(Finalized, 21 July 2006)

Trade-FDI-Technology Linkages in East Asia
Drafted byWillem Thorbecke and Masaru Yoshitomi*

Prepared for the NEAT Working Group on “Trade- FDI-Technology
Linkages in East Asia” Sponsored by the Research Institute of Economy,
Trade and Industry (RIETI) Tokyo, Japan,**
21 July 2006

Index of Contents
I.
II.

Introduction
Global Triangular Trading Patterns in East Asia
A. Determinants of FDI Flows
B. Intermediate Goods Trade in East Asia
C. China’s Role in the Global Triangular Trading
Patterns
III. East Asia Countries: Comrades or Competitors?
IV. Exchange Rates and Production Networks in East Asia
V. Policy Implications
A. How to Promote Production Networks, FDI Flows,
and Technology Transfer
1. How to Lower Service Link Costs
2. How to Facilitate Technology Transfer
Leveraged by Networks
3. How to Enlarge the Scope of FTAs
4. How to Enhance the Quality of Bilateral
Investment Treaties
B. The Appropriate Policy Mix for the Region
VI. Conclusion_____________________________________________________________________* Willem Thorbecke is a Senior Fellow at RIETI. Masaru Yoshitomi is President andChief Research Officer at RIETI. We thank Mizanur Rahman for excellent research
assistance.
** Extremely valuable and constructive comments by members of the NEAT Working
Group at the workshop on 7 July 2006 at RIETI have been incorporated (the participants
are listed at end of this draft).

1

I. Introduction

East Asia is characterized by intricate production and distribution
relationships, constituting part of a global triangular trading network. Verygenerally speaking, Japan, Korea, and Taiwan and MNCs located in ASEAN
produce sophisticated technology-intensive intermediate goods and capital goods
and ship them to China and ASEAN for assembly by relatively low skilledworkers. The finished products are then exported throughout the world, not only
to the U.S. and Europe but also to the rest of Asia. These production anddistribution networks have promoted economic efficiency and helped to make
East Asia as a whole (not just China) the manufacturing center of the world.
FDI flows and MNCs (multinational companies) have played an important part inthese triangular trading patterns. As Gaulier et al. (2005) discuss, FDI flows and
MNC activities have reduced costs in host countries, transferred technological andmanagerial know how, increased local procurement, multiplied trade in intermediate
goods, and strengthened distribution networks.
While networks are common in other parts of the world (e.g., parts andcomponents exported from the U.S. for assembly in Mexico), fragmentation in East
Asia is particularly sophisticated and well-developed. It involves complicatedcombinations of intra-firm trade, arms-length transactions, and outsourcing (Kimura
and Ando, 2005). One definition of these production networks has been provided by2

Borrus et al. (2000, 2):

By a lead firm’s “cross-border production network” (CPN) wemean the inter- and intra-firm relationships through which the firmorganizes the entire range of its business activities: from research anddevelopment, product definition and design, to supply of inputs,
manufacturing (or production of a service), distribution, and support
services. We thus include the entire network of cross-borderrelationships between a lead firm and its own affiliates andsubsidiaries, but also its subcontractors, suppliers, service providers, orother firms participating in cooperative relationships, such as standard
setting or R&D [research and development] analysis. 1

These networks have allowed firms to exploit comparative advantage byslicing up long production processes and allocating the production blocks createdin this way throughout Asia. Such trade-FDI linkages have establishedproduction-distribution networks in East Asia that can be characterized as verticalintra-industry trade (VIIT).
This VIIT differs both from the exchange of final goods emphasized bytraditional trade theory for vertical inter-industry trade between the North and theSouth (e.g., between capital goods and apparel) and for horizontal intra-industry
trade between the North and the North (e.g., between two differentiated types ofautomobiles). As Fukao et al. (2002) discuss, the production processes of anindustry (e.g., the electronics industry) has been split into fragmented production
blocks that can be located in different countries and the new VIIT is essentiallybased on differences in factor endowments in the fragmented production blocks
between developing, emerging, and developed economies in the region.
1

Also quoted in Yusuf et al. (2003).

3

To promote these trade-FDI-technology linkages it is important to lower theservice link costs between production blocks (Kimura and Ando, 2005). This canbe done by strengthening physical and ICT infrastructure across the region,
increasing the knowledge base, enforcing high standards of corporate governance,and providing legal remedies when firms within a network relationship violate
intellectual property rights agreements (Yusuf et al., 2003).
The rapid development of such value-added chain in the region has beenaccompanied by massive volumes of exports from East Asia (particularly China)
to the rest of the world and also by growing trade imbalances. The tradeimbalances are particularly large for East Asian trade with the U.S. The East
Asian surplus with the U.S. equaled $300 billion in 2004 and $350 billion in 2005,
while the overall U.S. deficit amounted to $650 billion and $770 billion,
respectively. 2
Many policy questions follow from the above considerations but only
some are mentioned in this Introduction. What practical steps can each country in
the region take to lower service link costs? What policy coordination will benecessary among countries in the region in order to strengthen service linkages
and lower related costs? How can each economy upgrade its technological andindustrial structure in the context of the production networks developed in theregion? Do production networks in East Asia have an export bias? Do overall
imports by East Asia grow less rapidly than overall exports by the region? Does

2 More than half of this surplus was recorded as being with China. If exports were measured on a valueadded basis rather than on a gross basis, however, the deficit with China would have been far less and the
deficit with the rest of Asia far more.

4the accumulation of foreign reserves that has accompanied the global imbalancesreflect an inefficient allocation of domestic resources within each of the Asian
countries? Are there better ways at present to allocate resources in order tostimulate demand than by relying on export expansion? If so, what policy mix
would be appropriate? (See our own NEAT Working Group Policy
Recommendation 2005).
This paper is organized as follows. The next Section presents ananalytical description of the global triangular trading patterns. Section III
considers whether East Asian economies are comrades or competitors. Section IV
discusses implications for exchange rates of triangular trading patterns and global
imbalances. Section V identifies the main issues (both analytical and empirical)
that need to be addressed. Section VI concludes.

II. Global Triangular Trading Patterns in East Asia
A. Determinants of FDI Flows

FDI has brought benefits to both the home and the host countries. It enabledhome countries’ firms to significantly lower costs and to use developing Asia
more and more as a production platform for less technology-intensive industrial
inputs as well as labor-intensive final goods. 3 It enabled host countries’ firms toacquire engineering and managerial skills and to facilitate technologicalassimilation. These firms were able to reap the efficiency gains associated with
exporting and competing in world markets. In addition, as foreign affiliates
3

ASEAN countries were not merely assembly platforms for labor-intensive goods. As discussed below,
MNCs in ASEAN also produced and exported sophisticated intermediate goods.

5increased their tenure in the host countries, they procured more and moreintermediate inputs from host country firms (see Kiyota, Matsuura, Urata, andWei, 2006).
Starting in the 1990s, China also became an important recipient of FDI. After
the Asia Financial Crisis of 1997-98, new flows to Southeast Asia slowed.
Meanwhile, China’s accession to the WTO in 2001 increased investor confidence
and resulted in a surge of investment. The lion’s share of FDI to developing East
Asia now goes to China (see Figures 1A and 1B).
There are several ways in which the development of FDI-trade linkages havebeen associated with technological upgrading in host countries (see Yusuf et al.,2005). Recently, for instance, lead brand name firms in Asia have started
requiring suppliers to become involved in the engineering and design aspects ofthe production process. As suppliers in host countries enhance their R&D
capabilities, they can attempt to progress from original equipment manufacturing(OEM) to original design manufacturing (ODM) and finally to original brandmanufacturing (OBM), though the last step is difficult to achieve by local firms inhost countries 4
Because of the benefits arising from foreign direct investment it is important
to know the factors that affect FDI flows. Instead of exploiting external markets
directly by exporting, why do firms choose to undertake FDI? When firms are
deciding on the optimal degree of fragmentation they need to weigh benefits andcosts along several dimensions (Kimura and Ando, 2005). One such dimension is

4This process of upgrading technology in host countries is often associated with local procurement by
MNCs and the resultant development of supporting industries.

