by the policy of pegging Yuan to dollar. Exporters are free from exchange risk and transaction costs attached to currency fluctuations. Western economists do not refer to the advantage afforded by the fixed exchange rate for Yuan. China has been under attack since 2002 from the U.S. and, in recent months, from others to revalue the currency. What has been ignored by western economists in assessing “China Price” is that it comes with a heavy social cost. It is a long debate and has gone on for nearly a decade. China has battled the issue both theoretically and diplomatically. It tilts the distribution of income from the consumers and wage earners to exporters. However, China seems to think that stability of employment is more important from a political point of view. China cannot also forget the experience of Japan after revaluation of Yen under Plaza Agreement. It had to meet with economic stagnation for two decades and is yet to come out of it.

From around 2007, China has turned inward and is trying to rebalance its economy. The heaviest price it has paid is when its export markets collapsed in the wake of the financial crisis in mid 2007. Around that time, its export to U.S. and Europe constituted 60 percent of its total exports. The earlier policies were on the assumption that China and its partners in Asia would continue to rely on external demand coming from the U.S. and Europe. The crisis established how fragile that assumption was.

Truly, warnings had been issued by analysts well in advance of the crisis. For instance, the IMF Paper referred to earlier doubt the sustainability of Asian growth based on the level and pattern of integration with China. It observed, “Chinese growth model remains rather extensive, with the use of large amount of domestic factors, first of all cheap labour, as well as foreign factors, foreign capital and also expensive imported inputs. China’s economy and indirectly the Asian economy still rely on American and European markets as growth engines.”

When, in 2007, the engines spurted, the economies were brought to a grinding halt. As another UNDP Study said, “… although intra-regional trade is booming, reflecting the specialization of many of the region’s exports still derived largely from western economies.” “As long as the world economy was booming, global integration was generally seen as providing opportunities: new and growing markets for exports of both goods and services; more foreign direct6 investment to create new production facilities and allow countries to develop export platforms; accessing international finance both external commercial borrowing and portfolio investments; allowing developing countries to benefit from the remittances and skill development that occur through the process of cross border migration for work.” (The Global Financial Crisis and the Asia Pacific region, UNDP, December 2009.) The outbreak of the financial crisis had put paid to all these expectations. It is unclear when there will be renewal of global growth and what new patterns will emerge. Sadly, it may no longer be reasonable to depend on consumption demand from the U.S. as in the post dotcom bubble years.

In a speech delivered on 19 October 2009, Mr. Ben Bernanke, the Federal Reserve Chief, had captured a possible scenario. He said, “Another set of lessons that Asian economies took from the crisis of the 1990s may be more problematic. Because strong export markets helped Asia recover from that crisis, and because many countries in the region were badly hurt by sharp reversals in capital flows, the crisis strengthened Asia’s commitment to export-led growth backed up with current account surpluses and mounting foreign exchange reserves. …To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows.” This is a small part of a larger debate on global imbalances currently going on. Indeed, it is a blame game indulged in by the western governments and they charge China and some other emerging economies of creating global imbalances.

There can be no finality to this debate and it is not clear how these issues would unravel. Indeed, one may not be sure about US increasing its savings and reducing its twin (budgetary and fiscal) deficits before it accuses other countries. Whatever the developments, it may no long be realistic to assume that the U.S. would provide the kind of encouragement or support to export-led programs as it had been underwriting heretofore – directly or through the Twin Sisters. We are already witness to a virulent anti-dumping wars going on between countries, especially between U.S. and China. Global Trade Alert provides data on the increasing number of protectionist measures. Grim reality is that in the coming years, Asian countries will have to turn inwards and can not look to the west for exports.

The export projections and programs will have to be modest and pragmatic. As far as possible, they would need to be confined to regional arrangements. There has been undue rivalry in entering into regional trade arrangements (RTAs) or bilateral agreements which pit one group against another. It is observed that there are around 230 agreements signed or proposed. These agreements have not led to the opening or widening of trade between member countries but rather create procedural hassles on issues like ‘country of origin’, ‘value addition’, etc. Many RTAs restrict access and introduce ‘special’ or ‘sensitive’ items. For instance, import of cars is restricted in RTAs with Malaysia. India has its list of ‘sensitive’ items even with a small neighbour like Sri Lanka. As the Economist wryly observes (February 6, 2010), “.. .Asian consumer-unlike counterparts in Europe, who compare prices for goods and even services across borders –inhabit fragmented markets. No sense of regionalism for them.”

As one of the early analysts explained, “.. the recent East Asian regional agreements are less threatening to the world trade system than they appear. … The major threat is more political than economic, if the struggle for Asian leadership becomes disruptive to harmonious relations.” (Asian regionalism: threat to the WTO-based trading system or paper tiger? Richard Pomfret, VOXEU, 22 June 2007.)

U.S. is seized of these threats at least as far as China is concerned. As a Congressional Report (East Asian Regional Architecture: New Economic and Security Arrangements and U.S. Policy, Dick K. Nanto, January 4, 2008) puts it, “At the core of U.S. concern over the developing regional architecture is that Asia is the growing influence of China. A danger exists that if China comes to dominate regional institutions in East Asia, it could steer them down a path inimical to U.S. interests. Some Asian nations, however, are wary of excessive Chinese influence and are hedging and manoeuvring against Chinese dominance.”

China entered the WTO after hard negotiations for over a decade. Very soon, it realised the heavy price it had paid and began to look to regional countries to increase its trade. It began to enter into trade agreement with several countries, especially in Asia. These arrangement are more for political and security reasons than for mere trade. Currency swaps and unions add another dimension. Chiang Mai Initiative (CMI) is a pointer to the defensive nature of ongoing arrangements.

China entering into an agreement with ASEAN for free trade arrangements which came into force from 1 January 2010 should cause concern to the U.S. It is perhaps to counter these attempts that the U.S. has launched a Trans-Pacific Partnership arrangement with Chile and Singapore. Two more partners – Australia and Peru – have expressed an interest. Japan and Vietnam have also agreed to attend. With its ability to trade its trade (market) with other countries, it is likely that the U.S. may tempt other countries to join this Partnership. India could well be a target given the burgeoning (as presumed) relations with the U.S. after the signing of the Indo-U.S. civilian nuclear agreement.

Given these political postures, realignments, fears and rivalries, it is difficult to conceive of an Asian Unity which can lend support to an Asian Economic Union or give new direction to Asian trade.Equally, it may no longer be practicable to launch pan Asian projects and we should be content with smaller, regional arrangements which seek to promote mutually beneficial trade and investment. As we commenced this piece, Asian trade is a broken glass and cannot be fitted back.

(The writer,Mr K.Subramanian, is former Joint Secretary, Ministry of Fianance, Government of India.He is also associated with the Chennai Centre for China Studies. The article is a revised version of a paper presented by the writer at the inaugural session of the conference on “Asian Develpment Dialogue- Asian Trade and the Way Ahead”, held at Trivandrum on 13 February

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