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Section 6
Turmoil in the World Trading Regime andMega-FTAs in East Asia
KIMURA, Fukunari

1. Standpoint of Middle Powers
The US-China confrontation has changed its nature from a trade war or a tariff war at first to a confrontation between superpowers. At the same time, theinterpretation of the key words “national security” and “sensible technologies”
has also broadened. The scope of US policy toward China was not just therule-breaking tariff policy, but it has also expanded to a series of measures imposed on Huawei, export regulations, foreign investment regulations, inward
investment regulations, government procurement restrictions, and “clean network” construction. After the Biden Administration was established, issues havebroadened further to those that are difficult to compromise on, such as humanrights and democracy. On the other hand, Chinese diplomacy has become aggressive not only toward the US, but also toward other nations. In addition toa series of assertive policies called “wolf worrier diplomacy,” China has alsoannounced various arbitrary policies symbolized by the Export Control Law enacted in December 2020.
Japan’s stance on China is identical to the US’s in many aspects. There aremany issues on which Japan basically shares common values with the US, suchas protection of intellectual property, state-owned enterprises, data flows, national security, democracy, and human rights. On the other hand, regarding thearbitrary interpretation of national security and sensible technologies, there aresome aspects on which Japan cannot easily agree. Japan and Japanese firms
want to maintain favorable economic relations with both the US and China. International trade relations differ from security relations in nature and do notnecessarily see a distinction between friends and enemies. Even with some aspects where the same values cannot be shared, it is possible to establish tradeand investment relations. Further, the US does not expect complete decouplingwith China. Currently, many American firms continue Chinese businesses particularly in the financial and high-tech areas, and American consumers enjoy
great benefits brought from the economic relations with China. In fact, China’s
exports to the US have grown significantly.
The nations sandwiched between the US and China—Japan, South Korea,
Taiwan, ASEAN, Australia, New Zealand and India—will be called “middle pow-

2. The Current Situation of Factory Asia
(1) The Pivotal Role of ASEANFirstly, we will look at the current situation of Factory Asia, as the background.
East Asia, which includes Northeast Asia and Southeast Asia, has led theworld in international production networks (IPNs) or the second unbundling,
particularly in the machinery industry, and has established Factory Asia sincethe 1990s2). Emerging and developing nations have actively adopted develop1) Refer to, for example, Freund, Maliszewska, Mattoo, and Ruta (2020).
2) Refer to Ando and Kimura (2005), Baldwin (2016).

Part Ⅱ
Part Ⅲers” hereinafter. Each middle power maintains a different political and psychological distance with the US and China, but they all have a deep economic connection with both nations.
What fears do middle powers have? The first fear is to be urged to choose
between the US and China and forced to stand at the forefront of unreasonableconfrontation. Middle powers want the scope of decoupling to be clarified, but
superpowers have some incentives to leave it ambiguous. The second fear isthat superpowers will form agreements that are convenient only for themselves.
For example, the Phase One agreement signed in January 2020 includes commitments that may damage third countries, such as the compulsory quotas imposed on imports from the US by China. In fact, the modeling and simulation of
the agreement shows a result that many third countries will obtain negative welfare effects1). The third fear is that the rule-based trading regime will weaken.
If rules are loosened by the confrontation between superpowers, an incentive
for nations to restrict themselves with the rules will diminish, especially for superpowers. For that reason, a danger of superpowers imposing forbidden trade
policies on nations that will never retaliate against them will increase, dependingon the political situation at that moment. No rule keeper fluctuates the norms of
the whole world.
Under these circumstances, it is unfortunate that middle powers have nomeans of completely controlling the confrontation between superpowers. In particular, what international trade policies can do is limited, but this does not meanthat they can do nothing. What we should aim for using international commercial policies are to stabilize the global trade order as much as possible and toestablish a trade policy system to achieve a rule-based trading regime in every
way possible. Working on this challenge requires the formation and utilizationof mega-Free Trade Agreements (FTAs).