6location. Another is ownership. A third is internalization. Locational
considerations and advantages include wage levels, factor endowments,
technology transferability, physical and human infrastructure, and marketsupportive institutions and political regimes. Ownership advantage is based upon
technological and managerial superiority of home country firms relative to hostcountry firms. Such superiority should be sufficient enough to overcome theextra costs incurred due to differences in business customs, formal and informal
norms, languages, etc. Thus ownership is linked with control, and control
becomes weaker as ownership becomes more diluted. Of course firms that
outsource or subcontract may retain some control if they are involved in longterm relations. There may also be benefits to relinquishing ownership if thebusiness partner has better managerial or technological ability in a particular
product. Internalization advantage refers to the net benefits obtained by FDI
firms through more captive and more integrated business activities conducted byparent firms. The optimal degree of internalization revolves around how tobalance the costs of asymmetric information, incomplete contracts, andineffective dispute settlement mechanisms with the efficiency gains of complete
outsourcing and deverticalization.
An important question is whether the surge in FDI flows to China has come at
the expense of other Asian countries. On the one hand, Yusuf et al. (2003)
documented cases where FDI inflows into China have come at the expense ofSoutheast Asia. These FDI flows were motivated by lower labor costs in China
than in places like Penang, Malaysia. On the other hand, Eichengreen and Tong

7

(2005) reported that increases in FDI flows to China are associated with increasesin FDI flows to other Asian countries but with decreases in FDI flows to OECD
countries. The authors do not discuss why there should be a complimentary
relationship between FDI flows to China and other Asian countries. Mercereau(2005) found that only two Asian countries, Singapore (and Myanmar), faced
decreases in inward FDI due to China’s success in attracting FDI. He argues that
Singapore might be affected because overseas Chinese living in Singapore may
have channeled funds that previously went elsewhere to China because they havefamily connection or linguistic and cultural ties with the mainland. Appendix 1
provides more detail on these and other studies that investigate whether FDI flows
to China have crowded out FDI flows to other countries.
How exchange rates affect FDI flows and production networks is yet anotherimportant issue for East Asia. Kiyota and Urata (2004) reported that exchange
rate volatility reduces FDI. They also find that an exchange rate regime that is
flexible but not highly volatile attracts the most FDI. These results make sense inlight of Kimura and Ando’s (2005) model since volatility increases uncertainty
and thus reduces the locational benefits of cross-border fragmentation. BénassyQuéré, Coupet, and Meyer (2005) reported that the higher the quality of acountry’s institutions (including transparency, property rights protection,
prudential standards, and the extent of corruption), the more FDI the country isable to attract. These findings also make sense in light of theoreticalconsiderations since the locational costs of shifting production across borders
decreases as a country’s institutions improve. Kamaly (2003) also found that8

exchange rate volatility reduces FDI flows and that more democratic institutions
are associated with larger flows.

B. Intermediate Goods Trade in East Asia

Matsunaga (2006) showed that increases in FDI into a country are associatedwith increases in intermediate goods exports to that country.
Triangular trading patterns involve Japan, South Korea, Taiwan, and MNCs
in ASEAN exporting sophisticated intermediate goods to China and ASEAN forprocessing and export of the final products all over the world. Examining theflow of intermediate goods can shed light on the evolution of production networks
in Asia. 5
Figure 2 (and Table 2) show Japan’s exports of intermediate goods to East
Asia. China received 38% of Japan’s exports for processing. Large quantities
also flowed to ASEAN countries and the East Asian NIEs (South Korea andTaiwan). Figure 3 shows the level of technological intensity of Japanese exports
to East Asia. 6 Not surprisingly, over 75% of these exports are either high-tech or

5

We differentiate between intermediate goods exports and parts and components exportsbut weconsider both. The difference between the two categories is that intermediate goods include partsand components and semi-finished goods. We focus on intermediate goods for two reasons: 1)
data for these (obtained from the CEPII-CHELEM database) are available until 2004 while datafor parts and components (from the RIETI-TID database) are only available until 2003, and 2) the
results are very similar using intermediate goods data or parts and components data. The data aredescribed in detail in Appendix 2 and the parts and components data are presented in Appendix 3.

6Technological intensity is calculated by the Centre D’Etudes Prospectives et D’Information
Internationale (CEPII) based on the type of goods exported measured at the HS 6 digit level. For
instance, 252 products at the HS 6 digit level are classified as high-tech. See Gaulier et al. (2005).

9

medium high-tech goods. In addition, almost none of these exports are low-techgoods.
Figure 4 (and Table 3) show the NIEs’ exports of intermediate goods to East
Asia. China receives half of the NIEs’ exports of intermediate goods to the region.
Figure 5 shows that 46% of the NIEs’ exports to the region are high-tech goods
and 70% are either high-tech or medium high-tech goods. 10% of these exports
are low-tech goods.
Figure 6 (and Table 4) indicate the back and forth nature of intermediate
goods trade in East Asia (see Kimura and Ando, 2005). Not only do ASEAN
countries receive large quantities of intermediate goods from East Asia, they also
export large quantities back. To see that ASEAN countries play an important rolein exporting intermediate goods note that in 2004 ASEAN’s exports ofintermediate goods to the rest of the region equaled about 60% of Japan’sintermediate goods exports to China. Figure 7 shows that 23% of the goods
exported by ASEAN to East Asia as a whole are low-tech goods. On the other
hand, Figure 8 shows that 75% of the goods exported by ASEAN to China areeither high-tech or medium high tech goods. These data highlight the importanceof MNCs operating in ASEAN countries.
Figure 9 (and Table 5) show China’s exports of intermediate goods to East
Asia. They indicate that China exported over $20 billion of intermediate goods toEast Asia in 2004. By contrast Japan’s intermediate goods exports to China thatyear equaled $70 billion. While Japan was the largest single recipient of China’s
exports for processing, 60% of these exports went to other countries in the region.

10

Figure 10 shows that over 30% of the goods that China exports to East Asia are
low-tech goods.
Figure 11 (and Table 6) report results for East Asia aggregated together. They
indicate that intermediate goods exports from East Asia to China exploded after
2001. Exports from the region to ASEAN 4 and the NIEs nevertheless remained
strong. As would be expected, intermediate goods exports from East Asia toJapan were the smallest. Even so, the rest of Asia exported $30 billion ofintermediate goods to Japan in 2004.
Given the multiplication of intermediate goods exports from East Asia to
China, the next section investigates Chinese processing trade in more detail.

C. China’s Role in the Global Triangular Trading Patterns

Table 7 shows China’s role in this triangular trading structure. The data aretaken from China’s Customs Statistics, which distinguish between imports andexports linked to processing trade and ordinary imports and exports. Imports forprocessing are goods that are brought into China for processing and subsequent
re-export. Processed exports, as classified by Chinese customs authorities, aregoods that are produced in this way. Imports for processing are primarily
intermediate goods but also include some primary goods and some final goods. 7
They are imported duty free and neither these imports nor the finished goods
7

In 2003 36% of imports for processing were semi-finished goods, 42% wereparts and components, 3% were primary goods, 5% were consumption goods, and
13% were capital goods. We are indebted to Deniz Unal-Kesenci for thisinformation.

11

produced using these imports normally enter China’s domestic market. By
contrast, ordinary imports are goods that are intended for the domestic market andordinary exports are goods that are produced using local inputs.
Table 7 shows that in 2005 42% of China’s imports were for processing. Of
this 42%, seven-tenths came from other East Asian countries. By contrast, lessthan one-twentieth each came from the U.S. and from the EU. This indicates that
the U.S. and the E.U. do not produce many intermediate goods demanded by
China for processing. It is worth noting that China imports more goods forprocessing from ASEAN countries than from the U.S. and Europe combined. As
stated above in Section II-B on intermediate goods trade in East Asia, this partly
reflects the influence of MNCs located in ASEAN that export sophisticatedtechnology-intensive parts and components to China.
Table 7 also shows that in 2005 55% of China’s exports were processedexports. Of this 55% one quarter went to the U.S., another one quarter went toEast Asia (excluding Hong Kong), one-fifth went to Hong Kong (largely as
entrepôt trade), and one fifth went to Europe. It is worth noting that China’s
processed exports go all over the world, not only to the U.S. and the E.U. but also
to the rest of Asia. In fact, the share of U.S. imports of China’s processed exports(including through Hong Kong) corresponds more or less to the share of U.S.
GDP in the world economy.
Reflecting the triangular trading structure where the U.S. and Europe largely
do not export many intermediate goods to China but China exports processed
goods to the U.S. and Europe corresponding to their respective GDP share in the12world economy, China runs large trade surpluses with the U.S. and Europe.
However, China runs trade deficits with East Asia. According to China’s official
statistics its surplus with the U.S. equaled $114 billion in 2005 ($195 billion
including Hong Kong, as explained below) and its surplus with Europe equaled$61 billion. Its deficit with East Asia (excluding Hong Kong) equaled $140
billion.
Because the size of China’s bilateral trade surplus with the U.S. is apolitically-charged issue, it is important to measure it accurately. Kwan (2006)
discusses how to correct for the distortionary effects of entrepôt trade throughHong Kong. He argues that in the face of entrepôt trade import data are much
more accurate than export data. When Chinese firms transship goods throughHong Kong, the Chinese government often does not know the final destination of
the goods. Thus they record these goods as being exported to Hong Kong. On
the other hand, when the goods arrive at their ultimate destination (e.g., the U.S.)
the importing country records the goods as coming from China. Thus Kwan
advocates using import data from both countries to calculate the trade balance.
Using this approach, the U.S. deficit with China in 2005 increases from $114
billion to $195 billion. 8 This implies that the lion’s share of China’s surplus with
Hong Kong in Table 7 actually represents an important part of China’s surplus
with the U.S.
It is also instructive to examine how processing trade has evolved over time.
Figure 12 (and Table 8) show that China’s imports for processing from East Asia

8

Of course, a more sophisticated analysis would have to take account of adjustments for c.i.f. – f.o.b
factors and the value-added by Hong Kong middlemen. See Fung and Lau (2003).

