The inability to conclude the comprehensive WTO Doha Round has spawned a proliferation of bilateral and plurilateral free trade agreements (FTAs) across the globe. While East Asia is a relative newcomer to FTAs, the region has seen dramatic growth in FTAs in recent years. A lively debate over the impact of FTAs on business in the region has resulted.
Data from East Asian exporters were lacking prior to an Asian Development Bank (ADB) firm-level survey conducted in 2007–2008. The survey results suggest that FTAs are indeed bolstering trade among firms – particularly as economic recovery takes hold – in the wake of declining trade volumes and the nascent protectionism triggered by the global economic crisis. To optimise use of the region’s multitude of FTAs, firms need to plan trade businesses more efficiently and effectively under a regime anchored by the region’s FTAs. Meanwhile, policymakers should seek to minimise transaction and administrative costs associated with an array of multiple, overlapping FTAs, while maximising benefits offered by preferential tariffs and increased market access.
The expansion of trade agreements in East Asia
For the past 25 years, rapid expansion in trade – both with developed markets outside the region and increasingly within East Asia itself – has accelerated the process toward regional economic integration. In addition, foreign direct investment (FDI) brought external funding, better production technology and management know-how, and efficient distribution channels linked to outside markets. This long period of market-driven expansion helped East Asia become a global factory by applying existing technologies and then innovating. East Asian firms acquired the technological capabilities to either compete internationally or become suppliers to multinational corporations. In addition, the intraregional concentration of trade and FDI activities rose as production networks involving Asian firms deepened regionally. For example, East Asia’s share of intraregional trade as a percentage of total trade increased from 30% to 54% between 1980 and 2007.
East Asian governments began to emphasise FTAs as instruments of trade policy in the late 1990s. In 2000, only three FTAs were in effect throughout the region. But today East Asia is at the forefront of world FTA activity. As of July 2009, there were 47 FTAs in effect, with another 64 in the pipeline (Figure 1).
Figure 1. Growth of FTAs in East Asia
Note: All FTAs include concluded FTAs, FTAs under official negotiation, and proposed FTAs in East Asia. East Asia covers the 10 ASEAN members; Japan; Korea; PRC; Hong Kong, China; and Taipei, China. Source: Asian Development Bank Asia Regional Integration Center (ARIC) Database; data as of June 2009.
Properly designed FTAs keep trade and FDI flowing, even when crisis strikes. Yet, the plethora of overlapping and complex FTAs in East Asia carries the risk of becoming unwieldy and making business cumbersome. Influenced by Jagdish Bhagwati's famous remark about a spaghetti bowl of FTAs, critics argue that the explosion of deals, with complex rules and variable tariffs, has increased transaction costs, particularly for small- and medium-sized enterprises (SMEs) – those that can least afford them (see Bhagwati, 2008 for an excellent synthesis). They also argue that the multiplicity of bilateral and plurilateral deals hinders the broader push toward a global trade agreements. The spaghetti bowl phenomenon is popularly known as the "noodle bowl" effect in Asia and has led Richard Baldwin and Philip Thornton (2008) to propose a "WTO Action Plan on Regionalism" that includes deepening of the transparency mechanism for FTAs.
For the first time, the ADB study on FTAs sought the views of those most directly affected – the region’s export-oriented firms. The results showed that these businesses view FTAs as a benefit rather than a burden and use them to expand trade to a far greater degree than had been previously thought. The benefits of FTAs include wider market access and preferential tariffs that make it easier to import intermediate materials needed for finished goods. Multiple country rules of origin (ROOs), which determine where goods originate from for a variety of purposes, including quotas and labelling, may add some administrative and transaction costs. But the large majority of exporters do not view ROOs as a significant hindrance to business activity. In addition, bilateral and plurilateral FTAs counter protectionist tendencies amid the current economic uncertainty. They provide a valuable stepping stone toward broader trade liberalisation in support of economic recovery.
An empirical view of FTA impacts at the firm level
Previous country- and industry-level studies suggested low FTA utilisation rates in East Asia, with the agreements being viewed as discriminatory and a drain on scarce trade negotiation capacity in developing countries. To test this hypothesis, the ADB study sought the views of and experience with FTAs from 841 manufacturing firms based in the People’s Republic of China (PRC), Japan, Singapore, the Republic of Korea (Korea), Thailand, and the Philippines (for an overview see Kawai and Wignaraja, 2009).
A plurality of the survey’s participating firms were from the electronics sector (32%), followed by the automotive (20%) and textile and garments (17%) sectors. The remaining firms were exporters of chemicals and pharmaceuticals, metals and machinery, and food processing. SMEs (100 or less employees) comprised 32% of the survey sample, “large” firms (100–1,000 employees) made up 44%, and “giant” firms (1000 or more employees) comprised the remaining 21%. The questions asked were:
- are FTA preferences being used?