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ment strategies with active participation in IPNs, and multinational firms such
as Japanese firms have contributed to the expansion and deepening of IPNs. In
the backdrop to this has been the long-lasting peace and the rule-based trading
regime in East Asia.
ASEAN’s commitment to Factory Asia is strong. China’s presence has
steadily grown in East Asia since it joined the World Trade Organization (WTO)
at the end of 2001. Looking at the trends in the trade of machinery, the large
volume of China’s exports is conspicuous. However, China’s machinery exports
are mostly to the rest of the world, and the ratio of exports to East Asia is small.
That is, IPNs including China take the form of strong ties with nations otherthan those in East Asia. In contrast, ASEAN has close import and export relations with Japan, China and South Korea. Although the relative weight against
China has been shrinking, ASEAN has continued to function as the IPNs’ hub.
To maintain its status as the hub, ASEAN established the ASEAN-plus-one
FTAs network in addition to the economic integration of ASEAN itself. Further,it has played an active role in the conclusion of the East Asia Regional Comprehensive Economic Partnership (RCEP). Why has ASEAN particularly promoted
the RCEP? It does not make sense for ASEAN to have considered only tariffelimination with the RCEP. Tariffs within ASEAN are already almost nil without
exception. With ASEAN-plus-one FTAs completed by 2010, ASEAN already concluded FTAs with six neighboring nations. The nations newly tied with FTAs
based on the RCEP are all non-ASEAN countries: Japan-Korea and Japan-China,
as well as India-China, Australia and New Zealand at the time when India wasparticipating in the negotiations. Therefore, unless tariff elimination between
ASEAN and non-ASEAN countries is advanced much more than in ASEAN-plusone FTAs, ASEAN may suffer from a negative trade diversion effect because
an increase in trade between non-ASEAN countries would push down ASEAN’s
exports. Nevertheless, the leaders of ASEAN have promoted the RCEP because
they expect a positive trade creation effect produced by the whole Factory Asia
being activated by the RCEP, in addition to other effects such as rules of origin(ROOs) and trade facilitation rather than tariff elimination. Further, they expectthat ASEAN can secure its centrality in the economic integration in East Asia.
We, however, should note that the degree of each ASEAN country’s participation in IPNs is significantly different. This means that such a situation has thepotential risk of weakening ASEAN’s centrality. When considering the directionof not only ASEAN, but also the whole Factory Asia, the important point is how
to maintain the solid ties within ASEAN. In particular, it is essential that Indonesia, which accounts for 40% of ASEAN’s economy and population, will continue
its commitment to free trade and investment and lead ASEAN.

3) The following is an argument by Ando, Kimura and Obashi (2021).
4) Kimura (2020) noted the risk that negative demand shocks would be prolonged.

Part Ⅱ
Part Ⅲ(2) COVID-19
Amid the outbreak of COVID-19 in China followed by the pandemic, concerns
over the vulnerability of global value chains (GVCs) arose. Some journalists argued that the era of GVCs was over and that factories in emerging and developing countries should return to home countries (reshoring). In contrast, anotherinsisted that facilitating the decentralization of production bases even further
would raise the robustness of supply chains and that the excess concentration of
production in China should be avoided. In addition, there was also an argument
suggesting that firms should improve risk management because we are entering an era of “just-in-case” rather than “just-in-time.” However, in the end supply
chains in East Asia, especially IPNs, have been retained as they were. Looking
back now, it seems that these arguments slightly overreacted to the initial shock
in some aspects.
Three factors are responsible for these overreactions3). Firstly, COVID-19
accompanied by city lockdowns and social distancing was a shock to supply
chains, and the nature of the shock was not properly perceived. Unlike global
financial crises and the Great East Japan Earthquake in the past, this time threekinds of shocks occurred on different timings and in different places: negative
supply shocks, positive demand shocks, and negative demand shocks. Negative
supply shocks first occurred in February 2020 in the form of imports of intermediate and final goods from China being disrupted, and then occurred in various
other countries as the infection spread. However, imports from China rapidly
recovered in the following month, and the shocks in other nations settled down
in a relatively short time. Meanwhile, facial masks and medical related products
were hit by positive demand shocks. When concerns over the supply of so-called
essential goods including foodstuffs, not just medical products, temporality increased, confusion spread because some countries restricted exports, prioritizing their own citizens (this is perceived as negative supply shocks by the othernations). However, the excess demand was resolved relatively quickly, except
for the current vaccination issue.
Rather than these two kinds of shocks, the most worrisome was actually thethird shock of negative demand shocks caused by the depressed global economy4). However, the unprecedented mitigation policies implemented by eachnation have kept the financial sector sound and the asset market has also notcollapsed, meaning that the situation will not worsen so much. In the recovery
process, positive demand shocks occurred concerning teleworking and stay-at-

