Updated: Sep 1
C3S Fortnightly Column No. F005 /2015
If Rip Van Winkle were to come to life, say, after three decades since 1980s, and survey the changes in the Asian economy which have taken place during that period, he will be bewildered. Everything has changed. They are in the manufacturing structures, intra-Asian trade relations, in the deeper investment/technology networks and other drivers of growth. He will not be able to find the vestiges of pre-war colonial era to which he can relate. Even the post-second world war (WW-II) neo-colonial links with the former colonial (metropolitan) economies have withered and newer relations come into force.
In the years immediately after WW-II, the U.S. began to have a sway in the area by providing a security cover in the context of its cold war strategiesand economic support in the wake of its rising global dominance which, in later years,was subsumed under the rubric of “globalization.”
Its security cover to the region has since come under attack with the rise of China. Disputes over China’s dominance in South China Seaare pointers. Some countries doubt the commitment of the U.S. to Asia. Its economic support or role has receded with the growth of Asian countries like Japan, China and Korea and, especially, with the growing intra-Asian trade, technology, and investment relations. The Great Economic Recession which erupted in 2007-08, the invasion of Iraq, wars in Afghanistan and some pockets of the Middle East, its excessive attachment to anti-terror campaigns globally have all weakened its financial clout as also its defence credibility.
It has become a cliché these days to refer to the Southern tilt in the global economic balance. Indeed, there is a tilt and much of this came about after the shabby (discriminatory) treatment which the Asian countries received from Western powers (read, the U.S.)in the aftermath of the Asian crisis of 1997. However, the so-called tilt should not be overblown. As we explain in the later parts of this paper, patterns of Asian trade have changed. Patterns of investment flows have changed. There are emerging, newer patterns of financial flows as also banking and currency relations. It is no exaggeration to suggest that China has been at the centre stage in these changes or acted as atrigger.It is a long story and we have to make it short.
It is fascinating to study the relations between foreign investments, foreign trade and government policies governing both. They are deeply inter linked. Ever since Western analysts led by the Washington Twins began to drum up the advantages of free trade and foreign direct investment (FDI), there have been debates among development theorists over the role FDI plays in promoting growth. The divide is between those who believe in the role of the free market and those who advocate state intervention and direction. Though the free traders oversold the story of the market, there is broad understanding that, in the post war years, the extraordinary growth of the newly industrializing economies (NIEs) like Japan, Korea, Taiwan, etc. was due to the state support to promote industrialization. (China joined the party in due course with its opening since early eighties under Deng.)It is also the accepted view that FDI plays positive a role in promoting trade, technology and development if the investment flows are managed deftly through policies which promote national objectives such as growth, exports and/or acquisition of high technology. Unlike any other developing country, China has perhaps played its cards with great care to achieve its growth objectives.
During the last three decades, the perceptions, compulsions and strategies of multinational corporations (MNCs) who are the major drivers of FDI and trade have changed. They reflect the changes in underlying economic realities in the countries and the policies adopted by the governments in host countries. Theories of MNC development capture these changes and there are many research studies on the subject. In the post-war years and until around 1990s, the most commonly held theory was the ‘flying geese model” in which one economy (a leader) leads other economies towards industrialization, like the first goose in a V-formation, passing older technologies to the followers, as its own income rises and it moves to higher levels of technology. This model suited post-war Japan’s growth as it startedmoving into neighboring countries. For the U.S./Europe based MNCs, the strategy was to jump the tariff “barriers” erected by developing countries to protect their domestic industries (infant industries) and capture the domestic markets. These were mature technologies and posed no threat to their export markets in third countries. The Manchester School economists led by Prof. Dunning posited these theories.