13

exploded after 2001. The Figure and Table also show that imports for processing
from the U.S. and Europe were not large. Since imports for processing from
Hong Kong were also small, this conclusion would continue to hold if U.S. andEuropean imports transshipped through Hong Kong were included.
Figure 13 (and Table 9) show China’s processed exports. Processed exports
to the U.S. and Europe also surged after 2001. Figure 14 then shows that China’s
surplus in processed trade with the U.S. and Europe has ballooned in recent years.
Figure 15 measures China’s value-added in processed trade. Value-added isdefined as the difference between the value of China’s processed exports and thevalue of China’s imports for processing, divided by the value of China’s
processed exports. It shows that 30-35% of the value-added comes from China
since the late 1990s, as compared with about 20% in earlier years..

III. East Asia Countries: Comrades or Competitors?

At first blush one would expect a complementary relationship between
developed and developing East Asian economies, and a competitive relationshipbetween developing economies in the region. Figures 17-20 present a modified
version of Belassa’s revealed comparative advantage measure. 9 Broadly speaking,the Figures indicate that Japan and the NIEs have a comparative advantage inintermediate and capital goods and that China and ASEAN in consumption goods.
Given the international slicing up of the value-added chain, Japan and the NIEs
9

The data are constructed for 71 individual products using shares of the overall trade balance rather thanrelative export structure as in Balassa (1965). Values for stages of production are then calculated bysumming. See www.cepii.fr for a detailed description of how the data are constructed.

14

should be partners with China and ASEAN while China and ASEAN shouldcompete with each other.
Some evidence is consistent with this scenario. Eichengreen et al. (2004)
report results from a gravity model indicating that an increase in China’s exports
to third markets tends to reduce the labor-intensive consumption goods exports ofother Asian countries. These results thus imply that there is essentially acomplementary relationship between China and developed Asia in sophisticatedintermediate and capital goods and largely a competitive relationship between
China and less developed Asian countries in labor-intensive consumer products.
Kwan (2002) also found evidence of a complementary relationship between
China and Japan and a competitive relationship between China and ASEAN
countries by using U.S. customs data and 1100 product items. He compared thevalue of exports from China to the U.S. in a product category with the value ofexports from another Asian country to the U.S. in the same product category, as apercentage of the other country’s total exports to the U.S. His work thus sheds
light on the extent to which China’s exports to the U.S. and other Asian countries’
exports to the U.S. are in similar product categories. The results, reported inTable 12, indicate that there is not much overlap between China’s exports to the
U.S. on the one hand and those of Japan and South Korea on the other hand. 10
There is considerably more overlap, however, between China’s exports to the U.S.
and those of ASEAN countries. Thus there should be much more competition

10

This overlap would be even less if one took account of the fact that in many cases much of the valueadded of goods recorded as being produced in China actually came from Japan and South Korea.

15

between China and ASEAN in third markets than between China and developed
Asia.
Bénassy-Quéré and Lahrèche-Révil (2003) also reported evidence of acompetitive relationship among Asian economies. Using panel data techniques
and annual data from 1984 to 2001, they reported that a 10% real appreciation in
one East Asian country (other than Japan) reduced real exports to other East
Asian countries by 8%. Thus individual East Asian economies may fear a loss ofcompetitiveness relative to neighboring countries.
Other evidence indicates that the relationship between East Asian countries
may be more nuanced. As discussed above, some evidence indicates that FDI
flows to China have not in most cases reduced FDI flows to other Asian countries.
The results in Table 12 indicate that there is a complementary relationshipbetween China and MNCs located in ASEAN that export sophisticatedtechnology-intensive parts and components there for processing. Ahearne et al.
(2003) report a positive relationship between China’s exports and the exports
from emerging Asian economies. They interpreted this to mean that China andemerging Asia are comrades, not competitors. Finally, as Gaulier, Lemoine, and
Nal-Kesenci (2006) report, ASEAN has not been crowded out of world export
markets nor lost market share in dynamic products such as electronics goods.
Figure 18 and Table 17 show that while final goods exports from China have
exploded, final goods exports from ASEAN countries have nonetheless remainedsolid.

16

Yet another way of analyzing whether China may be benefiting and harming
other East Asian economies is through observing effects on the terms of trade.
China imports large quantities of technology-intensive goods and primarycommodities and exports large quantities of labor-intensive final goods. In theprocess it has raised prices for the former goods and lowered prices for the latter
goods. This has improved the terms of trade for developed countries like Japanand worsened the terms of trade for other developing countries specializing inlabor-intensive exports but not necessarily primary commodities. This effect islikely to continue into the future.

IV. Exchange Rates and Production Networks in East Asia

How would exchange rate changes affect global triangular trading patterns?
Kamada and Takagawa (2005), controlling for imported inputs by including
current and future exports in regressions using quarterly data from 1990 to 2003,
found that in most cases the price elasticity of imports for East Asian countries
was not statistically significant. Ahearne et al. (2003), using a vector
autoregression and annual data from 1981 to 2001, found that income growth inimporting countries was a much more significant determinant of exports from
East Asia than exchange rate changes. Ito and Yoshida (2005), seeking to explain
East Asian exports in the context of a triangular trading model using annual datafrom 1990 to 2000, found that exchange rate volatility did not help to explain East
Asian exports to the U.S.

17

Thorbecke (2006a) disaggregated exports into intermediate goods, capital
goods, and consumption goods. Disaggregating by stages of production shouldshed light on how exchange rate changes affect trade within Asia, given theimportance of fragmented production blocks in the region. Using panel datatechniques and data between 1982 and 2003 he found that bilateral real exchange
rates appreciations in Japan, South Korea, and Taiwan relative to other East Asian
countries caused a small drop in intermediate goods exports and a large drop in
capital goods exports to East Asian trading partners. He also reported thatexchange rate volatility, as measured by the annual coefficient of variation
calculated using quarterly data, deterred intermediate goods exports but not
capital goods exports in the region. This evidence suggests that intermediate
goods exports, which play a key role in intra-firm exchanges, are not affected thatmuch by the level of the exchange rate but are affected by exchange rate volatility.
On the other hand capital goods exports, which are often part of arm’s lengthtransactions, are affected by the level of the exchange rate but not by exchange
rate volatility. These results indicate that 1) relative exchange rate stability would
facilitate the flow of intermediate goods through regional production networks,
and 2) appreciations in developed Asia relative to developing Asia would hamper
the flow of sophisticated capital goods that are difficult to procure elsewhere.
It is also necessary to consider how an appreciation of the RMB would affectChina’s trade balance. Marquez and Schindler (2006), using data from 1997 to
2004, regressed the share of China’s exports and imports relative to rest of theworld exports and imports on the multilateral RMB exchange rate and other18

variables. They reported that a ten percent appreciation of the RMB reduces theshare of China’s exports in world exports by half a percentage point and the shareof China’s imports in world imports by a tenth of a percentage point. Thus anappreciation of the RMB would cause a noticeable decline in China’s surplus.
Thorbecke (2006b) investigated how a bilateral appreciation of the RMB
against the dollar would affect China’s trade balance with the U.S. Using
cointegration techniques and quarterly data from 1987 to 2005 he found that thesum of the price elasticities of exports and imports exceeded unity. These results
indicate that an appreciation of the RMB would reduce China’s surplus with the
U.S.

V. Policy Issues and Recommendations

A. Promoting Production Networks, FDI Flows, and Technology Transfer

1) How to Lower Service Link Costs
Lowering service link costs between geographically separated production
blocks can facilitate the functioning of the sliced value chain. These costs can belowered along two dimensions, “distance” and “controllability” (Kimura andAndo, 2005). Our focus is on the former.
Costs along the distance dimension include transport costs,
telecommunication costs, and intra-firm coordination costs. Costs along thecontrollability dimension include the costs of imperfect information, lack ofcredibility, and loss of stable contracts. To lower service link costs policymakers

19should focus on strengthening physical infrastructure such as 1) the network of
highways, ports, and airports, 2) the ICT infrastructure, 3) container yards, andalso market-supportive institutional infrastructure such as 1) enforcement of thelegal system, 2) information on vendors, 3) enforcement of the stability of private
contracts, 4) corporate governance, and 5) legal remedies when firms violate
intellectual property rights agreements.
Lowering service link costs can lead to many firms locating in one area.
There are then economies of scale attached to the resulting agglomeration.
Service link costs are lowered because the large number of firms in close
proximity makes it easier for firms to procure parts and components and to handle
frequent specification changes. In addition, the many business partners anddifferent skills and technologies in close proximity help reduce costs associatedwith uncontrollability.
Developing countries seeking to promote trade-FDI-technology linkages
through agglomeration might do well to learn from the model of Shenzhen and
the Pearl River Delta and more recently the Yangtze River Delta. It is hard to
implement the necessary policy and infrastructural changes for a whole country
but probably easier to do for a city or province. 11 In these Deltas there are superb
networks of modern highways, ports, and airports. Many firms have located there,leading to economies of scale and profitable interactions between upstream anddownstream industries. If such infrastructure has to be built across countries,
regional coordination and cooperation will become indispensable.

11

Kimura and Ando (2005).

20

For instance, 80% of the international production of notebook PCs is now
produced in the Yangtze River Delta by a dozen Taiwanese Original Design
Manufacturers (ODMs). They form part of a network consisting of the makers ofOS (Microsoft) and MPU (Intel), branded makers (HP, Apple, Toshiba, etc.),
suppliers of key parts and components, and producers of basic industrial materials.
Both digital and human networks enable these producers to react efficiently inreal time to changes in consumer preferences and technology (see Yoshitomi,
2006).