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home related products such as telecommunication equipment and dishwashers
that were needed when working remotely. This supported economies, but it isa so-called k-shaped recovery because the impact differs depending on the typeof industry and business.
Secondly, empirical studies on the Asian Currency Crisis, the global financial crises and the Great East Japan Earthquake have proven that IPNs, which
are particularly sophisticated among GVCs, are robust against various supply
and demand shocks5). This fact, however, was not generally well recognized.
IPNs could certainly be a channel to transmit shocks, but relationship-specifictransactions, which are established through investments based on a medium- tolong-term outlook, are not easily interrupted (robust) and are quick to recovereven if interrupted (resilient) compared to normal transactions in a spot market.
This means that IPNs can play a role as a built-in stabilizer in a time of crisis. As amatter of course, firms designed and operated IPNs before the COVID-19 crisis,considering a trade-off between the efficiency brought by the decentralized location of a business base and the risk associated with it. Even though firms may
review IPNs with newly acquired information, there will be no change to themcontinuing to operate IPNs down the road.
Thirdly, it can be pointed out that the deterioration of the US-China relationship caused overreactions toward the decoupling movement. The voices insisting that business bases in China should leave became stronger, especially in Japan, because the negative supply shocks that initially started from China and thepositive demand shocks that hit medical-related products were connected withan alert against China. Labor-intensive processes have been relocated to third
counties for several years due to soaring wages in China. In addition, the relocations of sensitive technologies and rare earth-related production bases have also
been observed to some extent. But for many Japanese firms, Chinese operations
are important and large-scale withdrawals from China have not happened yet.
We should continue to pay close attention to the decoupling movement going
forward.
To make IPNs more robust and resilient, it is necessary to expand and deepen them by refining the investment environment and improving connectivity.
Although the form that the manufacturing industry should take will significantly
change amid the digital transformation, task-by-task specialization is unlikely
to lose its superiority for a while. On considering complementarity with digitaltechnologies, the advantages of Factory Asia should be used for the time being.

5) Refer to Ando and Kimura (2021).

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Part Ⅱ
Part ⅢPart Ⅳ

The mega-FTAs strategies, which Japan has been working on since 2013,reached a turning point when the RCEP was signed in November 2020. Once
the RCEP comes into effect down the road in January 2022, Japan will be tied toalmost all its major trade partner nations based on FTAs. If Japan seeks new FTA
partners, they will be the Common Market of the South (MERCOSUR), Brazil,
and South Africa, but these FTAs are unlikely to produce significant economic
effects. However, Japan should not lose interest in FTAs, and on the contrary, it
is important for Japan to deal with the new phase by using the characteristics ofmega-FTAs as “living agreements.”
Table 1-6-1 complies the status of recent Free Trade Agreements (FTAs)
negotiations involving Japan. Japan’s participation in the negotiation of theTrans-Pacific Partnership Agreement (TPP) has come up in conversation since
the administration period of the Democratic Party of Japan. Around the time
when the second Abe administration was inaugurated in December 2012 andJapan officially announced its desire to participate in the TPP negotiations inMarch 2013, the formation of mega-FTAs between major nations and the participation by many nations have become fully fledged. Japan’s participation in the
TPP negotiations also greatly stimulated the start of the Japan-EU Economic
Partnership Agreement (Japan-EU EPA) and the RCEP negotiations. Although
the US withdrew from the TPP soon after the Trump Administration was established in January 2017, the Comprehensive and Progressive Agreement forTrans-Pacific Partnership (CPTPP) was finalized under Japan’s initiative. Currently, the CPTPP has come into effect in eight nations. The Japan-EU EPA alsoreached agreement and came into effect in February 2019. Despite the prolonged negotiations, the RCEP was finally signed by 15 nations excluding India
in November 2020 and will be in effect in January 2022 among countries thathave completed domestic clearance.
For the past five years, international trade and investment have been exposed to a great risk. While rule-based trading regime has weakened and the
US-China confrontation has intensified, the formation of mega-FTAs has rather
been accelerated. In the backdrop to this has been a change in the expected roleof mega-FTAs.
The roles previously assigned to mega-FTAs were first, further liberalization and second, international rule making. The WTO should have played theseroles as the negotiation forum since its establishment in 1995, but it has hardly
functioned for this because it faced opposition from major developing nations
on every occasion. Meanwhile, economic globalization has steadily progressed,

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Table 1-6-1

Recent Free Trade Agreements Involving Japan
Start of negotiations

Trans-Pacific Partnership Agreement (TPP)

Jul. 2013 (Japan
participated in
the negotiations)

SignedFeb. 2016

Came into
effectParticipating countries

Not in effect(US withdrew
in Jan. 2017)