- what are the costs and benefits of FTAs?
- are multiple ROOs a burden, particularly for SMEs?
- is there enough support for domestic firms to utilise trade preferences under FTAs?
The percentage of surveyed firms utilising FTA preferences was higher than expected based on results from the few existing studies in the region: about 28% of respondents were using FTA preferences while another 25% had plans to do so. Firms from the PRC, Japan, and Thailand were the highest users of FTAs, while firms in Singapore, the Philippines, and Korea made the least use of FTAs (Figure 2).
Figure 2. Utilisation of FTA preferences (% respondents)
The larger use of FTAs in the PRC was attributed to the aggressive build-up of new and expanding production networks that required channelling resources across the region. The high levels of actual and planned FTA use in Japan may be explained by (i) the presence of giant manufacturing firms that are anchors for regional production networks and (ii) networks of private sector industry associations and public trade support institutions that provide services to help businesses adapt to FTA guidelines. Meanwhile, the relatively high use of FTAs in Thailand is likely the result of the country’s emergence as a regional production hub (for example in the automotive sector), high rates of export-oriented FDI, and the government’s reliance on FTAs as a tool of trade policy.
The relatively low rate of FTA use among the other countries surveyed may be due to several factors. For example, Korea only entered its first FTA in 2004, Filipino exports are concentrated in electronics, which have low most-favoured nation (MFN) tariff rates, and Singapore, even with its high-export orientation and large number of FTA agreements, may find less need for FTA use given its open trading system and low tariff margins.
Rules of origin not meant to be broken
Rules of origin are potentially the most challenging aspect of FTAs in East Asia. They determine which goods enjoy preferential tariffs to prevent trade deflection among FTA members. Some studies on FTAs argue that complex ROOs raise transaction costs for firms, while restrictive ROOs deter the use of FTA preferences. However, one key finding of the ADB study is that the region’s exporters do not view ROOs as much a burden as widely believed – only 20% of respondents reported that multiple ROOs significantly added to business costs.
Singaporean firms were most concerned about the burden associated with ROOs, which may also help explain their low FTA utilisation rate, while Chinese firms were least concerned (Figure 3). The survey also found that most firms want to choose least cost ROOs among various alternatives offered by overlapping FTAs.
Figure 3. Burden imposed by multiple ROOs in FTAs (% respondents)
Across countries in the survey, large and giant firms were more concerned about the costs of ROOs than SMEs. This is puzzling. A careful examination reveals that larger, older firms tend to use FTAs more frequently and are thus more familiar with their associated costs, while inexperienced SMEs with a focus on a single market abroad do not find the cost of facing multiple, overlapping ROOs high. The survey results suggest that the fixed costs associated with FTA use – researching various provisions, adjusting business plans to FTA tariff schedules, obtaining certificates of origin, and producing necessary documents – do favour larger, more-established firms with foreign equity over SMEs in terms of FTA use. Firms using FTA preferences reported that associated costs were outweighed by the primary benefits of wider export market access and lower costs of imported intermediate inputs.
Notwithstanding the overall positive view of FTAs expressed by the region’s exporting manufacturers, several issues may be contributing to the underutilisation of FTAs. To maximise the benefits of the more than 100 current and expected agreements that make up the “noodle bowl” of Asian FTAs, the ADB study offers several recommendations:
- reduce MFN tariffs to the extent possible;
- encourage the rationalisation of ROOs while upgrading origin administration (for example, reducing delays in issuing origin certificates);
- make wider alternative options of ROOs available;
- increase awareness of FTAs among potential beneficiaries;
- get business more involved in FTA negotiations; and
- improve public and private sector support, especially for SMEs.
The proliferation of FTAs in East Asia is a natural consequence of the region’s need to expand trade in the absence of a Doha-round agreement. FTAs bring both benefits and costs. At the firm level, the ADB survey results suggest that the region’s exporting firms are benefiting from FTAs. Still, there are several measures policymakers can take to mitigate associated costs, broadening FTA use to a wider spectrum of Asia’s exporters and consumers. Given the further proliferation of FTAs in East Asia, one can expect an increasing need for consolidation of overlapping ROOs and FTAs into a simpler, region-wide agreement. Finally, FTAs provide a practical means to help boost trade as the region’s economic recovery gains traction amid the current global economic crisis.
Baldwin, R. and Thornton, P. (2008), Multilateralising Regionalism: Challenges for the Global Trading System, London: Centre for Economic Policy Research.
Bhagwati, J. N. (2008), Termites in the Trading System: How Preferential Agreements Undermine Free Trade, Oxford: Oxford University Press.
Kawai, M. and Wignaraja, G. (2009), "The Asian Noodle Bowl: Is it Serious for Business?" ADBI Working Paper 136, April (Tokyo: Asian Development Bank Institute).