2) How to Facilitate Technology Transfer Leveraged by Networks
For developing countries in the region to reap the full benefits of the tradeFDI-technology networks, it is necessary for their economies to move up thevalue chain and not remain engaged only in labor-intensive assembling activities.
Technology transfer and upgrading is an essential element of this process.
The intra-firm transfer of managerial technology from foreign affiliates toindigenous workers can be expedited if workers in the host country are highly
educated. 12 Thus human capital formation is a prerequisite for technology
transfer.
Similarly, a strong local knowledge base is essential for supplier firms tobecome involved in the engineering and even design aspects of production. 13 To
build the knowledge base, students need a high quality education in science and12
13

Urata (2006).
Yusuf et al., 2003.

21

math at the secondary school level and scientific training at the university level(see Yusuf et al., 2003).
Appropriate R&D policy should take into account each country’s level oftechnological innovation. 14 Countries at early stages of development typicallyimitate imported technology. R&D at this stage largely takes the form of learning,
doing, using, failing (LDUF). Since imported technology is expensive, a carefulselection is necessary for assimilation rather than just imitation. In this case,domestic R&D supported by public research institutes can help indicate what
technologies are most appropriate to import.
Countries then advance from the imitation to the assimilation stage to begin
innovating and leveraging new technological capabilities. Public-private
cooperation, such as happened with Taipei, China’s industrial technology research,
can help at this stage.
Developing economies also receive technology spillovers when foreign
affiliates increase local procurement in the host countries. Local procurement
increases with the length of time the affiliate has operated in the host country.
To facilitate their long tenure it is necessary to sustain FDI-friendly environments
including consistent and coherent enforcement of laws and regulations at all
governmental levels as well as stable macroeconomic fundamentals. FTAs for
trade and FDI liberalization and facilitation are thus important.

3) How to Enlarge the Scope of FTAs

14

See Yoshitomi, Azis, and Thorbecke (1993).

22

Even if your trading partners do not liberalize, your country will reap thegains from trade by liberalizing unilaterally. This basic message of liberalization
is often forgotten, particularly when negotiating FTAs. Global liberalization
would produce even greater gains by leading to a more efficient allocation of
resources in the international economy along the lines of comparative advantage,as compared with the case of FTAs between a limited number of countries. FTAs
represent one step towards global free trade. There are losers in particular sectors
from liberalization, however. It is thus necessary to facilitate labor mobility andthe movement of firms from losing to gaining sectors by providing retraining andupgrading for workers displaced through trade liberalization and by reducing
entry barriers to new firms and facilitating exit through structural reform. Sectorspecific protectionist policies should be abandoned as much as possible, while
competition policy should be strengthened.
FTAs between developing and developed economies benefit different sectors
depending on the level of development. In general, agricultural liberalization indeveloping countries benefits the agricultural sector in developing economies. On
the other hand manufacturing and service liberalization benefits these sectors indeveloped economies. To enhance the benefits and quality of agreements, it isimportant to reduce the scope of these sensitive items in both economies and toenlarge the coverage of countries such as implementing a FTA for ASEAN+3 as awhole. The broader the coverage and the lower the tariffs on both external andinternal trade, the more the “noodle” effects of FTAs caused by the rules of origin
can be mitigated.

234) How to Enhance the Quality of Bilateral Investment Treaties 15

High quality bilateral investment treaties (BITs) help attract and retain foreign
investors in the host country. They can thus contribute to trade-FDI-technology
linkages in East Asia.
Ideally, BITs should provide three substantive clauses and one proceduralcomponent. The three substantive clauses are investment protection, investment
facilitation, and investment liberalization and the procedural component is disputesettlement. Investment protection provides compensation in the case of
expropriation and mandates fair and equitable treatment of foreign investment toavoid wrongful termination of government contracts. Investment facilitation
requires transparency (i.e., that all relevant laws be publicly proclaimed).
Investment liberalization emphasizes freer market access of investment (i.e., norestrictions on ownership). Along this line, national treatment, that is, that foreign
firms should receive the same treatment as domestic firms, should be mandated.
Dispute settlement involves state parties providing a “standing” offer to arbitratewith individuals or states in the case of a disagreement.
Minimum standard BITs provide only for investment protection and disputesettlement while high standard BITs also include an investment liberalization
clause.
High standard BITs are required to further promote Trade-FDI-Technology
linkages, but even the minimum standards are not met by some BITs in the region
including the China-Japan BIT of 1988.

B. The Appropriate Policy Mix for the Region 16

15

This Section draws on Kotera (2006).
We are very grateful to participants at both the 2005 and 2006 NEAT Working Group Meetings inTokyo for their valuable and constructive comments concerning the issues discussed in this Section.
16

24

In recent years Asian monetary authorities have accumulated large quantities
of foreign reserves and sterilized these purchases through issuing central bank bills.
The objectives of Asian central banks in accumulating these reserves have been: 1) tobe prepared for another capital account crisis which would drain foreign reserves due
to massive reversals of short-term capital flows, and 2) to maintain competitive
exchange rates in order to sustain the export-oriented thrusts of their economies. 17
While Asian economies have maintained their export dynamism, problems are
emerging. The massive quantity of central bank bills in bank balance sheets haseroded the profitability of commercial banks and interfered with the allocation of
credit through the financial system. In addition, the real return measured indomestic terms on the more than one trillion dollars of external reserves is likely
to be zero, far below the private and social rates of return that could be earned if
investments were channeled into the domestic economy (Summers, 2006).
It might thus be an opportune time for Asian countries to begin weaning
themselves away from foreign reserve accumulation and instead to allow theircurrencies to appreciate. A free floating regime, however, would probably beinappropriate for developing countries in the region. Given their shallow and narrow
domestic capital markets, a free float would generate excessively volatile exchange
rates and disrupt the flow of FDI and intermediate goods. Instead, greater exchange
rate flexibility in the context of a multiple currency basket-based reference rate with aband would be preferable. 18

17

Observers agree that reserves are far in excess of those needed to meet a capital account crisis (see,e.g., Summers, 2006).
18
Greater flexibility would benefit China because it will begin to increasingly face de facto capital
account convertibility with the free entry of foreign banks for renminbi-based financial activities

25

There are currently a variety of exchange rate systems in the region. Japanand South Korea have essentially free floating regimes; Thailand uses a managed
float; Indonesia has a dollar peg; and China has a de facto fixed exchange rate
regime. 19 Under the current system, if the trade imbalances documented above
triggered appreciations in the region, currencies in developed Asia would
appreciate relative to currencies in developing Asia. This would harm firms inJapan, South Korea, and Taiwan by causing large drops in intermediate andcapital goods exports to the rest of Asia. In addition, this would harm firms indeveloping Asia since it is difficult for them to procure vital imported inputs
elsewhere.

This problem could be mitigated if countries with less flexible

exchange rate regimes adopted more flexible regimes.
In addition, countries should consider seeking higher returns on their existing
excess reserves (those above what are needed to be prepared for a capital accountcrisis). Singapore has invested excess foreign reserves in stocks, bonds, and otherassets since 1981. These reserves, managed by the Government of Singapore
Investment Corporation, have earned a nominal return in Singapore dollars of
8.2% per annum on average since 1981. Other countries in the region with large
quantities of excess reserves should consider a similar strategy.
If Asian countries allowed their currencies to appreciate instead ofaccumulating additional reserves, it would have a recessionary impact. This could be

due to the terms of her WTO accession commitments. In this case wider bands would enable her
to maintain greater monetary policy autonomy in the face of volatile capital flows. In addition,
increased flexibility would provide Chinese banks and traders with experience in managing
exchange rate risk
19

China made the first step towards moving away from a fixed exchange rate system on 21 July
2005. More changes are likely to follow.

26

offset by appropriate macroeconomic and structural policies. Switching policies suchas exchange rate appreciations thus need to be combined with absorption-increasing
policies.
Absorption-increasing policies include employing fiscal and structural
policies to build both physical and human infrastructure (particularly in rural areas),using deregulation to promote competition and productivity growth in the nontradable sector, and strengthening social safety nets so that consumers would haveless need for precautionary saving. These policies could promote production fordomestic markets and thus rely more on domestic markets rather than exports tocreate jobs.
Combining expenditure-increasing policies with expenditure-switchingpolicies would thus be the appropriate policy mix for Asian countries that had
previously accumulated massive reserves. On the one hand, without exchange rate
appreciations, policies aimed simply at increasing domestic demand could produce
overheated economies. On the other hand, without policies to increase domestic
demand, exchange rate appreciations would be contractionary. By combining thesetwo, namely by implementing an appropriate policy mix, could Asian economies
move away from excessive reserve accumulation and simultaneously achieve external
and internal equilibria.