The flying geese model was led by Japan. Soon, it gave place to a newer model in which rising labor costs in the home country drove the MNCs to locate labor intensive segments to ‘cheaper’ labor locations and source them back for final assembly. Revolutionary changes in the electronics sector made it possible for MNCs to segment manufacturing, produce components (chips) in Asian locations and ship them back home for final assembly. This was indeed the major factor behind the exponential growth of the so-called “newly industrializing emerging economies.” (NIEs). MNCs from the U.S. preferred this route and it led to the phenomenal growth of the sector in the Silicon Valley. The U.S. authorities, in their turn, facilitated the process by changing the norms for customs duty purposes: under sections 801 and 802, they would charge duty only on the “value added” abroad and not for the whole value of the product. (Free traders can pretend that this was not state intervention!)
The appreciation of Yen vis-à-vis the U.S. dollar, undertaken under duress by the U.S. (and G-7) under the infamous Plaza Agreement of 1985 drove many Japanese MNCs to relocate their manufacturingin suitable Asian locations. In fact, more and more countries in Asia came under the NIE rubric even as labor and other costs began to vary (rise) from region to region with rising growth levels. It was a spatially moving equilibrium.However, these trends did not basically alter the trading pattern and western (advanced) countries were at the hub. Trade turned into vertical intercompany transactions. Doubts began to arise over the relevance of traditional trade theories a la Bhagawati dabbling in “comparative costs” or “two country-two commodity” models.
Later developments in technology and the resultant MNC strategies brought about sea changes in trading patterns. The flying geese model was given the go by even as manufacturing itself was getting fragmented. Later technologies established that it was no longer necessary to produce components and ship them for assembly elsewhere and they can create “supply chains” regionally. It was observed that “vertical inter-industry trade” was giving place to “vertical intra-industry trade.” Several academic studiesrevealed that international trade was no longer trade between countries but intra-company transactions within MNCs,i.e. trade between different departments of the same MNC. One UNCTAD study estimated that around 80 percent of global trade was accounted for by such flows.
The next stage was production sharing. This had become a widespread phenomenon and was reflected in the trade in “parts and components” in selected sectors. Apart from technological development, WTO agreement on patents, TRIPs, etc. contributed to this trend. One study said, “It has been driven by multinationals relocating their production and reorganizing their business activities across different countries in order to reduce costs and improve their production and technological capabilities. The FDI flow has followed the technology hierarchy from Japan and NIEs to China and ASEAN.” It was evident that China was getting more and more integrated with the ASEAN economies.
This was achieved in greater part by the industrial and FDI policies adopted by China and also by the responses or reactions of Asia neighbors to those policies. Equally important was their response to currency value variations under the new regime of flexible exchange rates or when ‘currency wars’ break out. One IMF study offers an insight into these developments. It draws attention to the role played in global trade by supply chains and the position occupied by China. It notes that import content of high technology exports increased by close to 30 percentage points from the mid-1990s to the mid-2000s. “This result confirms that the emergence of China as a major exporter of high technology goods has been boosted by processing trade, with significant imported contributions from Japan and other countries in the Asian supply chain. By the mid-2000s, China has by far the largest imported content in its high technology exports.” (Emphasis ours.) Moreover, it adds, “Together with other Asian countries, China increasingly plays a dual role in the global supply chain for high technology products, as an assembly country and exporter of intermediate inputs to other countries’ high technology exports.” These developments came about as a result of the growth policies pursued by China and made China the industrial hub or “the factory of Asia.” By now, the trade pattern described in the earlier part of this paper got inverted. Asian neighbors were feeding China’s factories and exports to advanced economies passed through China.
The above narrative would suggest that while there was de facto integration between China and ASEAN countries, there was no de jure integration in terms of a comprehensive and legally binding trade agreement. In the early years of China’s opening to the global economy (modernizing), there was reluctance to enter into bilateral trade agreements. With China’s accession to the WTO in 2001, there was a change in the policy and China began to negotiate FTAs with ASEAN or individual member countries. As many observers and analysts explain, China’s approach to FTAs or RTAs was governed as much by its foreign policy objectives as by its trade/economic policies. Rather, they were organically linked.
