助成

Institute forInternational Policy Studies
・Tokyo・

IIPS International Conference“Building a Regime of Regional Cooperation in
East Asia and the Role which Japan Can Play”

Tokyo
December 2-3, 2003

“Regional Cooperation in East Asia and FTA Strategies”
By
Dr. Peter Drysdale
Professor of Economics,
Asia Pacific School of Economics and Government
Australian National University

Regional Cooperation in East Asia and FTA Strategies

Peter Drysdale
Professor of Economics
Asia Pacific School of Economics and Government
The Australian National University

Presentation to IIPS Conference on 'Building a Regime of Regional Cooperationin East Asia and the Role which Japan Can Play', Tokyo, 2-3 December2003

The last decade of the twentieth century saw a marked shift in thinking about regional
cooperation in East Asia and the Pacific. East Asia became the locus of interest in
economic cooperation within the region. At the end of the decade, economic cooperation
across the Pacific within the framework of APEC seemed on the wane. This was not
simply a shift of direction in economic diplomacy. The wellsprings of the change werealso deeply political in character. Its timing had as much to do with how East Asia cameto perceive the need for a new framework for managing the growing dominance ofAmerica as it did with the steady rise of East Asian economic power. But both economic
and political forces drove the change. The policy attention devoted to East Asian
cooperation has not abated, but rather intensified in the past few years.
This paper examines the rise of the new regionalism in East Asia and the changing shapeof the regional economy that has been one of the forces encouraging it. It looks at thescale and character of regional trade and economic activity and how both provide
grounds for giving new priority to East Asian regional cooperation. It notes Japan'schanging role in the regional economy, and how that has prompted particular kinds ofpolicy initiative (such as espousal of bilateral FTAs as a way forward with trade policy)
aimed at closer East Asian regional economic and political links. At the same time it
remarks that many of the features of the East Asian economy that led Japanesepolicymakers to eschew such initiatives in the past have not fundamentally changed. The
contradictions in policy initiative and real economic and political circumstance have led
to some unpredicted policy reactions and outcomes and to some confusion in policy
strategies aimed at promoting East Asian cooperation more broadly. The paper reviews
the state of regional economic diplomacy and how Japan is situated in its evolution. The
imperatives of East Asian cooperation mean that the quest for it will continue. But what
is feasible and desirable, and are Japan's current policy approaches likely to deliver
something that is either feasible or desirable in terms of their stated aims? The creation ofan East Asian Economic Community requires leadership and a model that is consistent
with East Asian (not European or American) circumstances. Has Japan either to offer?

1Origins of the New Regionalism
The emergence of the new regionalism in East Asia was triggered proximately by events
surrounding the East Asian financial crisis. Earlier, when former Prime Minister
Mahathir of Malaysia proposed the formation of an East Asian Economic Caucus(EAEC), the aim was to stake out an East Asian position on NAFTA. But Mahathir's
initiative, in the early 1990s, received no support from Japan and lay dormant.
The circumstances in the late 1990s appeared quite different; this was partly a product of
the complex political response to Washington's role in the financial crisis. There was lossof faith in APEC's capacity to deal with the problems of the time. There wasintensification of preferential trading initiatives elsewhere, including in North America.
And there was the failure to launch a new WTO round of trade negotiations in Seattle, so
central to APEC's trade liberalisation agenda. All these developments were used to justify
heading off in a new direction on preferential trade arrangements in East Asia.
These circumstances also saw the emergence of a range of proposals for a new regional
financial regime. The crisis shook East Asia's confidence in established policy positions
and arrangements. Japan was notably on the back foot (Drysdale and Ishigaki 2002 pp.410). China appeared to be occupying the stage. Washington was alternately neglectful
and triumphalist. Groping around for new ways forward within the region was a natural
response. Aping the proliferation of FTAs elsewhere appeared more and more attractive.
So too did building a new framework for regional financial and broader economic
cooperation.
The new regionalism in East Asian had long-term structural as well as these more
proximate origins. The long-term forces that led the East Asian economies to begin tothink about the construction of a new regional framework for cooperation revolved
around two factors. The first and most important was the growth of economic andpolitical interaction among the East Asian economies themselves. The second was the
emergence of the new international economic and political environment after the end of2the Cold War, in which the resurgence of US hegemonic power challenged perceptions of
the growth of independence and national power within East Asia.
The growth and deepening integration of the East Asian economy is the result of threehuge waves of trade and industrial transformation. The first came with the rise of Japanand its emergence as a major industrial power, especially in the first three decades after
the Pacific War. The second was led by the newly industrialising economies (NIEs) of
Northeast and Southeast Asia in the late 1970s and 1980s. Now a third great wave issweeping the region, with the remarkable rise of China. These successive waves of tradeand industrial transformation have created a new centre of East Asian economic powerthat has begun to rival North America and Europe in terms of its contribution to world
output and world trade.
By one measure, the rise of East Asia in the world economy still has a long way to go.
When national products are valued at current exchange rates, the United States economy
appears resurgent against a flagging East Asian challenge (see Figure 1). Moreover,Japan, by this measure still the second biggest economy in the world, appears to dominate
the East Asian economy, accounting for roughly two-thirds of the region's total output.
But this is only one measure of the relative importance of East Asia in the world
economy, and probably not the most accurate, because of the way in which current
exchange rates, and short-term influences upon them, distort the underlying picture. A
better measure uses purchasing power parity (PPP) valuations of national product toestimate the relative size of economies. In Figure 2 East Asia's share of world output canbe seen to have risen substantially over the past two decades, from just over 15 per centin 1980 to around 27 per cent in 2002, overtaking the United States by 1993. Moreover,within East Asia, by 1994 China's share of world output had already surpassed that ofJapan and, by 2002, its share of world output was already more than half that of theUnited States. China’s economy, of course, remains less sophisticated than that of Japan,
but its sheer scale now gives it much larger weight in world output. While East Asia’s