VI. Conclusion

27

This paper has provided an analytical description of production networks inEast Asia. These networks have enabled firms to slice up long production
processes and allocate fragmented production blocks across developing, emerging,and developed economies in the region based on comparative advantage as
determined by relative endowments of capital, skill, and labor and by physical andinstitutional infrastructure. The resulting efficiency gains have been enormous.
Two sets of policy recommendations have emerged from the discussion inthis paper. The first concerns promote production networks, FDI flows, andtechnology transfer. The second concerns the appropriate policy mix for theregion.
In the first area lowering service link costs between fragmented production
blocks can facilitate the functioning of the sliced value chain. These costs can belowered by strengthening both the physical and the institutional infrastructure.
Developing countries can also facilitate technology transfer by investing in
education and public research institutes that indicate what technologies are mostappropriate to import. FTAs can also generate gains from trade, especially when
they are a stepping stone towards global liberalization. Finally, bilateral
investment treaties that guarantee a minimum standard under international law
can help attract and retain foreign investment in a country.
In the second area it is argued that continued reserve accumulation by Asian
central banks is becoming problematic. The accumulation of central bank bills onbank balance sheets has eroded the profitability of commercial banks and interferedwith the allocation of credit. In addition, the real return in domestic terms on the28

excess reserves is far below the private and social rates of return that could be earned
if investments were channeled into the domestic economy. Now might be an
opportune time for Asian countries to wean themselves away from continued foreign
reserve accumulation and instead to allow their exchange rates to appreciate. Suchexchange rate appreciations would be recessionary, however, and should be combinedwith absorption-increasing policies (e.g., investing in physical and humaninfrastructure).
Finally, governments in the region should consider seeking a higher return on
external reserves in excess of those needed to be prepared for a capital account crisis.
Singapore, for imstance, has invested excess foreign reserves in stocks, bonds, andother assets and earned a nominal return in Singapore dollars of 8.2% per annum on
average since 1981. If other East Asian countries were to receive comparable returns
on their massive reserves, the gains could equal $100 billion per year (see Summers,
2006).

29

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32

Figure 1A. Inward FDI Flows to East Asia

Percent of of Host Country or
Region GDP

7.0
6.0
5.0

China

4.0
S. Korea +Taiw an

3.0

ASEAN4

2.0
1.0
0.0
1993

1995

1997

1999

2001

2003

Year

Table 1A. Inward FDI Flows to East Asia (Percent of GDP)
Regions

1993

1996

1999

2000

2001

2002

2003

China

4.6

4.9

3.9

3.6

3.8

3.9

3.3

ASEAN 4

2.5

2.5

2.4

0.9

0.6

1.3

0.8

S. Korea + Taiwan

0.3

0.5

1.7

1.8

1.0

0.5

0.4

Source: CEPII-CHELEM Database.

33

Figure 1B. Outward FDI Flows from Japan and
the NIEs

Percent of GDP in HomeCountry or Region

1.6
1.4

Japan

1.2
1.0
0.8

S. Korea+
Taiw an

0.6
0.4
0.2
0.0
1992

1994

1996

1998

2000

2002

2004

Year

Table 1B. Outward FDI Flows from Japan and the NIEs (Percent of GDP)
Regions

1993

1996

1999

2000

2001

2002

2003

Japan

0.3

0.5

0.5

0.7

0.9

0.8

0.7

S. Korea + Taiwan

0.7

1.0

1.2

1.5

1.0

0.9

0.4

Source: CEPII-CHELEM Database.

34

Figure 2. Japanese Intermediate Goods Exports to East Asia
30000

Millions of U.S. Dollars

25000
20000
China
ASEAN 415000

S. Korea + Taiwan
10000
5000

03

04
20

20

02
20

01

00

20

20

99

98

19

97

19

19

95

94

96
19

19

19

19

93

0

Table 2. Japanese Intermediate Goods Exports to East Asia (Billions of U.S. Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

2004

China

6.2

9.2

10.1

12.1

12.6

15.6

21.1

25.7

ASEAN 4

12.0

20.0

14.3

18.4

15.5

15.8

17.3

19.7

S. Korea + Taiwan

14.5

19.5

16.3

20.1

15.0

16.6

19.3

22.9

Note: The data are defined in Appendix 2.

Source: CEPII-CHELEM Database

35

Figure 3. Exports from Japan to East Asia by Technological Intensity
Low-technology
products(2.94%)

Med.-low-technology
products(20.26%)

Medium-high-technology
prod.
(46.73%)High-technology
products(30.07%)

Source: CEPII-CHELEM Database
Note: Technological intensity is calculated based on the type of goods exported
measured at the HS 6 digit level. For instance, 252 products at the HS 6 digit
level are classified as high-tech. See Gaulier et al. (2005).

36

Figure 4. S. Korea and Taiwan's Intermediate
Goods Exports to East Asia
35000

Millions of U.S. Dollars

30000
25000
Japan
20000

China
ASEAN 415000

S. Korea and Taiwan
10000
5000

03

04
20

20

02
20

01

99

00

20

20

98

19

96

95

97

19

19

19

19

94
19

19

93

0

Table 3. S. Korea’s and Taiwan’s Intermediate Goods Exports to East Asia (Billions
of U.S. Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

2004

Japan

3.8

7.0

6.9

10.3

8.1

8.4

10.4

12.5

China

5.6

9.3

10.7

13.1

11.8

14.4

20.7

29.1

ASEAN 4

4.6

8.7

10.1

11.2

7.8

8.0

8.6

10.5

S. Korea + Taiwan

1.7

3.1

3.9

5.8

4.6

5.2

6.4

9.2

Note: The data are defined in Appendix 2.

Source: CEPII-CHELEM Database.

37

Figure 5. Exports from the NIEs to East Asia by Technological Intensity
Low-technology
products(9.83%)

Med.-low-technology
products(20.75%)High-technology
products(45.83%)Med.-high-technology
prod.
(23.59%)Source: CEPII-CHELEM Database
Note: Technological intensity is calculated based on the type of goods exported
measured at the HS 6 digit level. For instance, 252 products at the HS 6 digit
level are classified as high-tech. See Gaulier et al. (2005).

38

Figure 6. ASEAN 4's Intermediate Goods Exports to East Asia
16000
14000

Millions of Dollars

12000
10000

Japan
China

8000

ASEAN 4
S. Korea + Taiwan

6000
4000
2000

03

04
20

20

01

02
20

00

20

20

19

99

98

97

19

19

95

94

96
19

19

19

19

93

0

Table 4. ASEAN 4’s Intermediate Goods Exports to East Asia (Billions of U.S.
Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

2004

Japan

4.5

7.5

7.2

8.7

8.1

8.5

9.7

10.2

China

1.0

1.6

2.9

4.2

4.4

7.0

10.9

14.2

ASEAN 4

1.2

3.3

4.9

6.1

5.4

6.7

8.2

8.7

S. Korea + Taiwan

2.3

4.8

7.8

7.5

6.4

7.6

8.3

6.2

Note: The data are defined in Appendix 2.

Source: CEPII-CHELEM Database

39

Figure 7. Exports from ASEAN to East Asia by Technological Intensity
Med.-low-technology
products(16.89%)Med.-high-technology
products.
(21.64%)High-technology
products(38.55%)

Low-technology
products(22.92%)

Source: CEPII-CHELEM Database
Note: Technological intensity is calculated based on the type of goods exported
measured at the HS 6 digit level. For instance, 252 products at the HS 6 digit levelare classified as high-tech. See Gaulier et al. (2005).

40

Figure 8. Exports from ASEAN to China by Technological Intensity

Med-low-technology
products(11.41%)

Low-technology
products(14.27%)High-technology
products(58.10%)Med-high-technology
prod.
(16.22%)

Source: CEPII-CHELEM Database
Note: Technological intensity is calculated based on the type of goods exported
measured at the HS 6 digit level. For instance, 252 products at the HS 6 digit levelare classified as high-tech. See Gaulier et al. (2005).

41

Figure 9. China's Intermediate Goods Exports to East Asia
10000
9000

Millions of Dollars

8000
7000
6000

Japan

5000

ASEAN 44000

S. Korea + Taiwan

3000
2000
1000

03

04
20

20

01

02
20

00

20

20

19

99

98

97

19

19

95

94

96
19

19

19

19

93

0

Table 5. China’s Intermediate Goods Exports to East Asia (Billions of U.S. Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

2004

Japan

1.1

2.4

2.9

4.0

4.3

4.9

6.3

8.7

ASEAN 4

0.7

1.2

1.6

2.0

2.2

2.9

3.8

5.3

S. Korea + Taiwan

0.8

1.9

2.5

3.3

3.2

4.2

5.2

7.3

Note: The data are defined in Appendix 2.

Source: CEPII-CHELEM Database42

Figure 10. Exports from China to East Asia by Technological Intensity

Med.-low-technology
products(16.47%)High-technology
products(32.28%)Med.-high-technology
prod.
(19.97%)

Low-technology
products(31.28%)Source: CEPII-CHELEM Database
Note: Technological intensity is calculated based on the type of goods exported
measured at the HS 6 digit level. For instance, 252 products at the HS 6 digit levelare classified as high-tech. See Gaulier et al. (2005).