China’s push for the formation of a free trade area (FTA) embracing China and all the ten ASEAN members came at the ASEAN plus Three Summit in November 2000. Premier Zhu Rongji proposed: “In the long run, China and the ASEAN countries can also further explore the establishment of a free trade relationship.” China’s efforts bore fruit after two years of negotiations when in November, 2002, the China-ASEAN FTA (CAFTA) agreement was signed. By 2012, it enlarged the scope and launched new negotiations under the rubric of Regional Comprehensive Partnership (RECP) with ASEAN+6 countries. This was concluded in 2012. There are FTAs with other countries such as Chile, Costa Rica, New Zealand and Switzerland. After years of negotiations, an agreement was signed with Australia in November last. One Chinese analyst explained that though “China’s trade with FTA partners accounted for 22 percent of its total trade in 2012”, it suggests the great potential for China to liberalize trade with other partners via FTAs. The Third Plenum of the 18th Chinese Communist Party Congress in November 2013 called for Chia to boost cooperation with countries and regions through FTAs. China considers RCEP as an important platform to promote existing FTAs with economies in the Asia-Pacific to provide a comprehensive trade regime. It is interesting that, within Asia,other countries have also entered into FTAs creating a maze or a “noodle bowl” of agreements.Unravelling them or straight jacketing them into a new mosaic is an impossible task and cannot be achieved in our life time. Strangely, the U.S. seems to be impatient and wishes to do it in a time bound manner through its Trans Pacific Partnership (TPP) initiative! More of this in later parts.
By and large, China’s FTA arrangementsare aimed to suit the political sensitivities of partners and, accordingly, vary from one FTA to another. Some clauses remain vague or lack clarity and these are for tactical reasons. There are also differences in approaches contained in different FTAs and these continue to puzzle trade lawyers, especially of the U.S. variety. Unlike in the WTO which is said to be “rule-based”, there is a lot of flexibility and this reflects the political and class interests of the members and the stakeholders in the member countries. Another feature is that though FTAs have been in operation for some years, they are underutilized. For the reasons narrated above, India could negotiate and find a more agreeable place in an emerging RECP or Asian grouping than in the TPP of the U.S. This is further because of spirit of “open regionalism” in allowing new members. On the whole, ASEAN, RECP or the Asian Economic Community is not unified politically unlike the European Union and capture the continuing tensions and differences among members. The surprise is that despite their looseness, lack of clarity or other alleged“infirmities” frowned upon by western legal pundits, the Asian group has been emerging while the WTO negotiations, post Doha, have floundered. Some analysts have already written the epitaph of the WTO.
The U.S. has been engaging itself and making responses to China’s moves and growing influence in Asia. For instance, when China entered into the FTA with the ASEAN, the U.S. promoted the establishment of the APEC. Indeed, APEC was taken as a precursor to a new Free Trade Area of the Asia (FTAAP) and as counter to themoves in Asia to form an “Asia only” grouping.Sadly, APEC proved to be ineffective and a poor cousin of ASEAN. Though the Obama Administration insisted on its continuing with the Bush era strategy through the APEC, its attachment to APEC was ambivalent. It was on December 14, 2009, that USTR notified Congress that the U.S. would enter into negotiations with the members of the Trans-Pacific Strategic Economic Partnership (TPP) about U.S. participation in the regional trade agreement.
The TPP was brought about in 2003 by Singapore, New Zealand, and Chile as a move towards trade liberalization in the Asia-Pacific region. Brunei joined negotiations in 2005. The U.S. joined the negotiations in March 2008. Negotiations commenced with new members: Australia, Peru, and Vietnam. On November 14, 2009, President Obama committed the U.S. to engage with the TPP countries “with a goal of shaping a regional agreement that will have broad-based membership and high standards worthy of a 21ST century trade agreement.” Malaysia was included by consensus in October, 2010. In due course others – Canada, Japan, and Mexico- joined. The total membership is now 12. More members are said to be eager to get membership and doubts remain about their inclusion.