3

Figure 1 East Asian Shares in World Output: Take 1

35%
US
30%

East Asia 10

25%

20%
Japan
15%

10%
China
5%

0%
1980

1984

1988

1992

1996

Note: Output share valued at market exchange rates (per cent).
Source: Australian National University International Economic Database.

4

2000

Figure 2: East Asian Shares in World Output: Take 2

30%
East Asia 10

25%
US

20%
15%
China

10%
Japan

5%
0%
1980

1984

1988

1992

1996

2000

Note: Output share valued at PPP (per cent).
Source: Australian National University International Economic Database.

share of world trade has not grown so strongly in the last decade (see table 1), it morethan matches that of North America. Within East Asia, the story is one of rising tradeshare for China (measured here and appropriately as China’s trade plus the trade of Hong
Kong net of intra-China–Hong Kong trade) and steadily falling trade share for Japan.
These are the realities of the recent rise of the East Asian economy and the growing
weight of China within it, driven by what I have called the third wave of East Asian tradeand industrial transformation.

5

Table 1: China and East Asia: share in world exports (per cent)1991-1993 1994-1996 1997-1999 2000-2002
East Asia 10
China + Hong Kong
Japan
Korea
TaiwanASEAN 5

22.3
3.7
9.1
2.2
2.3
5.0

23.8
4.5
8.3
2.6
2.3
6.2

22.8
4.8
7.2
2.5
2.2
6.0

22.5
5.6
6.7
2.6
2.3
6.1

Source: Australian National University International Economic Database.

Japan and the Region
The three waves of industrial and trade transformation that have swept the East Asian
economy over the last half century or so were driven significantly by commitment tosteadily more liberal trade and investment regimes throughout the region. The increasing
openness of the newly industrialising economies of Northeast and Southeast Asia
provided opportunities for their fuller participation in the international division of labour,
spurred by foreign direct investment (FDI), and intensified regional economic integration.
Now China's rapidly growing and more open market is further deepening regional tradeand economic integration. China's accession to the WTO has entrenched this process andis reinforcing, and giving confidence in, the longer-term structural rise and integration of
the East Asian economy.