43

Figure 11. Intermediate Goods Imports of Individual East AsianCountries and Regions from East Asia as a Whole
80000

Millions of U.S. Dollars

70000
60000
Japan

50000

China

40000

ASEAN 430000

S. Korea and Taiwan

20000
10000

03

04
20

20

02
20

01

99

00

20

20

98

19

96

95

97

19

19

19

19

94
19

19

93

0

Table 6. Intermediate Goods Imports of Individual East Asian Countries andRegions from East Asia as a Whole (Billions of U.S. Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

2004

Japan

9.4

16.8

16.9

22.9

20.5

21.8

26.3

31.4

China

12.8

20.2

23.7

29.3

28.8

37.0

52.6

67.0

ASEAN 4

18.4

33.2

30.9

37.6

30.9

33.4

37.8

44.2

S. Korea + Taiwan

19.3

29.3

30.6

36.7

29.2

33.6

39.2

45.5

Note: The data are defined in Appendix 2.

Source: CEPII-CHELEM Database

44

45

Table 7.
China’s Processing Trade – 1993 and 2005
Imports (%)

1993
Total Imports
Normal Imports
Imports for
Processing
Others2005
Total Imports
Normal Imports
Imports for
Processing
OthersWorld

S. Korea &TaiwanJapan

ASEAN 5Hong Kong

United States

EuropeRest of World

100
37

18
2

22
8

6
3

10
1

10
5

15
8

19
9

35
28

11
5

8
7

2
1

7
2

2
3

2
6

3
5

100
42

23
6

15
5

11
3

2
1

7
4

11
6

31
17

42
16

14
3

7
3

6
2

1
0

2
2

2
2

10
4

World

S. Korea &TaiwanJapan

ASEAN 5Hong Kong

United States

EuropeRest of World

100
47
48
5

5
2
2
0

17
10
7
0

5
4
1
0

24
10
14
0

18
6
13
0

13
7
7
0

18
9
4
5

100

7

11

6

16

21

17

21

41
55
4

3
3
0

4
7
0

3
3
0

3
12
1

7
14
1

7
10
0

13
6
2

Exports (%)

1993
Total Exports
Normal Exports
Processed Exports
Others2005
Total Exports
Normal Exports
Processed Exports
Others46

Table 7 (continued).
China’s Processing Trade – 1993 and 2005

1993
Balance of trade
Normal trade
Processing trade
Others

World
-12.2
5.2
7.9
-25.2

2005
Balance of trade
Normal trade
Processing trade
Others

102.0035.43
142.46-75.88

Balance of Trade (billions of US Dollars)
S. KoreaJapan
ASEAN 5
&Taiwan
-14.0
-7.5
-1.3
0.3
0.7
-0.1
-9.5
-1.3
-0.6
-4.9
-6.9
-0.6

-99.84-12.91-69.25-17.69-16.42-2.45
4.49-18.46-23.81
1.95-13.31-12.44

Hong Kong
11.60
7.7
5.7
-1.7

United States
6.3
0
9.7
-3.4

Europe
-3.5
-2
4.2
-5.8

Rest of World
-3.8
-1.5
-0.3
-1.9

112.25
21.59
85.05
5.61

114.27
26.91
92.94
-5.58

61.37
14.36
60.42
-13.41-45.81-14.01-17.88-13.91

Notes: Source: Gaulier, Lemoine, and Nal-Kesenci (2005), China’s Customs Statistics, and calculations by the authors. Europe includes Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Luxembourg, Netherlands, Italy, Portugal, Spain, and Sweden.

47

48

Figure 12. China's Imports for Processing by Country andRegion10000090000

Millions of Dollars

80000
S. Korea + Taiwan

70000

Japan

60000

ASEAN 550000

Europe

40000

U.S.

30000

Hong Kong

20000
10000

04
20

20

02

00
20

19

98

96
19

94
19

19

92

0

Table 8. China’s Imports for Processing by Country and Region (Billions of U.S.
Dollars)
Regions

1992

1995

1998

2001

2002

2003

2004

2005

3.9

15.6

16.7

19.9

25.0

32.8

40.2

45.2

5.0

17.9

22.7

30.4

39.3

53.3

75.9

94.9

ASEAN5

1.3

4.2

6.7

10.4

14.9

22.6

30.0

37.4

U.S.

2.0

3.7

4.9

5.5

6.9

8.1

11.0

12.8

Europe

1.1

2.9

3.6

5.9

6.3

6.9

9.8

12.1

Hong Kong

16.6

6.3

5.2

6.6

8.0

7.7

7.8

7.7

Japan
S. Korea + Taiwan

Source: China Customs Statistics (2006)

49

Figure 13. China's Processed Exports by Country and Region
120000Millions of Dollars

100000U.S.

80000

Hong Kong
Europe

60000

Japan
S. Korea + Taiwan

40000

ASEAN 5

20000

04
20

02

00

20

19

20

98

96
19

19

19

92

94

0

Table 9. China’s Processed Exports by Country and Region (Billions of U.S.
Dollars)
Regions

1992

1995

1998

2001

2002

2003

2004

2005

3.5

14.8

17.5

25.3

28.2

35.1

43.5

49.7

0.8

5.0

5.9

8.7

10.9

14.5

21.0

25.7

ASEAN5

0.9

3.4

5.1

8.0

10.2

12.8

18.4

24.1

U.S.

27.1

17.2

23.4

36.3

46.8

62.4

83.7

105.7

Europe

2.4

8.5

12.2

21.9

25.5

39.9

55.5

72.6

Hong Kong

24.9

18.9

24.8

34.2

42.3

54.6

72.2

92.7

Japan
S. Korea + Taiwan

Source: China Customs Statistics (2006)

50

Figure 14. China's Trade Balance in Processed Goods byCountry and Region
120000100000

60000

U.S.

40000

Hong Kong
Europe

20000

Japan

0
04

S. Korea + Taiwan

20

20

20

02

00

98
19

96
19

94
19

92

-20000ASEAN 519

Millions of Dollars

80000-40000-60000-80000

Table 10. China’s Trade Balance in Processed Goods by Country and Region(Billions of U.S. Dollars)
Regions

1992

1995

1998

2001

2002

2003

2004

2005

-0.4

-0.7

0.9

5.3

3.1

2.4

3.3

4.5

-4.2

-12.9

-16.8

-21.8

-28.4

-38.7

-54.9

-69.3

-0.4

-0.8

-1.6

-2.4

-4.7

-9.9

-11.7

-13.3

U.S.

-2

13.5

22.3

30.8

40.0

54.3

72.7

92.9

Europe

1.4

5.6

11.5

15.9

19.2

33.0

45.7

60.4

Hong Kong

8.3

12.6

18.6

27.5

34.3

46.9

64.3

85.1

Japan
S. Korea + Taiwan
ASEAN5

Source: China Customs Statistics (2006)

51

Figure 15. China's Value-Added in Processed Trade
40
35
30

Percent

25
Series1

20
15
10
5
0
1992

1994

1996

1998

2000

2002

2004

Note: Value-added is defined as the difference between the value pf China’s processedexports and the value of China’s imports for processing, divided by the value of China’s
processed exports.
Source: China Customs Statistics (2006)

52

Figure 17. Japan's Revealed Comparative Advantage
20
15
10
5
Primary0-51993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004-10

Basic manufacturing
Intermediate goods
Equipment goods
Consumption goods

-15
-20
-25
-30

Note: The data are constructed for individual products using shares of the overall tradebalance rather than relative export structure as in Balassa (1965). Values for stages of
production are then calculated by summing. See www.cepii.fr for a detailed descriptionof how the data are constructed.

Source: CEPII-CHELEM database53

Figure 18. The NIEs' Revealed Comparative Advantage
60
40
20
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
-20

Primary
Basic manufacturing
Intermediate goods

-40
-60

Equipment goods
Consumption goods

-80
-100
-120

Note: The data are constructed for individual products using shares of theoverall trade balance rather than relative export structure as in Balassa (1965).
Values for stages of production are then calculated by summing. See
www.cepii.fr for a detailed description of how the data are constructed.

Source: CEPII-CHELEM database54

Figure 19. ASEAN's Revealed Comparative Advantage
50
40
30
20
Primary

10

Basic manufacturing

0-10Intermediate goods
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Equipment goods
Consumption goods

-20
-30
-40
-50

Note: The data are constructed for individual products using shares of the overall
trade balance rather than relative export structure as in Balassa (1965). Values forstages of production are then calculated by summing. See www.cepii.fr for a
detailed description of how the data are constructed.

Source: CEPII-CHELEM database55

Figure 20. China's Revealed Comparative Advantage
80
60
40
Primary
20

Basic manufacturing
Intermediate goods

0Equipment goods
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Consumption goods

-20
-40
-60

Note: The data are constructed for individual products using shares of the overall
trade balance rather than relative export structure as in Balassa (1965). Values forstages of production are then calculated by summing. See www.cepii.fr for a
detailed description of how the data are constructed.

Source: CEPII-CHELEM database56

Table 12. The Degree of Competition between Asian Countries’ Exports to the U.S. andChina’s Exports to the U.S. in 2003*_______________________________________________________________Japan
South Korea
TaiwanSingapore
Indonesia
Malaysia
Philippines
Thailand

21.9%
40.9%
68.8%
40.1%
66.8%
65.0%
60.7%
69.8%

_______________________________________________________________* A higher number indicates greater competition in individual product categories.
Source: Updated from Kwan (2002).