Australia, Brunei,
Canada, Chile, Japan,
Malaysia, Mexico,
New Zealand, Peru,
Singapore, the US and
VietnamMar. 2018 Dec. 2018

Mexico, Japan, Singapore, New Zealand,
Canada, Australia,
Vietnam, Peru (alreadyeffective in all of theabove), Brunei, Chileand Malaysia

Apr. 2013

Jul. 2018

Feb. 2019Japan and 28 EU
nations (27 nationsin Jan. 2020 due toBrexit, the UK being
included until the endof 2020 as a transition
period)Trade Agreement
between Japan andthe US and Agreement
Apr. 2019
between Japan andthe US Concerning Digital Trade

Oct. 2019

Jan. 2020

Japan and the US

Japan-UK Comprehensive Economic
Partnership Agreement(Japan-UK EPA)

Jun. 2020

Oct. 2020

Jan. 2021

Japan and the UK

May 2013

Nov. 2020(excl.
Jan. 2022
India)

Comprehensive andProgressive Agreement
for Trans-Pacific Partnership (CPTPP)

Japan-EU Economic
Partnership Agreement(Japan-EU EPA)

East Asia Regional
Comprehensive
Economic Partnership(RCEP)→

10 ASEAN nations,
Australia, China, Japan, South Korea, and
New Zealand (in effectonly with countries
that have ratified it)

and the level of liberalization and the coverage of international rules based on
the WTO have become totally insufficient. Impatient major nations decided tostep into liberalization and international rule making with mega-FTAs, although
they are fully aware that it is the second-best choice. The significance of these
two roles is not lost.
In addition to these roles, the third role was recently added to mega-FTAs,
which is to maintain the rule-based trading regime. The vulnerability of the rulebased trading regime increases the risk that each nation will deviate from thetrade rules and norms that are usually trusted. The policy risk emerging from itwill be a great hindrance for international businesses.
There are incentives, especially for superpowers, to use arbitral trade pol-

4. The Significance of the RCEPThe RCEP was finally signed in November 2020 and will be in effect in January2022 among signatories with ratification. What role can the RCEP play? We cansee its significance from the aspect of three roles. The first role, liberalization,
receives a harsh evaluation. The tariff elimination rate based on the number of
items, including those being gradually eliminated, stands at 91% for all participating nations, which is almost at the same level as existing East Asia FTAs.
However, the rate is low for partners newly tied with FTAs; that is, the rates ofJapan toward China and South Korea are 86% and 81%, and of China and South
Korea toward Japan are 86% and 83%, respectively. It is also unusual for a different tariff elimination schedule to be set by a partner nation. Considering that the
tariff elimination rate required for mega-FTAs by the CPTPP are set at 99–100%(95% only for Japan to protect the agriculture), the RCEP should endeavor toPart Ⅱ
Part Ⅲicies depending on their political motivation at that time without fear of retaliation. The US-China confrontation creates exactly a political environment thatencourages this. Further, the WTO’s function for settling disputes has notably
weaken, because the Biden Administration, following on from the Trump Administration, has been blocking the appointment of the WTO’s Appellate Body
members. If that is the case, it is unavoidable that nations other than superpowers will also easily deviate from the existing norms. Even mega-FTAs cannot
completely cut off the bad flow, but they are expected to be a deterrent to acertain extent.
Looking at Japan’s recent FTAs from such a viewpoint, it is apparent thatthe third role has strongly been perceived. The CPTPP shows high-level liberalization and new standards for international rule making, and at the sametime, it clearly intends that the middle powers sandwiched between the US andChina will unite and protect the rule-based trading regime as much as possible.
The UK decided to start accession negotiations in June 2021. Not limited to theUK, the CPTPP is also expected to develop as a forum for the middle powersthat will unite and aspire to free trade and investment. The conclusion of theJapan-EU EPA was also accelerated, aiming to jointly protect the trade order
disturbed by the Trump Administration. The Trade Agreement between Japanand the United States alone was hurriedly concluded not to aspire to free trade,as symbolized by the word “free” being omitted, but mostly to avoid the US’s
rule-breaking trade policies. The Japan-UK EPA was also concluded using theJapan-EU EPA as a model in order to stabilize Japan-UK economic relations after
Brexit.