The TPP arrangement as envisaged by the U.S. authorities is ambitious and far reaching. Though the U.S. claims to enlarge the APEC, some analysts look upon it as an attempt to bury it. Some others view it as an attempt to bring about a new world trade order to bypass the WTO whose progress is stuck in the mud after the collapse of the Doha Rounds. The U.S. envisages five key areas to be covered under the TPP. It will set new standards for global trade and incorporate issues to boost the competitiveness of member countries. It will cover market access. Under TPP, the region will be structured to embed the development of supply chains among members. This will call for regulatory coherence. TPP is supposed to promote trade in emerging technologies. It is designed to be a “living agreement” or supposed to be ever evolving. There are twenty chapters which have to be negotiated and agreed.
It would be evident that many of these issues are contentious and some of them like “Singapore Issues” have remained unresolved in the WTO. From the nature of the TPP membership thus far, it is clear that only those members who are already aligned with the U.S. politically or strategically are members. Even so, it is significant that, even after nineteen rounds of negotiations, there has been no agreement. By the end of the nineteenth round, “several states leaked reports of ‘turbulence amid protectionist reflexes casting doubt on the hopes of concluding agreement by year-end.” In every round, new deadlines are set only to be missed.It was reported that when TPP members met on the sidelines of the November 2014 APEC meeting in Beijing and sadly,“….. no major breakthrough was announced.”Given the number of countries and countries with differing levels of development, their lack of geographical contiguity and with a heavy weight like Japan with its own problems in agriculture, it may take, if at all, years to negotiate a final agreement. Even if any agreement is reached, it will resemble the picture of a camel drawn by the members of a cantankerous committee.
The stated goals of the U.S. may be expansion of global trade. But it can no longer pretend that it is the hegemon, which it was, when the Uruguay Negotiations commenced. It is no longer at the driver’s seat. Even the WTO collapsed in later years due to the declining weight of the U.S. economy and the rise of the emerging economies which began to question the dominance of West, their control over global institutions and their claim to set global trade/investment rules. More importantly, many analysts see the TPP initiative as a strategic move to recover the U.S.’ lost space in Asia. The revived interest of the U.S. or its “pivot Asia” is Janus faced. At one level it is a defence strategy to check the rise of China; at another, it is an attempt to check China’s position in the Asian economy. As explained in the earlier part, the U.S. has reasons to worry about China’s rise in the Asian economy and realized, rather late, that it should check its rise.
Unfortunately, the TPP initiative is misconceived and will be counterproductive. It creates a schism with China, at least in the short run. As one Asian Development Bank (ADB) Working Paper put it, “The TPP is at a crossroads as a building block. It could result in the establishment of economic integration in Asia and the Pacific, or it could trigger creation of two large blocs in the region. If “open regionalism” is chosen under the TPP, and PRC is not excluded, it will contribute to regional integration. Exclusion of the PRC could encourage Beijing to develop its own Sino-centric trade bloc.” The arguments of pro-TPP apologists about China being pressurized to join it with its expansion and inclusion of other countries like Korea are over blown. The TPP’s approach seems to be “anyone but China” (ABC). Even otherwise, China will not be able to agree to the demands and conditions underlying the TPP such as provisions relating to patents, FDI, public procurement and state-owned enterprises (SOEs). These are perhaps intended to exclude China! As the ADB paper argues, “If the TPP successfully progresses, the PRC will accelerate the FTA expansion with neighboring Asian countries. Its first and most important target will be an FTA with the Republic of Korea. … while a PRC-Republic of Korea-ASEAN FTA may be promoted by the PRC at the same time.” China’s own attempt is to exclude the U.S. from the Asian arrangements; however, it will be cautious as it looks to the U.S. and E.U. for its exports in the near term.
Many Chinese scholars are concerned over the implications of the TPP on their security and trade. They feel it would have a strong negative impact. They aver that it will result in “trade diversion.” Several studies undertaken by U.S. economists do not provide an optimistic scenario. Data suggest modest net gains for the U.S. The earliest study by the Peterson Institute of International Economics (PIIE) showed a “trade diversion” of US$100 billion for China and also diversion for Asia as a whole.