Already more than half of China’s imports are sourced from other countries in East Asia,with 30 per cent from Northeast Asia and 20 per cent from ASEAN countries. Lardy(2002) suggests that '(w)ithin a decade China’s trade is likely to surpass that of Japan and6Germany, making China the world’s second largest trader'. Properly measured, by
including Hong Kong's trade together with China's trade net of intra-Hong Kong-China
trade, China is already the fourth biggest single trading nation in the world after theUnited States, Germany and Japan.
A central feature of deeper East Asian economic integration has been the remarkable
growth of trade in intermediate goods and components, and China is now a major
element in this process. The location of relatively labour-intensive component production
and assembly within complex, integrated international production chains has been agrowing feature of the international division of labour, especially in East Asia (Sharpton
1975, Helleiner 1973, Feenstra 1998, Athukorala 2003). The process began in theelectronics and textile industries but is now common in many other industries. This
process is sometimes called international product fragmentation. A recent and careful
study of fragmentation trade in East Asia by Athukorala (2003) demonstrates just how
important it is to the growth of, and economic integration within, the region. Athukoralareports that the intra-regional share in final trade was 48.3 per cent compared to 52.3 percent of total trade. In 2000, over 60 per cent of ‘final exports’ from developing Asia
went to countries outside the East Asian region, significantly North America and Europe,up from 55 per cent in 1992 (p.18). The fragmentation of the supply chain accelerates thegrowth of trade in components and makes the region more heavily dependent on extraregional trade for 'growth dynamism' than is suggested by data that does not net out thetrade in components (Findlay 2003, Findlay 2003a). The most notable feature ofinternational product fragmentation in recent years, Athukorala shows, has been the rapid
integration of China into regional production networks. This development, he argues, isan important counterpoint to the popular belief that China’s global integration would
crowd out opportunities for export-led growth for other economies within the region (p.
19).
In the manufacturing sector, FDI has been the driver of the substantial intra-industry andintra-regional trade growth, and the role of FDI is expected to rise, fostering deeper
integration of the regional economy. The effort to cut production costs through7

improvement in productivity and more efficient procurement and outsourcing has led to
the relocation of some segments of multinational firms’ production processes within East
Asia. The effect on trade and investment flows is significant. The increased
fragmentation and specialisation in production and trade that has been promoted by theactivities of multinational firms in the region presents enormous opportunities for East
Asian economies to become integrated into international production chains and markets.
It lifts productivity, output and trade growth. But there are also challenges inpolicy positioning to take advantage of these opportunities. There may be more intensecompetition among economies with similar output levels, factor endowments, and export
structures. Similarity of export structure with China, it might be argued, for example, islikely to increase the intensity of competition faced in taking advantage of the growth offragmentation in regional trade in manufactured goods (Xu and Song 2002). McKibbin
and Woo (2003) suggest that China's WTO accession could create significant welfare
loss in the ASEAN 4 if foreign direct investment is significantly directed away fromthese countries towards China, and if the ASEAN 4 countries are unable to take measuresthat prevent the loss from reduced FDI inflow. If the ASEAN 4 are not to fall behindtechnologically, then they have to find niches within lengthened international production
chains. The evidence suggests that this is indeed what is happening and that China isproviding a positive boost to Southeast Asia trade in the process (Deutsche Bank
Research 2003).1
Opening up the service sectors, such as banking, transport and communications,professional services and distribution services, to international participation andcompetition is also offering enormous opportunity. Trade and income growth built on
exports from the more labour-intensive segments of these industries for the lessdeveloped economies and the more human capital-intensive segments for the moreadvanced economies is generally faster than growth of industrial goods trade and output,
within the region and globally.

1

The McKibbin and Woo conclusion follows from a simulation exercise which they undertake. See also
Abeysinghe and Lu (2003).

8

Growing intra-regional trade built on the opening, reform and rapid growth of theChinese economy in the last two decades or so has already profoundly changed thestructure of the East Asian economy. China's WTO commitments have greatly
strengthened the structural trend of the rise of China in the East Asian economy, and thealready evident relative decline of Japan. A corollary trend is that the rest of the East
Asian economy is becoming steadily more and more important to Japan and Japan
relatively less and less important to the rest of East Asia, including China but also theother economies in Northeast and Southeast Asia. A simple measure of this trend is therising share of these economies in Japan's trade and the falling share of Japan in theirtrade. This is true also for Australia, which is an integral part of the East Asian economy.
China is an increasingly important part of this change. China has already overtaken the
United States as Taiwan's largest export market. Within the next two decades, Chinaalone is projected to overtake the United States as Japan's largest export market.
Already in the 1990s, there were some in Japan who worried about the implication of thisdevelopment for Japan's role in the region. In the contest for regional leadership with
China, Japan 'passing' emerged as a concern, importantly and symbolically in the context
of US President Bill Clinton's historic visit to China without stopping over in Japan. The
early atmospherics of the Bush administration allayed those concerns at a diplomaticlevel, but the fundamental circumstance has not changed and is unlikely to change in the
future.
East Asian Economy in Brief
The trade and industrial transformation of the East Asian economy, in brief, is acontinuing dynamic. The scale of the change in China and its impact upon East Asian
economic integration will work itself out, barring major reversals, over the next two to
three decades, in the same way that the rise of Japan did in the last half of the twentiethcentury. The recovery of Japan's economic vigour (now in prospect but only assured if
there is delivery of more and substantial economic and related reform) will greatly restore
and enhance Japan's role and effectiveness in regional and international economic