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raise the degree of liberalization, using opportunities such as the fifth-year review after coming into force.
Meanwhile, rules of origin (ROOs) are more trade-friendly than the CPTPP,
and the aspects of custom procedures and trade facilitation can also be highly
evaluated. Regarding trade in services, the RCEP tried to adopt a negative-list
approach (listing services on hold for liberalization). The nations that did notcomplete the approach are about to progress the transition procedure from a
positive-list approach (listing services to be liberalized). For investments, ROOs
have promised a liberalization with a negative-list approach and have also stipulated royalty regulations and the prohibition of performance requirements,
including technology transfer requirements. As we have seen, the RCEP have
many aspects that are more advanced than the existing ASEAN plus one FTAs.
Once an agreement comes into force, it will bring certain economic effects.
The second role, international rule making, is highly evaluated on the pointthat it comprehensively covers various policy modes. The major policy modes
that are included in the CPTPP but not in the RCEP are only state-owned enterprises, labor, and environment. However, there are only a few rules asking
for strong commitments, such as significant changes in each nation’s domestic
policy. Instead, the RCEP can be positioned as the starting point for negotiations
when trying to involve China in international rules down the road.
Attention is being considerably focused on intellectual property (Chapter11), e-commerce (Chapter 12), and government procurement (Chapter 16). For
intellectual property, the RCEP has made a stronger commitment to trademarks
than the WTO’s Agreement on Trade-Related Aspects of Intellectual Property
Rights (TRIPS). Regarding e-commerce, the three principles of the CPTPP are
free cross-broader data flows, the prohibition on data localization requirements,
and the prohibition on forced disclosure of source code, and the RCEP specifies
the former two even though their effectiveness remains doubtful. Government
procurement has not been included in the previous FTAs in East Asia that muchand its contents are limited to transparency, promotion of cooperation, and future outlook, but it has taken a step forward.
We should pay attention most to the third role, the contribution to the maintenance of the rule-based trading regime. It is extremely meaningful that thenations where Factory Asia is being developed, including China in East Asia,
show their rule-oriented stance, being tied with one trade agreement. In addition, Chapter 18 stipulates that the RCEP Ministerial Meeting and the RCEP
Joint Committee shall be held annually, and that four subordinate committees
and an administration office shall be established. Although this is an imitationof ASEAN’s progressive economic integration model, ordinarily it can deepen

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the agreement step by step and function as one of the stable communication
channels when a dispute occurs. It does not mean that the RCEP will solve allissues, but it is expected that the establishment of such a forum including China
will be effectively used. Unfortunately, India dropped out in the middle of thenegotiations, but it should definitely come back to the RCEP if it wishes to join
Factory Asia down the road.

Part Ⅱ
Part Ⅲ

References
Ando, Mitsuyo and Fukunari Kimura. (2005), ‘ The Formation of International
Production and Distribution Networks in East Asia’, in T. Ito and A. Rose(eds.), International Trade in East Asia (NBER-East Asia Seminar on Economics, Volume14), Chicago: University of Chicago Press, pp.177-216.
Ando, Mitsuyo and Fukunari Kimura. (2012), ‘How Did the Japanese Exports
Respond to Two Crises in the International Production Networks? The
Global Financial Crisis and the Great East Japan Earthquake’, Asian Economic Journal, 26 (3), pp.261–87.
Ando, Mitsuyo; Kimura, Fukunari; and Obashi, Ayako. (2021) “International
Production Networks Are Overcoming COVID-19 Shocks: Evidence fromJapan’s Machinery Trade.” Forthcoming in Asian Economic Papers.
Baldwin, Richard. (2016) The Great Convergence: Information Technology and
the New Globalization, Cambridge: Belknap Harvard University Press.
Freund, Caroline; Maliszewska, Maryla; Mattoo, Aaditya; and Ruta, Michele.
(2020) “When Elephants Make Peace: The Impact of the China-U.S. Trade
Agreement on Developing Countries.” Policy Research Working Paper
9173, The World Bank.
Kimura, Fukunari. (2020) ’Exit Strategies for ASEAN Member States: Keeping
Production Networks Alive Despite the Impending Demand Shock’, ERIA
Policy Brief, No. 2020-03 (May).

Part Ⅳ

The US-China confrontation and the conflict between liberalist nations and China in the political and security arenas do not seem likely to settle down easily. However, the economic relations created through trade and investment arecontinuing and the conflict does not mean that both the US and China intend
to completely cut off their economic relations. Although international trade policies, including mega-FTAs, will not solve all issues, it is necessary to continue to
strive in order to maintain the rule-based trading regime. We should start withwhat we can do to begin with.

Part Ⅰ

5. Conclusion