A Briefing Report of the Centre for Strategic & International Studies offers the responses of many Chinese scholars and academics. They feel it will divert trade from China. Shen Minghui of the Chinese Academy of Social Sciences (CASS) observes that the implementation of the TPP would attract ASEAN countries and other U.S. allies in East Asia to adopt a policy leaning towards the U.S. and support its return to East Asia, which would in turn estrange China from those countries. Yang Jiemian suggests that “the U.S. pivot strategy dilutes and reduces China’s influence in the Asia-Pacific region, which could be considered soft confrontation. Other scholars were more strident. In an articletwo Taiwanese scholars say, “The TPP poses as a potential challenge to China’s plans (to rise peacefully), as U.S. presence in Asia may divide the Southeast Asia’s support for China. Economically, China is currently in the lead in the regional race for establishing RTAs.” “As an extension of APEC, the TPP is bound to challenge China’s new regional role and complicate integration in East Asia.” As narrated in the Freeman Briefing PaperChinese scholars feel that over the years China has built bridges with its neighbors and diminished the mistrust left over from history by entering into FTAs with them. China has an FTA even with Taiwan with a view to enhance the formation of “one China.” Similar are its overtures to ASEAN members. “With the Beijing leadership viewing the TPP agenda as a U.S. encroachment into China’s backyard, the Chinese government has decided to increase its pace on pushing its own FTA agenda to demonstrate to its neighboring countries that it will continue to be their reliable partner.”
The TPP has critics back home. Congress is in no mood to approve FTAs unless they conform to the stringent criteria it had set down some years ago. These invoke human rights, labor laws, etc. which are not recognized by developing countries. Moreover, the U.S. has double standards in applying them. Further, Congress has not extended the Trade Promotion Authority (TPA) which expired some years ago. With a fractured mandate in Congress, it is anybody’s guess how the U.S. government can get approval for any FTA. Despite these handicaps, the Obama administration pursues the TPP as a sop to come of its loyalist countries and, more importantly, to engage in shadow boxing with China.
As earlier indicated, the TPP is a threat to WTO. It has been criticized as a vehicle for undermining efforts to revive and push forward the WTO agenda, substantially stalled since 2008. The U.S. forgets that the main responsibility for this failure falls on the U.S. which believes the system of multilateral trade no longer offers the advantages it used to. The U.S. now “appears poised to fracture the WTO model in favor of regionally specific but more comprehensive agreement that together might provide a substitute for WTO multilateralism.”This shift in policy was emphasized in President Obama’s 2013 State of the Union Address. All along, the U.S. has been drumming up the slogan ofreviving the WTO negotiations (Doha Round) while issuing long and pontifical statements at the end of successive G-20 conclaves and its TPP initiative seeks to bypass the WTO.
Some international law professors have severely criticized the TPP negotiation process. They argue that the “functional and theoretical impact of the lack of transparency and accountability in the TPP and other trade negotiations institutionalizes the kind of process that the late Senator Daniel Patrick Moynihan criticized as policy making through ‘ignorant enterprises.’
Even if the negotiations, whether under the TPP led by the U.S. or the RECP steered by China, progress for long years, there may not be finality. The world would witness a fragmented trading system: the TPP, RCEP or FTAAP would be the largest fragments. TPP may not a different animal from the older ones like NAFTA fathered by Uncle Sam. As one ADB economist puts it, “The U.S. led TPP could be challenged by China-led ‘Beijing Road Map’…Neither vision is an end-game but merely one more stroke on an ugly picture of trade agreements characterized by an unsustainable amount of disorder and incoherence.”
Our own view is that the RCEP stands a better chance of getting enlarged in Asia with new members. Some analysts suggest that China could join the TPP once it has improved its standards, global competitiveness, etc. With its continuing reliance on exports to the U.S. and EU, it can ill afford get isolated. It may take years for China to get rebalanced and moved from its dependence on exports. On the other hand, should China rebalance in a big way in the near term, turn inwards and become less dependent on exports, its closeness to Asia willdeepen and, along with it, the effectiveness of the RECP. These are futurist scenarios and it is difficult to predict either way.