9

diplomacy. But China is already a major player regionally and globally and its potential
for growth is huge alongside that of Japan, an economy that is already economically anddemographically mature. Whatever Japan's strategies for, and role in, regional
cooperation, they must accommodate that reality.
Another feature of the East Asian economy noted above is its extra-regional trade andeconomic reach. A high proportion of the region's trade in intermediate, but especially infinal goods, is destined for the major industrial country markets of North America andEurope, outside the region. Large flows of FDI particularly into China, now the largest
recipient of direct capital inflows, cement economic interaction with the global economy.
And East Asia is a major interest in the international financial market as was discovered
painfully in the East Asian financial crisis.
In these and other respects, the structure and dynamic of the regional economy is very
different from that of Europe and North America, and it is likely to remain so for a very
long time. India is also now on the rise and there are growing ties between the East andSouth Asian economies. It has become fashionable to seek to emulate the European
model of economic integration in East Asia, but there is a question about whether
imposing the European model or, even, the North American model upon East Asia would
reinforce or derail integration East Asian-style.
A New Regional Architecture?
The imperative of deeper financial and trade cooperation in East Asia became clear
through the experience of the East Asian financial crisis. The crisis saw Japan's regional
leadership on these issues in disarray. Japan's own financial market was in a mess. The
call for the establishment of an Asian Monetary Fund (AMF) lacked credibility even
within the region. Japan was a major factor, though not the only one, in failure to makeprogress on trade liberalisation within APEC. And Japan exercised no sway or leadershiptowards averting the US retreat from a new WTO Round in Seattle. In this context, the10emergence of ASEAN + 3 reflected the interest in re-grouping and building a frameworkfor substantive economic cooperation within the region.
The real significance of ASEAN + 3 is its inclusion of China and Japan in the same
forum for high level political dialogue. China came to this, at the initiative of Korea,
embracing Japan within the same arrangement with unexpected enthusiasm. This was a
deeply political decision, much more than an economic policy strategy (Drysdale andIshigaki 2002 p.10, Drysdale 2002 pp. 129-143). China's interest in ASEAN + 3 wasencouraged by political events, like the Belgrade bombing and the Cox Report, as aninsurance against continuing problems in the US–China relationship (Drysdale and Zhang
2000). The international political environment has changed substantially since September
11 and the emergence of China's partnerships with America in the war on terror and inmanagement of the Korean peninsula problem. But the political rationale in Beijing for
fostering East Asian cooperation within the framework of ASEAN + 3 remains firmly
intact.
ASEAN + 3 is not a regional trading arrangement but rather seeks to provide aframework for demonstrating East Asian influence and leadership on regional andinternational affairs. The initial focus was very much on regional financial cooperation.
That was the hook on which the political level dialogue began. In January 2002 in
Singapore, Prime Minister Koizumi proposed an East Asian community encompassing
cooperation beyond trade and financial issues (and including Australia and New Zealand)
to promote regional integration. The agenda of ASEAN + 3 already extends far beyond
the issue of financial cooperation and the ambition, stated more clearly at the recent
meetings in Bali, is for the evolution of an East Asian Economic Community.
A parallel development was the rush towards bilateral or sub-regional FTAs. FTAs are
preferential or discriminatory trade arrangements. Preferential trade arrangements within
East Asia (including the participation of key regional economies such as Japan, China
and Korea) had never before found favour. They would have inflicted costs on importanteconomic partners, but also they were likely to elevate political tensions in predictable11