57

Appendix 1. Studies Investigating Whether FDI Flows to China Have
Crowded Out FDI Flows to Other Asian Countries 20
1. Kamaky, Ahmed. 2003. “Behind the Surge of FDI to Developing Countries in the
1990s: An Emprical Investigation,” Working Paper of Department of Economics,
American University of Cairo, Egypt.
Kamaly (2003) adopted a fixed-effects formulation with a lagged dependent variable,
which is ( FDI / GDP) ratio. More specifically, the model takes the form of:y it = α + μ i + δy it −1 + xit′ β + u it ,u it ~ iid (0, σ u2 )In line with Arrelano and Bond (2003), a set of explanatory variables of the model has
been used as instruments on the condition that E ( xit u is ) = 0, where s < t , for correcting
the bias that would arise from usual OLS or fixed effects (within) estimator. Using the
moment conditions involving the matrix of instruments, the paper obtained two variant of
GMM estimators of the parameters δ and β . The first estimation has been done in linewith Arrelano-Bond two step GMM-IV estimators, while the second estimation was
based on extended GMM-IV estimators, what the paper termed as GMM-SYS estimators.
The second approach has the benefit of no need of first differencing, since GMM-SYS
incorporates additional moment conditions by including additional instruments that are
not correlated with the country fixed effects, μi .
The estimation results of the base regression (as reported in Table-6) show that the lagged
dependent variable has statistically significant large coefficient of 0.73 exhibiting a highdegree of inertia in FDI flows. The second largest coefficient is -0.041 for ‘bond yield in
G7 countries’ as against 0.024 and 0.010 for ‘lagged real GDP growth rate’ and‘openness’ variables respectively. A very high magnitude of lagged FDI/GDP combinedwith relatively small quantitative effects of the explanatory variables has been attributed
to the persistence of FDI flows. The paper argued that the international interest rate has
also been more important driving force behind FDI flows, as against country specificfactors such as openness and economic growth. Overall, the past value of FDI largely
determines the current level of FDI flows, probably explaining observed stability in FDI
flows to some countries.
Controlling for other regressors such as exchange rate variability (as a proxy for
uncertainty), democracy, capital control and financial deepening, the study shows that
GMM-SYS estimators are found more consistent compared to other competing estimators
as derived OLS, between or within estimators or GMM_IV (Please see Table-8).

2. Mercereau, Benoit. 2005. “FDI Flows to Asia: Did the Dragon Crowd out the
Tigers?” IMF Working Paper WP/05/189.

Mercereau questioned use of log(FDI) as it assumes percentage change in FDI instead of
the changes in the levels of FDI flows and thus not capturing the very notion of crowding
20

This Appendix was written by Mizanur Rahman.

58

out effects. The paper rather used FDI to China relative to total GDP of other countries of
the region and also FDI to China relative to total FDI to the region and then estimated theimpact of China on FDI flows to other countries by the flowing equation:
fdi jt = δfdi jt −1 + βX jt + αChinat + μ j + ε jt , where fdi jt is FDI to GDP ratio of country
j at time t and Chinat is FDI flows to China scaled by either total GDP of the region or
total FDI flows to the region. The findings show that a 10 percent increase in China’s
FDI market share (i.e., China’s FDI relative to total FDI to the region) appears to havelowered, on average, annual flows to other nations by about 0.4 percent of GDP. Given
that China’s market share rose from an average of 26 percent in the pre-reform period(1984-91) to one of 56 percent in the post-reform period, 1992-2002, China’s negative
impact on flows of FDI to other countries was around 1.3 percent a year on average.
When the estimation is done with the interaction term (Chinat * country _ dummy ) , only
two coefficients (Singapore and Myanmar) come out to be statistically significant. The
paper argued that the role of overseas Chinese might explain the effect on Singapore, as
the overseas Chinese account for a significant share of foreign investment in China.
They invest in China because they have family connection or linguistic and cultural ties
in the mainland China. Here the paper further argued that since Taiwanese investors
channel their funds through Hong Kong and Singapore, a significant negative coefficientfor Singapore while a statistically insignificant coefficient for Taiwan appear plausible.
For Myanmar, the paper argued Singapore is the second largest investor to the country,
while the traditional large suppliers such as the US and the EU stopped investing there.
The study explained that a very restrictive investment and trading regime in Myanmar
might divert Singapore’s FDI from Myanmar to China.

However, it seems that FDI flows to countries are little correlated with theirmacroeconomic fundamentals, rather much to factors such as country’s strategic positionin the international trade. For example, East Asian countries received stable flows of
substantial share of FDIs, because these nations are the center of the gravity ofinternational organization of production. They belong to a cross-border integrated
production network where each country has its industrial organization in line withcomparative advantage in international trade. If this is true, technological development
and industrial upgrdation in those nations are endogenized by their dynamic position in
the international production networks. Flows of FDIs are then an outcome of thisintegrated production relationship, much less due to their idiosyncratic macroeconomic
policies and also factors such as GDP growth rate, exchange rate volatility, democracy
etc. The existing literature (e.g., Kamaly, 2003) documented that FDI flow shows apattern of long term inertia as the coefficient of lagged FDI/GDP ratio has outweighed
cumulative magnitudes of other impacts by a multiple of four.

3. Eichengreen and Tong (2005) estimated gravity model in an instrumental variable(IV) regression framework to examine impact of Chinese FDI inflows on regional FDI
inflows to Asia, Latin America, Central and Eastern Europe, and OECD countries. The
findings show that Chinese FDI has a significant positive impact on FDI inflows to Asia,

59

but a significant negative impact on FDI flows to OECD countries. The paper also showsthat there is little evidence on the impact of China’s FDI on other regions such as Latin
America, and Central & Eastern Europe. The paper argues that in addition to relative
costs of production, market-size considerations may have affected investors’ decisions tobring in FDI to China. However, the paper fails to address any issues surrounding theevidence of complimentary pattern FDIs in Asia. In further desegregation to examine
impact of China’s FDI on other Asian countries, they included interaction termsof country i * ChinaFDIfitted . They find significant positive coefficients for all Asian
countries—coefficients for Japan and Singapore are largest in magnitude, while they aresmallest for Korea, Pakistan and Bangladesh. The study explained Japan and Singapore
are two major producers of capital goods and electronic components that are used in
Chinese manufacturing and therefore are main originating countries of Chinese FDI.
Though the study attributed smaller coefficients for Bangladesh and Pakistan to their
weak link in the supply-chain of China, smaller coefficient for Korea has been labeled asa “hollowing out” effect of Korean domestic industry. This reasoning is likely to be
misplaced as we see a very wider trading relationship between Korea and China, which
has been along the line value-chain of international production organization in East Asia.
If it is so, positive impact of Chinese FDI on all Asian countries may not be robust if timeeffect is properly accounted for. As Kalamly (2003) found that FDI flows exhibit a highdegree of inertia to its observed pattern.

60

Appendix 2. The definition of intermediate goods and parts andcomponents.
1) CEPII Data_________________________________________________________________
CEPII Classification of Intermediate Goods(SITC Equivalents in Parentheses)________________________________________________________________________
Intermediate Goods

1. Engines, Turbines and Pumps(See note 1)
2. Electric Components(See note 2)
3. Vehicle Components(Parts and accessories of motor
vehicles)4. Tubes & 1st stage processing products(Iron and steel wire, tubes, pipes,
and pipe fitting)
5. Yarns and Fabrics(See note 3)
6. Wood Articles(Cork and wood manufactures,
excluding furniture)
7. Paper and Pulp
(Pulp, waste paper, paper, paperboard,
Articles of paperboard or paper)
8. Metallic structure(Iron, steel, aluminum structures and61parts, metal containers for storage andtransport)
9. Miscellaneous Hardware(See note 4 )10. Fertilizers(See note 5)
11. Paints(See note 6)
12. Plastics, Fibers and Synthetic resins(synthetic rubber, reclaimed rubber
waste of unhardened rubber, synthetic
and man made fibers for spinning),

13. Rubber Articles(Rubber manufactures)

Source: CEPII-CHELEM database
Notes:
1.
••••741 - Heating and cooling equipment, and parts thereof, n.e.s.
742 - Pumps for liquids, whether or not fitted with a measuring device; liquid elevators;
parts for such pumps and liquid elevators
743 - Pumps (other than pumps for liquids), air or other gas compressors and fans;ventilating or recycling hoods incorporating a fan, whether or not fitted with filters;
centrifuges; filtering or purifying apparatus; parts thereof
71 - Power-generating machinery and equipment

2.
•776 - Thermionic, cold cathode or photo-cathode valves and tubes (e.g., vacuum or vapour
or gas-filled valves and tubes, mercury arc rectifying valves and tubes, cathode-ray tubes,
television camera tubes); diodes, transistors and similar semiconductor devices;
photosensitive semiconductor devices; light-emitting diodes; mounted piezoelectric
crystals; electronic integrated circuits and microassemblies; parts thereof

62

3.
•
•
•
•
•
•

651 - Textile yarn
652 - Cotton fabrics, woven (not including narrow or special fabrics)
653 - Fabrics, woven, of man-made textile materials (not including narrow or special
fabrics)
654 - Other textile fabrics, woven
655 - Knitted or crocheted fabrics (including tubular knit fabrics, n.e.s., pile fabrics andopenwork fabrics), n.e.s.
657 - Special yarns, special textile fabrics and related products

4.
•
•
•
•
•
•
•
•
•

•

693 - Wire products (excluding insulated electrical wiring) and fencing grills
694 - Nails, screws, nuts, bolts, rivets and the like, of iron, steel, copper or aluminium
695 - Tools for use in the hand or in machines
696 - Cutlery
697 - Household equipment of base metal, n.e.s.
699 - Manufactures of base metal, n.e.s.
746 - Ball- or roller bearings
747 - Taps, cocks, valves and similar appliances for pipes, boiler shells, tanks, vats or the
like, including pressure-reducing valves and thermostatically controlled valves
748 - Transmission shafts (including camshafts and crankshafts) and cranks; bearing
housings and plain shaft bearings; gears and gearing; ball screws; gearboxes and otherspeed changers (including torque converters); flywheels and pulleys (including pulley
blocks); clutches and shaft couplings (including universal joints); articulated link chain;parts thereof812 - Sanitary, plumbing and heating fixtures and fittings, n.e.s.