Meantime, China has been strengthening its relations with the Asian countries through the formation of new financial institutions such as the New Development Bank established under the aegis of the BRICS, The Asian Infrastructure Investment Fund (AIIF), and the New Silk Road Fund. At the APEC CEO Summit meeting in Beijing in November, 2014, Xi Jinping called for pursuit of “Asia-Pacific Dream” and urged members to act “in the spirit of the Asia-Pacific community.” At the APEC China pushed for the Free Trade Area of the Asia-Pacific-Community (FTAAP). It was an attempt to take forward its concept of “Asia for Asians.” However, these plans met with resistance in the Beijing meeting. The U.S. and come other members wanted to focus on the completion of the TPP. Diplomatically, the U.S. supported the idea of an FTAAP but wants the TPP to be its main building block. China, on its part, “cautiously welcomed the TPP talks but emphasized Beijing’s desire that they should be transparent and open.” In their view, “TPP will have far-reaching and profound impact on international trade.” The Beijing talks would clearly emphasize that silent wars on trade arrangements or FTAs will continue. The sparring will continue as both sides realize their mutual dependence: China, for its access to US/Europe; and U.S., for its access to cost effective imports from Asia and, more importantly, for China’s continued investment in and holding of U.S. Treasuries. Despite the vehemence in rhetoric, there is a deeper understanding of mutual reliance.
For a balanced study of Asia’s relative position, see Nayyar, Deepak, Catch Up: Developing Countries in the World Economy, Oxford University Press, 2014 and The South in the World Economy: Past, Present and Future, Occasional Paper 2013/01, UNDP, 2013.
There is a rich body of literature on this issue. See in particular Ha-Joon Chang, Kicking away the Ladder: The “Real” History of Free Trade, December 2003 available at http://fpif.org/authors/ha-joon-chang.
See Yang, Laike (2014): Production Sharing in East Asia: China’s position, Trade Pattern and Technology upgrading, htw Berlin, Working Paper No.07/2014, June 2014.
Paprzycki, Ralph (2010): Investment and Trade Networks as Drivers of East Asian Integration, Discussion Paper No.67, APEC Study Center, Columbia University, January 2010.
 Ibid Note 3 Yang Laike.
IMF (2011): Changing Patterns of Global Trade, International Monetary Fund, June 15, 2011.
Xiaoming Pen (2014): China’s FTA Strategy, The Diplomat, June 01, 2014.
Martin, Michael F (2010): The Asia Pacific Economic Cooperation (APEC) Meetings and the U.S. trade policy in Asia, Congressional Research Service, February 4.
 CRS (2015): The Trans-Pacific Partnership (TPP) Negotiations and Issues for Congress, January 30.
Backer, Larry Cata (2014): The Trans-Pacific Partnership: Japan, China, the U.S. and the Emerging Shape of a New World Trade Regulatory Order, Washington University Global Studies Review, Volume 13 (Issue 1).
Ibid. Note 8, p.4
Cheong, Inkyo (2013): Negotiations for the Trans-Pacific Partnership agreement: Evaluation and implications for East Asian regionalism, ADBI Working Paper Series, No.428.
Ibid Foot note 8, p.12 Box Item.
Yuan, Wen Jin (2012): The Trans-Pacific Partnership and China’s Corresponding Strategies, A Freeman Briefing Report, C.S.I.S., June 2012.
Yang Jiemian (2012): The change of America’s Power and Restructure of International System, International Studies, No.2, 2012, p.57.
Hung Ming-The and Tony Mai-Ting Liu (2012): The Trans-Pacific Strategic Economic Partnership and its Implications for Chia’s role in East Asia Integration, Journal of Contemporary Eastern Asia, Vol.11, No.2.
Ibid Foot note 8 above. P.7
Zaki Laldi (2013): Opinion, Trade Deal Show Power Politics is Back, Financial Times, March 31, 2013 quoted in the article at Note 9.
Ibid Foot Note 9 .
Ibid Note 9.
Menon, Jayant (2014): APEC and the battle of free trade agreements’, VOX CEPR’s Policy Portal, 10 November, 2014.
Mitchell, Tom (22014): China trade area plans meet APEC resistance, Financial Times, November 9, 2014.