ways among countries that were included and those that were excluded from sucharrangements. That was acknowledged explicitly in designing the architecture for APEC.
Yet there has been a rash of new proposals and initiatives in East Asia over the last fiveor six years to promote bilateral FTAs of an explicitly discriminatory kind.
Within the region, the Japan-Singapore Agreement has already been signed. Singapore
has also signed agreements with Australia and the United States. The first significant
proposal was for an FTA between Japan and Korea at the time of President Kim Dae
Jung's historic visit to Japan in 1998. Japan–Korea, Japan–Singapore (concluded in
January 2002), Japan–Mexico, China–ASEAN, Korea–Chile, Japan–ASEAN, Thailand–
Australia, Singpore–New Zealand, Korea–ASEAN, US–ASEAN, CER–ASEAN, Japan–
Korea–China or Taiwan are some of the arrangements that have been mooted or are on
the slipways. Except for the China–ASEAN proposal, all the negotiation of arrangementswith ASEAN countries is proceeding bilaterally rather than with ASEAN collectively (Ito2003).
At the centre of this shift in policy direction was Japan. Japan was then the only major
economy in the world other than China or Korea that was not a member of any FTA or
economic union. For Japan to choose a strategy of bilateral (or sub-regional)
discriminatory trade arrangements was bound to have considerable reverberations within
East Asia and the Pacific and throughout the world trading system. What is remarkable isthat such a fundamental shift in Japan's trade policy diplomacy was effected without
public debate in Japan and the reactions to it from partner countries were almost entirely
unanticipated by Japanese policymakers. A central reference point in East Asian trade
diplomacy – Japan's insistence on non-discrimination in international trade and economic
dealings – has been lost. More specifically, the multilateral trading system is no longer
Japan's central priority (Ito 2003).
One of the consequences of Japan's FTA initiatives was to encourage China to join the
FTA game too. Most importantly China, in dealing with the sensitivities in Southeast

12

Asia about its economic rise, was freed to propose an FTA with ASEAN. Because of amore open approach to agricultural trade it was able to trump Japan in its Southeast Asian
diplomacy (Drysdale and Ishigaki 2002) and move forward with a bolder and more
attractive schedule for negotiations and engagement with Southeast Asia more broadly.
The reaction in Australia was also of consequence. Advised that a comprehensive FTA
was not on with Japan because of agriculture, Australia's initial reaction was to try tosecure an arrangement between CER and ASEAN. Rebuffed in that bid, Australia,
significantly, scrambled to negotiate an FTA with the United States – with problematiceffects on its East Asian interests – and sought to do deals with Singapore and Thailand(both of which have been signed). The negotiation with the United States – adevelopment made possible in the aftermath of September 11 and Australian support for
the Bush Administration’s campaign in Iraq (Garnaut 2003) – is now at a critical stage
and there is no guarantee that it will reach conclusion. For Australia's, and perhaps also
for Japan's, interests this outcome is fraught with economic and political problems theresolution of which is still unclear. Australia, despite its deep integration into East Asia,
appears diplomatically adrift in the region. It is not a member of ASEAN + 3. It shares
this circumstance unenviably with Taiwan. The structure of its relations with the region
and the way in which its economic interests deeply intersect with those of America(importantly but not only in agriculture), leaves negligible prospect of, or economic sense
in, an FTA with any of its three major trading partners in the region.
State of Regional Economic Diplomacy
Where is East Asia at, then, with FTAs as an engine for closer economic integration?
The rich countries in East Asia and the Pacific, such as Japan, Korea, Singapore,
Australia, New Zealand and the United States, have all signed one or more FTAs with
their trading partners in recent years. Developing countries in the region, such as China

13

and ASEAN, have also shown growing interest in FTAs and a China–ASEAN FTA isalready under negotiation and there are pre-commitments to 'early harvest'.2
The motivations for participating in FTAs vary from country to country (Findlay, Piei
and Pangestu 2003).3 Despite longstanding commitment to, and continuing fundamental
strategic interest in, the non-discriminatory liberalisation of trade, economic and politicalcircumstances have led East Asian countries down the track of discriminatory tradeliberalisation.
The long-term rise in East Asian economic interdependence provided the background to
this shift in policy thinking, even though East Asian trade and economic interests remain
more globally oriented than those of any other major economic area in the world(Drysdale and Ishigaki 2002). In economic diplomacy, the multilateral-oriented
institutions appeared to have faltered and failed to move forward quickly within either the
WTO or the APEC framework. However mistakenly, given the complex structure of theregional economy, FTAs were seen to offer a way to more rapid progress. There was adecisive move away from working through multilateral-oriented regional arrangements
like APEC towards the proposal and negotiation of bilateral FTAs, and the regionalgrouping, ASEAN + 3, also emerged in East Asia.
In Japan, where the move towards bilateral negotiation of FTAs in East Asia had its
recent origins, the focus was first on forging an agreement with Korea as part of theprocess of political rapproachment in the late 1990s. The proposal emphasised industrial
integration and deliberately avoided hard agricultural trade issues. But thus far there has
been no substantive progress towards a deal. A ‘New Economic Partnership Agreementwith Singapore’ (where there were no major agricultural trade issues to deal with, except
the famous goldfish and cut-flower exports from Singapore to Japan) was negotiated andlegislated in 2002. The Singapore agreement broke Japan’s virginity on long2