5.
•

•

591 - Insecticides, rodenticides, fungicides, herbicides, anti-sprouting products and plantgrowth regulators, disinfectants and similar products, put up in forms or packings for retailsale or as preparations or articles (e.g., sulphur-treated bands, wicks and candles, and flypapers)
56 - Fertilizers (other than those of group 272)

6.
•
•
•
•
•
•

598.1 - Wood- and resin-based chemical products
598.3 - Artificial waxes and prepared waxes
598.4 - Mixed alkylbenzenes and mixed alkylnaphthalenes, n.e.s.
598.5 - Chemical elements doped for use in electronics, in the form of discs, wafers orsimilar forms; chemical compounds doped for use in electronics
598.6 - Organic chemical products, n.e.s.
597.2 - Anti-knock preparations, oxidation inhibitors, gum inhibitors, viscosity improvers,anti-corrosive preparations and other prepared additives for mineral oils (including
gasoline) or for other liquids used for the same purposes as mineral oils

63•

53 - Dyeing, tanning and colouring materials

1) RIETI-TID Data

Parts and Components are defined based on the Broad Economic Classification(BEC) of the United Nations. They include 1) parts and components of capital goods(BEC code 42) and parts and accessories of transport equipment (BEC code 521)

64

Appendix 3. Parts and Components Exports from East AsianCountries.
Figure 2A. Japanese Parts and Components Exports to East
Asia
30000

Millions of U.S. Dollars

25000
20000
China
ASEAN 415000

S. Korea + Taiwan
10000
5000

03

04
20

20

01

02
20

00

20

20

99

98

19

97

19

19

95

94

96
19

19

19

19

93

0

Table 2A. Japanese Parts and Components Exports to East Asia (Billions of U.S.
Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

China

4.5

7.6

11.2

14.1

14.8

18.6

26.8

ASEAN 4

13.2

23.8

15.8

20.4

18.1

19.4

20.7

S. Korea + Taiwan

14.4

18.7

17.7

22.2

16.5

18.1

21.2

Note: The data are defined in Appendix 2.
Source: RIETI-TID database.

65

Figure 4A. S. Korea and Taiwan's Parts and Components
Exports to East Asia

Millions of U.S. Dollars

25000

20000
Japan

15000

China
ASEAN 4
10000

S. Korea and Taiwan

5000

03

04
20

20

02
20

01

99

00

20

20

98

19

96

95

97

19

19

19

19

94
19

19

93

0

Table 4A. S. Korea’s and Taiwan’s Parts and Components Exports to East Asia
(Billions of U.S. Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

Japan

2.9

6.6

7.5

11.3

9.0

9.4

10.9

China

0.5

1.7

4.2

6.3

6.4

10.2

19.2

ASEAN 4

2.9

6.5

8.1

8.7

6.3

7.7

7.8

S. Korea + Taiwan

1.2

2.5

3.7

5.5

4.1

5.0

6.4

Note: The data are defined in Appendix 2.
Source: RIETI-TID database.

66

Figure 6A. ASEAN 4's Parts and Components Exports to East
Asia
16000
14000
Millions of Dollars

12000
Japan

10000

China

8000

ASEAN 4

6000

S. Korea + Taiwan

4000
2000

03

04
20

20

01

02
20

00

20

20

99

98

19

97

19

19

95

94

96
19

19

19

19

93

0

Table 4A. ASEAN 4’s Parts and Components Exports to East Asia (Billions of U.S.
Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

Japan

1.9

4.4

6.4

9.2

7.9

7.5

8.9

China

0

0.6

2.5

4.9

6.3

9.4

14.8

ASEAN 4

1.3

4.2

5.5

7.6

6.5

8.9

9.8

S. Korea + Taiwan

1.3

3.7

6.8

10.4

8.7

8.8

9.0

Note: The data are defined in Appendix 2.
Source: RIETI-TID database.

67

Figure 9A. China's Parts and Components Exports to East Asia
12000

Millions of Dollars

10000
8000
Japan
ASEAN 4

6000

S. Korea + Taiwan
4000
2000

03

04
20

20

01

02
20

00

20

20

99

98

19

97

19

19

95

94

96
19

19

19

19

93

0

Table 6A. China’s Parts and Components Exports to East Asia (Billions of U.S.
Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

Japan

0.7

2.7

4.1

5.8

6.5

7.6

9.6

ASEAN 4

0.2

1.2

1.7

2.2

2.7

4.0

5.7

S. Korea + Taiwan

0.2

1.6

2.6

3.8

4.0

5.3

7.2

Note: The data are defined in Appendix 2.
Source: RIETI-TID database.

68

Figure 10A. Parts and Components Imports of Individual East
Asian Countries and Regions from East Asia as a Whole
70000.00

Millions of U.S. Dollars

60000.00
50000.00
Japan
40000.00

China
ASEAN 430000.00

S. Korea and Taiwan
20000.00
10000.00

03

04
20

01

02

20

20

99

00

20

20

97

98

19

19

95

96

19

19

94

19

19

19

93

0.00

Table 6A. Parts and Components Imports of Individual East Asian Countries andRegions from East Asia as a Whole (Billions of U.S. Dollars)
Regions

1993

1996

1999

2000

2001

2002

2003

Japan

5.4

13.8

18.1

26.2

23.3

24.5

29.4

China

5.0

9.9

17.9

25.3

27.4

38.2

60.8

ASEAN 4

17.5

35.4

31.0

38.9

33.5

40.0

44.0

S. Korea + Taiwan

17.0

26

30.8

41.8

33.3

37.2

43.8

Note: The data are defined in Appendix 2.
Source: RIETI-TID database69

NEAT Working Group Workshop on“Trade-FDI-Technology Linkages in East Asia”
7 July 2006, RIETI, Tokyo
The Name of Participants
Member<Brunei>Dr. Siew Yean Teo

Economics Lecturer, Department of Economics, Faculty of Business,
Economics and Policy Studies, Universiti Brunei Darussalam<China>Dr. Liping HE

Professor and Chair of Department of Finance at School of
Economics and Public Administration, Beijing Normal University<Indonesia>
Dr. Ninasapti Triaswati

The Indonesian Institute, Board of Advisor, responsible for advising
any economic issues associated with project carried out by the firm

<Korea>Prof. Choong-Lyol

Lee, Professor, Department of Economics, Korea University at
Suchang Campus<Laos>
Mr. Sitthiroth RASPHONE

Research Officer, National Economic Research Institute (NERI),
Committee for Planning and Investment (CPI)<Singapore>Prof. John Wong

Research Director of the East Asian Institute (EAI) of the National
University of Singapore<Thailand>
Dr. Chawin Leenabanchong

Associate Professor, Faculty of Economics, Thammasat
University<Vietnam>
Mr. Nguyen Tien Phong

Lecturer at the World Economic Faculty, Instittute for International
Relations<Cambodia> (absent)
Mr. PUTH Hemonna

Deputy Director ASEAN & Int’l Organization Department Ministryof Commerce Phnom Penh

<Malaysia, Myanmar and Philippines>
Nobody was recommended by County Coordinators<Japan>Dr. Masaru Yoshitomi, President and Chief Research Officer, RIETI (Chairman)
Dr. Willem H. THORBECKE, Senior Research Fellow, RIETI (Co-author with Dr.Yoshitomi)

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ParticipantsProf. Akira KOTERA

Professor of Graduate School of Arts and Sciences, University ofTokyo /Faculty Fellow, RIETI

Mr. Shigeaki SHIRAISHI Director, Policy Planning and Research Division, Trade Policy
Bureau, METI / Consulting Fellow, RIETI
Prof. Shujiro URATA

Professor of Graduate School of Asia-Pacific Studies, Waseda
University /Faculty Fellow, RIETI

Observers
Mr. Kozo OIKAWA

Chairman, RIETI

Mr. Yasuo TANABE

Vice-President, RIETI

Mr. Yuji HOSOYA

Director of Research

Mr. Masahiko OZAKI

Coordinator of Research, RIETI

Dr. LIU Junsheng

Visiting Scholar, RIETI

Amb. Naotoshi, SUGIUCHI

Councilor, the Japan Forum on International Relations (JFIR)

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