China and ASEAN reached an agreement on a framework to establish an FTA at the end of 2001. Japan
has also declared interest in forming an FTA with ASEAN countries (information on Japan’s FTA strategy
is available at the Ministry of Foreign Affairs of Japan’s official website
http://www.mofa.go.jp/policy/economy/fta/strategy0210.html. Accessed November 2003.)

14

commitment to the principle of non-discriminatory trade. Although the agreement wastrivial in its impact on the Japanese economy, it came to be rationalised in Japan as a wayof pushing the domestic reform agenda but, like almost all such arrangements, it was avery doubtful instrument for achieving that objective.
The Japanese policymakers who initiated these moves had no comprehension of what thereaction to them would be elsewhere in the region, especially in China. Beyond Japan,
Korea was flirting with a broader bilateral FTA strategy, but even the negotiations with
Chile became bogged down. Australia moved rapidly to mimic Japan’s deal with
Singapore, then Thailand, but the formal negotiation of an FTA with the United States ismuch more significant not only for the region but also for the international trading system.
At the Bali ASEAN + 3 summit, China again seized the initiative in pressing a broader
East Asian trade arrangement, supporting the ASEAN strategy for deepening Southeast
Asian integration and outflanking Japan’s initiatives for more divisive bilateralagreements with Southeast Asian countries. The United States has done its own deal with
Singapore and mooted bilaterals with other ASEAN countries.
Both economic and political considerations have influenced thinking among the Chinese
leadership about the change in trade policy strategy. Findlay (2003a) and Lu (2003)
provide the best interpretation of the background to China's evolving FTA strategy.
In the face of Southeast Asian fears about being crowded out by China's growth, China
offered an FTA as a way of providing some reassurance and as a vehicle for cooperation.
An FTA involving all these economies would also make the whole region more attractive
to foreign investors: ASEAN members had been particularly concerned about the effectof China’s WTO entry on patterns of FDI flows (Zhang 2003).
Zhang (2003) argues that an agreement between China and ASEAN could accelerate
moves for Japan and Korea to form their own bilateral agreements with ASEAN, andpush China, Korea and Japan themselves towards further progress on bilateral3

See Findlay, Piei and Pangestu (2003) for an excellent discussion of risks and motivations behind FTAs.

15

arrangements of their own and a broader East Asian regional arrangement. In this view,
the China–ASEAN FTA is seen as a building block for wider regional cooperation. But
this view is contestable.
Zhang (2003) further argues that the interest in a more formal institutional arrangement
follows from concern about the vulnerability of market-based integration and from theemergence of institutionally-based integration in Europe and the Americas.
The ASEAN + 3 arrangement, apart from providing a framework for projecting East
Asian influence and interests, includes an agenda for the establishment of an East AsianFree Trade Area, cooperation on macro-economic policy and financial market
strengthening, and joint action in the provision of regional public goods. Zhang (2003)
refers to the common interest in responding to problems of drug trafficking, piracy,
illegal migration, environmental disasters, money laundering and international terrorism,
and to other trans-boundary issues. Beyond these issues there might be interaction in
relation to defence and military affairs, but that cooperation involves a much longer time
horizon (Findlay 2003).
The FTA strategy is designed, from this perspective, to contribute to China’s capacity to‘form at some point a counter power comparable to the US and Europe by unifying Asian
countries’.4 It is interpreted as part of an attempt by China to build a ‘strategic
partnership’ within East Asia, a partnership that can be used to ‘work closely on regional
and international issues’. Whether the FTA component is actually required to achieve
this goal is problematic, but certainly that is how it is presently viewed widely, both inChina and Japan (Lu 2003).
Zhang (2003) admits that it is too early for China to consider a fully institutionalised East
Asian arrangement, given that neither Japan or Korea is yet ready to negotiate anagreement with China. There remains a large element of political schizophrenia in Japan

4

Naoko Munakata from the Research Institute of Economy, Trade and Industry (RIETI) in Tokyo, quoted
in the Far Eastern Economic Review, 17 July 2003, p. 29.

16

about China, and moving into a highly institutionalised FTA or formal common market
arrangement that included China would be difficult to digest, not only economically but
also politically. Another reason is that the region is unable to confront the issues thatwould arise from the treatment of Taiwan in a larger arrangement. So the agenda in theimmediate term is actually a sub-regional one, with the focus on China and ASEAN.
How that will finally influence the shape of broader regional cooperation arrangements is
yet to be seen, but certainly there is limited room for Taiwan (and presently, we might
add, Australia) in the growing institutionalisation of regional cooperation arrangements inEast Asia.
The other important Chinese regional initiative is the Closer Economic Partnership
Arrangement (CEPA) with Hong Kong, signed at the end of June 2003.5 This
arrangement is still evolving but it provides for duty free access to a broad range of goods
imports that qualify in terms of specified rules of origin, and a for number of designatedservice providers. The agreement is deepening the integration of Hong Kong into thesouthern Chinese economy.
The stalling of the Doha Round of WTO negotiations at Cancun has given further
impetus to the surge of preferential bilateralism in East Asian and international trade
diplomacy. But none of the bilateral agreements that have been put in place so far has
made any really substantial contribution to trade liberalisation (Adams et al. 2003).
In short, the confusion of FTA arrangements, with more and more complicated rules oforigin, is more likely to distort and derail than to encourage broader and deeper economic
integration of the kind that we saw above as so critical to continuing the momentum of
East Asian trade and industrial transformation (Garnaut 2003, Garnaut 2003a, Garnaut
5

So far 273 tariff items are covered under the agreement. Other exporters of these products to China aresubject to tariffs that range from 5 to 35 per cent. Other products will be added to the list at the request of
manufacturers. In the initial phase of the agreement, the rules of origin requirements are spelt out for eachproduct. Rules of origin requirements were not settled until September 2003. The criteria are thatprocessing must involve either a change in the tariff heading or 30 per cent value added in processing.
There is also accelerated access under WTO accession obligation for service providers in 18 sectors,
including telecommunications, added after conclusion of the initial agreement (Findlay 2003, pp.5-7).

17and Bhagwati 2003, Findlay, Piei and Pangestu 2003, Findlay 2003, de Brouwer 2003).
All the analysis suggests that the bilateral FTAs in East Asia are in fact of limited
economic value and can have quite damaging costs for those outside them. These include
the economic costs of trade diversion but also the political costs of exclusion. The politics
of FTAs in East Asia revolve around three poles: their impact on Southeast Asianpolitical coherence; their impact on China's regional interests and relationships, including
those with Taiwan; and their impact on relations across the Pacific with the United States.
In both economic and political terms a rapid move towards a broader East Asian FTA
would be greatly preferable to the mess of arrangements that there is in the region now(Scollay and Gilbert 2001). But as already noted that is not an objective on which there
will be easy or rapid progress. What the end-point of this game will be is still an open
question.
Another question is how emerging East Asian architecture and policy initiatives relate to
APEC and whether they will complement or conflict with the trans-Pacific architecture
for policy dialogue and initiative.
Prospects for an East Asian Community
The trajectory of economic growth and the nature of trade and industrial transformation
define both the special character of the East Asian economy and economic integrationand the shape of regional cooperation arrangements that are feasible and will sustain it.
East Asian growth and integration is now riding the third great wave of industrial
transformation, at the base of which is China. A recent study for the Governor of
Guandong suggests that, between 2025 and 2030, Guangdong will attain per capita
income levels equal to those in Japan today, and much higher in Guangzhou andGuangdong’s other large cities.
There are risks in all such historic events. The most important risk to Chinese success
relates to political system reform.

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The core of Chinese trade and economic success is the growth of the private sector, bothprivate foreign-invested enterprise and domestic private enterprise. The private sector
now accounts for two-thirds of China’s trade and economic growth. It is the engine roomof the Chinese economy's remarkable success. But the opaque relationship between theprivate sector and the state in a one-party political system is the root cause of endemic
corruption and, at some critical point, is doomed to derail such economic success.
Transparent, arms-length transactions under a strong and independent legal andregulatory framework inexorably become more and more important to economic successas an economy grows increasingly industrially and commercially sophisticated. Openness,transparency and independence of legal rights and appeal are essential to capturing thefull gains from deeper integration into the world economy and participation in global
financial and other markets. Without timely political system change there is danger ofwhat I have called elsewhere the 'Latin Americanisation' of the Chinese economy andpolity.
The good news is that the Chinese leadership appears aware of the nature and theimportance of this problem. President Hu Jintao's historic and carefully argued address tothe joint sitting of the Australian Parliament on 24 October 2003 is encouraging in thisrespect. But the task is huge in a country of the size and complexity of China. And it is atask that will take some time to complete, when time is fast running out because of
China's very success in reform, opening and growth.
In these affairs the development of close and extensive policy dialogues and the sharingof experience and knowledge between China and its advanced country neighbours can bevery helpful in exploring, testing and experimenting with new institutional systems. Thisdimension – the facilitation of a wide range of routine and easy policy dialogues – isamong the most fundamental and important interests in building cooperation
arrangements in East Asia and in the creation of an East Asian Economic Community.
At the heart of the process of future East Asian economic integration will be the deeper
and deeper integration of the Japanese and Chinese economies. This is reflected in the

19projected trade shares mentioned above. But it is also and already reflected in thestrategic re-positioning of almost every leading Japanese corporation in the Chinese
market, and in the rapid growth in the importance of China-related business to Japan andJapan-related business to China. Korea will be an important part of this story. So too will
Southeast Asia and Australia, for which China is now assuming a role similar to that ofJapan in the 1960s and 1970s.
Of course the global economic and political environment will affect the degree to which
there is a smooth economic and political transition towards an effective East Asian
Economic Community. In terms of economic policy strategy, the United States ispresently disengaged from East Asia, although the political contretemps over Chinese
textiles and steel trade in the lead-up to the US Presidential election is a reminder thatstrategic disengagement is unlikely to remain benign. And how trans-Pacific political andsecurity affairs evolve will depend, among other things, upon how quickly there develops
a sense of shared East Asian interests and an understanding of the political importance ofwhat is happening in the East Asian economy, nowhere more so than in Tokyo. Theseelements will be critical to confident, open and constructive dealings with Washington.
On this, there is a very long way to go.
All this might seem to suggest the development of a China-centred East Asian
community. On current policy trends and strategies, one would have to conclude that thisis the most likely outcome. The weight and growing power of China, both economicallyand politically, means that an architecture of regional economic and, therefore, political
relations designed around a system of bilateral and preferential arrangements, rather thanrooted in rules and institutions that are multilateral in their obligations, will increasingly
deliver China the whip hand. In this architecture China will become the natural hub in theeconomic and political structure of the region over the next generation or two. This is thearchitecture that Japanese policymakers have put in place over the last half dozen years,
and it is precisely the outcome that the region is stumbling towards should nothing bedone to change it.

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There is no evidence that this construct, of a web of limiting bilateral arrangements inwhich the big and promising always have superior leverage and power, is the choice that
China would have made or would want to make unconstrained. Precisely the reverse.
The sensible and rational choice for China is a global choice, the acceptance andentrenchment of global obligations and responsibilities in a multilateral 'pluralist' setting,as President Hu described it a few weeks ago in Canberra. No region, not even East Asia
including Japan, is big enough to accommodate the scale of China's economic ambition.
The global theatre and the multilateral system, rationally, is crucial to China's realising its
modernisation ambitions over the next generation.
These are the dangers in the course in trade and economic diplomacy upon which Japanis presently embarked. It is not that the ambitions for an East Asian Economic
Community are not well founded, in the economic and political circumstances withwhich the region now has to deal. The emergence of an effective East Asian Economic
Community should be an entirely positive development. But the priority for an East
Asian Economic Community is to create a force for leadership within the global trade andfinancial system, to deliver real reform at home and maintain openness in theinternational economy. (A start would be to activate an East Asian coalition for making
progress within the global trade negotiations.) The objectives of so-called 'closer
economic partnership' arrangements are better served by non-discriminatory trade
agreements than by distorting and limited bilateral FTAs. Much of the focus in East
Asian cooperation needs to be on the joint provision of the institutional and physicalinfrastructure to facilitate trade, investment and people movement, and does not require
the discriminatory baggage of bilateral or sub-regional FTAs. And the prerequisite is thecreation of effective fora for policy dialogue and their development through an East
Asian Economic Community.
Discriminatory regional trade arrangements might well have been the basis for building
modern Europe or dealing with particular political and economic problems in North
America. But they are reflective of another place and another age, not the needs andcircumstances of the East Asian economy at the beginning of the twenty-first century,

21and specifically the need to accommodate the growth and opening of the Chinese
economy within the regional and global economic systems.
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